Crypto collapse: FTX first-day hearing, Genesis screws DCG, Silvergate Bank

We just posted our latest on the crypto crash series. This one is on David’s blog. [David Gerard]

Here’s some of what we cover in this episode:

  • FTX had its first-day hearing in its Delaware bankruptcy.
  • The SEC was told to back off from FTX by eight members of Congress, five of whom got donations from FTX founders.
  • Genesis sets parent company DCG teetering.
  • Gemini Trust was exposed to risk via Genesis.
  • DCG is not bailing out Genesis this time around.
  • Silvergate said its FTX exposure was limited to deposits. It’s not about the deposits!
  • Binance is fine, and nothing is wrong! Probably!

Image: The FTX legal team entering the court.

Al Jazeera: FTX meltdown threatens to end ‘Wild West’ era for crypto

The editor of Al Jazeera Asia contacted me for a story about crypto, so I wrote about how the collapse of FTX will result in regulators coming down hard on the space. This was my first story for Al Jazeera. [Al Jazeera]

South Korea, Singapore, and Japan had the greatest number of users on FTX, according to CoinGecko. After Binance pulled out of Singapore last year, many crypto traders in the city-state switched to FTX.

This story was a bit of work because I had to interview five different people. You may recognize some of them — David Gerard, Martin Walker, and Stephen Diehl, among others.

One of my favorite quotes is from Stephen, who predicted: “the crypto industry will mostly be relegated to the dark corners of the financial system as it slowly slides into irrelevance.”

Crypto collapse: Celsius’s Interim Examiner Report

  • By Amy Castor and David Gerard
  • Our work here is funded via our Patreons — here’s Amy’s, and here’s David’s. Your monthly contributions help greatly with our coffee and ibuprofen budgets!

Shoba Pillay, the examiner in the Celsius bankruptcy, filed her first interim report on Saturday at 11:45 p.m. ET. [Report, PDF]

Appointed by the Office of the US Trustee — an arm of the Department of Justice — Pillay is here to work out precisely what on earth happened here. She is already conducting Rule 2004 investigations, which let her look into almost anything.

This interim report specifically examines Celsius’ crypto holdings, where they were and are stored, and the change from Earn accounts to Custody and Withhold accounts in April 2022, during which time Celsius was feeling the heat. 

Who owns what and under what terms is hugely contentious, with legal briefs flying back and forth: [Debtors’ brief, PDF; Unsecured Creditors’ brief, PDF; Custodial brief, PDF; Withhold brief, PDF]

This investigation revealed that Celsius reacted to the regulatory scrutiny by launching its Custody program without sufficient accounting and operational controls or technical infrastructure … As a result, customers now face uncertainty regarding which assets, if any, belonged to them as of the bankruptcy filing.

This isn’t the bomb under the Celsius bankruptcy that we have been waiting for — it’s just an interim report ordered by Judge Martin Glenn ahead of the Celsius Custody and Withhold hearings on December 7 and 8.

Nevertheless, it’s jam-packed with the sort of hilarity and horrors that you find when anyone looks inside how any crypto firm actually works. All crypto firms are Quadriga. It’s just that some haven’t exploded yet.

The current report is a window into the fraught issue of whose cryptos are in the Custody and Withhold accounts. It will help the court decide whether the depositors will get back 100% of what they put in or whether the cryptos go into the general bankruptcy estate.

The word “Ponzi” does not appear in this report. Whether the Examiner will look into possible Ponzi scheming by Celsius has yet to be determined. The Unsecured Creditors’ Committee — consisting of seven individuals representing the largest Celsius creditors, who are mostly from the crypto industry — wanted to look into this question themselves.

We think the task should be handed to the examiner, a neutral party — and many of the smaller retail investors concur. Also, we’re impressed by what a relentlessly thorough job the examiner did in this interim report.

Celsius hampered the examiner’s investigation as much as they thought they could get away with:

Documents or information responsive to certain requests were not received until days prior to the filing of this Interim Report, and some were not received at all, which may require the Examiner to further supplement the information contained in this Interim Report when she issues her Final Report.

… In addition, Celsius imposed limitations on interviews of its employee witnesses, including by requesting that the Examiner preview any topics to be covered during the interviews and limiting the time of many interviews to two hours. Further, Celsius claimed privilege over communications between Celsius and the regulators, further limiting her ability to obtain the full scope of relevant facts.

On page 19, the examiner cites one of Amy’s 2017 articles for CoinDesk to define what an ERC-20 token is. [CoinDesk]

Custody accounts

Earn was Celsius’ main product. You would deposit cryptos and be paid interest on them.

Regulators in multiple states had been lining up to shut down Celsius’ Earn product through 2021 and early 2022 — they thought it was the unregistered security that it obviously was. New Jersey in particular said that since Celsius was selling the product from their state, the New Jersey cease-and-desist order would take effect for the whole US. The SEC was also subpoenaing information from Celsius. BlockFi had already suffered cease-and-desists for its similar product.

Regulatory heat was a major factor in the creation of Custody and Withhold accounts. Yarden Noy, who headed regulation for Celsius, told Pillay: “Given the regulators, we came up with Custody.”

Celsius was working under the gun — they worried about having a month unable to accept fresh customer deposits — but they had to release Custody before the regulatory deadline or stop accepting any cryptos from retail US customers.

A lack of fresh cryptos coming in from new investors to pay out previous investors would be a serious issue if Celsius happened to be Ponzi-ing.

Celsius was short of developers. Celsius Engineering Director Steven Koprivica characterized the procedure as: “go back to blackboard, do the minimum of all minimums, this may be manual for the start, involve less developers, let’s discuss deadlines.” So everything about the Custody accounts ended up a mess.

Celsius was already tracking the company’s cryptos in the most advanced software known to cryptocurrency: a Google Sheets spreadsheet called the “Freeze Report.” This was an improvement over Celsius’ previous system, which was to just look at each blockchain address and check the balances by hand.

It wasn’t even clear precisely what the “Custody” product was. The accounts certainly weren’t “custody” in the sense that every other crypto custody firm uses the word — storing the keys for a customer’s large crypto holding securely. Different groups in Celsius had different understandings of what the accounts were supposed to do.

Celsius Custody launched on April 15, 2022. Celsius didn’t tell anyone about Custody ahead of its launch — they worried that customers would leave the platform, and they worried that regulators would give them a hard time about the Custody product itself.

Custody was run badly. Celsius didn’t have time to do anything properly. Rather than relying on software, Celsius used manual reconciliation and hoped to add a more robust process later.

Employees were told to tell customers: “Celsius continues to safeguard customer assets.” In fact, Celsius did not safeguard customer assets. Celsius represented each customer’s Custody account as separate — but in practice, they aggregated all of the crypto, lumping everything into one big pile and kept track of the amounts … shoddily.

Celsius had to manually reconcile the amount of crypto listed in each Custody account with the actual cryptos in the aggregate Custody wallet. This was entirely ad-hoc. On 16 dates, there were shortfalls; Celsius topped up the Custody wallet from the Main wallet as needed, and vice versa. (The report details every occasion in Schedule 2, and there’s a graph on page 12. This report is thorough.)

But the key point is that “the Custody wallets ran a substantial deficit relative to Celsius’s Custody liabilities.”

Custody had new terms of service that changed conditions in important ways, such as who owned the cryptos — but customers weren’t necessarily required to click their acceptance, or to read the terms before clicking. This has been a point of serious contention in the bankruptcy — many customers didn’t agree to the terms.

Withhold accounts

Earn customers who were in states where Celsius didn’t feel safe to offer Custody accounts were transferred to a new group, called “Withhold.” This was supposed to just be Celsius holding the coins for customers to then take out later.

Customers didn’t understand this:

Withhold customers expressed confusion about their accounts. For example, one user explained that he “discovered that [he] had a ‘Withhold Account’” only because it “appeared without explanation on the Celsius app.”

Celsius didn’t consider Withhold a product, so it didn’t create a Terms of Use for Withhold.  

But that didn’t stop Celsius from using cryptos in Withhold for revenue generation — loans, rehypothecation, and so on. Also, Celsius didn’t put Withhold funds into separate wallets per customer or even segregate Withhold accounts from their large general pool of cryptos.

The asteroid strikes

The Terra-Luna collapse blew a hole in the Celsius accounts: “In its May 2022 Board Minutes, Celsius reported that its ‘capital sits near zero.’”

Spooked customers withdrew $1.4 billion in crypto between May 9 and May 24, 2022. Cryptos on hand ran so low that Celsius could no longer honor withdrawals — despite CEO Alex Mashinsky’s frequent tweets of reassurance around this time.

Celsius paused all withdrawals on June 12, citing “extreme market conditions” — specifically, that customers wanted their money back.

Custody and Withhold balances increased after withdrawals were cut off — because customers could still deposit, and “customer assets were allocated to Custody when they attempted to withdraw their coins from Earn.”

What happens next?

Pillay’s report outlines the most contentious issues in the bankruptcy in detail — but it doesn’t point to any clear resolutions for them. Judge Glenn is going to have to untangle all of this himself.

The Examiner and the UCC have to resolve who will investigate the “so-called Ponzi schemes” by Celsius. There’s no clear date for this, but the next omnibus hearing is December 5.

The next interim Examiner’s report is due in the first half of December.

Other news in Celsius

Celsius now has an approved bar date. Creditor claims must be in by January 3, 2023. Government claims need to be in by January 10, 2023. [Order, PDF]

Celsius hasn’t put together any plausible business plan as yet. They are asking the court if they can have until March 31, 2023, an extra 141 days to come up with one. [Doc 1317, PDF]

Declaration of John Jay Ray — FTX is worse than Enron

John Jay Ray III took over FTX in the wee hours of November 11. Hours later, he filed for Chapter 11 in a Delaware court.

The new CEO filed his first-day declaration this morning. It’s incredible. David Gerard and I summarize it — this one is on David’s blog. [David Gerard]

  • In his 40-year career, Ray, who oversaw the Enron liquidation, has never seen “such a complete failure of corporate controls.”  
  • Ray has divided SBF’s empire into four silos, but the accounting is all unreliable because he’s gotten the numbers from SBF. 
  • Ray and his team will have to create a balance sheet and financial statements from scratch using what records they have of cash transactions.
  • FTX Digital Markets, the company’s Bahamas subsidiary, filed a for Chapter 15 in SDNY. Ray’s team is asking the court to move the Chapter 15 case to Delaware. 
  • Ray thinks the filing in SDNY was shenanigans by SBF and unnamed agents of the Bahamas government!
  • SBF’s late night DMs with a Vox reporter, published the next day, make it looks like he was in on the plot.

Crypto.com’s bad weekend — crypto exchanges are shaky

  • By Amy Castor and David Gerard

“i have a lot more respect for the binance guy, having seen a competitor stumble and taken the opportunity to very publicly shank them five or six times while they’re on the ground, under the guise of trying to help”

— infernal machines, SomethingAwful

We’re exhausted keeping up with all the good news for bitcoin.

Crypto.com didn’t have the greatest weekend. As we write this, withdrawals are clogged, but some are reported to be coming through okay.

The test an exchange faces is: can it stand a run on the bank?

The test bitcoin as a whole faces is: how will the price hold when lots of people are dumping for cash?

Number go down

After the bitcoin price had been floating at around $20,000 for several months, FTX crashed. On the day Binance reneged on its offer to buy FTX’s remains, BTC dropped below $16,000. It’s a bit above that now.

The actual dollars have gone home, and the wider crypto casino is having to pretend harder and harder that the alleged mark-to-market value of illiquid trash means anything.

Real dollars continue to disappear from crypto. Retail trading at Coinbase was down 43% in the third quarter of 2022, compared to Q2.

Reddit /r/buttcoin has a new header image

A slight case of the runs

Crypto.com is not having a great time.

The crypto markets are jittery. After the dramatic collapse of FTX, crypto holders are left shell-shocked and traumatized. They don’t trust any centralized exchange now at all.

It doesn’t take much to set the markets off. 

Despite claiming to have near-zero exposure to the fallout of FTX, over the last year, Crypto.com sent multiple very large stablecoin transfers to FTX, totaling approximately $1 billion. [Reddit, Australian Financial Review]

On November 12, crypto Twitter caught wind of the fact that Singapore-based Crypto.com and China-based Gate.io were passing funds back and forth to post stronger-looking proof of reserve statements, suggesting they didn’t have the funds they purported to have.   

Crypto.com CEO Kris Marszalek waved it off as just a whoopsie, saying they accidentally sent $400 million of their ETH to Gate.io on October 21, instead of their cold wallets, but that Gate.io had sent the money back. Everything was fine. [Twitter, archive; WSJ]

The crypto market wasn’t buying it. Instead, the news set off an FTX-style bank run, as panicked users raced to get their funds off Crypto.com. Within hours, more than 89,000 transactions pulled customer funds out of Crypto.com wallets. You could watch it in real time on Etherscan. [Chainsaw, Twitter]

Picture old-timey cartoons of guys in a stock exchange, hats popping off their heads and cigars falling out of their mouths in shock, shouting, “SELL! SELL! SELL!” Crypto.com was like that but in basements around the world.

By Monday, the run had made mainstream international news —  Sky, AFP, and Reuters, as well as financial outlets such as Bloomberg. [SkyNews]

Crypto.com should have collapsed right then, but it didn’t. Binance bailed Crypto.com out with infusions of ETH and USDC from their “recovery fund.” Cryptocurrency just reinvented the idea of a central bank as a lender of last resort. [Twitter; Twitter; Twitter]

Of course, given what he had just done to FTX, is it really a smart idea to let CZ know you have liquidity problems?

The following day, Marszalek did an Ask-Me-Anything to reassure everyone that the funds were safe. “At no point were the funds at risk of being sent somewhere they could not be retrieved,” he said. “It had nothing to do with any of the craziness from FTX.” [YouTube

Binance also held an AMA to tell everyone that everything is fine. [Twitter; Verge]

The life and times of Kris Marszalek 

Kris Marszalek co-founded Crypto.com in 2016. It was initially called Monaco but bought the “crypto.com” domain from cryptographer Matt Blaze in 2018.

Based in Singapore, the firm has spent huge money on ad campaigns, including a $700 million deal to put its name on LA’s sports arena (formerly Staples Center) and a “Fortune Favors the Brave” Super Bowl commercial featuring Matt Damon. [GQ]

The company makes money by charging fees for trades on its smartphone app. It promises Ponzi-like yields — up to 14.5% annually, paid out in stablecoins. 

To access the higher stake yield, you have to buy Cronos (CRO), the platform’s native trader token, whose price floats freely. CRO tanked over the weekend over concerns about Crypto.com’s reserves. [BeinCrypto]  

Marszalek, 42, is a Polish-born serial entrepreneur who lives in Hong Kong. He dropped out of college and started his career selling computer equipment. He doesn’t appear to have any trading experience at all prior to Crypto.com.

You’ll be delighted to hear that Marszalek has the sort of background you want in a crypto CEO. Specifically, running a voucher sales company that collapsed in 2016 and stiffed everyone.

Founded in 2010 in Singapore, Ensogo offered Groupon-style “daily deals” and so forth. After going through multiple name changes and acquisitions, Ensogo was listed as a standalone company on the Australian Securities Exchange. It pivoted to an “open marketplace platform” in late 2015. [ASX, PDF]

By April 2016, Ensogo had closed its Malaysian office and had stopped paying merchants. The company’s first-quarter report to the ASX showed an AUD$5 million deficit, despite firing half its staff in the first quarter of 2016. It had already lost AUD$67 million in 2015. Ensogo finally stopped operations in June — leaving merchants and consumers in the lurch. One Hong Kong merchant lost HK$20,000. [Tech in Asia; Tech in Asia; Tech in Asia]

Other exchanges 

In the third quarter of 2022, US exchange Coinbase suffered “another tough quarter.” Institutional trading was down 22% and retail volume was down 43%, compared to the previous quarter. Net revenue in Q3 was $576 million, down from $803 million in Q2, and $1.2 billion the year before. The company lost $545 million in Q3, compared to a net profit of $406 million in the same period last year. [FT, archive; Shareholder letter, PDF]

In Hong Kong, AAX has suspended withdrawals. The crypto exchange had just blogged that it had no exposure to FTX and that user funds were never exposed to counterparty risk. [AAX; AAX; Coindesk]

What’s a user to do?

The FTX collapse has taken out a variety of firms across crypto, including other exchanges and crypto hedge funds. Many projects used FTX like it was a bank. So many projects are now wrecked because they treated FTX like it was a safe place to store their cryptos.

Expect more trouble and possible bankruptcies to come. People keep treating crypto exchanges as banks. They are not banks.

The hard part is: what do you do instead?  

Loud and weird crypto nerds, particularly bitcoin maxis, are saying “not your keys not your coins” again a lot.

Back in the real world, approximately 100% of crypto users are in it for the money. And that’s only achievable with the coins on an exchange, where they can actively buy and trade them.

More importantly, almost all crypto users have flat zero technical knowledge. They have no idea how any of it works. They trusted the newspaper headlines. They just about get “number go up.” They won’t be self-custodying en masse.

DeFi traders will tell you that self-custodying is the only way to do anything, but they also get rekt a whole lot.

