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Risk Disclosure Statement

This Risk Disclosure Statement forms part of our Aquanow Client Agreement. Capitalised terms not defined in this Risk Disclosure Statement have the meanings provided in the Aquanow Client Agreement. By using our Services, you acknowledge and agree with the following:

Trading and investing in virtual assets is inherently risky and may result in financial loss. It is important that you fully understand the risks involved with virtual asset trading and investing before deciding to execute any virtual asset trades. This Risk Disclosure Statement is not a complete statement of all risks involved in virtual asset trading. It is your responsibility to educate yourself as to all risks applicable to virtual asset trading and investing. Virtual asset trading and investing involves risk to your capital, including the risk that the entire amount invested may be lost. You should always ensure that you have adequate financial resources to bear the risks involved in virtual asset trading and investing and that you monitor your positions carefully. You should not invest, trade or risk money or value that you cannot afford to lose.

This risk disclosure statement cannot and does not disclose all risks and other aspects involved in holding and trading virtual assets, but sets out some of the principal risks involved with virtual asset trading and investing:

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1. Market Risk

The market for virtual assets is still new and uncertain. No one should have funds invested in virtual assets or speculate in virtual assets that they are not prepared to lose entirely. Virtual assets are subject to frequent and extreme price fluctuations. Whether the market for one or more virtual assets will move up or down, or whether a particular virtual asset will lose all or substantially all of its value, is unknown. This applies both to traders that are going long and to traders that are shorting the market. Participants should be cautious about holding Virtual assets and Virtual asset positions.

The returns on investments in virtual assets with the Firm are not guaranteed in any way.

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2. Liquidity Risk

Markets for virtual assets have varying degrees of liquidity. Some are quite liquid while others may be thinner. Thin markets can amplify volatility. There is never a guarantee, representation nor warranty that there will be an active market for you to sell, buy, or trade virtual assets or products derived from, or ancillary to, them. Furthermore, any market for virtual assets may abruptly appear and vanish. You acknowledge there may be delays in liquidating your virtual assets, particularly in times of extreme volatility.

The Firm, though its Group, provides liquidity directly to clients and also has a wide range of relationships with exchanges, brokers, liquidity providers and market participants in order to access liquidity. Despite this, the Firm provides no guarantee, representation or warranty that it can access liquidity at any given time and especially in times of extreme volatility.

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3. Legal Risk

The legal status of certain virtual assets may be uncertain. This can mean that the legality of holding or trading them is not always clear. Whether and how one or more virtual assets constitute property, or assets, or rights of any kind may also be uncertain and different legal treatments may be applied to the same virtual asset by courts in different jurisdictions. Participants are responsible for knowing and understanding how virtual assets will be addressed, regulated, and taxed under applicable law.

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4. Exchange Risk (Counterparty Risk) 

Having virtual assets on deposit or with any third party in a custodial relationship has attendant risks. These risks include security breaches, risk of contractual breach, and risk of loss. Participants should be wary of allowing third parties to hold their property for any reason. The Firm undertakes due diligence at the time of establishing a relationship with a new counterparty and ongoing however the Firm provides no guarantee, representation or warranty regarding any counterparty including but not limited to outsource service providers, partners, liquidity providers, financial institutions or any others.

The Firm provides an incidental custody service directly for its Broker Dealer Service clients and also utilises Zodia Custody Limited for an external third-party custody service.

Because certain purchases, sales, financing arrangements, derivative transactions and other transactions in which the Firm facilitates involve instruments that are not traded on an exchange, but are instead traded between counterparties based on contractual relationships, the Firm and its clients may be subject to the risk that a counterparty will not perform its obligations under the related contracts. Although the Firm intends to enter into transactions only with counterparties or on exchanges that the Firm believes to be creditworthy, there can be no assurance that a counterparty will not default and that a client will not sustain a loss on a transaction as a result. Such risks may differ materially from those entailed in exchange-traded transactions that generally are backed by clearing organisation guarantees, daily marking-to-market and settlement of positions and segregation and minimum capital requirements applicable to intermediaries.

The Firm trades as a Dealer (principal) and receives liquidity and related services from its parent, CLTS Technologies Ltd.

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5. Trading Risk 

In addition to liquidity risks, values in any virtual asset market are volatile and can shift quickly. Participants in any virtual assets market are warned that they should pay close attention to their position and holdings, and how they may be impacted by sudden and adverse shifts in trading and other market activities.

