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Readers should be aware that the findings and views in this Report are not findings of fact by an OSC hearing panel and have not been tested before the OSC tribunal or a court. This Report represents Staff’s views of the evidence reviewed and, should further records and information become available, those views could be affected.

Executive Summary

The downfall of crypto asset trading platform QuadrigaCX (Quadriga) resulted from a fraud committed by Quadriga’s co-founder and CEO Gerald Cotten (Cotten). Clients entrusted their assets to Quadriga, which provided false assurances that those assets would be safeguarded. In reality, Cotten spent, traded and used those assets at will. Operating without any proper system of oversight or internal controls, Cotten was able to misuse client assets for years, unchecked and undetected, ultimately bringing down the entire platform.

Cotten was able to misuse client assets for years, unchecked and undetected, ultimately bringing down the entire platform.

The collapse of Quadriga caused massive losses for investors from Canada and around the world. On January 14, 2019, Quadriga announced that Cotten had died in India the previous month. By February 5, the Quadriga platform had ceased operations and filed for creditor protection. Over 76,000 clients were owed a combined in assets. Approximately 40 per cent of these clients were Ontarians. Ernst & Young, the bankruptcy trustee, was able to recover or identify just $46 million in assets to pay out to clients. The people who trusted Quadriga with their money and crypto assets collectively lost at least $169 million.

Staff of the Ontario Securities Commission (OSC) undertook a review of Quadriga’s business operations to determine how the platform was run, what caused its collapse, and where the money went. Over a period of approximately ten months, a multi-disciplinary team of Enforcement Branch Staff analyzed trading and blockchain data, interviewed key witnesses and collaborated with numerous regulatory bodies in Canada and abroad.

Footnote 1

All amounts expressed in Canadian dollars except as otherwise indicated.

Most of the $169 million asset shortfall resulted from Cotten's fraudulent conduct.

It has been widely speculated that the bulk of investor losses resulted from crypto assets becoming lost or inaccessible as a result of Cotten's death. In our assessment, this was not the case. The evidence demonstrates that most of the $169 million asset shortfall resulted from Cotten's fraudulent conduct, which took several forms.

The bulk of the asset shortfall—approximately $115 million—arose from Cotten's fraudulent trading on the Quadriga platform. Cotten opened Quadriga accounts under aliases and credited himself with fictitious currency and crypto asset balances which he traded with unsuspecting Quadriga clients. He sustained real losses when the price of crypto assets changed, thereby creating a shortfall in assets to satisfy client withdrawals. Cotten covered this shortfall with other clients’ deposits. In effect, this meant that Quadriga operated like a Ponzi scheme.

Cotten lost an additional $28 million while trading client assets on three external crypto asset trading platforms without authorization from, or disclosure to, clients. He also misappropriated millions in client assets to fund his lifestyle. In its final months, Quadriga had almost no assets left and was operating like a revolving door—new client deposits were immediately re-routed to fund other clients’ withdrawals.

What happened at Quadriga was an old-fashioned fraud wrapped in modern technology.

What happened at Quadriga was an old-fashioned fraud wrapped in modern technology. There is nothing new about Ponzi schemes, unauthorized trading with client funds and misappropriation of assets. Crypto asset trading platforms, however, are novel and the regulatory framework for these platforms is evolving. Quadriga did not consider its business to involve securities trading and it did not register with any securities regulator. This lack of registration facilitated Cotten's ability to commit a large-scale fraud without detection. So did the absence of internal oversight over Cotten. From 2016 onwards, Cotten was in sole control of a company that had hundreds of thousands of clients and transacted over a billion dollars of fiat currency-denominated assets and over five million crypto asset units. He ran the business as he saw fit, with no proper system of internal oversight or controls or proper books and records.

Similarly, Quadriga clients could not have known what Cotten was doing. Under the Quadriga business model, clients entrusted their money and crypto assets to Quadriga. Quadriga provided no meaningful insight into how those assets were being stored, moved and spent. To the contrary, Quadriga provided false assurances about asset storage. Clients had no means of verifying these claims or obtaining meaningful information about the handling of their assets. This lack of transparency also facilitated Cotten's fraud.

Under normal circumstances, these findings would likely have led to an enforcement action against Cotten and/or Quadriga. However, this is not practical given that Cotten is deceased and Quadriga is bankrupt, with its assets subject to a court-supervised distribution process. Nevertheless, we believe it is in the public interest to share our findings with the public to help investors understand what happened to Quadriga and hopefully prevent this type of situation from recurring.

The misconduct we uncovered in relation to Quadriga is limited to Quadriga and should not be understood as applying to the crypto asset platform industry as a whole. Properly conducted, crypto asset trading is a legitimate and important component of our capital markets. We remain committed to working with this industry to foster innovation. Financial innovation has always been critical to the health of our economy and the competitiveness of our capital markets.

It is equally critical that investors have confidence to access new technologies and platforms that drive this innovation and competition. To that end, the investing public should be aware that using crypto asset trading platforms carries risks and that many crypto asset trading platforms are not registered and have taken the position that they are not required to register with securities regulators. Anyone considering entrusting assets to a crypto asset trading platform should take steps to learn about the platform’s operations and approach to risk management prior to using it. This may not be possible with the current level of disclosure offered by some platforms.

Platform operators should be aware that, depending on their business model, they may have to register with the OSC and they should take appropriate steps to comply with Ontario securities laws. For guidance, platform operators should consult CSA Staff Notice 21-327 Guidance on the Application of Securities Legislation to Entities Facilitating the Trading of Crypto Assets and joint CSA/IIROC Consultation Paper 21-402 Proposed Framework for Crypto-Asset Trading Platforms. Platforms should also consider Issues, Risks and Regulatory Considerations Relating to Crypto Asset Trading Platforms, a report published by the International Organization of Securities Commissions. Platforms should review their operations to ensure that they have procedures in place to manage risks to clients and that they are accurately disclosing key information about their operations to clients.