We concur that users should treat centralized exchanges as risky places to store cryptos. The trouble is, what else to do with them? If you don’t want to do the sensible thing — i.e., dump your coins and get the heck out of crypto — you’re going to have to learn way more about how the technology works than you ever wanted to.

It’s going to suck because — despite the user-friendly Super Bowl ads — crypto is not a product. It’s a pile of wires on a lab bench. Get out your soldering iron, you’re gonna be your own bank.

FTX files for bankruptcy, and the fallout begins. Who’s next?

It’s been an exhausting week trying to keep up with the chaotic news coming out on FTX. Here’s our latest crypto collapse update and analysis. This one is on David’s blog. [David Gerard]

While many people have been comparing the fall of FTX to Enron or Lehman Brothers, it’s really more like MF Global, a major global financial derivatives broker that went belly-up in 2011.

MF Global’s fatal flaw was the same as FTX-Alameda: They failed to segregate funds and used billions of dollars in customer money to cover up losses in trading.

Everyone should have seen this crash coming, especially the “sophisticated” venture capitalists who neglected to do due diligence on FTX and instead kept shoveling money into the fire, creating the myth of Sam Bankman-Fried, boy genius, in the process.

You should assume that every offshore crypto firm is like the failed Canadian exchange Quadriga — Zeppelins flying high, waiting for a single spark to set them off.  

Image: Hindenburg exploding

Crypto collapse: J. Pierpont Moneygone — FTX rekt, bought by Binance

  • By Amy Castor and David Gerard
  • Send us money! Our work is funded by our Patreons — here’s Amy’s, and here’s David’s. Your monthly contributions help greatly!

The 2021–2022 crypto bubble made a lot of traders look like geniuses. Then the bubble popped, the tide went out, and the traders turned out to be hugely overleveraged formerly-lucky idiots.

Sociologists know that when a cult prophecy fails, most cultists exit the cult, and the remaining factions turn on each other.

Crypto watchers know that this can also be exceedingly funny.

Imaginary assets, real liabilities

Sam Bankman-Fried’s boosters compare him to the legendary banker J. P. Morgan. He’s spent the crypto collapse bailing out ailing companies to keep the entire market afloat.

Bankman-Fried runs three large crypto enterprises:

  1. Alameda Research, his crypto hedge fund;
  2. FTX, his unregulated offshore crypto casino that doesn’t allow US customers;
  3. FTX US, his exchange for US customers that purports to operate under US law and accepts actual dollars.

On November 2, Coindesk’s Ian Allison posted an explosive story on a partially leaked balance sheet for Alameda. [CoinDesk]

Of Alameda’s $14.6 billion in claimed assets, $5.8 billion is FTT — FTX’s internal exchange token. You can use FTT for cheaper trading fees and increased commissions. FTT is also traded outside FTX.

Allison also noted that $5.8 billion is actually 180% of the circulating supply of FTT!

Alameda’s liabilities are listed at $8 billion, most of which is $7.4 billion of loans — quite a bit of that from FTX.

Alameda is super cashed-up … if you account for FTX’s own FTT token at mark-to-market, and not what you could actually get for that much of their private illiquid altcoin.

To make matters worse, Dirty Bubble notes that a lot of Alameda’s other assets are crypto tokens from other Sam Bankman-Fried enterprises. [Dirty Bubble Media]

Alameda and FTX seem to have printed FTT, pumped its price using customer assets — FTX was quite open that it was the FTT market maker, and there’s no other real demand — and used the mark-to-market value of their illiquid made-up token as collateral for loans, or as evidence that pension funds should invest in crypto companies.

This works great while number is going up!

Regular readers will know that this sort of flywheel scheme is precisely what Celsius Network tried to run with their CEL token and Nexo with their NEXO token. Celsius is bankrupt, and regulators have noticed that Nexo is only solvent if you allow them this particular tricky bit of accounting.

Alameda CEO Caroline Ellison said the leaked balance sheet Coindesk got a hold of was “incomplete,” and there were $10 billion in assets not listed there. [Twitter, archive

The crypto world spent a few days wondering if Alameda was the next Three Arrows Capital.

CZ pulls the plug

Large flows of FTT were noticed on the blockchain on November 6. Binance CEO Changpeng Zhao confirmed that this was Binance selling off its FTT: [Twitter, archive]

“As part of Binance’s exit from FTX equity last year, Binance received roughly $2.1 billion USD equivalent in cash (BUSD and FTT). Due to recent revelations that have came to light, we have decided to liquidate any remaining FTT on our books.”

The remaining FTT that Binance sold was worth $530 million. [Bloomberg]

CZ was also annoyed at Bankman-Fried’s lobbying efforts for crypto regulation in Washington: “We won’t support people who lobby against other industry players behind their backs.” [Twitter, archive]

The crypto market is incredibly shaky. Alameda and FTX operate as separate corporations, but the market seems to think they’re closely entwined. Trouble at Alameda leads to worry about FTX.

So panicked holders, thinking Alameda might be insolvent, started withdrawing funds from FTX as fast as possible — and hardly deposited anything at all.

FTX paused all withdrawals on the Ethereum, Solana, and Tron blockchains around 11:37 a.m. UTC on November 8, according to Steven Zheng at The Block. [The Block]

Finally, just after 4 p.m. UTC, Bankman-Fried and CZ announced that Binance was buying FTX. Specifically, they have a non-binding letter of intent, pending due diligence. [Twitter, archive; Twitter, archive]

Essentially, CZ started a bank run on FTX, then swooped in to buy his competitor after breaking it. CZ did to Bankman-Fried what Bankman-Fried has been accused of doing to a string of others.

At present, this is only a letter of intent, not a done deal — CZ is making Bankman-Fried suffer. He could just let FTX go hang.

How screwed are FTX and Alameda?

CZ said FTX was in a “significant liquidity crunch.” This is the sort of “liquidity crunch” that everyone else calls “insolvency.” If it were just liquidity, FTX could have borrowed against its assets and found another way out of this. [Twitter, archive]

We don’t know for sure that Alameda was trading with FTX customer funds — but this sort of fractional reserve operation is the only not-entirely-fraudulent reason that FTX could have run out of customer funds in this way.

Bankman-Fried claimed on November 7 that “FTX has enough to cover all client holdings. We don’t invest client assets (even in treasuries).” This appears not to have been true, and he later deleted the tweet. [Twitter, archive]

If FTX couldn’t get its funds back from Alameda quickly, that would have then led to the liquidity crunch.

What about FTX US?

Bankman-Fried was quick to reassure customers that FTX US was not affected and that it was “fully backed 1:1, and operating normally.” So at least FTX US explicitly claims it isn’t playing the markets with your deposits. [Twitter, archive]  

FTX US is also attempting to buy the remains of the bankrupt Voyager Digital, a deal that we think is likely to go through.

The separation of customer funds and platforms is the whole point of FTX US versus FTX. It’s there to make Sam look good to regulators.

But it’s all Sam Bankman-Fried. It’s Sam’s left pocket versus his right pocket.

We think that if your paycheck goes into FTX US, you probably want to stop doing that immediately.

What happens next? It’s contagion time!

Alameda has likely been borrowing against the FTT it held — the FTT that is now crashing. (Earlier today, FTT was worth $19; as we post this, it’s trading at $4.60.)

Binance might rescue FTX, but it’s sure not going to rescue Alameda.

This means a series of margin calls by everyone who’s lent to Alameda. If Alameda defaults, those lenders will likely end up with worthless FTT.

BlockFi and Genesis have a pile of money in Alameda. BlockFi is or will be owned in some unspecified manner by FTX US, but that doesn’t make the books balance — there’s already a rumor of a 24-hour margin call by BlockFi against Alameda. [Twitter]

Remember that Three Arrows Capital collapsed when their UST turned out to be worthless. This then took out a pile of other crypto trading firms — most notably Celsius Network and Voyager Digital.

We’re left with two questions:

  1. Who is lending to Alameda?
  2. Who’s lending to those lenders — and risks going down in turn?

The crypto market is not happy. Bitcoin has been up and down like a yo-yo today, from $19,500 just before 4 p.m. UTC to a peak of $20,500 and a trough of $17,500.

We predict more market excitement to come — specifically, a possible Alameda collapse, a chain reaction of lender failures, and attempts to cover sudden balance-sheet holes, much as we saw after the Terra-Luna and Three Arrows collapses.

But Caroline Ellison from Alameda insists there’s another $10 billion behind the sofa or something. Maybe it’s all fine!

Image: FT Alphaville

Celsius bankruptcy hearing November 1, 2022: stablecoins, KERPs and Ponzis

A hearing was held in the Celsius bankruptcy proceedings on November 1 at 11 am ET.

It went on for three hours. I sat threw all of it and drafted a story. David Gerard polished the draft and added more comments and analysis. You can read the full post on David’s blog. [David Gerard]

Here’s what we covered:

  • Secret Celsius employees will not get bonuses.
  • The examiner expands her work plan to include the CEL token and how Celsius marketed its services — send us your coins! We’re your friend, banks are you enemies! HODL!
  • The P-word came up multiple times in the hearing.
  • Celsius can’t sell its $23 million in stablecoins until it’s clear who owns them.
  • The examiner report is a ticking time bomb set to blow up the best made plans.

Please take a moment to subscribe to our Patreon accounts. We need your support, even if it’s just a few dollars a month. Links are in the blog post!

Crypto collapse: Bitcoin stagnant, selling Celsius and Voyager, how 3AC died

“I kept up the bluff, hoping that I might eventually hit upon some workable plan to pay all my creditors in full.” 

— Charles Ponzi, The Rise of Mr. Ponzi

Crypto has crashed, and some of our readers are asking us why the price of bitcoin has been holding steady at around $19,000 to $20,000 for the past few months. Why won’t it go down further?

We think the price of bitcoin is a high wire act. If the price drops too low, some leveraged large holders could go bust. So the number needs to be kept pumped above that level. If the price goes up too far, the suckers — not just retail, but the bitcoin miners — may be tempted to cash out at last.  

The idea is to pump just enough to keep the price up — but not so much that suckers dump their bitcoins directly into the pump.

If too many bagholders try to sell, what quickly becomes obvious is there are no actual buyers. At least, none with real money. 

The party is over. Retail investors have all gone home, so there are no more suckers getting in line to pump the price up anymore. Coinbase’s 10-Q showed a drop in retail dollars.

In addition to a dearth of real dollars, there’s also been a dearth of fresh tethers coming in since June. That dearth lasted until October 25 — when a billion tethers were printed and prices suddenly jumped 10%, just in time to liquidate a pile of short-margin traders on FTX.

Bitcoin miners in North America have been taking on increased debt, so there’s still no real incentive for them to sell their bitcoin. Core Scientific is the exception, as we note below, because they’re running out of cash — not least because they’re stuck with hosting Celsius.

Bitcoin derivatives — assets that derive their value from bitcoin — aren’t doing well either. The ProShares Bitcoin Strategy ETF (BITO) tracks the CME’s bitcoin futures. These are just bets in dollars on the price of bitcoin. Bloomberg Intelligence analyst James Seyffart says: “If you just want exposure to Bitcoin” — i.e., not doing anything so gauche as touching a bitcoin — “BITO is the best option in the ETF landscape, at least in the US.” But in the more than a year that it’s existed, BITO has performed even worse than bitcoin itself. BITO holders have mostly stayed holding, so its holders are just like bitcoin bagholders too. [Bloomberg

Celsius: the state of play

Celsius Network is dead. It’s an ex-parrot. Most of the back-and-forth in the bankruptcy is over the spare change that might be in the corpse’s pockets. Also, the spare change is being nibbled away by lawyers’ fees and operational costs. So the creditors think it’s time to see what they can get by just selling it all for parts.

At the same time, Celsius is saying “I’m not dead yet!” and throwing up plans to come back to life. That’s the difference between a Chapter 7 liquidation and a Chapter 11 reorganization — Celsius has to pretend it has a future.

And also, the US Trustee got an examiner on the case, to see just what happened here — if this bankruptcy was the result of ineptitude … or of Celsius being a scam. 

The examiner’s report is a wild card. It could blow up the whole bankruptcy proceeding. We think the Trustee, who is part of the Department of Justice, suspects Celsius is a crime scene.

Celsius’ bidding process approved

Judge Martin Glenn has approved the bidding procedure plan for Celsius to sell virtually all of its assets — including its mining business. He is quite concerned that this business is, in bankruptcy jargon, a “melting ice cube,” and wants to make the sale happen for the sake of the creditors. [Memorandum Opinion and Order, PDF]

The initial bid deadline is November 21. Final bids are due on December 12. An auction, if necessary, is scheduled for December 15.

The court directed the Trustee to “promptly” appoint a privacy ombudsman with experience in consumer privacy laws to protect consumer data. The Trustee has appointed Lucy L. Thompson. [Appointment, PDF; Order, PDF]

The Trustee, the examiner, and the consumer privacy ombudsman will be able to listen in on the auction — but they can’t interfere.

Celsius is required to submit any stalking horse approval to the court. A stalking horse is a bid that is arranged in advance to prevent other bidders from making lowball offers.  

The final deadline for bids falls after the examiner begins to reveal her findings. An interim report is due on November 18, and an initial report is due on December 10.

Your keys, whose coins?

The court has yet to decide whether the contents of Celsius Custody and Withhold accounts belong to the individual customers, or to the bankruptcy estate. 

The issues are set to be heard on December 7 and 8, and they’ll raise a host of questions about what constitutes ownership in crypto. If someone else controls the keys to your crypto, is that really your crypto? There is no straightforward answer to this.

In a letter filed with the court on October 17, Judge Glenn notes: “cases involving cryptocurrency may raise legal issues for which there are no controlling legal precedents in this Circuit or elsewhere in the United States or in other countries in which cases arise.”

So, he’ll be using the Law Commission of England and Wales’ lengthy and detailed “Digital Assets Consultation Paper” as his framework in this case. [Doc 1073, PDF; Consulting Paper]

We think he’ll be particularly interested in Chapter 16 of the paper, which specifically talks about custody and what happens in an insolvency. 

This is surprisingly big news for US crypto in general — it will introduce a whole swathe of legal thinking that’s entirely new for US crypto regulation and jurisprudence. This may turn out to be a lasting consequence of the Celsius bankruptcy.

Who owns cryptos in custody is already fraught. A few months ago, it turned out that cryptos held in Coinbase Custody are not the customer’s cryptos, being held by Coinbase — instead, they’re assets of Coinbase that are liabilities Coinbase has to the customer, just like cryptos on deposit on the Coinbase trading platform. This is precisely not what Coinbase was selling Custody to its customers as! But that’s how SEC regulations said to account for it.

No equity committee for you

Judge Glenn has denied the motion for an official equity committee, which would have allowed Celsius investors to bill their professional fees to the bankruptcy estate. We discussed this motion last time.

It’s actually not uncommon for equity security holders to request the appointment of official equity committees to represent their interests in bankruptcy cases — and to get a formal seat at the negotiations table. 

But in this case, Judge Glenn wasn’t convinced. He thinks the equity investors already have adequate representation in the form of existing stakeholders, particularly the board of directors, who literally represent the owners of the company. The court also feels there is little chance investors will recoup any of their $400 million — it’s normal in bankruptcy for equity holders to get zero — and the costs involved are unlikely to benefit the estate. [Doc 1166, PDF]

The equity investors also want Celsius to list liabilities and assets in dollars, not crypto — which is quite normal even for volatile and illiquid assets like crypto. [Doc 1183, PDF

Discharge objections

The purpose of filing Chapter 11 is to wipe out debt and start anew. But a party can object to the discharge of a particular debt — or the entire bankruptcy case — by filing an adversary proceeding, as we detailed last time.

In Chapter 11, the deadline to file objections to dischargeability is 60 days after the first creditors’ meeting. Celsius has agreed with state regulators to extend the states’ deadline by six months, to April 18, so the states can finish their investigations. And they’ve agreed on the same with the Federal Trade Commission. [Doc 1107, PDF; Order, PDF]

The Securities and Exchange Commission wants to extend its deadline to January 17. If Celsius raised money in a way that knowingly violated securities law or other laws — which they totally did, come on — then those debts might not be dischargeable. [Order, PDF]

Other Celsius stuff

As we mentioned last time, Core Scientific doesn’t want to keep paying the ever-increasing electricity bills for hosting Celsius’ bitcoin mining. Core Scientific, Celsius, and the Unsecured Creditors’ Committee are asking Judge Glenn to schedule a hearing on the matter on or after November 9. [Scheduling, PDF]

Celsius’ bills are a big problem for Core Scientific, who are already short on cash. Core Scientific dumped $20 million of bitcoin in September, and still only has $27 million in cash on hand — they burned through $25 million in the last month. They are on the verge of filing for bankruptcy themselves: [SEC]

“Furthermore, the Company may seek alternative sources of equity or debt financing, delay capital expenditures or evaluate potential asset sales, and potentially could seek relief under the applicable bankruptcy or insolvency laws. In the event of a bankruptcy proceeding or insolvency, or restructuring of our capital structure, holders of the Company’s common stock could suffer a total loss of their investment.”

