The FTX fallout and what it means for accountants

And it’s now up to their tax agents to sort through the quagmire of legal paperwork to try and help them make a claim.

Maryna Kovalenko, founder of Syla, an Australian software solution to crypto tax and compliance, said faced with the loss of their crypto, many investors will be wanting to claim the loss as a tax write-off.

“As a tax agent, you will need to advise your clients on whether they are able to claim the loss, and when that might occur. Eventually, it should be possible to claim the capital loss, but not until the appointed administrator confirms what has occurred, and the size of the loss for each user,” she said.

Ms Kovalenko said FTX was one of the world’s largest crypto exchanges and was highly regarded by many in the industry.

“The downfall of FTX certainly would have come as a shock to many, considering they were actively working towards higher regulatory oversight, having just received an AFSL to provide derivatives products to Australian consumers,” she said.

“The largest concerns are the allegations of unethical misappropriation of client funds, meaning assets that were meant to belong to users, had actually been taken and lent out to other entities to undertake risky investments and speculation on crypto markets.”

The fallout from the collapse and its implication for Australian investors and their tax agents will be complicated she said and likely to be drawn out over many years for individuals and businesses.

“When an entity goes through administration and insolvency, the process can take years to sort out,” she said.

“There are a large group of Australian FTX users, who are now creditors, with no certainty on when the process will be finalised.”

Ms Kovalenko said Australian crypto investors are currently locked out and unable to access their funds on FTX and now face the prospect of a partial or total loss of the assets they once held.

“Insolvency is usually a long, complicated process, so crypto investors may have to wait for years to receive any outcome on what happened and if they will ever get back any of their assets,” she said.

Ms Kovalenko said one of the main tasks tax agents and accountants now had to do was to advise their clients on whether they are able to claim the loss and when that might occur.

To be able to claim a capital loss, the ATO requires taxpayers to show evidence of their investments that have been affected. In order to do this, accountants and their affected clients are advised to gather as much evidence to help substantiate their claim.

This may include having full historical transaction records from FTX; screenshots to confirm holdings on the exchange; and other records such as emails, articles, and insolvency notices confirming the event that has occurred.

“When the capital loss is eventually claimed, you should be able to claim the reduced cost base of the asset as a capital loss,” Ms Kovalenko said.

“To be able to claim the loss correctly, you can utilise crypto tax software such as Syla, that will help you to accurately track the cost base, apply the unrecoverable classification, and calculate the correct tax outcome under Australian tax law.

“Accountants will need to be prepared to explain to their crypto clients that they can’t claim a tax loss just because withdrawals are suspended. Taxpayers will need to be patient and wait for the FTX administrator to assess the situation and provide clarity on the unrecoverable amounts.”

The ramifications of the FTX collapse will be widely felt throughout not just the crypto industry but affect other businesses as well, Ms Kovalenko said.

“FTX was a large source of liquidity for many businesses in the crypto industry. Many businesses undoubtedly chose to use FTX as a place where they could manage their crypto inventory by placing buy and sell orders, or hedging their positions through the use of derivatives,” she said.

“Any business that was using FTX as a liquidity source will have some impact on their operations. If a business held a large amount of cash or crypto on FTX, then the exposure is larger and could have a catastrophic impact on the business.

“We are seeing record outflows from centralised exchanges even when there is no direct exposure to FTX. Users are withdrawing their crypto to their personal wallets. For exchanges that do not hold client assets 1:1, they may soon be, or are already facing crypto’s equivalent of a bank run.”

There will also be a number of other challenges accountants will face because of the collapse, she said.

“Counterparty risk is far from a new concept, either with traditional investments or with crypto. The FTX situation is certainly the largest example in recent times and will be a painful reminder for many crypto investors of the risk when dealing with centralised financial institutions, whether that be crypto or traditional finance,” she said.

“With trust in centralised exchanges dropping, many crypto investors will be looking to self-custodial options such as a hardware wallet solution. Rather than having an exchange manage their crypto assets, a hardware wallet instead allows an investor to have complete control over their assets.

“Although this solution is effective at removing the counterparty risk of the exchange, it does lead to a new set of risks that investors should educate themselves on. Crypto investors who self-custody will need to educate themselves on how to safely and securely self-custody their crypto assets. That includes setting up secure passphrases and storing backups.

“For investors who are not comfortable to self-custody their assets, they will have to continue to rely on a third-party such as an exchange to do this for them. Investors will likely start looking for exchanges that hold client assets 1:1, undertake regular external audits and who don’t lend client assets to other entities.

“Many exchanges are already mobilising to bring this added assurance to their users. Investors may also start considering managed investment products that provide exposure to crypto through a regulated AFSL environment.

“Accountants will likely have clients that had funds on FTX, so will need to carefully consider if a capital loss can be claimed, and when that might be possible. Those with SMSF clients, should be encouraging Trustees to revisit their investment strategy, particularly around the aspects of storage, and which exchanges are to be utilised.”