The market prices of virtual assets may be highly volatile and subject to a number of factors, including:

  • An increase in the global virtual assets supply;
  • Manipulative trading activity on virtual asset exchanges or broker dealers, which may be largely unregulated;
  • The adoption of virtual assets as mediums of exchange, stores-of-value or other consumptive assets and the maintenance and development of the open-source software protocols of the virtual asset networks;
  • Forks in the Virtual asset networks;
  • Investors’ expectations with respect to interest rates, the rates of inflation of fiat currencies or virtual assets and virtual asset exchange rates;
  • Consumer preferences and perceptions of virtual assets;
  • Fiat currency withdrawal and deposit policies on virtual asset exchanges and broker dealers;
  • The liquidity of virtual asset markets;
  • Investment and trading activities of large investors that invest directly or indirectly in virtual assets;
  • A “short squeeze” resulting from speculation on the price of a virtual asset, if aggregate short exposure exceeds the number of such virtual asset available for purchase;
  • An active derivatives market for virtual assets;
  • Monetary policies of governments, trade restrictions, currency devaluations and revaluations and regulatory measures or enforcement actions, if any, that restrict the use of virtual assets as forms of payment or the purchase of virtual assets on virtual asset markets;
  • Global or regional political, economic or financial conditions, events and situations;
  • Fees associated with processing a virtual asset transaction and the speed at which virtual asset transactions are settled;
  • Interruptions in service from or failures of major virtual asset exchanges or broker dealers;
  • Decreased confidence in virtual asset exchanges or broker dealers due to the unregulated nature and lack of transparency surrounding their operations; and
  • Increased competition from other forms of virtual assets or payment services.

The prices for virtual assets may be subject to momentum pricing due to speculation regarding future appreciation in value. Momentum pricing typically is associated with growth stocks and other assets whose valuation, as determined by the investing public, is impacted by anticipated future appreciation in value. Momentum pricing may result in speculation regarding future appreciation in the value of virtual assets, which inflates prices and leads to increased volatility. As a result, virtual assets may be more likely to fluctuate in value due to changing investor confidence in future appreciation or depreciation in prices.

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6. Settlement Risk

The Firm and its affiliates make absolutely no guarantee, representation nor warranty on the settlement times of virtual assets and/or fiat currencies. While the Firm operates in a capacity which attempts to optimise settlement times for its clients, there may be delays in settlement or an inability to settle due to a variety of technical, operational, legal, regulatory or market related reasons. Settlement risk may also be increased in times of extreme market volatility

 

7. Risk of Loss

Virtual assets can become irretrievably lost if you forget or lose your password or private keys to your virtual assets. There is a risk that some or all of your virtual assets could be lost, stolen, destroyed or inaccessible, through computer or human error (e.g., mistyping an address), or through theft or criminal action, potentially by the loss or theft of the private keys associated with the public addresses that hold the virtual assets. Multiple thefts of virtual assets from other holders have occurred in the past. Because of the decentralised process for transferring virtual assets, thefts can be difficult to trace, which may make virtual assets a particularly attractive target for theft. The Firm has adopted security procedures intended to protect Client Assets, but there can be no assurance that those procedures will be successful in preventing such loss, theft or restriction on access. You should not invest unless you understand the risk that you may lose possession or control of your assets. Access to virtual assets could be restricted by natural events (such as an earthquake or flood) or human actions (such as a terrorist attack).

Virtual assets may be an appealing target for hackers or malware distributors seeking to destroy, damage or steal virtual assets or private keys.

Security breaches, cyber-attacks, computer malware and computer hacking attacks have been a prevalent concern for virtual asset Service Providers (“VASPs”). Any cyber security breach caused by hacking, which involves efforts to gain unauthorised access to information or systems, or to cause intentional malfunctions or loss or corruption of data, software, hardware or other computer equipment, and the inadvertent transmission of computer viruses, could result in losses. VASPs may in particular be at risk of cyber security breaches orchestrated or funded by state actors. Any problems relating to the performance and effectiveness of security procedures used by the Firm to protect the virtual assets, such as algorithms, codes, passwords, multiple signature systems, encryption and telephone call-backs will have an adverse impact on an investment. Furthermore, cybersecurity attacks orchestrated or funded by state actors may be particularly difficult to defend against because of the resources that state actors have at their disposal.

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8. No Investment Advice or Fiduciary Relationship 

Any opinions, news, research, analyses, prices, or other information contained on the Firm’s services are provided as general market commentary, and do not constitute investment or trading advice or any other type of professional advice. We do not offer any advisory services. The Firm will not be responsible for any loss arising from any investment or trade based on any information provided on our platform, via our services or by any of our representatives. You confirm that all trades you make are made without reliance on any information or advice that the Firm or its representatives may have provided to you.

You are solely responsible for evaluating the suitability and commercial reasonableness of your trades.

You acknowledge that the Firm is not in a fiduciary relationship with you.

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9. Protection and Treatment of Virtual assets and Fiat Currency Held in Your Account

Your account with the Firm is not a deposit or investment account. Virtual assets and fiat currency deposited or otherwise held in your account are not protected by any government deposit protection scheme, investor protection fund, other similar funds or insurance, or any other government backed investor or account balance protection program. The Firm is not a bank, credit union or trust. Virtual assets and fiat currency held in your account will not accumulate interest. 

When you deposit fiat currency, it will be held by the Firm in a Client Money Account with a regulated bank and be handled in accordance with the applicable VARA Client Money Rules.

When you hold virtual assets in your account with us, they will be held by the firm in accordance with the applicable VARA Client Asset rules.