Data Finnovation thinks he’s found Tether’s loans to Celsius, which are a major point of contention in the Celsius bankruptcy. “We found the Tether-Celsius loans, Tether’s equity investment into Celsius, and can therefore prove a lot about both defects in the Celsius business model and questionable conduct by Tether.” [Data Finnovation

There’s failing upward, and then there’s whatever this is: ex-Celsius exec Aaron Lovine joins JPMorgan as the new executive director of crypto regulatory policy! [Reuters]  

The next Celsius omnibus hearing is November 1. The November 30 omnibus hearing has been rescheduled for December 5. [Doc 1169, PDF]  

Voyager Digital 

Voyager is trying to sell itself off to FTX US. The deal is still tentative. Texas is concerned that FTX is offering unregistered securities to US retail customers. New York is sniffing around Voyager as well.

Voyager’s sale to FTX is part of Voyager’s broader bankruptcy plan, which creditors need to vote on next month. If they vote yes, the court still has to confirm the plan. A hearing for plan confirmation is set for December 8. In the meantime, Judge Micheal Wiles wants Voyager to stay open to better offers. 

The sale to FTX is valued at about $1.4 billion, of which $51 million is in cash. As part of the sale, FTX US would move customers onto its platform and return them 72% of their claims. [Second Amended Plan, PDF; Bloomberg; Bloomberg Law, archive]

Only creditors who transition to FTX US will receive crypto — customers who don’t go to FTX US will receive cash from the bankruptcy estate. FTX US doesn’t support Voyager’s VGX token, but it has offered to purchase all VGX for $10 million.

Voyager is pushing the FTX sale plan hard. Creditors have until November 29 to cast their votes. [Voyager, archive]

We mentioned on October 16 that Texas objected to the Voyager sale because the state was going after FTX, and then the rest of the crypto media covered the story the day after we posted it. The Texas Tribune spoke to Joe Rotunda, Director of the TSSA Enforcement Division, who discovered that FTX would let him trade securities from his Austin office. [Texas Tribune]

In its response to objections, Voyager holds that the sale to FTX is within its business judgment. For Texas’ objections regarding FTX, they’re adding a note that nothing should be construed as restraining state regulators. [Doc 558, PDF, Doc 559, PDF]

The New York Department of Financial Services has applied for an order lifting the automatic bankruptcy stay on an action against Voyager to “permit DFS to proceed with an investigation into whether the Debtors, or any one of them, have engaged in fraudulent activity and/or violated applicable law with respect to unlicensed cryptocurrency business activities within New York.”

There’s a provision in section 362 of the Bankruptcy Code for “police action” to proceed during a stay. Payment of a fine might be delayed — but that shouldn’t stop an investigation. The DFS outlines why it thinks it could just proceed anyway — but it’s asking nicely. There’s a hearing on November 15. [Doc 573, PDF

The fall of Three Arrows Capital

Kadhim Shubber from the Financial Times spotted a hilarious detail in a disclosure statement that Voyager filed on October 17 — on precisely how Three Arrows Capital screwed them over. [Doc 540, PDF, p47 on; Twitter]

Terraform Labs’ UST and luna tokens collapsed in mid-May. This sent 3AC bust, immediately — they were up to their necks in Terraform’s Anchor protocol and had a ton of UST.

Voyager asked their debtors if they had been affected by the UST-luna crash. Voyager’s contact at 3AC assured them everything was fine.

Later that month, 3AC reached out to Voyager asking to borrow even more from them — when 3AC was already 25% of Voyager’s loan book. Voyager said no.

Celsius froze withdrawals on June 12. Voyager again reached out to its debtors, asking how things were. Their 3AC contact assured Voyager on June 13 that 3AC was not exposed to Celsius.

Voyager put out a press release on June 14 assuring everyone that everything was fine. [Press release, archive]

Upon seeing the press release, Voyager’s 3AC contact called them straight away and told them that the founders of 3AC had gone silent and weren’t answering queries from their own employees. Their contact suggested that Voyager should recall all of its loans to 3AC immediately. This was the point at which Voyager knew that it, too, was bust.

We now know, of course, that 3AC’s founders had skipped Singapore sometime in late May — as soon as they realized there was no way to come back from the UST-luna collapse. They just locked the office doors and vanished. We even have a photo of the mail piling up on the office floor.

(You can tell it’s a rug pull from the lack of a carpet.)

Teneo is the court-appointed receiver in 3AC’s bankruptcy. Teneo wants US Judge Martin Glenn — yes, the same one overseeing Celsius — to let them subpoena 3AC founders Zhu and Davies via Twitter and email.

Teneo previously requested that Advocatus Law, the Singapore law firm representing the founders, accept the service of papers. Advocatus resisted. [Doc 54; Doc 55; The Block

The CFTC and SEC are looking into the collapse of 3AC, according to “people familiar with the matter.” The question is whether 3AC broke any laws by misleading investors about the strength of its balance sheet and not registering with the agencies. [Bloomberg

Terra-Luna

Laura Shin’s podcast with Terraform Labs founder Do Kwon is now up! David Z. Morris at CoinDesk dissects it, straight-up calling Kwon a sociopath. [Unchained; CoinDesk]

Celsius Network bankruptcy hearing, Thursday 20 October 2022

A hearing in the Celsius bankruptcy was held via Zoom at 10 a.m. Eastern on 20 October. Anyone could listen in — so I did, and took copious notes.

David helped me go through the notes, add comments and analysis, and polish things up. Next thing you know, we have another blog post.

If you’re curious about melting ice cubes and stalking horses, head on over to David’s blog. [David Gerard]

Image: Judge Martin Glenn

Crypto collapse: 40 states chasing Celsius for possible securities fraud; Texas chasing Voyager and FTX for possible securities fraud

  • By Amy Castor and David Gerard

“Of all the offspring of Time, Error is the most ancient, and is so old and familiar an acquaintance, that Truth, when discovered, comes upon most of us like an intruder, and meets the intruder’s welcome.” 

~ Charles Mackay, Extraordinary Popular Delusions and the Madness of Crowds

Celsius: dodge the cops by diving down the drain

Celsius Network seems to be admitting the company’s dead and it’s not coming back. The debtor companies filed a motion on September 29 to sell off whatever assets remain.

The leading contender is, wait for it, Sam Bankman-Fried of FTX, who was previously noted to be sniffing around the gaping balance sheet hole called Celsius. [Bloomberg]

Here’s the filing to sell off everything, with its marvelous title in full: Debtors’ Motion Seeking Entry of an Order (I) Approving the Bidding Procedures in Connection with the Sale of Substantially All of the Debtors’ Assets, (II) Scheduling Certain Dates with Respect Thereto, (III) Approving the Form and Manner of Notice Thereof, (IV) Approving Contract Assumption and Assignment Procedures, and (V) Granting Related Relief. [Motion, PDF]

The filing asks to start a bidding process, in a conventional manner, for any remaining spare change to be found in the stiff’s pockets. Celsius would like bids to be put in by November 15, with a hearing to approve the winner around November 28. Celsius hopes to sell any remaining assets by December 20. The auction would be advertised in the New York Times and CoinDesk.  

This isn’t actually a bad idea. We’ve said repeatedly that taking Celsius out of everyone’s misery is the right move. Celsius is an ex-parrot. It is bereft of life. There’s no viable business here. In any ordinary bankruptcy, selling off whatever’s left would be the correct thing to do at this point.

But this isn’t an ordinary bankruptcy. Vermont’s filing sets out the issues. There have been shenanigans here, and Vermont doesn’t want those put aside before the examiner can report: [Objection, PDF]

“As of the Petition Date, at least 40 state securities regulators were engaged in a multistate investigation arising from, inter alia, concerns about potential unregistered securities activity, mismanagement, securities fraud, and market manipulation by Celsius and its principals. At least six of those states had taken regulatory enforcement action against Celsius as of the Petition date, and several more states have done so since then.”

Ownership of the “custody” and “withhold” accounts have yet to be resolved. Do the accounts belong in full to the named creditors or are they part of the general pool of assets? (See our list of Celsius account types.) And who owns the stablecoins?

If any of the assets constitute securities, Vermont wants those to be registered as offerings of securities. (Spoiler: many of them are likely to constitute securities, and none are registered.)

Also unresolved: Celsius insiders withdrew nearly $18 million in cryptos in the weeks before Celsius froze withdrawals on June 12.  

Texas, Alabama, Arkansas, California, the District of Columbia, Hawaii, Maine, Missouri, New York, North Dakota, and Oklahoma all concur with Vermont’s objections. The states want to see the examiner’s report before any sale goes forward. They also want to approve the bidders to verify that they are compliant with state regulations, or can become compliant in a timely manner. [Texas objection, PDF; Coordinating states’ objection, PDF]

The US Trustee also objects to the auction. As well as the above objections, the Trustee asks that a privacy ombudsman be appointed, as “customers of these Debtors have significant concerns regarding transparency and irregularities.” [Objection, PDF]

Some individual creditors object on the same grounds — e.g., Daniel Frishberg, who thinks the examiner’s report may show that Celsius was a Ponzi scheme. Immanuel Herrmann has objected on behalf of an unofficial “Steering Committee” of Earn, Loans, and CEL depositors — they don’t object to an asset sale but do feel this current proposal is rushed. [Frishberg objection, PDF; Herrmann objection, PDF]

The forlorn quest for your money

The US Trustee held a 341 creditors’ meeting on October 13. Celsius interim CEO Chris Ferraro responded to questions under oath — and Ferraro knows nothing, nothing! Most of his answers amounted to “I’ll have to follow up on that,” “I don’t know,” and “I need to consult with my lawyers.” [Reddit]

The next Celsius hearing is on October 20 at 10 am ET. There’s an omnibus hearing on November 1 at 11 a.m. ET.  Custody and withhold hearings are scheduled for December 7 and 8 at 9 a.m. ET. [Schedule, PDF]

Celsius has requested to set a “bar date,” the deadline for customers to submit proofs of claims, of December 13, 2022. [Motion, PDF]

If you agree with the schedules of assets and liabilities that Celsius filed earlier, you don’t need to file a claim. Go to page 92 to check your claim. [Schedule, PDF]

If you do need to file a claim, Celsius has submitted a form for approval with the bar date motion. 

An inspector calls

As soon as she was appointed examiner in the Celsius bankruptcy on September 29, Shoba Pillay, previously an assistant US attorney, set to work.

She has already spoken to the debtors. She has outlined the various documents she will be requesting and has set forth a plan on how to avoid duplicating work already done.

Pillay has also filed a “Rule 2004 Motion,” to collect almost anything she might need. This motion will be heard on October 20 and is sure to be granted. [Rule 2004 motion, PDF; Notice motion, PDF]

Federal Rule of Bankruptcy 2004 — that’s a rule number, not a year — allows tremendously broad discovery and deposition. A witness in a 2004 examination is not always entitled to attorney representation or cross-examination and has only a limited right to object to questions. 2004 exams are sometimes referred to as “fishing expeditions” — because they need to be, in order to do their job. [Cullen Dykman; Nolo]

Pillay has proposed a work plan: [Motion, PDF]

  • Interview 15 to 25 witnesses under Rule 2004.
  • Monitor investigations by governmental entities.
  • Hire professionals as needed. She’s already put forth a motion to retain as counsel Jenner & Block, the Chicago law firm where she serves as a partner.
  • Hire Huron Consulting Group as her forensic accounting and financial advisor. 
  • Ascertain if the scope of the investigation needs to be expanded.

Hosting services

Core Scientific provides hosting services to Celsius Mining. Core claims the bankrupt company owes them $5.4 million. They’re tired of subsidizing Celsius’ failing mining business. They want their money, or they want out of their contract before Celsius turns them into a dead parrot too.  

Celsius argues that Core breached their agreement by failing to deploy mining machines on time, and is unjustly trying to pass on power charges. They say Core is in violation of the automatic stay, which stops creditors from trying to collect debts until court bankruptcy proceedings are completed. They have called for a hearing on October 20 to ask the court to enforce the stay. [Filing, PDF; Coindesk; The Block]

Core responded saying that Celsius’ claims were “premised on the incorrect notion that Core Scientific must subsidize the Debtors’ money-losing mining business to the tune of millions of dollars a month.” 

Core says they have deployed all of the mining equipment Celsius gave them and are paying out of pocket to keep the machines running. They are seeking relief from the court to either terminate their contract or to get paid. They want to delay the hearing on October 20 and they are requesting a status conference. [Letter, PDF]

Celsius’s lawyers responded that Core’s request for a status conference is “unwarranted and premature.” We think Celsius is dragging this out for as long as they can run up a tab with Core that will never be paid. [Letter, PDF]

Cold, so cold

There’s a new tool that lets you search the Celsius creditor database with your name and find your coinage! You can use the leaderboard to find the top losers. [Celsiusnetworth; Gizmodo]

US federal prosecutors from the Southern District of New York subpoenaed Celsius days after it blocked withdrawals in June. The subpoena was issued by a grand jury. Federal grand juries are used by Department of Justice prosecutors to conduct criminal investigations and potentially issue indictments. [FT, archive

The SDNY subpoena is disclosed on p. 48 of this October 5 filing. Pages 48-50 list investigations by multiple state regulators. [Filing, PDF]

Celsius has filed its proposal for a key employee retention plan (KERP). They want to divvy up $2.96 million amongst 62 key non-insider employees — so as to keep them working on the dumb “Kelvin” plan to revive this dead parrot. Celsius currently has 275 employees in total. [Motion, PDF]

Alex Mashinsky, who recently stepped down as Celsius CEO, is dumping his CEL tokens for USDC dollar-equivalent stablecoins. [Twitter, Twitter

Celsius cofounder Daniel Leon, who also just stepped down, sold $11.5 million worth of CEL in 2020 and 2021. [FT]

Jason Stone of KeyFi, a.k.a. DeFi whale 0x_b1, used to manage Celsius’ investments. Stone sued Celsius in July, saying they hadn’t paid him and called Celsius a Ponzi scheme. Celsius countersued in August, claiming Stone was an incompetent thief. Anyway, Celsius has just updated their counterclaim. [Complaint, PDF

Voyager Digital, FTX, and Texas

In a Chapter 11 bankruptcy, the debtor has to file a disclosure statement with their bankruptcy plan. The statement needs to provide “adequate information” about the debtor’s financial affairs so creditors can make an informed decision when they go to vote on the bankruptcy plan. 

Voyager filed its first amended disclosure statement related to its second amended joint plan on October 5. The plan involves selling off all of its assets to FTX US. [Statement, PDF]

The US Trustee objected to Voyager’s disclosure statement. The plan doesn’t say it’s a liquidation plan, but the proposal is basically to liquidate Voyager. The plan also shields Voyager CEO Stephen Ehrlich and his assets from third-party claims. The Trustee wants clearer disclosure for creditors of precisely what this statement is. [Objection, PDF]  

The Texas State Securities Board objects to the sale of Voyager to FTX, “because, at this time, the Debtor and FTX are not in compliance with Texas law.” Texas thinks the plan “attempts to limit the Debtors’ liability for unlawful post-petition — but pre-sale closing — conduct for which state-regulatory fines and penalties may apply.” That is, they think the quick sale is an attempt to hide malfeasance. [Objection, PDF]

Specifically, Texas thinks FTX has been offering investment contracts that constitute unregistered securities to Texas residents. The affidavit from Joe Rotunda, Director of the TSSA Enforcement Division, details Texas’ ongoing case against Voyager since April 2022 for unlicensed offerings of securities — and then it gets stuck into FTX.

Rotunda states that the interest-bearing accounts offered by FTX US are likely unregistered securities. FTX US claims to be registered with FinCEN as a money transmitter — but it isn’t registered with Texas as a money transmitter. FTX Capital is registered with Texas as a broker-dealer, so that’s nice. 

The FTX trading app lets US customers use FTX non-US despite FTX Trading’s claims not to serve US customers, and despite Rotunda correctly entering his address as Austin, Texas. Rotunda transferred ether to a wallet on FTX. Rotunda is pretty sure the FTX (US or not) yield program is an investment contract and not a registered one.

Rotunda also confirms that “The Enforcement Division is now investigating FTX Trading, FTX US, and their principals, including Sam Bankman-Fried.” [Affidavit, PDF]

The lawyers want their money 

Bankruptcies are expensive. The professionals operating on behalf of Voyager Digital and Celsius Network have begun submitting their bills. 

