Poloniex gets busted by SEC for $10M, and Circle pays — again

Sometimes you make a bad business decision, and you keep paying for it. And for Circle — the company behind the USDC stablecoin — that bad decision was Poloniex, the crypto exchange it bought in February 2018 for $400 million.  

The Securities and Exchange Commission announced in a press release on Monday that Poloniex agreed to pay $10 million to settle charges that it operated an unregistered securities exchange. Poloniex neither admits or denies the claims by agreeing to the settlement. 

Circle, which plans to go public via a special-purpose acquisition company merger, will cover the cost of the settlement, adding to the $156.8 million it already lost when it sold Poloniex in October 2019 — only 18 months after buying the troubled exchange. 

According to the SEC, Poloniex allowed users to trade digital assets that were unregistered securities from July 2017 through November 2019, though it didn’t specify exactly which tokens were securities. 

Exchanges that sell securities have to register with the SEC or apply for an exemption, according to Section 5 of the Security and Exchange Act of 1934. 

Although Circle had plans to turn Poloniex into a regulated exchange, those plans never materialized. Instead, Circle ended up paying for Poloniex’s mistakes.

History of Polo

Poloniex launched in January 2014. In its early days, it operated out of Somerville, Massachusetts, not far from Circle headquarters in Boston. 

The exchange started off allowing users to trade bitcoin for a number of “promising” altcoins — such as Namecoin, Memorycoin, Klondikecoin, Earthcoin, and the like — as you can see from this 2014 web archive. 

In March 2014, Poloniex lost 12.3% of its bitcoin supply (97 BTC), worth around $48,000 at the time, when it was hacked, leaving the company insolvent.  

“I take full responsibility; I will be donating some of my own money, and I will not be taking profit before the debt is paid,” Poloniex then-owner Tristan D’Agosta said on BitcoinTalk, writing under the username Busoni.

By July 2014, D’Agosta said he had paid back the debt, thanks to the popularity of Monero, a privacy coin known for its use in money laundering, darknet markets, ransomware, and cryptojacking. 

Later, the exchange allowed users to trade altcoins against Ether and increasingly Tether — a stablecoin with dubious backing. 

Since Poloniex was never able to get proper banking, it remained a crypto-to-crypto exchange. If you wanted to exit into fiat, you had to move your BTC or ETH to a banked crypto exchange, such as Kraken or Coinbase.

All through the initial coin offering craze and bitcoin bull market of 2017, Poloniex cashed in, listing a slew of ICO tokens in the same manner that it had previously listed all those altcoins. 

Circle knew the SEC was breathing down Polo’s neck when it opted to purchase the exchange.

According to Circle’s consolidated December 31, 2020, and 2019, financial statements, which were part of its SPAC filing, the SEC had filed a complaint against Poloniex in December 2017 related to “the trading of cryptocurrencies that may be characterized as securities.” Circle set aside $10.4 million to pay for the settlement. 

In July 2017, the SEC released its infamous DAO Report, effectively saying that most ICOs were investment contracts. The report also warned crypto exchanges that they needed to register with the SEC as a national exchange or apply for an exemption — if they were going to list these tokens. 

At that time, Poloniex should have delisted every single one of its ICO tokens. Instead, the exchange put profits ahead of common sense. 

“Poloniex chose increased profits over compliance with the federal securities laws by including digital asset securities on its unregistered exchange,” Kristina Littman, chief of the SEC enforcement cyber unit, said in a statement.  

Big plans

Circle purchased Polo with pie-in-the-sky plans. A few months after the purchase, Circle would get $110 million in funding led by Bitmain, a Chinese crypto mining company, to launch USDC. Eventually, the stablecoin business would become more attractive. 

Jeremy Allaire and Sean Neville, Circle’s co-founders, described turning Poloniex into a marketplace for “tokens which represent everything of value,” including physical goods, real estate and even creative productions. 

