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Bitcoin,  Cryptocurrencies

Coinbase CEO speculates on QuandrigaCX management coverup

Analysis points to possible trouble long before the CEO’s death

As the QuadrigaCX saga continues to play out, Coinbase CEO Brian Armstrong has jumped into the fray. The chief executive at the largest U.S. exchange suspects that management at its  largest Canadian competitor is using its founder’s death to cover up what could be a massive fraud.

“We did our own internal research, including some blockchain analytics, to see if we could help,” Armstrong posted on Twitter on Thursday, claiming that Coinbase went over the data. He said there were indications that massive losses at the company going back a year before the death of QuadrigaCX CEO Gerland Cotten this past December.  “If so, then it’s possible that untimely death of their CEO was used as an outlet to let the company sink.”

Investigators are scrambling to find $190 million in lost crypto since Cotten took his company’s password to the grave. But Armstrong said there’s evidence their problems started long before the death of their CEO. “Important to note that this is just our best guess.” Armstrong tweeted. “Take it as *pure speculation*, nothing more.”

So where is their money? Armstrong said he’s suspicious of fund transfers over a year ago. “We identified clusters that look like QCX’s ‘cold storage’, were controlled by a human (manually), and balances were moved out by early 2018.”

Nonetheless, Armstrong still doesn’t call the exchange an outright fraud. “QCX was one of the oldest exchanges in existence (founded in 2013),” Armstrong said. “If they planned an exit scam, it likely would have been timed better.” QuadrigaCX has retained Ernst & Young to help their creditors get repaid, according to a statement posted to their website.

Ernst & Young's wallet.
Ernst & Young’s wallet.

Modern Consensus was able to find EY’s ether wallet that holds a test transaction of 0.01 ether followed by a transfer of ETH 960.35 from the same wallet used by QuadrigaCX for over 448,260 day-to-day transactions. The wallet’s current value as of Thursday night is $140,875.50. That’s less than 1 percent of the reported $190 million missing.

The other 99 percent missing may be harder to come by. QuadrigaCX ran entirely off of the CEO’s encrypted laptop until he died in a Jaipur hospital while on a trip to India. He did not leave a secret key somewhere in case something happened to him, but he did sign a will just 10 days before he died.

Cotten suffered from Chrohn’s disease, so planning for the inevitable was normal, even expedient. In his will, he left his $9 million estate to his wife, Jennifer Robertston, along with airplane, a sailboat, a 2017 Lexus, and real estate in British Columbia and Nova Scotia. He also kindly left a $100,000 trust fund will provide lifelong care for his two chihuahuas. But nothing was left for his estimated 115,000 unpaid customers who claim as much as $250 million in crypto value.

In a separate, but no less unnerving incident in 2017, QuadrigaCX lost $14 million in ether due to a smart-contract error. Armstrong also noted that “they suffered a multimillion dollar bug in June 2017 (before things went vertical).” This is CEO-speak for “before things got worse.” Armstrong noticed a pattern  in the blockchain. Whenever the company got into trouble outside, they started locking their funds up on the inside. “This is when we start to see movement of funds to ‘cold storages’.”

“Patterns of sends from cold storage suggest they tried keeping exchange afloat, and maybe attempted to trade their way out of a hole; (again just a guess here).” If true, this would make Quadriga more of a Ponzi scheme than an exchange.

“Liquidity dried out and bear market of 2018 may have caught up with them,” Amstrong speculated.

After looking at the data, Amstrong sees a cover-up might be evident. “Sequence of events suggests this was a mismanagement with later attempt to cover for it,” Armstrong concluded.

“This implies that at least few people inside Qadriga [sic] knew that they were running fractional.” Thus management could keep the exchange could afloat, but they could not honor all of their accounts.

Armstrong suggested that the company knew it was in trouble and is using the excuse of its CEO’s death as a way to avoid admitting accounting problems. If that’s the case, the accounts aren’t locked up, but many of them could already empty.