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10. Additional Risk and Information

This Risk Disclosure Statement cannot and does not disclose all risks associated with virtual asset storage and trading through the Firm’s services. Consequently, you should take time to adequately educated yourself, regarding virtual asset storage and trading, and of the technologies underlying virtual assets, before making deposits or trades using the Firm’s services. As appropriate, you should also seek third-party expert advice prior to using the Firm’s services.

Several government agencies and regulatory bodies have also published advisory documents surrounding the risks of virtual assets. For example, see publications from the Canadian Securities Administrators, the Consumer Financial Protection Bureau, the Financial Industry Regulatory Authority, the Dubai Virtual asset Regulatory Authority, the Securities and Commodities Authority, the UAE Central Bank, the Financial Conduct Authority, the Hong Kong Monetary Authority, the Monetary Authority of Singapore and the Securities and Exchange Commission.

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11. Conflicts of interest

Conflict of Interest refers to a situation where an individual's personal interests or actions are inconsistent or may appear to be inconsistent with the interests or actions of the Firm or a client. Such conflicts of interest may arise when an individual has a personal, financial, or other interest that may influence or appear to influence the judgment or behaviour of the individual in performing their duties.

All employees, directors, and officers of the Firm are required to disclose any actual or potential conflicts of interest to their supervisor or the Compliance Officer as soon as they become aware of them. The disclosure should include all relevant information that may be required to identify the nature and extent of the conflict of interest. All employees, directors, and officers of the Firm are also required to disclose outside business interests, gifts and entertainment and personal dealing accounts and transactions as these can lead to actual or potential conflicts.

All employees, directors, and officers of the company are required to act impartially and in the best interests of the Firm and its clients. They should avoid situations where their personal interests or actions may compromise their judgment or ability to act impartially. 

Employees, directors, and officers of the company are prohibited from engaging in any transaction or activity that may create or appear to create a conflict of interest with the Firm. Such transactions or activities include, but are not limited to, engaging in business with family members, close friends, or other related parties without prior approval from the Compliance Officer.

If a conflict of interest arises, the Compliance Officer will assess the nature and extent of the conflict and take appropriate actions to manage or mitigate the conflict and promptly disclose such conflict to all affected Clients. Such actions may include, but are not limited to, recusal from decision-making, divestment of personal interests, or seeking advice from legal counsel. In the event a Board Member discloses to the Board a material interest in a transaction, the remaining Board members must take appropriate action after reviewing if the conflict may affect the objectivity of that member and/or their ability to perform company tasks properly.

The Firm shall not enter into transactions with any Related Party without the prior written consent of the Board of Directors where the value of the transactions exceeds 5% of its issued share capital. Written consent of the Board is also required if there is a significant change to the terms of these transactions. Related Parties that obtain the above consent shall not participate in any voting in terms of the decision taken by the Board in respect of such transactions.

The Firm maintains detailed records of all disclosures of conflicts of interest and actions taken to manage or mitigate the conflicts. These records are maintained for a minimum of eight years and will be made available to VARA upon request.

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12. Whistleblowing and Complaints

All employees of the Firm or other parties are encouraged to report any potential violations in a way that facilitates the effective investigation and remediation of potential issues. In general, this means open or confidential reporting, rather than anonymous, although employees or other parties may make anonymous reports.

The Firm will take reasonable measures to ensure that confidentiality will be maintained not just of the name of the whistleblower but also to the disclosure of any “identifying information”, as often when facts are known only to a few, that information can easily be traced back to the source.

A staff member or other party who chooses to report on an anonymous basis must provide enough information concerning the basis of the allegations and sufficient detail or supporting evidence that the matter can be pursued reasonably. Otherwise, the matter usually cannot be pursued further. Even where anonymous allegations are sufficiently detailed or supported to permit a reasonable investigation to be conducted, no final finding of misconduct will be made based solely on the anonymous allegations without independent corroboration. 

The Firm’s complaints procedure is published on the website. Complaints or whistleblowing may be done from the Firm’s website or by telephone.

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13. Data Privacy 

The Firm’s Data Privacy Policy can be found our website and should be read together with the Client Agreement and this Risk Disclosure Statement.

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14. No Operating History of the Firm. Although the Firm is part of a larger group, the Firm is a newly formed entities and has no or limited operating history.

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15. Employee misconduct 

The Firm’s reputation is critical to maintaining and developing relationships with existing and prospective clients, as well as with the numerous third parties with which the Firm does business. In recent years, there have been a number of highly publicised cases involving fraud, conflicts of interest, or other misconduct by individuals in the financial services industry, and there is a risk that an employee of or contractor of the Firm or any of their affiliates could engage in misconduct that adversely affects the Firm or one or more virtual asset markets. It is not always possible to deter such misconduct, and the precautions the Firm takes to detect and prevent such misconduct may not be effective in all cases.

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16. Risks related to Virtual assets

The further development and acceptance of virtual assets is subject to a variety of factors that are difficult to evaluate. The slowing or stopping of the development or acceptance of virtual assets may adversely affect your investments in one or more virtual assets.