The timing of the purchase was terrible. In February 2018, Bitcoin had lost half of its value since reaching nearly $20,000 in December 2017. Retailers were selling their bitcoin and getting out of the crypto markets. And Poloniex was left with a backlog of 140,000 open customer tickets to deal with.

Circle figured that if it could transform Poloniex into a respectable alternative trading system — a type of exchange that would qualify for an exemption — the SEC would not push charges. 

According to a leaked slide from a Circle presentation, the SEC told Circle that it would “not pursue any enforcement action for prior activity” at Poloniex as long as Circle turns it into a regulated exchange. 

Only the ATS never happened. Instead, Circle moved most of Poloniex’s international operations offshore to Bermuda in July 2019, so that it could sidestep US regulations. 

Around the same time, Poloniex announced a partnership with payment processor Simplex in mid-2019 that allowed users in 80 countries to fund their accounts with cash and have their money automatically “tokenized” into USDC.  

Meanwhile, throughout 2019, Poloniex’s problems kept adding up.

Circle received subpoenas from the US Treasury Department’s Office of Foreign Assets Control (OFAC) and an Iranian government agency looking into Poloniex registered accounts and transactions that may have violated sanctions. According to its SPAC filings, Circle estimated the penalty would be between $1.1 million to $2.8 million.

Several Poloniex investors lost money in May 2019 when CLAM token suffered a flash crash, causing substantial numbers of margin loans to default. The exchange had to socialize $14 million in losses, opening itself up to class-action lawsuits. 

Circle estimated it would have to pay $1.3 million for two settlements, according to its filings. The company says “the remaining prospective claims are not probable of being successful at the current time and will continue to monitor developments around these claims and other claims made by affected lenders.”

Enough is enough

In October 2019, Circle decided to spin off Poloniex to a new entity — Seychelles-based Polo Digital Assets Ltd — backed by an Asian investment group. Tron CEO Justin Sun led the consortium with plans to invest $100 million into the exchange. 

Why did Circle sell Polo? It is likely the crypto downturn of 2018 made operating the exchange too costly. And I’m guessing it was a lot more work to turn Polo into a regulated exchange than Circle anticipated, given all Polo’s previous mishaps. 

Neville stepped down from Circle after the sale. He didn’t give an explicit reason why, but he told Coindesk that the company’s recent sale of Polo was one of several factors that made “the time appropriate for me to transition.” 

After that, Circle decided to put all of its energy into its USDC stablecoin, of which there are now 26.7 billion in circulation. 

News: EU to make BTC traceable, Circle’s stab at transparency, DoJ probes Tether for bank fraud

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Regulation

It’s time for Bitcoin to put on its big-boy pants. If you want to be real money, it turns out, you have to follow real money rules.

In light of that, the European Commission, the EU’s executive body, wants to apply FATF’s travel rule to crypto to make transactions more traceable. The rule, which already applies to real money transfers, will require all transfers of crypto assets to be accompanied by full details of both the sender and the receiver. 

“Crypto assets are increasingly used for money laundering and other criminal purposes,” the European Commission VP said in a press conference. “We’ll now bring crypto assets fully in scope of EU AML rules. (Press release; BBC)

In my last newsletter, I touched on a new stablecoin academic paper — “Taming Wildcat Stablecoins.” I’m bringing it up again because of the paper’s political importance, which is getting overlooked right now.  

The paper describes Tether as an equity instrument akin to a money-market fund and all other stablecoins as debt instruments. This appears to be an intentful regulatory distinction. I’m guessing it will come up again when the hammer falls on stablecoins — particularly Tether. Read the paper!

A bipartisan infrastructure bill agreed on by Senators and President Biden proposes to raise $28 billion from crypto investors by applying stricter IRS reporting requirements to exchanges and other parties. (Bloomberg)

CFTC Commissioner Dan Berkowitz spoke about decentralized finance at DACOM DeFI 2021. He has talked about DeFi platforms in the past. But this time, he said the contracts themselves are illegal. (Youtube)

“If you have a system where you take out the intermediary and you just have a bunch of people trading contracts, those contracts are still in violation of the Commodity and Exchange Act,” he said. “It’s not just the intermediaries that are regulated — it’s the instruments themselves and the people that are using them.”