Even if that truly happened, it doesn’t excuse the gross negligence of the company for not having some kind of “dead man’s switch” in case of catastrophe. Even early Bitcoin developers use multi-signature keys for just this reason.  Craig Wright, Dave Kleiman and Phil Wilson—who have a strong claim to being the Captain Planet-like figure that we call Satoshi Nakamoto—developed keys that could only unlock if two others came together.

Some Redditors have speculated that this might be an “exit scam”—a shady boondoggle where a reputable firm still takes in orders in its last months to rake in cash before it goes belly up. “Gerald Cotten reportedly died in early December 2018. But complaints about withdrawal issues on Quadriga escalated in mid 2018,” one wrote on Friday.

Complaints piled up throughout 2018. One user claims that in January 2019, before news broke of the CEO’s lost password, he was told to drive three hours to a listed address to pick up $1,000 from his Quadriga account in cash instead of being offered a bank withdrawal.

“So maybe after about a month of debate (Dec – Jan),” Armstrong tweeted, “management decided to cut losses and release a statement claiming that access to money was lost with CEO’s death?” Here’s where the weird story gets weirder, as Armstrong points out. Cotten died December 9, 2018. The company didn’t even announce his death until a January 14, 2019 Facebook post. The first reports of his lost password didn’t surface until February 1, 2019.

The company had troubles in 2018. Their CEO died in December. In January, they start acting strange. But only in February, they announce to their clients that their funds are frozen forever.

Ernst & Young's claim in Nova Scotia.
Ernst & Young’s claim in Nova Scotia.

Ernst & Young claimed in a Nova Scotia court that in total, 51 bitcoins (roughly $185,500 at that time), 951 ethers ($116,000), 33 bitcoin cashes, 2,000 bitcoin golds, and 822 litecoins were transferred. That is less than $1 million in total recovered assets.

Dentacoin because... why not?
Dentacoin because… why not?

Modern Consensus also found an extra $5,135 in over 109 ethereum tokens that are a who’s-who of failed 2017 token projects, including $3,826 in CANDY and $369 worth of DENTACOIN—the ether based token for dentists. None of these have not been transferred to EY cold storage.

Armstrong still isn’t pointing any fingers. “While this story isn’t perfect, it does seem plausible. I do want to emphasize that these are our best guesses based on the available data. As the case unfolds we might find out we were incorrect.” It’s one thing to be told about a CEO’s death over a number of months, but quite another thing if the ledger can show us what problems they had on the books at that time.

As for Coinbase spending their own resources to see what’s going on, it’s important to remember that crypto is still in its wild-west stage. Or, more accurately, the industry is a mix of privateers and pirates. But at sea, all boats operate under the “obligation to render assistance.” Ships at sea have a duty to respond to each other’s distress calls and warn others of pirates.

The bear market could have sunk Coinbase, but the sinking of Quadriga could have troubled the waters for all crypto exchanges. Even in crypto’s early days, the failure of Mt. Gox nearly destroyed the nascent market. Interestingly, a new data-mining report from MIT found that Mt. Gox was guilty of price manipulation long before it went under.

The Supreme Court of Nova Scotia has granted QuadrigaCX creditor protection, issuing a 30-day stay of proceedings. But they won’t need more time than that if the money is already gone. Cotten’s widow, Jennifer Robertson, said in her affidavit to the court that he had single-handedly managed transfers between the exchange’s wallets and that after his death, the access to cold wallets was lost.

Nova Scotia Supreme Court judge Michael Wood suggested that any recovered hot wallet funds be sent to the safety of new cold wallets maintained by EY.

In the end, QuadrigaCX is like a shipwreck. Those who escaped with their lives are luckier than the captain of that ship. But even after a shipwreck there is heartbreak, anguish and lost baggage. And there are also lawsuits. But unique to this case is that other crypto firms are helping the investigators find out what the hell happened and how to avoid it in the future.

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Brendan Sullivan is a writer, producer, and author of the memoir Rivington Was Ours: Lady Gaga, the Lower East Side, and the Prime of Our Lives. Disclosure: he owns cryptocurrencies. Follow him on Twitter.