Kirkland & Ellis in Voyager: $2,994,615.46 for July 5 to July 31. [Fee statement, PDF]

Kirkland & Ellis in Celsius: $2,570,322.67 for July 13 to July 31 July — yes, that’s only two and a half weeks. [Fee statement, PDF]

Akin Gump in Celsius: $741,898.56 for July 13 to Aug. 31. [Fee statement, PDF]

Alvarez & Marsal in Celsius: $2,961,249.80 for July 14 to Aug. 31. [Fee statement, PDF]

Other good news for crypto finance

South Korean crypto investment firm Blockwater Technologies defaulted on a loan from TrueFi, a decentralized lending protocol. TrueFi issued a “notice of default” to Blockwater on October 6 after Blockwater missed a payment on a loan of 3.4 million BUSD. TrueFi said the debt represents about 2% of its total outstanding value. Blockworks’ loan was “restructured” in August, and they paid back 654,000 BUSD at that time. TrueFi wants “a potential court-supervised administrative proceeding” —i.e., putting Blockwater into something like bankruptcy. [TrueFi blog; Bloomberg; Twitter]

Do Kwon is the founder of Terraform Labs, whose UST “stablecoin” collapsed in May, took the rest of crypto down with it, and started us on writing this newsletter series. Kwon talked to Laura Shin for her Unchained podcast on October 14 from a totally legitimate unknown location where he definitely isn’t on the run. The podcast comes out on October 18. [Twitter; Unchained]

Grayscale runs crypto investment funds, most notably GBTC, which Amy has dissected at length. Grayscale is now creating Grayscale Digital Infrastructure Opportunities, to buy up used bitcoin mining rigs from distressed mining companies. These will be used for mining by Foundry Digital, which is also owned by Grayscale owner Digital Currency Group. This will be made available as a fabulous investment opportunity to “accredited investors such as hedge funds and family offices at a minimum investment of $25,000.” [Bloomberg]

The Department of Justice has issued a new report on crypto crime: “The Role Of Law Enforcement In Detecting, Investigating, And Prosecuting Criminal Activity Related To Digital Assets.” This report was as required by President Biden’s March 2022 executive order on crypto. [DOJ, PDF]

When Wells notice? Yuga Labs, the SEC is coming for you

I’ve been saying for months now that ApeCoin is an unregistered penny stock offering, and Yuga Labs should expect the SEC to come knocking.

Well, guess what? They are knocking. The SEC is probing Yuga Labs to see if Bored Ape Yacht Club NFTs — as well as ApeCoin — are unregistered securities offerings. On Oct. 10, Bloomberg wrote: [Bloomberg]

“The SEC is examining whether certain nonfungible tokens from the Miami-based company are more akin to stocks and should follow the same disclosure rules, according to a person familiar with the matter, who asked not to be named because the probe is private. Wall Street’s main regulator is also examining the distribution of ApeCoin, which was given to holders of Bored Ape Yacht Club and related NFTs.”

Yuga Labs is the parent company of Bored Ape Yacht Club, a collection of NFTs with spin-off NFT projects, such as Mutant Ape Yacht Club and Bored Ape Kennel Club. Yuga is also behind the yet-to-launch MMO game Otherside — which it is building in partnership with Animoca Brands — and the issuance of Otherdeeds, NFTs representing land parcels in the game. 

Bored Ape Yacht Club launched ApeCoin, an ERC20 token, on March 17. The very same day, ApeCoin listed on Coinbase — a first for a coin, but then two Andreessen Horowitz (a16z) people sit on the Coinbase board, and a16z is a major Yuga Labs backer. 

Are Bored Apes securities?

A token is deemed a security if it passes the Howey test, which says that an investment contract — a security — exists “when there is the investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others.” [SEC]

Are NFTs securities? Possibly? Maybe? They are non-fungible, so the argument is not so clear. Each NFT is unique, and in the case of Bored Apes Yacht Club, they represent art. Regulators have yet to issue any strong warnings against NFTs. 

However, some NFTs do have characteristics of securities. In April, two state regulators ordered Sand Vegas Casino Club to stop selling NFTs, alleging the Cryprus company was illegally offering unregistered securities. Sand Vegas had promised holders of its Gambling Apes NFTs profits from the proceeds of the casinos, so you can see why they landed into trouble. [Texas order; Alabama order; Coindesk

Otherdeed land sale

Likewise, Yuga Labs’ Otherdeed NFTs have characteristics of securities. Otherdeeds represent 200,000 plots of virtual land in the upcoming Otherside metaverse.  

Yuga Labs sold 55,000 Otherdeeds on April 30, 2022, in what it called the “biggest mint in NFT history.” Yuga netted over $300 million worth of ApeCoin in the sale. ApeCoin was the only currency accepted. [Twitter

Specific wording in the terms makes it sound like Yuga suspected Otherdeeds might attract the attention of regulators. You had to essentially agree that you were buying these for fun, not for profit: [Otherdeed purchase agreement, archive

Artistic Purposes Only. Purchaser represents and warrants that Purchaser (A) is purchasing the Otherdeed for personal enjoyment purposes, and (B) is not purchasing any Otherdeed with the intent or expectation of profits from any appreciation in value or otherwise from the Otherdeed or any Access Rights that may from time to time be granted by Animoca or third parties.”

Do Otherdeeds pass the Howey test? Let’s see. 

  • Was there an investment of money? Yes. Buyers paid 305 ApeCoin to purchase an Otherdeed on April 30. 
  • Was there a common enterprise? Yes. The Otherside game. Yuga sold virtual plots of land to investors in exchange for the promise of owning land in a functioning metaverse tomorrow.
  • Was there an expectation of profit? Yes. Despite the language in the terms, Otherdeed owners immediately began flipping their Otherdeeds for more money. Case in point: Otherdeed #59906 sold for 625 ETH ($1.5 million) just 10 days later. Some Otherdeeds even came with one or more creatures on them called Kodas, also represented by NFTs. Otherdeeds with Kodas fetch a significantly higher price on third-party marketplaces. [The Block; OpenSea]
  • Was the profit to be derived from the efforts of others? Yes. If the investor has a significant hand in the success of an investment, it’s most likely not an investment. Otherdeeds are meant to involve the participants in the game. According to Otherside’s website, “Rather than a static representation of a piece of land, your Otherdeed is designed to evolve along with what you choose to do in the game.” But the game does not exist yet. So, as of now, everything is based on the efforts of Yuga and Animoca and their ongoing promotion of the game. [Website]

ApeCoin, a clear case

While Otherdeeds could be a securities offering, there is an even stronger case to be made that ApeCoin is a security.  

ApeCoin is fungible, and it carries voting rights. Critically, its value is dependent on the work of Yuga Labs. 

SEC Chair Gary Gensler has given clear warning about ERC20 tokens. He has already stated, more than once, that most cryptocurrencies are securities. [CNBC; SEC]  

“I think, and my predecessors thought this as well, that most of these tokens are in fact that the public is investing, anticipating and hoping for profit, based on somebody else’s efforts.”

Yuga Labs never sold ApeCoin directly for cash. However, they did sell Bored Ape and Mutant Ape NFTs for money. If you were a holder of one of these NFTs, you got an allotment of ApeCoin worth up to $80,000. Many chose to HODL, hoping the price would go up. It did, for a while. [Decrypt]

When Yuga Labs held its massive Otherdeed land sale, ApeCoin surged to $27.50. It’s now trading for just under $5.

But we’re decentralized!

Yuga Labs went to great lengths to hide the fact that they were behind ApeCoin, saying it was issued by the ApeCoin DAO made up of members who were not Yuga Labs employees. APE Foundation was also formed to administer the decisions of the ApeCoin DAO. 

If you hold ApeCoin, you get voting rights — akin to voting shares in a company. You can vote on proposals put forth by the ApeCoin DAO. In June, ApeCoin holders voted to keep the token on the Ethereum blockchain. [Bloomberg]

Around the time that ApeCoin launched, Yuga Labs received a $450 million round led by a16z. Investors in the round also received a distribution of ApeCoin. 

Here’s how 1 trillion ApeCoin were initially distributed:

  • 1% to charity
  • 8% to Yuga Labs founders 
  • 14% to launch partners, including a16z and Animoca 
  • 15% to Yuga Labs
  • 15% to Bored Ape/Mutant Ape owners
  • 47% to ApeCoin DAO

In mid-September, the ApeCoin DAO released 26 million ApeCoins, so investors could freely dump their bags on retailers via Coinbase. [Decrypt]

David Gerard explains exactly how VCs make millions of dollars via securities fraud: [David Gerard]

“The entire venture capital push for Web3 is so that Andreesen Horowitz (a16z) and friends can dump ill-regulated tokens on retail as fast as possible. This gives the VCs very fast liquidity events — the bit where they make money — and much faster than they get from investing in actual companies.”

ApeCoin will also be the official token of the Otherside game, supposedly to prove that ApeCoin is a decentralized utility token and not an altcoin that investors are hoping to cash out on. 

If you are wondering how all of this decentralized nonsense comes into play — Bill Hinman, when he was working for the SEC as the director of the Division of Corporation Finance, declared that ETH was not a security because it was “sufficiently decentralized.” [SEC

Yuga Labs is trying to model itself after Ethereum, so it can effectively say to the SEC, “You can’t sue us, bro!”

They’ve got someone good coaching them. Hinman, who has since retired from the SEC, now works for a16z. [a16z

Securities laws exist to prevent fraud. Companies that offer securities are subject to strict disclosure rules for this reason — to protect investors. Yuga Labs main founders Greg Solano and Wylie Aronow thought it would be great to remain CryptoGarga and GordonGoner until they were “doxxed.” [Buzzfeed

They were upset when Buzzfeed wrote that story, and they shamelessly brought a lot of ire from the crypto community onto the author of the piece, when their true identities were something they should have openly and responsibly disclosed from day one. 

Solano and Wylie are about to get an education in securities laws, along with the sobering realization they were never witty or clever or even lucky, just pawns in a game that VCs have been playing for years.

With celebs shilling their Bored Ape NFTs on national TV, Bored Apes Yacht Club has gotten a ridiculous amount of press. The SEC will want to make an example of Yuga Labs. I suspect, at some point, Solano and Wylie can look forward to a Wells notice from the SEC, giving them a heads up that an enforcement action is coming down the pipes.

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Crypto collapse: Celsius reveals its creditor list, 3AC NFTs, Terra-Luna, Voyager

The latest crypto crash update is up!

David Gerard and I discuss:

  • Liquidate Celsius already. There’s no viable business here, and Mashinsky has taken all his money out. Krissy’s got her money, too.
  • Celsius filed its schedule of assets and liabilities, listing the names of every creditor and every transaction they made in the last 90 days.
  • Crypto is horrified. My name’s in a public record, omg!
  • Teneo got its hands on 3AC’s NFT collection. We can’t find our friend CryptoDickButt #1462 though!
  • South Korea is clipping Terraform Labs creator Do Kwon’s wings. No more passport. He says he’s not on the run anyway.
  • Voyager is pissed off at Wave Financial’s interview with CoinTelegraph. They’ve filed a very defensive letter with the court.

The full update is on David’s blog this time. Head on over there and read it! [David Gerard]

Image: They look smug here, yes?

The SEC busts Kim Kardashian over EthereumMax, pour encourager les autres

  • By Amy Castor and David Gerard, for their sins
  • Our work is funded by our Patreons — here’s Amy’s, and here’s David’s. Your monthly contributions help us greatly in steeling ourselves to dive into this jaw dropping foolishness!

Reality show queen Kim Kardashian is not stupid. She’s a billionaire businesswoman. She clearly has basic competence.

Kardashian is even studying law. She passed the first-year “baby bar” exam in December 2021, on her fourth attempt. (This isn’t unusual — the pass rate is around 21%.) [The Guardian; Elle]

But that doesn’t mean she understands securities laws — or that putting “#ad” on the end of an Instagram post promoting a security does not, in fact, leave you in the clear.

Section 17(b) of the Securities Act specifically states that you need to spell out how much you’re being compensated for a promotion — and Kardashian neglected that bit when she posted about EthereumMax (EMAX) to her 225 million Instagram followers on June 16, 2021.

How could Kardashian have known EthereumMax was a security? Paragraphs 6 to 9 of the SEC order against her detail how blatant EMAX was. Kardashian’s post even promoted a token burn that was supposedly “giving back” to the “community” — implying financial benefit. [SEC press release; Order, PDF]

The SEC came down hard on Kardashian. She has agreed to a $1 million fine, and disgorgement of the $250,000 she was paid plus $10,415.35 in prejudgment interest. Kardashian must not promote a “crypto asset security” in the next three years. She will also “continue to cooperate with the Commission’s investigation in this matter.”

We’re pretty sure Kardashian knows what a security is now.

Kardashian is currently launching a private equity firm, SKYY Partners. So she’d better be on top of this stuff. [Fortune]

What’s EthereumMax?

EthereumMax is an ERC-20 token on the Ethereum blockchain. The promotion for EMAX promised all sorts of amazing visionary aspirations — but it’s just another worthless altcoin that doesn’t do anything. [CoinDesk; EthereumMax white paper, archive, PDF

EMAX was launched in May 2021, only a month before the June 2021 celebrity push. Kardashian, boxer Floyd Mayweather, and former NBA player Paul Pierce hawked EMAX to their massive social media followings — though this didn’t halt the token’s ongoing price collapse. 

Paid to pump

In September 2021, a few months after Kardashian’s EMAX post, Charles Randall, the head of the UK’s Financial Conduct Authority, gave a speech that called on online platforms to crack down on financial scams. He specifically noted Kardashian’s post: [FCA speech]

“Which brings me on to Kim Kardashian. When she was recently paid to ask her 250 million Instagram followers to speculate on crypto tokens by ’joining the Ethereum Max Community,’ it may have been the financial promotion with the single biggest audience reach in history.

The problem is much wider than Kardashian. Celebrity endorsements for financial toxic waste are an ongoing problem. Actor Ben McKenzie speaks up about it from time to time — including on the case of Kardashian — and suggests celebs stick to promoting non-trash: [Slate]

“To criticize celebrities shilling crypto isn’t to impugn them as people or to say that I’m above accepting an easy payday. (Call my agent, legit companies with not-scammy products!)”

Citing quotes from a “crypto marketing agency” executive, the Financial Times wrote this on celeb crypto promotions: [FT, archive]

“It’s considered easy money,” said an executive at a crypto marketing agency, who asked not to be named, adding that the endorsements are often pushed by talent agents who will offer deals that include posts by several of their high-profile clients, with price tags ranging from tens of thousands to millions of dollars. “You ain’t seen nothing yet.”

Fundamentally, Kardashian’s people failed to realize that the EthereumMax sponsorship would blow up on her. We expect a deeply displeased Kardashian sent more than a few heated texts to her minions along the lines of “what on earth?” — or however you phrase that in Kardashian.

We don’t know of any evidence that Kardashian cared about EthereumMax or knew anything about crypto in general. The only past involvement she had with crypto is that she apparently used some chips with bitcoin logos on them in a charity poker game in 2018. We doubt she cared about crypto then either. [Cointelegraph]  

How about those NFT shills?

Celebrities have been hawking NFTs at top volume for the past year — such as Jimmy Fallon and Paris Hilton pumping bored apes on late-night television, and Madonna tweeting that she finally got her “very own ape” in March. (Madonna’s talent manager Guy Oseary represents Yuga Labs, the company behind the BAYC project. He is also an investor though his fund Sound Ventures.) [Mashable; Twitter]

Almost no celebs would understand the many NFT deals we saw them taking through 2021. Likely, their people would have just told them: “It’s a sponsorship for internet art, free money!” and they’d go “Sounds good, tell me when you need me to nod and smile.”

So far, NFTs are not securities. Mostly. Probably. But they’re still stupid investments best left entirely to the crypto speculators.

Celebrity NFT promotion would be under Federal Trade Commission rules — where disclosing that your promotion is an “#ad” is probably sufficient. Though almost no celebrity Bored Apes promoters did so, for instance.

Some of this stuff flies a bit close to the sun. When celebrities go on TV promoting Bored Apes NFTs, they’re not just promoting Bored Apes, but the entire ecosystem that Yuga Labs has created — including Apecoin, which is an obvious and blatant security offering. 

It’s so unfair!

The SEC moved quicker on Kardashian than on many previous crypto-related violations. It only took a little over a year to charge Kardashian. The SEC hasn’t charged EthereumMax directly for not registering its offering. 

Anyone who calls this “regulation by enforcement” is a clown. This is just enforcement. There’s absolutely no reasonable question of the facts or laws here. The SEC has been warning about this nonsense since 2017. [SEC, 2017

Floyd Mayweather in particular already settled with the SEC in November 2018 for failing to disclose payment for promoting ICO tokens. That settlement barred Mayweather from accepting payment for promoting securities — and his EthereumMax promotion in June 2021 would have been within that period. We wonder if there’s an order coming his way too. [SEC press release, 2018; order, PDF, 2018

Action against unregistered securities isn’t restricted to the SEC — private citizens can bring actions against unregistered offerings, and against their promoters. In January, a class action was brought against EthereumMax founders Steve Gentile, Giovanni Perone, and Justin French, and promoters Kardashian, Mayweather and Pierce, claiming investor losses on this alleged unregistered security. [Complaint, PDF; The Block]

Kardashian didn’t just fly too high — she set a course directly for the sun, and she got burnt. EMAX was blatantly an offering of securities, the SEC had given clear warning over the previous several years, and there are clear laws governing disclosures when you promote a security. 

Why did she so blatantly just not follow the law? Because she was likely ill-advised, and crypto seemed like easy money.

But it is incredibly irresponsible — and that’s why it’s so reprehensible. You’re encouraging people to engage in risky investments, where they invariably lose money. 

Kardashian is a billionaire — $1.26 million is a trivial fine for her. But this is excellent enforcement by the SEC, pour encourager les autres.