The use of virtual assets to, among other things, buy and sell goods and services, or to serve as the basis for other virtual assets to facilitate transactions or services (including DeFi financial transactions), is part of the new, experimental and rapidly evolving virtual asset industry. Some virtual assets, such as Bitcoin and Ethereum are more prominent than other parts of this industry. The growth of this industry is subject to a high degree of uncertainty. The factors affecting the further growth and development of this industry, include, but are not limited to:

  • continued worldwide growth in the adoption and use of virtual assets;
  • government and quasi-government regulation of virtual assets and their use, or restrictions on or regulation of access to and operation of virtual asset networks;
  • changes in consumer demographics and public tastes and preferences;
  • the maintenance and development of the open-source software protocol of the virtual asset networks;
  • the availability and popularity of other forms or methods of buying and selling goods and services, including new means of using fiat currencies;
  • the further development of “second-layer” applications and scaling solutions; and
  • general economic conditions and the regulatory environment relating to Virtual assets, and negative consumer or public perception of virtual assets.

Virtual Assets Generally

Virtual assets may be loosely regulated, or not regulated at all, and there is no central marketplace for virtual asset exchange. Supply is typically determined by a computer code, foundations or groups of developers or users, not by a central bank, and prices can be extremely volatile. Additionally, VASPs may suffer from operational issues, such as delayed execution, that could have an adverse effect on one or more virtual asset or market. Virtual asset exchanges and broker-dealers have been closed due to fraud, failure or security breaches.

Several factors may affect the price of virtual assets, including, but not limited to: supply and demand, investors’ expectations with respect to the rate of inflation, interest rates, currency exchange rates or future regulatory measures (if any) that restrict the trading of virtual assets or the use of Virtual assets as a form of payment. There is no assurance that virtual assets will maintain their long-term value in terms of purchasing power in the future, or that acceptance of virtual asset payments by mainstream retail merchants and commercial businesses will continue to grow.

Virtual assets are created, issued, distributed, transmitted, secured and stored according to protocols run by computers in virtual asset networks, decentralised networks of computers that operate on cryptographic protocols. No single entity owns or operates a virtual asset network, the infrastructure of which is collectively maintained by a decentralised user base. It is possible these protocols have undiscovered flaws which could result in the loss of some or all of the virtual assets. There may also be network-scale attacks against these protocols, which result in the loss of some or all of the virtual assets. Some virtual assets may be created, issued, distributed, transmitted, secured or stored using experimental cryptography which could have underlying flaws. Advancements in quantum computing could break the cryptographic rules of protocols which support the virtual assets. The Firm does not make any guarantees about the reliability of the protocol or cryptography used to create, issue, distribute, transmit, secure or store any virtual assets.

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Virtual Asset Networks

Many virtual asset networks are online end-user-to-end-user networks that host a public transaction ledger, known as a blockchain, and the source code that comprises the basis for the cryptographic and algorithmic protocols governing such networks. In many virtual asset transactions, the recipient of the virtual assets must provide its public key, which serves as an address for a virtual asset wallet, to the party initiating the transfer. In the data packets distributed from virtual asset software programs to confirm transaction activity, each virtual asset user must “sign” transactions with an output derived from entering such user’s private key into a “hashing algorithm,” and this signature serves as validation that the transaction has been authorised by the owner of such virtual asset. This process is vulnerable to hacking and malware, and could lead to theft of the virtual asset wallets and the loss of virtual assets. Virtual asset exchanges and broker-dealers have been closed due to fraud, failure or security breaches. In many of these instances, the clients or customers of such virtual asset exchanges were not compensated or made whole for the partial or complete losses of their account balances in such virtual asset exchanges or broker dealers. Additionally, users of several virtual asset exchanges or broker-dealers have been subject to “phishing” scams, where hackers have fraudulently obtained account credentials and perpetuated large-scale thefts of users’ virtual assets.

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Limited Use

Currently, there is relatively limited use of any virtual asset (including Bitcoin and Ethereum) in the retail and commercial marketplace in comparison to relatively extensive use as a store of value, thus contributing to price volatility that could adversely affect an investment. Virtual assets have only recently become selectively accepted as a means of payment for goods and services by many major retail and commercial outlets, and use of virtual assets by consumers to pay such retail and commercial outlets remains limited. Banks and other established financial institutions may refuse to process funds for virtual asset transactions; process wire transfers to or from VASPs; or maintain accounts for persons or entities transacting in virtual assets. Conversely, a significant portion of virtual asset demand is generated by investors seeking a long-term store of value or speculators seeking to profit from the short- or long-term holding of the asset. Price volatility undermines any virtual asset’s role as a medium of exchange, as retailers are much less likely to accept it as a form of payment. Market capitalisation for a virtual asset as a medium of exchange and payment method may always be low. A lack of expansion by virtual assets into retail and commercial markets, or a contraction of such use, may result in increased volatility or a reduction in the value of the asset, either of which could adversely affect an investment. There can be no assurance that such acceptance will grow, or not decline, in the future.

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Legal Tender

Virtual assets are not legal tender and are not backed by any government-issued legal tender, such as by the UAE Central Bank, or any commodity such as silver or gold.