On June 27, the Senate Banking Committee held a hearing called “Cryptocurrencies: What are they good for?” If you don’t have time to listen to the whole thing, Alexis Goldstein, senior policy analyst at nonprofit coalition Americans for Financial Reform, recaps the important bits in a Twitter thread.

Sen. Elizabeth Warren is concerned about the risk crypto poses to the financial system. In a letter to Treasury Secretary Janet Yellen, she suggested Yellen tap the Financial Stability Oversight Council — a panel of top regulators that the Treasury secretary chairs — to “act with urgency.” Warren cited stablecoins, DeFi, exposure to hedge funds, and risk to banks. (Politico)

Tether’s criminal probe

The big news: The US Justice Department is investigating Tether for bank fraud. It looks like the DoJ may have leaked a target letter to Bloomberg. (If you’re not sure what that is, here is a sample target letter.)

I wrote a blog post explaining Tether’s banking history. David Gerard and I also did a podcast on the topic for “When the Music Stops.” 

Why would the DoJ leak a target letter? Because they are giving the public a heads up on what is to come. Fifty percent of all bitcoin is still traded against tethers and this could have a potentially big impact on the market. In other words: Get your funds off Tether exchanges now. 

The Tether printer is still paused, as it has been since the end of May/early June. There are currently 62 billion USDT in circulation, with Tether having burned another 200 million USDT in the last week. 

We don’t know why Tether stopped printing. But the timing corresponds with China’s crackdown on crypto and all the stuff going on with Binance. It’s also possible Tether knew the DoJ was onto them.

Tether says that its reserves consist mostly of commercial paper, which would make it one of the largest commercial paper holders in the world. Is it Chinese commercial paper? Tether won’t say, but if it is, that could pose a problem for Tether as Chinese regulators want real estate developers — major issuers of CP — to start disclosing more details of CP issuance on a monthly basis. (CNBC)

In their infinite wisdom, Tether execs — CTO Paolo Ardoino and General Counsel Stuart Hoegner — decided it would be a good idea to go on CNBC to be interviewed by Deirdre Bosa. (Youtube)

Naturally, Bosa asked them about their commercial paper. 

“We don’t disclose our commercial partners, so that is quite important,” Ardoino said. “Given our portfolio composition in commercial paper, we believe that it is quite important to respect the privacy of the banking partners that we work with.” 

Privacy of banking partners? Just about every money-market fund out there lists all of its holdings by size and issuer and CUSIP — a unique code assigned to most financial instruments.  

“Everything in this interview melted my brain,” says Bloomberg’s Matt Levine. 

Circle releases a new attestation

Circle released its May attestation with additional transparency around its USDC stablecoin. The Boston firm is trying to go public via a SPAC. 

In the past, Circle’s attestations pointed vaguely to “approved investments.” Now it has released a full breakdown of its investments, sort of. (Doomberg)

Sure, it’s a step toward greater transparency, but why doesn’t Circle just go ahead and release its Q1 financials? If everything is on the up and up, that would seem like the simplest way to remove any doubt about USDC’s backing. 

Frances Coppola, who worked in banking for over a dozen years, thinks Circle is commingling funds. (Twitter thread)

Binance loses another wheel

The wheels keep falling off the Binance bus. UK bank NatWest has joined Santander and Barclays in cutting off payments to the crypto exchange. (Coindesk)

The bad news follows the UK’s Financial Conduct Authority issuing a consumer warning about Binance on June 26, which Binance played down as no big deal.  

In the UK, crypto businesses are required to register with the FCA. Binance Markets Ltd., the company’s UK arm, applied but withdrew its application on May 17 after intensive engagements with the FCA who had concerns with the exchange’s AML safeguards and lack of a headquarters. 