SEC chair Gary Gensler even made a nice video about celebrity endorsements! Securities TikTok awaits. [YouTube]

Crypto collapse: States bust Nexo, Terra’s Do Kwon on the run, Celsius CEO resigns, FTX buying Voyager and eyeing Celsius, ETH miners screwed

David Gerard and I just published our latest news roundup and analysis on the ongoing crypto crash.

In this update, we cover:

  • A slew of state regulators drop the hammer on crypto lender Nexo.
  • Terra-Luna: Where in the world is Do Kwon?
  • After a two-week auction, FTX US emerges as the highest bidder for Voyager Digital’s assets. What is SBF buying other than a giant hole in Voyager’s balance sheet?
  • Under pressure from the UCC, Alex Mashinsky steps aside as CEO of Celsius.
  • The US Trustee appoints an examiner to investigate Celsius.
  • Celsius wants to sell off some stablecoins to fund its operations. Texas agencies object! They want the debtor to hold off until the examiner comes out with her report.
  • Crypto miners are unhappy. Good!

Head over to David’s blog to read the full post! [David Gerard]

Image: GPU crypto miners in Vietnam appear to be jet washing their old mining gear before putting the components up for sale.

Crypto collapse: Celsius, Voyager, SkyBridge — the liabilities are real, the assets are fake

“To the crowd there assembled, I was the realization of their dreams….The ‘wizard’ who could turn a pauper into a millionaire overnight!”

~ Charles Ponzi

Celsius Network

For years, Celsius founder Alex Mashinsky told people banks were the enemy, and Celsius was your friend. Now everyone is wondering where their money went. Here’s our summary of the current situation at Celsius:

  • The money is gone. There’s almost nothing left for creditors.
  • The lawyers are stripping the last shreds of meat off the bones. 
  • Celsius’ ludicrous plan to run a bitcoin mining operation to get out of debt is a way for execs to put off liquidation a bit longer while they fill their pockets. 
  • Insiders will keep paying themselves with the remaining funds for as long as they can get away with it.
  • An examiner report could lead to a liquidation, possibly more. Any party can file a motion to convert to a liquidation “for cause.” The sooner that happens, the better, as far as we’re concerned. It’s time to close the curtains on this clown show.
  • We can hope for criminal charges — but those would require something like solid evidence of a deliberate Ponzi scheme, which could well come from the examiner, once appointed. 
  • Both the Trustee and the judge have the power to refer a case to the Department of Justice. If the examiner finds evidence of federal crimes, the case will have already been made. 

Let’s review the four types of Celsius customers:

  • Earn: Celsius promised up to 18% APY if you gave them your crypto to invest in … secret things. Crypto deposited into Earn accounts became the property of Celsius. The Earn product resembled an unregistered securities offering. When you give someone your money and they do stuff with it to make more money, that’s an investment contract — a security.

    Not registering such an investment contract when offering it to the public is why BlockFi had to fork over $100 million to state regulators and the SEC, and why Coinbase ultimately had to abandon its Coinbase Lend product.
  • Borrow: Celsius let you take out loans against your crypto assets. Borrow customers were usually crypto gamblers borrowing USDC (casino chips) to play the DeFi markets. You paid interest monthly, and then paid the principal in one lump sum at the end. Similar to Earn, the crypto you put up as collateral became Celsius property.
  • Custody: Celsius launched a Custody solution on April 15, 2022 — 89 days before it filed for bankruptcy, making all of those funds subject to a 90-day clawback under the bankruptcy code.

    Custody was a response to state regulators casting an acerbic eye upon Celsius’ Earn product. “New transfers made by non-accredited investors in the United States will be held in their new Custody accounts and will not earn rewards,” Celsius said. [Celsius blog post, archive]

    Custody essentially served as storage wallets. In the bankruptcy proceedings, this has led to ongoing discussion on whether Custody account holders are secured creditors who will get their money back right away … or unsecured creditors, whose funds are now part of the bankruptcy estate. Judge Martin Glenn, who is preceding over the bankruptcy, says he hopes to resolve the matter sooner rather than later.
  • Withhold: If you lived in a US state where Celsius became unable to offer serviceable Custody accounts, you had to move your Earn funds to Withhold accounts, where they remained frozen. The Withhold group accounts for $14.5 million of the $12 billion in digital assets stuck on Celsius when it stopped withdrawals in June.

The big question now in the Celsius bankruptcy is how to classify creditors: who’s first in line to get their money back, and who’s last in line? This is why, in addition to the official Unsecured Creditors’ Committee (UCC), there are currently three ad-hoc groups, all vying to get the judge’s attention. 

Celsius believes that funds held in Earn and Borrow accounts are property of the bankruptcy estate, meaning those customers will have to wait until the lawyers finish to see what’s left. But Celsius wants to return money held in specific Custody and Withhold accounts to customers now. [Motion, PDF]

Celsius argues that $50 million of the $120 million in Custody and Withhold accounts should go back to customers, if they meet one of the following criteria: [Twitter]

  • The accounts are pure Custody or pure Withhold with funds that were transferred from an external wallet — not Earn or Borrow programs.
  • In instances where the Custody and Withhold accounts do contain funds transferred from the Earn or Borrow programs, they want customers to have their money back, if the transfers were less than $7,575, a specific legal threshold under the bankruptcy code clawback provision, 11 U.S. Code § 547(c)(9). This is an adjusted amount. [Twitter; LII; LII]

Much of the discussion at the third bankruptcy hearing on Sept. 1 centered around whether custody holders should be able to get their money back. [Coindesk]

During the hearing Judge Martin Glenn also emphasized: “Nobody is getting their money back if they remain anonymous. Let me make that clear.” [Twitter]

According to new financial docs, Celsius seems to have magically found $70 million “from the repayment of USD denominated loans.” Imagine that! The company originally forecasted it would run out of money by October, but now it has more runway. [Docket #674, PDF; Coindesk]  

Last month, the Trustee called for an independent examiner and filed a motion to show cause. [Motion, PDF] Creditors — the UCC and the ad-hoc groups — are worried that an examiner will drain more of their dwindling pool of funds.

David Adler, a lawyer with the firm McCarter & English, representing four Celsius borrowers, says an examiner will cost too much money. The group thinks the job can be done with a Chapter 11 Trustee. [response, PDF]

The Vermont Department of Financial Regulation says Celsius sure looked like a Ponzi scheme and is urging the court to appoint an examiner. Vermont is concerned about Celsius’ offerings of unregistered securities. “At a minimum, Celsius has been operating its business in violation of state securities laws. That improper practice alone warrants investigation by a neutral party.” Vermont also alleges that without Celsius’s holdings of its own native CEL token, the firm has been insolvent since at least February 2019. [FT; court filing, PDF]

Celsius has agreed to the Trustee hiring an examiner — as long as the examiner does not duplicate work already done by the UCC. Celsius says they’ve reached an agreement with the Trustee on this point. [response, PDF]

The next Celsius bankruptcy hearing is set for Sept. 14. There is also a hearing scheduled for Oct. 6 to discuss the custody account holders.

Meanwhile, Celsius has announced a Celsius-themed Monopoly game! It appears to be an unlicensed knockoff — not officially endorsed by Hasbro. This seems to have been in the works since well before the bankruptcy. [Web 3 Is Going Great]

Alex Mashinsky had a favorite slogan: “Unbank Yourself.” His wife Krissy is now selling a new T-shirt: “Unbankrupt Yourself.” [Twitter]

Daniel Leon, one of the founders of Celsius, says his 32,600 shares of Celsius stock are worthless. It looks like he wants to use them as a tax write-off. [Docket 719, PDF

Voyager Digital

On Aug. 30, the US Trustee held the first 341 creditors’ meeting for Voyager, where the Trustee and the creditors got to ask CEO Steven Ehrlich questions about the bankruptcy — under oath. The Trustee is an agent of the federal government. If you lie to the Trustee, it is like lying to the FBI — a federal crime. 

(We wrote about Celsius’ 341 meeting previously.)

Listening to creditors, it’s clear that they’re upset and confused as to why their crypto, including USDC, has become part of the bankruptcy estate. They thought the money was theirs and they could have it back at any time. It didn’t help that Voyager gave users the false impression that their money was FDIC insured.

Ehrlich kept referring the distraught creditors back to the customer agreement, which many had never read, or never fully understood.

Ehrlich noted during the meeting that Voyager is still staking crypto. He said the firm had filed a motion asking the court if it’s okay to stake even more. The court has allowed Voyager to continue staking pursuant to their ordinary business practices. The UCC oversees their staking. [Docket 247, PDF]

Staking is risky!

Some staking, such as proof-of-stake staking, doesn’t risk losing the coins in that currency. Once Ethereum switches to proof-of-stake and, perhaps several months later provides a way for you to withdraw your stake, there’s little risk when your ETH staking is denominated in ETH.

But most staking activity involves first moving your liquid crypto (such as ETH) into a company’s own crypto (such as CEL or UST), which is basically a self-assembled Ponzi scheme for staking. And a lot of “staking” is just lending to a DeFi structure, which means you’re at risk even when it’s denominated in that staked crypto.

Voyager says it got multiple bids to buy the company. The deadline for bids was Sept. 6 — extended from Aug. 26 — so now it’s headed to auction. The auction will be held on Sept. 13 at 10 a.m. ET in the New York offices of Voyager’s investment bank Moelis & Co. A court hearing to approve the results is scheduled for Sept. 29. [Bloomberg; court filing, PDF]

Sam Bankman-Fried’s FTX and Alameda disclosed a joint bid for Voyager in July. Voyager dismissed this as a lowball bid — but we think SBF is the one who is most interested in Voyager. Maybe they’ll up their offer in the auction?

What is there left to buy anyway? That’s what we want to know. Voyager is in much the same position as Celsius — its liabilities are real, but its assets are fake. What does FTX get if it buys Voyager?

The Georgia Department of Banking and Finance has a limited objection to the sale of Voyager. Voyager is a licensed money transmitter in the state of Georgia. If the auction is a success, the department is asking the court to stay the acquisition unless or until the new buyer is also licensed in the state as a money transmitter. We wonder how harshly that will limit the field of buyers. [limited objection, PDF

Bankruptcies are expensive. Quinn Emanuel, special counsel for Voyager, has submitted their first-month fee statement: $244,080. That’s for 196.7 hours of work. The lead lawyer ​​charges $2,130 an hour for his services. Voyager brought Quinn Emanuel on board in July to look into the possibility of insider trading at 3AC. [Doc 358, PDF; Bloomberg Law]

The next Voyager omnibus meeting is on Sept. 13 at 11 ET. The deadline for filing a proof of claims is Oct. 3. 

SkyBridge

FTX is paying an undisclosed sum for a 30% stake in Anthony Scaramucci’s SkyBridge, and SkyBridge will buy $40 million of crypto to hold “long-term.” Scaramucci is not giving up any of his own share of SkyBridge. [Bloomberg; FT]

SkyBridge used to be a general hedge fund then went hard into crypto. “We will remain a diversified asset management firm, while investing heavily in blockchain,” says Scaramucci.

The weird part of this is that SkyBridge is already an investor in FTX and FTX US. We’re reminded of how FTX “bailed out” Voyager, then it turned out that Voyager owed FTX a bundle.

Other stuff

Three Arrows Capital (3AC) withdrew 20,945 staked ether (worth about $33.3 million) from Curve and $12 million in various assets (wrapped ETH, wrapped bitcoin, and USDT) from Convex Finance. Nobody seems to know why they withdrew the funds. [The Block]

The Algorand Foundation has admitted it had $35 million (in USDC) exposure to collapsed crypto lender Hodlnaut. [Algorand blog]

Another class action has been brought against Terraform Labs. This one was brought by Matthew Albright. He is represented by Daniel Berger of Grant & Eisenhofer. The claim alleges Terraform violated the RICO act by artificially inflating the price of their coins and publishing misleading information following UST and luna’s collapses to cover up for an $80 million money laundering scheme. “UST amounted to a Ponzi scheme that was only sustained by the demand for UST created by Anchor’s excessive yields.” The proposed class is all individuals and entities who purchased UST and luna between May 1, 2019, and June 15, 2022. [Complaint, PDF]

From May: Chancers, the Korean crypto streamer who went to Terraform CEO Do Kwon’s house. [BBC

Reggie Fowler, Bitfinex/Tether’s US money man, seeks 6-month sentencing delay

After a series of delays that have plagued his case since he was first indicted in April 2019, Reggie Fowler was supposed to be sentenced on Sept. 13. (His sentencing was originally scheduled for Aug. 30.)

This Tuesday, a Manhattan District Judge was to decide how many years the 63-year-old Fowler, who is charged with bank fraud, money laundering, and running an unlicensed money transmitting business, would spend behind bars. Likely, the rest of his life, given bank fraud alone carries a max imprisonment of 30 years. This would have meant that Fowler was enjoying his last weekend as a free man.

But on a Saturday night — three days before sentencing — Fowler’s lawyer Ed Sapone wrote to Judge Andrew Carter asking for a six-month adjournment. Sapone said that he (not his client) has been ill and still needs time to gather material relevant to the sentencing: [letter]

“I recognize that this is an unusually lengthy adjournment request. I have been suffering with a serious medical condition that is requiring invasive medical treatments. In addition, a significant amount of information and material relevant to an analysis under 18 U.S.C. §3553(a) must be obtained from financial institutions, entities, and individuals located in Europe. The requested adjournment will afford me the opportunity to gather the relevant material and prepare a sentencing submission for the Court’s consideration, while addressing my medical condition.” 

Sapone said that US prosecutors were okay with the request. 

Fowler is the ex-football guy and Arizona businessman tied to hundreds of millions of dollars of missing Tether and Bitfinex money. He is accused of setting up a network of shadow banks so crypto exchanges could skirt the traditional banking system. Fowler told the banks that the accounts were for his real estate business. He is also accused of funding a sports league with money that wasn’t his.

After fudging a plea deal that likely would have meant only spending five years in custody, Fowler was supposed to head to trial in May 2022. But in another surprising last-minute twist, he decided to enter a guilty plea and throw himself at the mercy of the court.  

My only guess as to why he did this is that trials are incredibly expensive and by this time, Fowler was down to one lawyer: Sapone. His previous legal team ditched him in 2021, saying their client owed them $600,000 and had been stringing them along for months with promises of “the check’s in the mail.”

I’ll be curious to hear what Judge Carter says, but given the government has no objection to Sapone’s request for adjournment, I suspect he will say, “sure whatever.” Fowler is currently living in Chandler, Arizona, free on bail

Update: Judge Andrew Carter has approved the motion. Reggie Fowler’s sentencing hearing has been adjourned until March 14, 2023, at 12 p.m. ET. [Order]

Crypto collapse: Celsius sues KeyFi, BlockFi’s FTX deal, Scaramucci’s SkyBridge, Voyager suit, 3AC going to jail?

David Gerard and I posted our latest episode of “Everything is going to hell in a handbasket.” This one is on David’s blog! [David Gerard]

In this update:

  • Celsius strikes back — Mashinsky is countersuing Jason Stone and KeyFi. This is what happens when two crypto firms do business on a handshake. (They don’t need a lawyer until they need lots of lawyers!)
  • How FTX saved BlockFi from being as utterly screwed as everyone else.
  • SkyBridge Capital — you can’t withdraw your money, but that’s okay because Anthony Scaramucci is coming out with a new fund!
  • Voyager pays the boys a little less than planned. Its KERP goes through but with smaller bonuses.
  • 3AC accuses Teneo of misleading the High Court of Singapore as to its corporate structure.
  • A bunch of crypto exchanges are treading water and/or closing their doors.
  • The crypto crash is a slow-motion train wreck. We keep writing about it, but what happens next? 

Crypto collapse: 3AC yacht ‘Much Wow’ back on the market, Celsius maybe-Ponzi, Voyager pays off the boys, Hodlnaut

“Crypto sceptics are a bit like the boy who cried wolf, except a villager gets eaten every damn time and the rest of them are still going ‘why did you cry wolf, FUDster?'”

— GunterWatanabe

Toot toot, I’m a boat

Everyone trusted Zhu Su and Kyle Davies at Three Arrows Capital (3AC). They knew what they were doing, right?

Only now, the pair have disappeared — and their fabulous yacht is back on the market. “The unclaimed yacht looms as a slightly ridiculous avatar of the hubris, greed, and recklessness of the firm’s 35-year-old co-founders.” [Intelligencer

Here’s the 3AC yacht in all its glory: the Much Wow. Yes, Zhu was into Dogecoin too. [Much Wow; Boat International, archive]

3AC talked like competent hedge fund guys — which straight away made them look a zillion times smarter than the rest of the crypto bros. But they weren’t good at this at all. They had no clue on how to hedge their bets. The 2021 crypto bubble saved 3AC’s backside — they could keep looking like geniuses a little longer.

3AC used a “spray and pay” strategy: invest in a whole pile of trashy minor altcoins, and hope for a return.

On May 26, 2022 — by which time 3AC had likely already abandoned their Singapore office and skipped the country — Davies tweeted that “it doesn’t matter specifically what a VC invests in, more fiat in the system is good for the industry.” This is correct, if you view crypto as a single unified scam casino. [Twitter]

Articles about the wider crypto collapse talk about 3AC a lot. This gives the impression that 3AC is fundamentally to blame.