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Scaling

Virtual assets may face scaling obstacles that can lead to high fees or slow transaction settlement times, and attempts to increase the volume of transactions may not be effective. Increased fees and decreased settlement speeds could preclude certain uses for virtual assets (e.g., micropayments and processing data-intensive smart contracts), and could reduce demand for, and the price of virtual assets.

There is no guarantee that any of the mechanisms in place or being explored for increasing the scale of settlement of transactions in virtual assets will be effective, or how long these mechanisms will take to become effective, which could adversely impact an investment.

 

Private Keys

Virtual assets are controllable only by the possessor of both the unique public key and private key or keys relating to the “virtual wallet” in which the virtual asset is held. Private keys must be safeguarded and kept private in order to prevent a third-party from accessing the virtual asset while held in such wallet. To the extent a private key is lost, destroyed or otherwise compromised and no backup of the private key is accessible, you may be unable to access, and may effectively lose, the virtual assets held in the related virtual wallet.

 

Irrevocable Nature of Blockchain-Recorded Transactions

Virtual asset transactions recorded on a blockchain are generally not reversible without the consent and active participation of the recipient of the transaction or, in theory, control or consent of a majority of the aggregate hashrate on the respective virtual asset network. Once a transaction has been verified and recorded in a block that is added to the blockchain, an incorrect transfer of virtual assets or a theft of virtual assets generally will not be reversible. It is possible that, through computer or human error, or through theft or criminal action, virtual assets could be transferred in incorrect quantities or to unauthorised third parties.

 

Internet Disruptions and attacks

A significant disruption in Internet connectivity could disrupt a virtual asset network’s operation until the disruption is resolved, and such disruption could have an adverse effect on the price of such virtual asset. In particular, some virtual assets have experienced a number of denial-of-service attacks, which have led to temporary delays in block creation and virtual asset transfers. While in certain cases in response to an attack, an additional “hard fork” has been introduced to increase the cost of certain network functions, the relevant network has continued to be the subject of additional attacks. Moreover, it is possible that as a virtual asset increases in value, it may become a bigger target for hackers and subject to more frequent hacking and denial-of-service attacks.

Virtual assets are also susceptible to border gateway protocol hijacking, or BGP hijacking. Such an attack can be a very effective way for an attacker to intercept traffic en route to a legitimate destination. BGP hijacking impacts the way different nodes and miners are connected to one another to isolate portions of them from the remainder of the network, which could lead to a risk of the network allowing double-spending and other security issues. If BGP hijacking occurs on a Virtual asset network, participants may lose faith in the security of such virtual asset, which could affect such virtual asset’s value.

Any future attacks that impact the ability to transfer a virtual asset could have a material adverse effect on the price of such virtual asset.

 

Network Control 

Virtual asset networks are subject to control by entities that capture a significant amount of the network’s processing power or a significant number of developers important for the operation and maintenance of the virtual asset network.

If a malicious actor or botnet obtains control of more than 50% of the processing power on a virtual asset network, such actor or botnet could manipulate the blockchain to adversely affect a Virtual asset. Virtual asset networks are subject to control by entities that capture a significant amount of the network’s processing power, percentage of the virtual assets issued and outstanding, or number of developers or intermediaries important for the operation and maintenance of the network, depending on the algorithm used to secure the network.

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Proof of work

Many blockchain networks, including the Bitcoin network, are secured by proof-of-work algorithms, whereby the collective strength of network participants’ processing power protects the network. If a malicious actor or botnet (i.e., a volunteer or hacked collection of computers controlled by networked software coordinating the actions of the computers) obtains a majority of the processing power dedicated to mining on a virtual asset network, it may be able to construct fraudulent blocks or prevent certain transactions from completing, either in a timely manner or at all. The malicious actor or botnet could control, exclude or modify the ordering of transactions. While a malicious actor would not be able to generate new virtual asset interests or transactions using such control, it could double-spend its own virtual assets (i.e., spend the same interests in more than one transaction) and prevent the confirmation of other users’ transactions for so long as it maintained control. To the extent that such malicious actors or botnet did not yield its control of the processing power on a network or the network community did not reject the fraudulent blocks as malicious, reversing any changes made to the blockchain may not be possible. Further, a malicious actor or botnet could create a flood of transactions in order to slow down confirmations of transactions on a network.

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Proof of stake and staking

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Certain virtual asset networks, including the Ethereum network, use a proof-of-stake consensus mechanism. Unlike proof-of-work, in which miners expend computational resources to compete to validate transactions and are rewarded virtual assets in proportion to the amount of computational resources expended, in proof-of-stake, miners (sometimes called validators) risk or “stake” virtual assets to compete to be randomly selected to validate transactions and are rewarded virtual assets in proportion to the amount of coins staked. A stake is a fixed amount of funds that are committed to a blockchain by a validator in order to participate in block creation and attestation. Any malicious activity, such as mining multiple blocks, disagreeing with the eventual consensus or otherwise violating protocol rules, results in the forfeiture or slashing of a portion of the staked virtual assets. Proof-of-stake is viewed as more energy efficient and scalable than proof-of-work and is sometimes referred to as virtual mining.