Hedge funds are also backing away from the ticking time bomb that is Binance. Tyr Capital has significantly reduced its exposure, along with ARK36. (FT)

Binance changed its withdrawal limit from 2 BTC to just 0.06 BTC for all users without KYC. The change goes into effect for new users right away and existing users on Aug. 4. (Binance website; archive)

Either Binance is making a greater effort to comply with AML rules — or they are insolvent. I’m going to go with #2. 

Meanwhile, CZ is pretending everything is fine, so people don’t move all their funds off the exchange in a panic, causing the entire house of cards to collapse, like Mt Gox in 2014. 

CZ talks a big game about making Binance compliant, but that is all it is and all that it’s ever been — talk. Along those lines, he is now discussing taking Binance US public via an IPO. (Cointelegraph)

He also says he wants to hire a new CEO as the exchange tries to comply with regulations.(Coindesk)

If you still have money on Binance, get it off now. Otherwise, #SFYL.

A world of hell for BlockFi

New Jersey-based crypto lending firm BlockFi is getting into all sorts of trouble over its high-yield BlockFi Interest Accounts, or BIAs, which look a lot like unregistered securities.

You send crypto to BlockFi and they issue you BIAs, which earn 7.5% interest. You get paid monthly, and the incentive is to just keep rolling the funds back into BIAs, because look how rich you are — on paper!

The New Jersey Bureau of Securities issued a summary cease and desist order to BlockFi ordering the company to stop offering BIAs to customers in NJ. Originally, the order was set to hit on July 22, but it has been delayed to Sept. 2, according to BlockFi. 

In a press release on July 21, the Alabama Securities Commission said it has issued a show of cause to the firm. The order gives BlockFi 28 days to explain why they should not be directed to cease and desist from selling unregistered securities in Alabama. 

Following that, the Texas State Securities Board said in a notice of hearing on July 22 that the BIA is a security under state law. A hearing is set for Oct. 13. Texas also claims BlockFi violated the state laws by selling securities without being registered as a dealer or agent. 

Vermont also issued a show of cause order on July 22.

Meanwhile, BlockFi CEO Zac Prince has spun this like a bunch of good news. “We’ve said time and again that the key to our industry’s success is appropriate regulation. Ultimately, we see this as an opportunity for BlockFi to help define the regulatory environment for our ecosystem,” he said in a blog post.

Virgil Griffith taken into custody

Virgil Griffith, the former Ethereum developer who got himself into hot water by going to DPRK and giving a talk on crypto, has got himself into more hot water. 

Griffith, who has been living with his parents since his indictment, violated his bail conditions by trying to access his crypto on Coinbase. The judge thinks he is a flight risk, so he’s put Griffith behind bars to await trial in September. 

Since his arrest in November 2019, Griffith’s $100,000 in ETH has grown to $1 million in ETH. He had his mother reach out to Coinbase on his behalf. Griffith is a smart guy, who apparently does dumb things. 

“Though the defendant is a bright well-educated man, his method of circumvention of the Order was neither clever nor effective,” the judge said. (Court filing)

Other newsworthy bits

MicroStrategy just posted a $299 million loss for Q2 after betting the house on Bitcoin. But like any crazed degenerate gambler, Michael Saylor plans to keep buying more bitcoin. (Press release; Forbes)

El Salvador’s President Nayib Bukele is pioneering hustle bro populism. Bukele distracted from his self-coup when he announced bitcoin soon after. (FP)

El Faro got a copy of the presentation Cardano gave to the El Salvador government. This is somewhere between hilarious and tragic. Bukele and his regime want to implement their colón-dollar stablecoin by Sept. 7, yet they literally have no plan for how to make it happen, so they are fishing for anything. (Leaked presentation)

Coinbase is the target of a class-action. The lead plaintiff, Brandon Leidel, claims he lost money investing in COIN when the price of the shares fell right after all the VCs cashed out. (Complaint; Law360, paywalled)