3AC deserves a lot of the blame because they were greedy and stupid. But everyone else was also greedy and stupid. 

Terraform’s Anchor protocol paid 20% interest rates — the highest available. 3AC offered the next-highest interest rates available, by putting the money into UST/luna and skimming some off the top.

So everyone else put their money into Anchor and 3AC. Many of these were feeder funds, who skimmed a bit off the top themselves.

You can picture the crypto investment market as an inverted pyramid, where the point is UST/luna — a Ponzi box full of hot air. 3AC was the box above that. Everyone else is in a funnel down to those two. The bottom two Ponzi boxes collapsed, and the whole inverted pyramid came tumbling down with them.

Terraform was running the load-bearing Ponzi box; we put most of the blame on Do Kwon. But we also blame Terraform’s enablers — the rest of the crypto investment firms.

There’s a lot to blame 3AC for — the way that Zhu and Davies just kept going “this is fine” even as they knew it was going to hell. They were greedy fools.

But anyone who put their money into 3AC was also a greedy fool.

Voyage to the bottom of the sea

Voyager Digital’s official unsecured creditors’ committee (UCC) held a town hall on August 11. The meeting was led by UCC counsel Darren Azman and Chuck Gibbs at McDermott Will & Emery. Amy wrote up some notes. [YouTube; presentation]

Azman says: if you want to buy Voyager, hurry! The deadline to submit bids is August 26. Sam Bankman-Fried’s FTX has already submitted a bid. It may have been a low-ball bid, but SBF’s Alameda Research is a borrower from, lender to, and shareholder of Voyager. We expect FTX will want Voyager the most — if anyone really wants it at all. 

Azman and Gibbs say that Voyager is aiming to file a restructuring plan in October — and that creditors might get their money back as soon as November! What money there is, anyway.

This time frame would be welcome, but isn’t plausible — Mt. Gox (2014) and QuadrigaCX (2019) creditors are still waiting for their money years later.

Meanwhile, the boys gotta get paid. Voyager wants $1.9 million to pay bonuses to 38 employees as part of a “Key Employee Retention Plan.” (KERP). In a bankruptcy, KERP is a way to incentivize upper management to keep working throughout the bankruptcy — and not flee the sinking ship.

Voyager is also seeking to file under seal all pertinent information about KERP participants — their names, job titles, supervisors, salary, and proposed bonus. These folks are definitely not insiders, and Voyager can’t give you their names — but trust them.

When your ship is sinking, the last thing you want is people leaving with all your deep, dark secrets. Keep them happy — and quiet. 

The US Trustee objects to the sealing: “The payment of bonuses, let alone bonuses in such a significant sum to such a limited number of individuals under the circumstances that brought Voyager to this Court, should not be countenanced.” 

The UCC also objects — of Voyager’s 350 employees filed, only 12 have resigned so far. Nobody’s leaving. In fact, nobody’s been asked to leave.

Creditors are pissed that Voyager hasn’t bothered to reduce employee headcount at all, given the platform has been frozen since July 1. What are the employees doing, other than collecting paychecks? [motion, PDF; objection, PDF; objection, PDF; Coindesk]

Just days before Bernie Madoff was formally charged by the SEC, he wanted to distribute hundreds of millions of dollars in early bonuses to employees. We’re sure he was just being nice to them too. [National Post, 2008]

Celsius: When you’re in a hole, keep mining

Celsius submitted their Budget and Coin Report, reflecting the funds they were holding as of July 29. (They filed for bankruptcy on July 13.) The company plans to file similar reporting on a monthly basis throughout their bankruptcy. [Notice of filing and coin report, PDF

The report shows just how much money Celsius wants to set on fire. Over a three-month period from August through October, Celsius is allocating $14 million to payroll, $57.3 million to mining, and $33 million to restructuring costs. By the end of October, they’ll be operating hugely in the red.

Those negative numbers were the elephant in the room during Celsius’ second-day hearing on August 16. Amy summarized this hearing previously. Here’s the slide deck that Celsius lawyers from Kirkland & Ellis presented. [presentation, PDF]

Celsius has this mad idea that they can crypto-mine their way out of bankruptcy. First, they plowed customers’ money into stunningly risky investments. [Twitter thread] Now they want to feed the remaining customer funds into their money-gobbling bitcoin mining operation.

Celsius sought approval from the court to sell their mined bitcoin — so they could use the proceeds to fund Capex for their Texas mining operation. 

The US Trustee’s attorney, Shara Cornell, objected on the grounds that Celsius wasn’t being transparent about what bitcoin it planned to sell, or how much the mining business was expected to generate.

Despite those objections, Judge Martin Glenn approved the motion — though he had reservations: “At bottom, this is a business judgment decision that may turn out to be very wrong, but we will see.”

We think he should have had stronger reservations. Celsius says its mining will be profitable in January, but the numbers don’t add up. 

Celsius expects to generate 10,118 BTC this year and 15,000 BTC next year. Last year, they only mined 3,114 BTC, according to filings. The company has paid for 120,000 rigs, of which 49,000 are in operation.

Even if Celsius mines and sells 1,000 BTC per month, that’s only $2 million when their hosting costs are $19 million per month, with only half the rigs operational. This business simply isn’t viable. It’s just an attempt by Celsius CEO Alex Mashinsky to postpone his company’s liquidation.

Well, that was a huge arithmetic error. Sorry about that. We blame the intern. (i.e.,ourselves.)

A question of trust

Celsius also wanted to sell some de minimis assets. These turned out to be notes/bonds and equity in other crypto companies — but Celsius hadn’t bothered to mention that bit.

Cornell from the US Trustee said, “The motion makes it sound like the debtor is selling office furniture.” Judge Glenn said he had “no inkling the debtor was proposing to sell millions of dollars of equity or notes/investments in other crypto businesses.” He did not approve the motion.

US Trustee William Harrington has had enough of Mashinsky messing around. Days after the hearing, Harrington filed a motion requesting the court appoint an examiner to investigate what’s really going on inside Celsius and present their findings to the court. [motion, PDF

As grounds for hiring an examiner, the Trustee lists allegations of incompetence or gross mismanagement — including the offering of unregistered securities — significant transparency issues, and widespread mistrust in the debtors. 

Under US bankruptcy laws, an examiner can be appointed in any bankruptcy case if someone requests it and the court finds the company’s debts exceed $5 million. We have no doubt Judge Glenn will approve the request.

The language in the motion suggests that Mashinsky can’t be trusted. (We concur.) Among other things, it points out that Celsius owes $20 million in back taxes. Unpaid taxes are senior debt. The IRS gets first dibs on the remaining assets before the unsecured creditors.

The Celsius UCC is “concerned” about the Trustee hiring an examiner because “It will run up millions in costs.” [Twitter

We know for sure that it’ll be costly — the examiner in Lehman Brothers’ 2008 bankruptcy cost $100 million, up from a projected cost of only $23 million. The examiner for Enron was $90 million. So our guess is the examiner will probably cost creditors $25 million, if not more. 

The seven-member UCC feels it can conduct its own investigation and doesn’t need an examiner. The problem there is that the UCC is selected from a list of the largest Celsius creditors. These people represent companies that have a vested interest in the crypto space succeeding. They are not in any way neutral.

The P-word

A “341 meeting” was held on August 19 — a creditors’ meeting, named after section 341 of the Bankruptcy Code, where the debtor answers questions about their financial status under oath.[LII]

At the 341 meeting, Celsius CFO Chris Ferraro admitted that Celsius was paying old investors rather more money in rewards than they were actually getting in yield.

“In hindsight, we did not generate enough yield to support the return,” says Ferraro. He confirms Celsius was paying “over 100%” at times — 120% to 130% of the actual yield. There’s no transcript, but Kadhim Shubber from the Financial Times and Thomas Braziel from 507 Capital live-tweeted the call. [Twitter; Twitter]

If Celsius was paying this excess yield from incoming investor money … then that’s literally a Ponzi scheme. (A lawsuit filed against Celsius on July 7, also claimed Celsius was operated as a Ponzi.)

Ferraro said, “I don’t think it was that connected” — but he didn’t answer where else the money could have been coming from. It was just “hyper-growth mode,” see. [Twitter; Twitter]

A question of competence

Mashinsky is a good salesman — but he’s not so great at any other part of the job. In January, Mashinsky ordered Celsius’ in-house investment team to sell bitcoin worth hundreds of millions of dollars. A day later, Celsius had to repurchase it all at a loss. “He was ordering the traders to massively trade the book off of bad information,” said one of the traders. “He was slugging around huge chunks of bitcoin.” [FT, archive

Mashinsky is selling his $2.5 million home in Austin, Texas. He bought it only a year ago. [Twitter]

Canadian pension fund CDPQ has written off its CA $200 million investment in Celsius. “We arrived too soon in a sector which was in transition.” Whoever authorized the investment definitely wasn’t a foolish and greedy investor in a bubble, who didn’t look into the already-insolvent company at all. [La Presse, in French]

Elsewhere amongst the wreckage 

Last week, we talked about Coinbase’s horrific $1.2 billion Q2 loss. Frances Coppola took a deeper dive into the company’s 10-Q. She explains why Coinbase’s balance sheet has massively inflated. [Coppola Comment]

Genesis Trading CEO Michael Moro has quit, effective immediately — definitely a thing that happens all the time in healthy companies where things are going well. Moro “will continue to advise the company through the transition.” Genesis is also laying off 20% of its staff. The company had lent $2.36 billion to 3AC, and Genesis’ parent company DCG has made a claim against 3AC for $1.2 billion. [press release; The Block]

BlueBenx, a Brazilian crypto lending platform, has bitten the dust following a $32 million hack — or, its users think, a “hack.” Withdrawals have been halted, and employees have been laid off. [CoinTelegraph]

Hodlnaut has applied for creditor protection in Singapore. This is the equivalent of Chapter 11 in the US. They’re insolvent. [Hodlnaut announcement, archive; CoinDesk

In court filings, Hodlnaut formally admitted that they had lost money in the Terra-Luna crash via their Hong Kong entity. Hodlnaut had previously told customers they had no Anchor exposure. We knew they had, and wrote about it in our previous update. [Twitter; CryptoBriefing]

All deposits are part of the bankruptcy estate. If Hodlnaut is liquidated, even stablecoin depositors will only get a fraction of what they had on account at the company.

Hodlnaut is now facing a probe from the Attorney-General’s Chambers and the Singapore Police Force — “pending proceedings,” though they didn’t give any other details. About 40 out of the 50 employees the company had have been laid off. [Straits Times

Celsius second bankruptcy hearing — court approves setting more customer funds on fire

On August 14, Celsius filed a Budget and Coin Report, which put into full view the ongoing train wreck. The company is burning through piles of “cash,” while creditors watch in horror as their remaining hopes of recovering lost money go up in smoke before their eyes. [Docket 447

To generate 18% returns on its Earn product, Celsius dived head-first into some stunningly risky “investments” and lost $1.2 billion in customer funds, at least. The company filed for Chapter 11 on July 13. 

Now, Celsius founder Alex Mashinsky wants creditors to put their faith into another reckless gamble. The company is shifting its entire business model from crypto lending to bitcoin mining — with ludicrous plans to mine its way out of bankruptcy. 

Over a three-month period from August through October, Celsius is allocating $14 million to payroll, $57.3 million to mining,* and $33 million to restructuring costs. By the end of October, Celsius will be operating hugely in the red.

Bitcoin mining is a money-losing proposition, as David Gerard and I detailed in an earlier report. Celsius’ mining business, headquartered in Texas, is currently burning through $19 million of customer money per month. In July, they only mined 432 BTC, worth $8.6 million!

Celsius argues this is because its facilities aren’t fully operational yet — but the facilities will be fully operational if the court will allow them to keep throwing more money into the flames.

All Celsius and its lawyers need to do is to convince creditors — and the judge — that the business will be profitable one day in the fabulous future.    

On August 16, two days after filing its budget report, Celsius had its second-day bankruptcy hearing. The judge ultimately signed off on a motion allowing Celsius to sell mined bitcoin to fund its mining operations but withheld approving a motion authorizing the debtor to sell stocks and shares due to Celsius obfuscating what they were really selling. 

What follows are my notes and comments on the hearing. 

Second-Day Hearing

Judge Martin Glenn began the two-hour hearing by noting that the court has received hundreds of letters from Celsius customers. The letters are all being filed in the docket. “Some have raised important issues that will have to be addressed in this case,” he said.

Molly White has been pulling out excerpts of these letters, and they are indeed heart-wrenching. These are real people, some of whom have lost their life savings because they believed the promises of Celsius founder Alex Mashinsky. [Molly White]

Celsius’s lead lawyer at Kirkland & Ellis, Josh Sussberg, was the first to present at the hearing. Before delving into a nine-page PowerPoint, he took a moment to rant about the “relentless” and “inaccurate” media coverage surrounding the bankruptcy. Sussberg said he’s told Celsius “to take the repeated punches,” and not respond. [Celsius presentation]

Sussberg has clearly been in close talks with Mashinsky, who has a pattern of deflecting blame. When Celsius initially filed for bankruptcy, Mashinsky pinned his company’s failure on “misinformation” in the media and on social media for encouraging customers to withdraw $1 billion in funds over five days in May. Mashinsky’s new message is that the banks are lying, the media is lying, but you can trust me with your money, even though I just lost it all.  

Sussberg noted the elephant in the room: everyone knows that Celsius will run out of money by the end of October. He said that Celsius is working to expedite a restructuring plan that will lead to the company being liquid.  

Celsius is also trying to sell its business and its digital assets to a third party. “We have multiple offers outstanding with several more coming in,” said Sussberg. 

In addition to the official unsecured creditors’ committee, two ad-hoc creditors’ groups have formed. One is for custodial holders, represented by Togut, Segal & Segal. They have $180 million in claims. The other, represented by Troutman Pepper, is for withhold account holders. These were customers in states where Celsius was not licensed. When they tried to withdraw funds, the money went into holding accounts. They represent $14.5 million in claims. Kirkland has been in talks with both groups, Sussberg said. 

Celsius is not seeking to dollarize claims on the petition date. Instead, it wants to return crypto. In other words, Celsius is counting on the markets to rebound — i.e., bitcoin will moon again and everyone’s problems will be solved.  

Interestingly, the creditors also do not want to dollarize claims. Greg Pesce at White & Case, the lead lawyer for the creditors’ committee, said that they too want an in-kind recovery of coins. 

Pesce said the committee has begun its own investigation into Celsius in the hopes of recovering more money for creditors, as they believe they are the only ones able to fight for the customers’ interests. Their search will take them “across the globe, across the country, and across the blockchain.”  

In addition to the possibility of identifying potential insider trading, Pesce seems to be alluding to the Tether loan. Tether loaned Celsius $840 million in USDT backed by bitcoin, and then sold the bitcoin Celsius loaned as collateral just before Celsius filed for bankruptcy. Any attempts to retrieve that bitcoin will be a sideshow in and of itself.

Judge Glenn notes that Celsius’ Earn product attracted lots of government investigations into whether Celsius was selling unregistered securities. The Securities and Exchange Commission has been looking into Celsius since January. Celsius had already been thrown out of Alabama, New Jersey, Texas, and Kentucky for unregistered offerings of securities.

“Since the debtor business model was so heavily dependent on the so-called Earn accounts, and given the number of securities regulator investigations as to whether the debtors were engaged in the sale of unregistered securities, what is the business model going forward?” 

“That’s the $64,000 question,” Pesce responded.

Celsius had 1.7 million customers at the time it filed its petition. About 58,000 held crypto in Celsius’ custody accounts — they might get their crypto back first depending on whether they are deemed secured or unsecured creditors. 

Judge Glenn wants to resolve the custodial accounts sooner rather than later. But Celsius didn’t set up its custodial business until April 2022, and he wants to make sure custodial accounts weren’t a vehicle for insider trading: 

“I am certainly going to want to know whether there are insiders and employees with custodial accounts and whether any of them were able to transfer crypto assets from other accounts into the custodial accounts — and what did they know at the time they made the transfer? Were they contemplating that the business was trending negative and the best way for them to individually protect the value of their accounts was to try and transfer assets into custodial accounts?”

Judge Glenn previously ordered all versions of Celsius’ terms of service going back to 2018. He wanted to trace through all of the changes made over time to determine what is and what isn’t the property of the bankruptcy estate. “Little did I know there were going to be 1,100 pages of them,” he said.   

Bitcoin sell motion

After the presentations, the hearing moved on to the motions.  

Celsius wants to sell bitcoin generated by its mining business and use the cash to fund its mining operations. “We are still in the capital-intensive part of the business and also, importantly, we don’t have all of the mining rigs,” said Sussberg.  

US Trustee attorney Shara Cornell said the Trustee needs more information to form an opinion on the matter: “As of today, we still do not know what expenses are being paid or what bitcoin is being sold,” she said. “We know what the debtors expect to generate but we have no idea what it is going to cost to generate any of that.” 

