Cryptocurrency and the Rise of SPACs: A Match Made in Investor Heaven?

Already this year, numerous high-profile cryptocurrency trading and mining companies—including eToro, Bakkt and CompoSecure—have or are planning to IPO via SPACs. It’s a desirable approach for cryptocurrency companies, as SPAC IPOs are typically faster, simpler and more cost effective than the traditional method. Many in the space are taking lessons learned from watching Coinbase go through its lengthy IPO process over more than six months.

Likewise, cryptocurrency companies are a new and potentially appealing opportunity for SPAC investors. Beyond what we’ve already seen in the market with Coinbase emerging as a serious power player in technology and financial spheres and transaction providers like PayPal making investments in cryptocurrency acquisitions, some traditional banks are also now responding to consumer demand for banking products and services that offer cryptocurrency. This is creating a buy vs. build dilemma for many traditional financial institutions. Given the regulatory challenges, complexity and technical nuance of building a cryptocurrency infrastructure from scratch, it’s likely this tension will fuel even more acquisitions and SPAC-driven movement.

Yet because cryptocurrency is new, and remains largely an enigma to many, investors are often uncertain about how to valuate a crypto company, understand its business model at a technical level and verify the digital assets it claims to keep under custody. Investors may be unsure of which questions to ask or how to find the right answers in support of due diligence and overall assessment of the target company. SPAC investors not familiar with cryptocurrency will want reassurance of what exactly they are buying, which will involve complex analysis in addition to standard due diligence processes.

The crux of the issue for investors is to determine underlying risks or inaccuracies in a target company’s cryptocurrency assets, framework and business model. And for cryptocurrency companies, to demonstrate differentiators and that the correct procedures to support crypto-based business activities are in place.

In recent months, experts have identified reliable methodologies to conduct these complex technical assessments of cryptocurrency assets in a fast, in-depth and cost-effective manner. Through digital forensic investigation techniques, it’s now possible to sample and verify digital wallet ownership, digital asset ownership, assets under custody and the value and validity of assets. SPACs and their investors can rely on an expert-led crypto-focused technical assessment to determine:

• Risks within cryptocurrency-related contracts, privacy, security, Know Your Customer, Anti-Money Laundering, signatures and other policy controls.
• Code audits across wallets, user interface and application programming interfaces.
• The full scope of digital asset holdings, including hot wallet services, cold wallet storage, multi-signature (multisig) and shared wallet services, portfolio management, etc.
• Size, locations, duties and other key details relating to technical and sales support, and development teams, which are especially important considerations for investors given the pace of change and innovation in the cryptocurrency space.
• The organization’s technical structure and overall stability.

Another important note is that increased SPAC activity has prompted U.S. regulators to take a closer look, with the Securities and Exchange Commission indicating that it’s considering new restrictions on SPACs. Investors and organizations playing in this area will need to maintain constant diligence and caution and be prepared for new audit and compliance requirements for SPACs and companies that have listed for public trading through them. Couple this with the evolving regulatory outlook for the cryptocurrency sector, and it’s clear that SPACs must also consider the legal and governance implications of a cryptocurrency investment across regulations, security, privacy, third-party partnerships, data use and obligations.

A detailed assessment before a deal can reveal risks and eliminate guesswork, as well as support any post-investment remediation work that is needed to ensure the target company’s long-term viability and compliance.

Steven S. McNew is a senior managing director within the technology practice of FTI Consulting. In his role, he helps clients evaluate and implement blockchain solutions and builds cost-effective, defensible strategies to manage data for complex legal and regulatory matters. Mr. McNew is an expert in blockchain, information and data security, complex discovery and digital forensics. He completed studies in blockchain and cryptocurrency at MIT and has led engagements involving blockchain assessments, pilot projects and software selection and implementation. He has also led disputes involving issues related to blockchain and various forms of cryptocurrency.

The views expressed herein are those of the author(s) and not necessarily the views of FTI Consulting, its management, its subsidiaries, its affiliates, or its other professionals.