Dfinity has been hit with a class-action claiming the company sold its Internet Computer Project (ICP) tokens as an unregistered security. The suit targets Olaf Carlson-Wee’s crypto hedge fund Polychain Capital, venture capital firm Andreessen Horowitz, and Dfinity’s founder Dominic Williams as the “controlling defendants.” (Complaint; Decrypt)

DeFi exchange Uniswap is blocking 100 tokens from its website — including tokenized stocks and some derivatives. The move came right after the CFTC commissioner said contracts were illegal on DeFi. (Alexis Goldstein)

Paxos’ General Counsel takes aim at Tether and USDC, claiming that the two stablecoins it issues — Paxos Standard and BUSD — are both regulated, while Tether and USDC are not. It also claims Paxos Standard and BUSD are are backed by 96% cash or cash equivalents. (Paxos blog post; The Block)

Multilevel-marketing schemes are a predatory wealth transfer from low-information people recruited into the scheme directly to the company upper ranks’ pockets. Stephen Dhiel writes about unintentional scams. (Blog post) 

Bitcoin’s gold rush was always an illusion. Millions of people have bought into the idea that crypto could make them rich, fast. But these booms are fake. Really good story in the New Statesmen.

What’s backing Circle’s 25B USDC? We may never know

Jeremy Allaire is taking his Boston-based company Circle public via a SPAC. Circle is best known for its stablecoin USDC, which now has a market cap of $25.5 billion. 

In all his press interviews talking up the future potential of stablecoins — “Circle sits at the center of the next major transformation that the internet is bringing to the world,” he said in an investor website video  — there is one question Allaire consistently avoids giving a straight answer to: 

What is backing USDC? 

Based on his current scheme to take his company public, he may not have to come up with an answer anytime soon. 

What’s a SPAC?

SPAC stands for special acquisition company. 

Otherwise known as a “blank check” company, a SPAC is basically a shell set up by investors with the sole purpose of raising money through an initial public offering to eventually acquire another company  — “a company for carrying on an undertaking of great advantage, but nobody to know what it is.”*

Going public through an IPO is a rigorous process. It requires you to file a Form S-1 with the US Securities and Exchange Commission. An S-1 is a full-body exam, a cavity search, where you lay out all of the material weaknesses of your company. There is really nowhere to hide in an S-1. 

When you take your company public through a SPAC, however, the SPAC goes through the IPO process — not the company it ends up buying. And since a SPAC is just a room full of investment banks and private equity dudes, its S-1 is simple and straightforward. A SPAC has no skeletons in the closet. 

Once the SPAC submits its S-1 and raises money via an IPO, it goes out and finds a private company to buy and then merges with the company. In the merger, the private company gets the money and the SPAC holders get shares in the new combined entity.

The merging process requires considerably less due diligence than a traditional IPO, which is why the space is full of frauds and get-rich-quick schemes. Not all SPACs are frauds, of course, but it’s a clever way to lever up and then sell the debt to the public via shares. 

Because many of the companies taken public this way have little to show in terms of a business plan, SPACs have resulted in a slew of shareholder lawsuits. The most glaring example is electric truck startup Nikola. Three months after the company went public with a $3.3 billion valuation via a SPAC, short-seller Hindenburg Research revealed it was an intricate fraud. (The truck was rolling downhill!) Nikola’s stock collapsed, its CEO ended up stepping down, and a series of class actions followed.

“SPACs are oven-ready deals you should leave on the shelf,” an FT headline read in December. Then-SEC Chairman Jay Clayton voiced similar concerns last year. 

“I’m still keeping my mind open to the fact that there could be a good SPAC out there,” Hindenburg founder Nate Anderson told the FT. “I just haven’t seen it yet.”

Details of Circle’s SPAC

Circle is merging with Concord Acquisition Group (NYSE: CND), a SPAC sponsored by investment firm Atlas Merchant Capital. The transaction is expected to close in the fourth quarter, according to the press release.

When the transaction closes, a new company will acquire both Concord and Circle and become publicly traded on the NYSE under the ticker symbol “CRCL” — and CND will disappear. 