Cornell said that the Trustee is considering hiring an examiner to address Celsius’ rampant transparency issues. She noted that Celsius said it planned to file a long-term mining plan. “Maybe what we need to do is put this motion on hold until we have more information.”

(Update: Just after I published this story, the Trustee entered a motion for the appointment of an examiner. This is a big deal!)

Surprisingly, Pesce said the creditors’ committee has not made a decision on the mining. Frankly. I was sort of expecting the creditors to push for a liquidation.  

Not all Celsius customers support the idea. 

If they raised a virtual hand during the Zoom hearing, creditors were allowed to speak. One creditor said: “We didn’t sign up to be part of the mining business. We signed up to be part of an exchange. As a fellow miner, I don’t see it being very profitable in the long run.” 

Judge Glenn approved a motion to allow Celsius to sell bitcoin generated from its mining business, but he clearly had reservations: “At bottom, this is a business judgment decision that may turn out to be very wrong, but we will see.” [Order 187]

Not so ‘de minimis’ after all

Celsius wants to sell assets that they claim are “de minimis” and “non-core” to the business to bring in more cash for operating expenses. It turns out these are notes/bonds and equity in other crypto companies, but Celsius never bothered to tell anyone. 

De minimus means too small to be taken into consideration. Debtors can sell assets free and clear of liens. But sales of bankruptcy estate property must be approved by the bankruptcy court.  

Prior to the hearing, the Trustee had objected to the motion, saying the debtor hadn’t provided enough information for the Trustee to evaluate the motion. [Docket 400]

Trustee attorney Shara Cornell told Judge Glenn: “The motion makes it sound like the debtor is selling office furniture or similar hard-type assets that they no longer need. One of our questions in objection had to do with whether or not that might be mining equipment. But what they are actually looking to sell are equities and stocks. And that, in our opinion, is not a de minimis.” 

Judge: “Did you find out what stock they were talking about?” Cornell: “No.” 

Judge Glenn declined to approve the de minimis sales motion and told Celsius to work it out further with the Trustee. Even he was surprised. 

“Certainly I had no inkling the debtor was proposing to sell millions of dollars of equity or notes/investments in other crypto businesses. Those were not what I would normally consider to be de minimis assets, so I want some better definition.”  

Celsius’ business model going forward is all predicated on number go up and making sure the boys get paid. I’m not sure how long this will drag on before the “restructuring” turns into a liquidation, and Celsius management is booted. Likely not before Celsius burns through the rest of their customers’ funds, pays as many of their friends as possible, and the bankruptcy attorneys make their millions. 

The next Celsius hearing is September 1. 

*Celsius calls running mining rigs “hosting.” 

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​​

Bankrupt Voyager Digital’s search for a buyer — notes from the first committee town hall

If you are interested in Voyager Digital’s Chapter 11 proceedings, the official creditors’ committee town hall held on August 11 is a good one to watch. [YouTube, presentation]

The session was put on by committee lawyers Darren Azman, Chuck Gibbs, and Gregg Steinman; the committee’s financial advisor Michael Cordasco; and Jason Raznick, CEO of trading news site Benzinga, who is the chair of the creditors’ committee. 

Azman and Gibbs, both partners at McDermott Will & Emery, did most of the talking. 

The group outlined the bankruptcy process and offered a (very aggressive, perhaps overly optimistic) timeline for how things could pan out. What follows are a few notes I pulled from the meeting. Read through the entire creditor presentation for more. 

Seeking bids for a buyout

Voyager is soliciting bids from companies to acquire its assets. The creditors’ committee is actively involved in the process. A lot of conversations are happening behind the scenes. Formal bids are due on August 26; an auction will occur on August 29.

Sam Bankman-Fried’s FTX offered a bid earlier, but the creditors’ committee pooh-poohed the bid. 

“I can tell you that FTX is not the only interested party. The company has received several indications of interest,” said Azman. He added that FTX’s offer was the lowest bid.

By the end of August, he said they should have a good idea of who the winning bidder is and the terms of the sale. 

Bankman-Fried’s FTX and Alameda Research have deep ties to Voyager and its bankruptcy wipeout, stretching back to mid-2021. In the Voyager bankruptcy, Alameda is a borrower, a lender, and a shareholder, so I expect FTX is going to have the strongest interest in purchasing Voyager.

A plan of reorganization

The conclusion of Chapter 11 ends with the confirmation of a plan, which could result in a reorganization — or a liquidation. Voyager has 120 days to come up with a plan, and creditors get to vote on whether to accept a plan.   

But before Voyager can put forth a plan for a vote, the company has to file a written disclosure statement, which the court then has to approve.

The disclosure statement is similar to a securities prospectus. It will contain detailed information about the debtor’s financial affairs, how it got into the mess in the first place, a description of its assets, and a description of claims and liabilities and how those claims will be handled. 

The disclosure statement will have a plan of reorganization attached to it, but the two are separate documents.

After Voyager files its disclosure statement, the court will hold a hearing to decide if the statement has adequate information. The plan must be feasible, meaning that after the plan is confirmed, it will not be followed by a plan to liquidate the company under Chapter 7. 

McDermott Will & Emery expect confirmation of a plan by the end of October and distribution of funds sometime in November. 

This is extremely optimistic! Large bankruptcy proceedings generally take years. In the case of QuadrigaCX, which went dark in early 2019, the creditors are still waiting for disbursement as everything is tied up with the Canada Revenue Agency, which insisted on doing its own audit. Similarly, Mt Gox fell apart in early 2014, and its creditors are also still waiting for their money. 

Voyager’s financials 

As of June 30, Voyager has total assets worth USD $1.26 billion:

  • Operating cash: $140 million  
  • Loan portfolio: $470 million 
  • Various crypto holdings: $655 million  

It has total claims so far of $1.8 billion, leaving a hole in its balance sheet of $550 million. 

These numbers do not include the $270 million in cash held in Metropolitan Commercial Bank’s FBO accounts. The numbers also don’t include the $650 million loan to Three Arrows Capital, which 3AC defaulted on. 

Voyager will need to dip into its operating cash to pay its employees and cover benefits and severance pay. Also, bankruptcies are expensive. As David Gerard and I mentioned in a recent crypto crash update, administrative costs could easily end up being $100 million or more. 

(You can read more about Voyager’s mess here.)

A possible interim distribution? 

The creditors’ committee is pursuing an interim distribution. This is rare and unusual, the lawyers explained in the town hall, and only Voyager can put the motion in front of the judge. 

Azman: “We have had productive conversations with Voyager about making an interim distribution and ultimately we are hopeful they will do so.” 

He says there is no guarantee that it will happen or that it will happen any faster than the plan approval.

I seriously doubt that it will happen at all, but we’ll see. 

Insider investigations

Before Voyager filed for bankruptcy, it formed a special committee of certain directors, Azman explained. Part of the special committee’s mandate is to investigate certain actions of insiders (directors and affiliates of Voyager) “with a particular focus on the loan that Voyager made to Three Arrows Capital.”

The special committee retained a separate law firm to handle the investigation. Ultimately, the special committee will produce a report that presents their views on whether insiders are liable for any wrongdoing. 

“It should not surprise any of you to hear that we, the creditors’ committee, believe preliminarily that there are a number of people and companies that may be liable for wrongdoing and should and will be held accountable,” said Azman. “Thus we are conducting our own investigation of insiders and their potential wrongdoing.” 

If the Voyager special committee concludes there are no claims against insiders then Voyager will seek to release those insiders from all liability under their Chapter 11 claim, he warned.

Azman went on to explain that if Voyager succeeds in doing that, the creditors’ committee will not be able to pursue claims that the company has against those insiders. 

“If the creditors’ committee disagrees with the special committee’s conclusions, we will recommend to creditors that they vote to reject any plan that attempts to release insiders so that they do not receive releases. And second, we will reject the confirmation of the plan on the grounds that the releases are improper.” 

Azman and Gibbs say they’ll be putting on more town halls in the near future to keep Voyager creditors updated on the case. 

Claims are due October 3 and McDermott Will & Emery are posting key documents on their website.

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Crypto collapse: Coinbase’s billion-dollar bloodbath, Hodlnaut goes down, Celsius, Voyager, 3AC

It’s time for another episode of “all the money’s gone.” David and I are taking turns posting. This one is on his blog. [David Gerard]

In this episode, we cover:

  • Coinbase’s disastrous Q2 financials.  
  • Hodlnaut’s brave attempt to stay afloat before going under. 
  • More legal wrangling in the Celsius and Voyager bankruptcies.
  • Tether — a secured or unsecured Celsius creditor?
  • Other innocent victims of the CeFi fallout.

If you like our work, please do sign up for our Patreons — here’s Amy’s and here’s David’s.

Bitcoin mining in the crypto crash — the mining companies’ creative accounting

  • By Amy Castor and David Gerard
  • If you like our work, please do sign up for our Patreons — here’s Amy’s, and here’s David’s.

Bitcoin mining is a highly lucrative business as long as the price of bitcoin keeps going up — and as long as investors believe it will keep going up.

When the price crashes — and the price of bitcoin has halved since the start of the year — crypto miners face margin calls, they have to dump their bitcoins, and reality comes knocking.  

In this post, we outline some of the biggest problems facing North American bitcoin miners:

  • Miners are nothing like as profitable as they report to the public stock markets that they are.
  • Miners don’t want to sell their freshly mined bitcoins, as this would risk crashing the price of bitcoin — so instead, they borrow against the bitcoins, and against their rigs, too!  
  • This business model only works if number goes up forever.
  • Number doesn’t go up forever.

During the bitcoin bubble of 2021, miners wanted to lure in naïve investors from the capital markets who thought that crypto mining companies were a great way to get exposure to bitcoin — without the risk of actually touching a bitcoin. The miners would hold their bitcoins, subsidize their business with debt, and you could just buy their stock!

So the bitcoin miners promoted themselves as enthusiastic bitcoin “to the moon” boys — in the hope of luring in other prospective moon boys. Buy now and watch your profits soar! Number can’t go down!

The cunning plan

Bitcoin miners used to be ruthless economic agents, in it for the money. They knew how volatile crypto was, so they sold their coins as soon as they mined them to cover power bills and other business expenses.

As some point, miners’ business model changed from selling bitcoin to holding bitcoin — and borrowing against it.

This model doesn’t make any sense unless you first assume that the number will never go down, and that the bitcoin bubble will never burst — even though bubbles always burst. 

The change started in mid-2021 when bitcoin miners were kicked out of China. Most eventually settled in the US and Canada — because these countries had the world’s next-cheapest reliable electricity. 

The US is now the world’s largest bitcoin mining hub, making up about 37% of the global hash rate. [CBECI]

North American miners filed to become publicly-traded companies. Marathon Digital Holdings (MARA) and Riot Blockchain (RIOT) were the first to be listed on Nasdaq. Other miners soon followed. [Investopedia; Compass Mining]

Going public gave the miners access to the mainstream capital markets, investors, and new lines of credit — way more financial resources than they’d ever had before.

The miners marketed themselves to capital markets as massive bitcoin enthusiasts. Get in, this is the magical future! Here’s Whit Gibbs from Compass Mining in January 2022: [CoinDesk]

“With ample access to funding and investors pouring in money, miners didn’t have to sell their bitcoin to fund operational costs, said Compass Mining’s CEO Whit Gibbs. ‘And since miners are incredibly bullish on bitcoin, this allows them to do what they want to do naturally, which is to speculate on bitcoin’s positive price appreciation,’ he added.”

Miners spent mid-2021 onward racking up debt to finance the construction of facilities, buy mining equipment, and pay their executives enormous salaries.

The companies’ operating expenses were paid for by borrowing against their freshly-mined bitcoins. Some loans even used mining rigs as the collateral.

The miners also did accounting tricks, such as depreciating mining rigs over five years — and not the 15 months they should have — to make the companies look like better investments. Meanwhile, their executives were paid well beyond the carrying capacity of the companies.

In 2021, outgoing Marathon CEO Merrick Okamoto earned a shocking $220 million — although most of that was awarded in stock. Riot Blockchain’s top five execs collectively were paid $90 million the same year with a net loss. [SEC; SEC] ​​

Riot Blockchain failed its say-on-pay shareholder vote on executive compensation for 2021. It’s an advisory vote that the company doesn’t have to act on — but it’s an embarrassing thing to have to admit publicly to failing. Thankfully, coiners have no capacity for embarrassment. [SEC]

Bitcoins sold by publicly traded mining companies, January to May 2022. [graph]

Bitcoin loans

While the price of bitcoin was going up through 2021, mining saw profit margins as high as 90%. Bitcoin hit $64,000 in April 2021 and $69,000 in November 2021. [Bloomberg, archive]

Margins on mining were especially good in 2021 because the supply of state-of-the art mining rigs was constrained due to the worldwide chip shortage. If everyone could get rigs, the margins would go away. 

But by 2022, when bitcoin lost 70% of its price from its November high, it was a different story.

Miners need actual money to pay their operating expenses. Energy can account for as much as 90-95% of a miner’s overheads. Power companies don’t take bitcoins or tethers. But the crypto trading system was running low on naïve retail suckers to supply fresh dollars. [Reuters

So the miners needed to do their part in propping up the price of bitcoin. Their solution was to avoid selling their bitcoins, and instead to hold them and use them as collateral against low-interest loans. 

Marathon had started the fashion of borrowing against mined bitcoins as early as October 2020 — and the other mining companies soon followed the same plan.

Mainstream financial institutions didn’t really get into lending to bitcoin miners. The main lenders to miners were their fellow crypto companies: Galaxy Digital, NYDIG, BlockFi, Foundry Networks, Silvergate Bank [SEC], Celsius Network, and Babel Finance. (Note that Celsius is bankrupt, and Babel has suspended withdrawals.)

In fact, Marathon just entered a new $100 million revolving loan with Silvergate to add to their existing $100 million line of credit from Silvergate. This is while Marathon has thousands of mining rigs lying idle, waiting on a deal for cheap electricity. [SEC; CoinDesk]

Bitcoin miners are also trying to hedge against the downturn by betting against the bitcoin price going back up. Marathon has been selling call options at, say, $50,000. If bitcoin doesn’t hit this price, those options expire worthless. [Bloomberg]

Miners did deals with politicians and the power industry to get cheap electricity in Texas, as low as 2.5c/kWh — the sort of prices that miners were paying in China. [Bloomberg; press release]

But the Texas grid is notoriously unreliable — and can’t fall back on the other two continental US national grids. With 2022’s summer heat, electricity usage went up significantly, and ERCOT has told miners to switch off from time to time. [Bloomberg; Washington Post; The Verge]

Some miners, such as Riot, made money from credits for not using power in this time. [press release]

Margin calls

Borrowed money, one day, needs to be paid back. When the collateral dropped in value, miners’ loans got margin-called. They had to dump some of their vast holdings.

Miners started dumping big time in June 2022, some selling all their mined bitcoins and some of their “stockpile.” Bitfarms dumped 3,000 coins — half its stockpile — in mid-June. A month later, miners collectively sold 14,000 bitcoins, with a face value of roughly $300 million, in a single 24-hour period — when the CeFi crash was in full swing. [Reuters; Bloomberg; Cryptoslate]

Compass Mining — which sells people mining machines that are then hosted in third-party facilities — posted a list of publicly-listed miners in North America who were selling off their stashes. [Compass Mining

Arcane Research’s Jaran Mellerud analyzed the cash flows and balance sheets of public miners. Marathon was the weakest: “Marathon has 6.2 times higher remaining machine payments in 2022 than their accumulated current operating cash flow accumulated out the year. This will drain them of liquidity.” He thinks Marathon will be forced to sell off their bitcoin stockpile as well. [Tweet thread; Arcane report]

Some loans even used mining hardware as collateral. But mining rigs are even worse collateral than bitcoins. The price of mining rigs on the second-hand market is extremely sensitive to the price of bitcoin — and those loans are now undercollateralized.

As of June 2022, almost $4 billion in loans to bitcoin miners are coming under stress, posing a risk to crypto lenders, as many of the rigs posed as collateral have halved in value. [Bloomberg, archive]

Miners still hold huge piles of unsaleable bitcoins. CryptoQuant says that miners’ holdings have been increasing. As of July 2022, miners held 1,856,000 BTC. [CoinTelegraph]

Mining accounting

Bitcoin miners are not as profitable as they’ve been reporting.

Paul Butler points out that bitcoin mining companies are using questionable accounting methods. [blog post]

When you buy capital equipment with a lifetime longer than your financial year, you can allocate the cost of the purchase over its expected useful lifetime, rather than all in one hit. This is called depreciation.

Publicly-traded mining companies typically depreciate their assets over five years — but the equipment is good for about fourteen to fifteen months, and it’s most profitable in its first nine months. Bitcoin miners play on their “success” in the early years to raise capital to buy additional mining rigs.

The excessively long depreciation on mining rigs is a way to hide that the miners’ real costs are much higher than they’re reporting. The miners are not putting away money for future equipment. This is as well as overpaying their executives. 

Cost of mining versus cost of bitcoin [Bloomberg]

Tick … tock. Next block?

In a bubble, you can sell mined bitcoins for far more than the cost of the electricity to play Extreme Bingo trying to guess a winning hash.