Staked virtual assets may be locked up and you may be unable to unstake or transfer such virtual assets, in which case such virtual assets staked will generally be illiquid.

 Staked virtual assets could be the subject of a slashing event, that is, a penalty enforced at the protocol level designed to discourage validator misbehavior and is irreversible. Malicious activity, such as violating voting and attestation rules, may result in a portion or all of such staked virtual assets being slashed. Validators that are fully slashed are prevented from participating in the protocol further and are forcibly exited. Validators may also be penalised if they are offline for a certain period of time when they are meant to be participating in the protocol. Typically, such validators will not have their staked virtual assets slashed but may stand to lose what they would have gained as rewards had they been participating correctly in the protocol. However, there may be no predefined penalty for being offline, and if a validator is offline regularly or for an extended period of time, all or a portion of its staked virtual assets could be slashed.

 There can also be no assurances that staking activity will result in additional income despite the additional risks. For example, validators that stake virtual assets may not automatically earn rewards. Instead, they may need to be randomly selected (with preference given to the validators that have staked the most Virtual assets) to validate transactions in order to earn rewards.

 

Centralisation

 While virtual asset networks are typically decentralised and do not need to rely on any single government or institution to create, transmit and determine value, in reality a single personality or entity may have the ability to exert centralised authority over a network. Additionally, for virtual assets that rely on miners, sophisticated miner groups may become unduly influential over time if system or bandwidth requirements become too high. Where a single personality or entity exerts an outsized influence, an adverse event impacting that individual or entity, such as an insolvency proceeding or hack of the entity, could result in a reduction in the price of a virtual asset.

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Developers

 A malicious actor may also obtain control over a virtual asset network through its influence over core or influential developers. For example, this could allow the malicious actor to stymie legitimate network development efforts or attempt to introduce malicious code to the network under the guise of a software improvement proposal by such a developer. Any actual or perceived harm to a virtual asset network as a result of such an attack could result in a loss of confidence in the source code or cryptography underlying such virtual asset network, which could negatively impact the demand for virtual assets and therefore adversely affect an investment.

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Faulty code and bugs

Flaws in the source code for virtual assets may be exposed and exploited, including those that expose users’ personal information and/or result in the theft of users’ virtual assets. Several errors and defects have been publicly found and corrected, including those that disabled some functionality for users and exposed users’ personal information. Discovery of flaws in, or exploitations of, the source code that allow malicious actors to take or create money in contravention of known network rules have occurred. In addition, the cryptography underlying a virtual asset could prove to be flawed or ineffective, or developments in mathematics and/or technology, including advances in virtual computing, algebraic geometry and quantum computing, could result in such cryptography becoming ineffective. In any of these circumstances, if a client holds the affected virtual asset, a malicious actor may be able to steal the virtual asset. Even if the client did not hold the affected virtual asset, any reduction in confidence in the source code or cryptography underlying virtual assets generally could negatively impact the demand for virtual assets and therefore adversely affect an investment.

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Network Development and Support

Certain virtual asset networks operate based on open-source protocol maintained by a group of core developers. As these network protocols are not sold and their use does not generate revenues for development teams, core developers may not be directly compensated for maintaining and updating network protocols. Consequently, developers may lack a financial incentive to maintain or develop the networks, and the core developers may lack the resources to adequately address emerging issues with the networks. There can be no guarantee that developer support will continue or be sufficient in the future.

Additionally, some development and developers are funded by companies whose interests may be at odds with other participants in the network or with investors’ interests. To the extent that material issues arise with a network protocol and the core developers and open-source contributors are unable or unwilling to address the issues adequately or in a timely manner, such network and an investment in the associated virtual asset may be adversely affected.

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Governance

Governance of decentralised virtual asset networks is achieved through voluntary consensus and open competition. In other words, such virtual asset networks have no central decision-making body or clear manner in which participants can come to an agreement other than through overwhelming consensus. The lack of clarity on governance may adversely affect a virtual asset networks’ utility and ability to grow and face challenges, both of which may require solutions and directed effort to overcome problems, especially long-term problems. Should a lack of clarity in a network’s governance slow the network’s development and growth, the value of an associated virtual asset may be adversely affected.

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Forks

Generally, virtual asset Blockchains are open source, meaning that any user can download the software, modify it and then propose that the users and miners of the blockchain adopt the modification. When a modification is introduced and a substantial majority of users and miners consent to the modification, the change is implemented and the blockchain remains uninterrupted. However, if less than a substantial majority of users and miners consent to the proposed modification, and the modification is not compatible with the software prior to its modification, the result is a so-called fork of the network. In other words, two incompatible networks would then exist: one network running the pre-modified software and another network running the modified software. The effect of such a fork would be the existence of two versions of the blockchain running in parallel, yet lacking interchangeability.

Forks occur for a variety of reasons. First, forks may occur after a significant security breach. For example, in response to a hack, a majority of participants in a network may agree to adopt a fork that effectively reversed the hack. However, a minority of users may continue to develop the original blockchain. As a result, there may now be two virtual assets which could have an adverse impact on the price of the resulting virtual assets.

Second, forks could be introduced by an unintentional, unanticipated software flaw in the multiple versions of otherwise compatible software users run. Such a fork could adversely affect the virtual asset’s viability. It is possible, however, that a substantial number of users and miners could adopt an incompatible version of the virtual asset while resisting community-led efforts to merge the two chains. This would result in a permanent fork. If a permanent fork were to occur, then a client could hold amounts of both the original digit asset and the new alternative.

Third, forks may occur as a result of disagreement among network participants as to whether a proposed modification to the network should be accepted. Forks could impact demand and therefore adversely impact an investment in the associated virtual asset.

Forks can also introduce new security risks. Virtual asset Service Providers or networks may be targeted by replay attacks (i.e., attacks in which transactions from one network were rebroadcast to nefarious effect on the other network) or other attacks post forking.

Another possible result of a fork is an inherent decrease in the level of security. After a fork, it may become easier for an individual miner or mining pool’s hashing power to exceed 50% of the processing power of the virtual asset network, thereby making virtual assets that rely on proof of work more susceptible to attack.

It may be unclear following a fork which fork represents the original virtual asset and which is the new virtual asset. Different metrics adopted by industry participants to determine which is the original virtual asset include: wishes of the core developers of a virtual asset, the blockchain with the greatest amount of hashing power contributed by miners or validators, or the blockchain with the longest chain.

If a client holds a virtual asset at the time of a hard fork into two virtual assets, the client would be expected to hold an equivalent amount of the original virtual asset and the new virtual asset following the hard fork. However, the client may not be able, or it may not be practical, to secure or realize the economic benefit of the new virtual asset for various reasons. For instance, the firm or a relevant partner or counterparty may not agree to provide access to the new virtual asset. It may be determined by the Firm that there is no safe or practical way to custody the new asset, or that trying to do so may pose an unacceptable risk to Firm or the client’s holdings in the original virtual asset, or that the costs of taking possession and/or maintaining ownership of the new virtual asset exceed the benefits of owning the new virtual asset.

The timing of any such occurrence is uncertain, and the Firm has sole discretion whether to claim a new asset created through a fork of a virtual asset network, subject to certain restrictions that may be put in place by any relevant service providers or regulatory bodies.

A fork in the network of a particular virtual asset could adversely affect an investment in a virtual asset. Laws, regulation or other factors may prevent a client from benefitting from the new virtual asset even if there is a safe and practical way to custody and secure it. For example, it may be illegal for the client to sell the new asset, or there may not be a suitable market into which the client can sell the new virtual asset.

Forks in a virtual asset networks may also result in taxable income.

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Airdrops

Virtual assets may become subject to an occurrence similar to a fork, which is known as an air drop. In an air drop, the promotors of a new virtual asset announce to holders of another virtual asset that they will be entitled to claim a certain amount of the new virtual asset for free. For the same reasons as described above with respect to hard forks, clients may or may not choose, or be able, to participate in an air drop, or may or may not be able to realise the economic benefits of holding the new virtual asset.

The timing of any such occurrence is uncertain, and the Firm has sole discretion whether to claim a new virtual asset created through an air drop. Any inability to recognise the economic benefit of a hard fork or an air drop could adversely impact an investment.

Air drops may also result in taxable income.

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Modifications to protocols

Virtual asset networks are open-source projects, often with no official developer or group of developers that control them. However, historically the development of certain virtual asset networks has been overseen by core developers. The core developers are able to access and alter a network’s source code and, as a result, they are responsible for quasi-official releases of updates and other changes to the network’s source code.

Core development of network source codes has increasingly focused on modifications of the virtual asset protocols to increase speed and scalability and also allow for financial and non-financial next generation uses. Such projects may utilise virtual assets as tokens for the facilitation of their uses, thereby potentially increasing demand for virtual assets and the utility of the networks as a whole. Conversely, projects that operate and are built within the blockchains may increase the data flow on the virtual asset networks and could either bloat the size of the blockchains or slow confirmation times, thereby adversely affecting the network and any associated virtual asset.

 

Supply and Demand

The market for virtual assets is characterised by supply constraints that differ from those present in the other markets. The mathematical protocols under which certain virtual assets are mined permit the creation of a limited, predetermined amount of currency, while others have no limit established on total supply.

If the amount of virtual assets acquired by particular investment vehicles or speculative investors is large enough, relative to global supply and demand, further purchases or sales by such persons could have an impact on the supply of and demand for the relevant virtual asset in a manner unrelated to other factors affecting the market for virtual assets. Such an impact could affect the trading prices for the relevant virtual asset.

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Intellectual Property

Third parties may assert intellectual property claims relating to the holding and transfer of virtual assets and their source codes. Regardless of the merit of any intellectual property or other legal action, any threatened action that reduces confidence in long-term viability or the ability of end-users to hold and transfer a virtual asset may adversely affect an investment in that virtual asset. Additionally, a meritorious intellectual property claim could prevent a client and other end-users from accessing, holding, or transferring the virtual asset, which could force its liquidation (if such liquidation is possible). As a result, an intellectual property claim could adversely affect an investment.