You can even run old mining rigs that might otherwise be scrapped. Old rigs might spend $30,000 to mine a bitcoin — but that’s fine if you can then sell that bitcoin for $40,000.

So what happens when the bitcoin price drops too low for mining to be profitable?

We’re seeing this now. Miners are taking inefficient hardware offline, causing visible drops in the hash rate charts since May 2022. In November 2018, the price of bitcoin dropped below $3,800 and a lot of miners threw out all their old equipment. The hash rate dipped noticeably.

The real trouble starts when bitcoin falls below $15,000. (As we write this, bitcoin is around $23,000.) Break-even for the most efficient machines is somewhere between $9,000 and $11,000, based on an electricity cost of 5c/kWh. In June 2022, JPMorgan put the cost of mining at $13,000 per bitcoin. [Bloomberg]

If the price drops too low, will the bitcoin blockchain stop ticking along? Probably not — bitcoin really doesn’t need much mining to keep running.

There was a slowdown on the bitcoin (BTC) blockchain in late 2017, when bitcoin cash (BCH) — a fork of not just the bitcoin software, but also its full transaction history — was trying to compete to become the official version of bitcoin. Large miners such as Bitmain switched a large proportion of their mining pools to the BCH chain.

The BTC chain took an hour between blocks at times in November 2017 — about 15% of the previous hash power.

Hardly anyone noticed — they were too busy having fun on the exchanges, which is where the action was in the 2017 bubble. Nobody really cares about the blockchain itself.

Bitcoin mining is green, actually

LOL, no it isn’t.

Proof-of-work mining has long been cryptocurrency’s biggest public relations battle, especially since Elon Musk — formerly the avatar of energy transition — bought bitcoins for Tesla in February 2021.

The general public thinks of crypto as nerd money for nerds to rip each other off. But when the public hear about proof-of-work crypto mining, and how it consumes an entire country’s worth of electricity, they get angry.

So it’s extremely important for the crypto industry to pretend as hard as possible that bitcoin mining isn’t as stupidly and egregiously wasteful as it obviously is — so that they’re allowed to keep mining at all.

The Bitcoin Mining Council claims that bitcoin uses 0.16% of all the electricity in the world. The BMC also claims that 58.4% of bitcoin mining energy use is from sustainable sources, based on claims by its members. [BMC, PDF]

Neither of these numbers is true — and BMC doesn’t show its working. Sources that do show their working — and don’t have a financial interest in fudging their numbers — put the sustainable energy percentage at 25.1%, and the percentage of the world’s electricity consumption over 0.5%. [Joule, paywalled; Digiconomist]

We’re also boggling that the BMC calls 0.16% of all the electricity in the world “negligible” — for the most inefficient payment network in human history. Even Christmas tree lights are more useful to humanity.

You’d almost think that coiners will say any bizarre and egregious nonsense if only it lets them keep trading their magic beans.

What happens next?

Number goes down, loans get margin-called, and the mining companies go broke because of a market downturn.

We expect the mining companies to blame everyone else they possibly can — the CeFi companies for crashing the market, bitcoin for just refusing to go up forever. They have to, really.

Bitcoin mining stocks are already down — MARA is down 58% year-to-date, RIOT is down 75%, and Core Scientific (CORZ) is down 74% since the beginning of the year. Meanwhile, crypto stock short sellers were up 126% as of June. [Reuters]

This scheme was never a sustainable business model. But none of these guys are long-term planners. So we don’t expect they had a coherent exit plan either.

The crypto companies who lent dollars to the miners should have been sufficiently capable of joined-up thinking to realize this was never a sustainable business model. Somehow, they didn’t. 

But then, for an example of the forward thinking skills of crypto guys, we remind you that Michael Novogratz of Galaxy Digital — one of the big lenders to miners — got a Terra-Luna tattoo in January 2022. [Twitter]

Those loans are never getting paid off. The mining rigs are near-worthless, and the bitcoins held as collateral can’t be dumped without taking the market down even further. The lenders get to take a bath on this one.

The bitcoins will likely be dumped, putting more sell pressure on the price of bitcoin.

Along with the rest of the crypto collapse, this is thankfully isolated within crypto. The only “real” financial institution involved is Silvergate, and they have almost no non-crypto customers these days. Any hit to Silvergate is unlikely to be contagious.

Of course, the investors can always sue the bankrupt corpses of the mining companies.

Crypto collapse: 3AC’s Grayscale two-step — and where in the world are Zhu and Davies?

We’ve just come out with another crypto crash update — this one is on David’s blog, so head on over there and read it!

Before you read, please take a moment to subscribe to our Patreons — mine is here and David’s is here. Your support is important. The news is free, but we depend on donations.

In this latest update, we talk about:

  • How bankruptcy works and how administrative costs suck up hundreds of millions of dollars before creditors see a penny.
  • How the collapse of UST has hit the crypto market worldwide.
  • Legal ramifications for 3AC founders if they don’t play ball.
  • How 3AC benefited from the GBTC arbitrage opportunity — and how Grayscale and Genesis may have helped!
  • Why Tether may be required to return $840 million in assets to Celsius.
  • The FDIC and the Feds cease and desist statement to Voyager.
  • FTX’s partial bailout offer to Voyager.

Crypto collapse: Terra Luna, 3AC’s Singapore liquidation, Celsius, Voyager 

“Lotta stadiums getting renamed in the next few years”

Ben McKenzie
Daniel Shin and Do Kwon while number was going up. Source: Terraform Labs

TerraUSD

Centralized finance (CeFi) is centralized DeFi — investment firms that played the DeFi markets. CeFi was where a lot of the money in DeFi came from.

CeFi looked like an industry of separate institutions — but it turned out to be a few companies all investing in each other. The chart of who invested in who would look like an inverted pyramid resting on a single point — Terraform Labs’ Anchor protocol.

Anchor offered 20% interest rates on holdings of dollar-equivalent stablecoin Terraform USD (UST), the interest being paid in UST. You could get UST by buying Terraform’s luna token from exchanges like Crypto.com or KuCoin. (Crypto.com Arena used to be Staples Center in Los Angeles.)

All the other CeFi firms just put their money into Anchor at 20%, then offered slightly lower interest to their own investors and skimmed the difference. Terraform made its money by dumping luna on these UST buyers.

UST and luna were both tokens that Terraform made up one day — neither had any reason to be worth anything. Everyone in DeFi knew how rickety UST/luna was for months — they just went along with it while it made them money. A truly fiat currency.

The party ended on May 9, when UST and luna imploded, setting off a cascade of insolvencies across cryptoland. We’re still seeing the fallout.

Crypto hedge fund Three Arrows Capital (3AC) went into liquidation as it was heavily invested in UST and luna. Firms that had big loans to 3AC, such as Voyager, Celsius, and BlockFi, had to file bankruptcy or seek bailouts from other crypto firms. Even crypto exchanges had been playing the CeFi markets with customer funds, and many had to close their doors.

Thousands of South Koreans also lost money when UST and luna collapsed. Terraform Labs founders Daniel Shin and Do Kwon are stuck in South Korea for now, while investigators look into the incident.

On Wednesday, July 20, investigators from the Seoul Southern District Prosecutors Office raided seven crypto exchanges, including Upbit, Bithumb, and Coinone. They’re looking for clues as to whether Terraform intentionally caused the collapse. They also raided some exchange executives’ homes and the home of Daniel Shin. [Yonhap News; Donga News, in Korean]

Elsewhere, South Korean prosecutors have discovered a shell company called “Flexi Corporation” that Kwon allegedly used to launder large sums of money out of Terra and into his own private accounts via over-the-counter trades. How can this be? Kwon said he only took a small salary from Terraform. [KBS, in Korean; Twitter

Three Arrows Capital 

UST and luna went under, and pulled crypto hedge fund Three Arrows Capital down with them.

The Terra collapse completely nuked 3AC. Their exposure was about $600 million. (This is triple what co-founders Su Zhu and Kyle Davies had claimed in mid-June.) [Fortune]

Zhu and Davies are in now hiding. Nobody knows where they are. They told Bloomberg they were headed to Dubai. [Bloomberg, archive]

The pair knew immediately that they were screwed. But on May 11, when investors asked if 3AC had survived the Terra collapse, 3AC told them everything was fine — and kept taking in money! 

3AC had abandoned its Singapore office by late May — they just locked the door and skipped the country — and they finally admitted there were problems only in mid-June.

But Zhu and Davies have been telling the public — especially their creditors — how they lost money too, how they fear for their lives, and how they are so overwhelmed that they can’t turn over banking information just yet, but they’ll get to that soon, for sure.

The two old school buddies say they were shocked by how quickly things unraveled. “What we failed to realize was that luna was capable of falling to effective zero in a matter of days.”

Never mind that the instability of UST/luna was obvious to outside observers, that UST/luna worked exactly the same way as the Titan/Iron pair that collapsed in 2021, and that these guys were supposed to be a crypto hedge fund with alleged competence, and not the drooling crypto degen brainlet rubes they appear to have been trading like.

Zhu and Davies never planned for number go down, and had just been piling leverage on leverage. “We positioned ourselves for a kind of market that didn’t end up happening,” Zhu told Bloomberg. Never mind that a “hedge fund” is named for the act of hedging your speculations, and not just assuming you’re a genius because there’s a bubble going on.

Teneo is the firm handling 3AC’s liquidation, and they are moving quickly. They filed Chapter 15 in the US on July 1. Shortly after, they also filed for recognition of 3AC’s British Virgin Islands liquidation with the Singapore high court. 

Someone leaked Teneo’s 1,157-page Singapore filing earlier this week. The comprehensive document is a gem — it gives us a full update on the bankruptcy proceedings up to July 9. Teneo’s Christopher Farmer and Russell Crumpler left no rock unturned. [Filing, archive]

We recommend reading at least the first 35 pages — it tells the story of Ponzi borrowing, multiple defaults, ghosting creditors and liquidators, and doing deals with some lenders while cutting out others. The rest of the filing is exhibits, other court filings, and affidavits of furious creditors.

3AC’s biggest creditor is Barry Silbert’s Digital Currency Group, the parent company of Genesis Trading, which had a $2.4 billion partially collateralized loan to 3AC. DCG is now stuck with up to $1.1 billion in losses. [The Block]

Other large creditors include Voyager Digital ($687 million), Blockchain.com ($302.6 million, up from the originally claimed $270 million), and Deribit ($80.6 million).  

Kyle Davies’ wife, Chen Kaili Kelly, filed a claim for $65.7 million, and Zhu Su himself submitted a $5 million claim. We have no idea how 3AC was structured to allow an owner and a cofounder to be a listed creditor in a bankruptcy.

Zhu and Davies reportedly made a $50 million down payment on a yacht — with borrowed money, while they defaulted on their lenders. (We’re definitely feeling the Quadriga vibes with this one.) They wanted it to be bigger than any of the yachts owned by Singapore’s billionaires, and ready for pick-up in Italy. Zhu told Bloomberg that the yacht story was a “smear.”

Tai Ping Shan Capital, an over-the-counter desk in the BVI, claimed it operated independently of 3AC, but it turns out to have tight connections. On June 14, 3AC transferred $30.7 million in USDC and $900,000 in USDT to TPS. It’s unclear where those funds subsequently went. [Coindesk]

Good news! In a supplemental Chapter 15 filing, Teneo says it’s recovered $40 million of assets! The bad news is that this is a drop in the bucket. Creditors have so far submitted $2.8 billion in claims, and there’s plenty more coming. [Court filing]

3AC creditors have picked a creditor committee consisting of the largest creditors: Voyager, DCG, CoinList, Blockchain.com, and Matrixport. The committee will work closely with Teneo to “maximize the value of the assets available for distribution.” [The Block

Blockchain.com is struggling to survive in the aftermath. It just laid off 25 percent of staff. [CNBC

In addition to owning CryptoDickButt #1462, 3AC had also started a $100 million NFT fund with pseudonymous NFT trader Vincent Van Dough. They supplied the funding, while Van Dough curated the art. (We mentioned CryptoDickButt last time, and we’re shocked that some of you thought we were just making that up. You should know by now that crypto is always stupider.)

The fund, called “Starry Night Capital” planned to launch a physical gallery in a “major city” by the end of 2021. [The Block, 2021]

The Defiant noted on June 17 that the Starry Night portfolio had been aggregated into a single Ethereum address, probably controlled by Zhu, Davies, and Van Dough. Teneo has noticed and is concerned. [The Defiant]

Celsius

Celsius promised 18% returns on your crypto. When too many people tried to pull their money out at once, Celsius paused withdrawals on June 21 and filed for bankruptcy on July 13. We covered the bankruptcy filing and CEO Alex Mashinsky’s declaration in our last post. 

Celsius admits to a $1.2 billion hole in its balance sheet. Others think the assets are fake and the liabilities are very real, which would put the hole at $4 billion to $5 billion.

Mashinsky says that Celsius’ losses include $15.8 million from investments in UST and luna, along with $40.6 million in loans to 3AC. He also said that Celsius lost 35,000 ether tokens in 2021 due to an incident involving a staking provider that “misplaced” the keys to its tokens. Oops!

Celsius held its first bankruptcy hearing on July 18. SDNY Judge Martin Glenn is presiding over the case. Kadhim Shubber from the Financial Times live-tweeted the hearing, which took place over Zoom. Here’s a copy of the presentation Celsius gave to the judge on Monday. [Stretto; Twitter thread]

Celsius’ lawyer Patrick Nash told the judge there won’t be a liquidation. Celsius has a recovery plan: to HODL — and mine bitcoins! That’s right, Celsius wants to mine their way out of bankruptcy. Nash says the plan is to mine 10,000 bitcoins in 2022.

How did Celsius end up in bankruptcy? You might think it had something to do with Celsius making horrible investments and losing everyone’s money, but no! As Nash explained, Celsius was driven to insolvency by unfounded Terra/luna fears, worries about Coinbase’s bankruptcy risk factor disclosure in May, and a bank run that knocked over an otherwise well-run business.

Former Celsius employees tell a different story. Celsius compliance and financial crimes director Timothy Cradle spoke of the company’s “sloppiness and mismanagement.” [Coindesk

Cradle also told CNBC that Celsius execs “were absolutely trading the token [CEL] to manipulate the price.” A former HR employee said she was told not to do a background check on Yarom Shelem, the former Celsius CFO who was arrested in Israel for fraud. [CNBC]

Celsius creditors have been filing claims since July 18. [Twitter] The letters make for some disturbing reading. Molly White has been posting excerpts on Twitter. It’s a reminder that Celsius investors were ordinary people lured in by Mashinsky’s false promises. [Twitter thread]

Québec pension fund CDPQ also has some questions to answer. CDPQ invested $150 million in Celsius in October 2021 as part of a $400 million funding round co-led by WestCap Investment Partners LLC. “We understand that our investment in Celsius raises a number of questions.” [Bloomberg

Celsius’ next bankruptcy hearing is August 10.

Voyager

Crypto broker Voyager said its secret sauce was “low-risk investments.” Yet it loaned out three-quarters of its assets under management to 3AC.

In June, the firm signed an agreement with Sam Bankman-Fried’s Alameda Ventures for a revolving line of credit so it could keep the music playing a bit longer. But on July 1, Voyager Digital filed Chapter 11 bankruptcy.

Coffeezilla points out that Voyager is trying to sell people on this “Chapter 11 bankruptcy reorg,” and hides the fact that under bankruptcy law, a company that describes itself as a broker cannot file Chapter 11. They should be required to liquidate under SIPA. (Securities Investor Protection Act) [Youtube; Twitter]

The CEO of of crypto media outlet Benzinga will be on the unsecured creditor committee in the Voyager bankruptcy. Jason Raznick is among the largest unsecured creditors for Voyager. [Inside Bitcoins]

Voyager’s next bankruptcy hearing is on August 4. It has $350 million of customer money in an omnibus account at Metropolitan, and it keeps reassuring everyone that they’ll get their money soon! It just has to work things out with the judge first. [Voyager blog; archive]

In the meantime, Bankman-Fried proposed a partial bailout. Under his proposal, Voyager customers would have the opportunity to open new accounts at FTX with a cash balance funded by their bankruptcy claim. They would be able to withdraw the cash, or use it to purchase crypto on FTX. [FTX press release; FT, archive]

Other CeFi firms that are definitely robust and doing fine 

Vauld is a Singapore-domiciled crypto lender that serves mainly customers in India. It stopped withdrawals on July 4 and owes $402 million in crypto to its customers. 

After suspending withdrawals and laying off 30% of its staff, Vauld filed for protection against creditors in Singapore on July 8. [WSJ]

A Singaporean moratorium order is similar to Chapter 11 in the US. It allows Vauld to avoid a complete cessation of operations and liquidation of assets, while it tries to get its act together. 

Vauld later disclosed they were short $70 million, partly from exposure to UST/luna. Vauld issued a statement on July 11. Vauld and Nexo are still discussing an acquisition of Vauld. [Vauld blog, archive]

BlockFi released its Q2 2022 transparency report. The report showed it had $1.8 billion in open loans from retail and institutional investors by the end of June and $600 million in “net exposure.” [BlockFi blog, archive; Decrypt]