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Mining Incentives

With respect to virtual assets that are developed through mining, miners generate revenue from both newly created virtual assets, known as the block reward and from fees taken upon verification of transactions. If the aggregate revenue from transaction fees and the block reward is not sufficient to support the miner’s ongoing operating costs, the miner may cease operations. If the award of new interests of a virtual asset for solving blocks declines and/or the difficulty of solving blocks increases, and transaction fees voluntarily paid by participants are not sufficiently high, miners may not have an adequate incentive to continue mining and may cease their mining operations.

A reduction in the block reward may result in a reduction in the aggregate hashrate of the network as the incentive for miners decreases. Miners ceasing operations would reduce the collective processing power on the network, which would adversely affect the confirmation process for transactions (i.e., temporarily decreasing the speed at which blocks are added to the blockchain until the next scheduled adjustment in difficulty for block solutions) and make the network more vulnerable to a malicious actor or botnet obtaining sufficient control to manipulate the blockchain and hinder transactions. Any reduction in confidence in the confirmation process or processing power of a network may adversely affect an investment in any associated virtual asset.

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Mining Collusion 

Miners, functioning in their transaction confirmation capacity, collect fees for each transaction they confirm. Miners validate unconfirmed transactions by adding the previously unconfirmed transactions to new blocks in the blockchain. Miners are not forced to confirm any specific transaction, but they are economically incentivised to confirm valid transactions as a means of collecting fees. Miners have historically accepted relatively low transaction confirmation fees. If miners collude in an anticompetitive manner to reject low transaction fees, then virtual asset users could be forced to pay higher fees, which could result in reduced confidence in, and use of, a virtual asset network. Any collusion among miners may adversely impact the attractiveness of a network and may adversely impact an investment in any associated virtual asset.

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Derivatives

Regulated derivatives markets for virtual assets are developing as registered futures exchanges and swap execution facilities, are beginning to offer futures, options, and swaps on virtual assets. There is, however, no assurance that any particular virtual asset derivative products will be brought to market or that trading in products that are offered will be liquid or at beneficial prices to clients. Additionally, virtual asset forks or other similar events may pose significant challenges for derivatives exchanges or other markets to address.

The existence of regulated markets that offer trading in virtual asset derivatives, the volume of transactions on those markets and the nature and sophistication of participants may impact the value of investments in virtual assets, even if a client does not invest in such derivatives.

In that regard, markets in virtual asset derivatives could also affect prices, liquidity, and other aspects of virtual asset spot markets and other related markets. Virtual asset derivatives markets could facilitate larger volumes of short positions in virtual assets than may be possible in spot market trading only. Thus, trading in virtual asset derivatives could be used by market participants to accumulate short positions in virtual assets, which could reduce the price of virtual assets.

 

Large scale sales and market participants

Some entities hold large amounts of a virtual assets (or derivates) relative to other market participants, and to the extent such entities engage in large-scale hedging, sales or distributions on nonmarket terms, or sales in the ordinary course, it could result in a reduction in the price of such virtual assets and adversely affect an investment.

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Political or economic crises

Political or economic crises may motivate large-scale sales of virtual assets, which could result in a reduction in price of virtual assets. As an alternative to fiat currencies that are backed by central governments, virtual assets, which are relatively new, are subject to supply and demand forces based upon the desirability of an alternative, decentralised means of buying and selling goods and services, and it is unclear how such supply and demand will be affected by geopolitical events. Nevertheless, political or economic crises may motivate large-scale acquisitions or sales of virtual assets either globally or locally. Large-scale sales of a virtual asset would likely result in a reduction in the price of such virtual asset.

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Outbreaks of Infectious or Contagious Diseases 

Pandemics and other widespread public health emergencies have and are resulting in market volatility and disruption, including in the markets for virtual assets, and future such emergencies have the potential to materially and adversely impact economic production and activity in ways that are impossible to predict, all of which could result in significant losses.

 

Banking Services

A number of VASPs have been unable to find banks that are willing to provide them with bank accounts and banking services. Similarly, a number of such VASPs have had their existing bank accounts closed by their banks. Banks may refuse to provide bank accounts and other banking services to VASPs or companies that accept virtual assets for a number of reasons, such as perceived compliance risks or costs. The difficulty that many VASPs have and may continue to have in finding banks willing to provide them with bank accounts and other banking services may decrease the usefulness of virtual assets as a payment system and harming public perception of virtual assets or could decrease its usefulness and harm its public perception in the future. Similarly, the usefulness of virtual assets as a payment system and the public perception of virtual assets could be damaged if banks were to close the accounts of many or of a few VASPs. This could decrease the value of virtual assets.

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17. Responsible Persons

Philemon Sham, CEO

Raven Room-Baker, Chief Compliance and Risk Officer and MLRO

Faizan Ahmad, Director of Strategic Operations