Concord raised $276 million in its December IPO. Here’s Concord’s S-1. It’s short, only a few pages. Compare that to the 200-page S-1 of Coinbase, the US crypto exchange that went public via direct listing in April — quite a difference.

Investors have committed another $415 million in PIPE financing to sweeten the Circle deal. PIPE, or private investment in a public equity deal, is a way to raise capital from a select group of investors who receive shares at a discount to the public market price.

Circle also raised $440 million in a May funding round. That leaves Allaire’s company — valued at $4.5 billion in this deal — with $1.1 billion in gross proceeds upon the close of the transaction. 

Circle’s finances

What do we know about Circle’s finances? Specifically, the assets behind its stablecoin? Not a lot, really.

Concord Acquisition filed an 8-K with the SEC announcing the upcoming merger. The form links to several documents. Of those, the only financial information on Circle is an investor presentation and Circle’s financial statements from December 31, 2020 and 2019. 

Here’s the thing — six months ago, Circle was in an entirely different situation than it is now. In December 2020, USDC had a $4 billion market cap. Its market cap grew to six times that in the first half of this year. Six times! Yet somehow, Circle appears to be going public without submitting its financials for Q1.

This is curious given that Q1 was a prosperous period for most crypto companies. Between January and March, $6 billion USDC were created. In that same timeframe, the price of bitcoin climbed from $29,000 to 59,000. So why would Circle leave out its March 31, 2021, financials?

This doesn’t mean that we’ll never see them. Circle could post its Q1 financials before the merger goes through.

Also, Concord still needs to file a Form S-4. An S-4 is required in a de-SPAC transaction (closing of the SPAC merger) where the SPAC’s shares are exchanged for the target’s shares.  

I wrote to Concord and Circle asking them these three questions:

  • When do you plan to file your S-4 in regard to your Circle transaction?
  • Do you plan to file the breakdown of the collateral backing the Circle stablecoin?
  • Do you have a target for your SPAC combination? If so, what is the date?

Circle and Concord answered none of the questions. Instead, they sent me back a list of 2020 and 2021 press quotes from Allaire and a link to their press release. You can see their response here.

What we know

Circle, founded in October 2013, first announced USDC in September 2018. The stablecoin is managed by a consortium called Centre — here’s their original white paper. Circle was the first member of the consortium. Coinbase joined in October 2018, and so far, there are no other members. 

Circle bought crypto exchange Poloniex in February 2018 for about $400 million with big plans to turn it into a regulated exchange. The experiment failed, and Circle ended up selling Polo less than 18 months later at a $156 million loss. 

Sean Neville, Circle’s co-founder, stepped down shortly after, without giving any clear reason for his departure. 

In December 2019, right about the time Neville left, Circle spun off its Circle Trade over-the-counter desk to focus exclusively on stablecoins. USDC issuance was slow and steady at first and then took off like a rocket in late 2020. 

Stablecoins issuers have the reputation of being like wildcat banks — a reference to banks in the 19th century that flaunted regulation and issued bank notes with abandon and often without any intention of redeeming them. 

Under the gold standard in operation at the time, these state banks could issue notes backed by gold and silver coins — though the quality of these reserves was often a question. State regulations did exist but wildcat banks, generally located in remote, hard to reach areas, were known for their creative workarounds.

Stablecoin companies issue virtual dollars that act a bit like real dollars, only they’re on a blockchain. USDC, which began life as an ERC-20 token on Ethereum, is currently on four blockchains with plans to expand to several more. 

USDC reached its first $1 billion market cap in July 2020. In the following 12 months, it literally created $24.5 billion worth of stablecoins — and we have no idea what is backing those.  

According to Centre’s website, USDC “is issued by regulated and licensed financial institutions that maintain full reserves of the equivalent fiat currency.” Every USDC is supposedly redeemable on a 1:1 basis for US dollars. 

USDC receives monthly attestations provided by accounting firm Grant Thornton LLC. These are not full audits — they are more like snapshots in time. 

The most recent snapshot is for April 30, 2021, when there were 14.7 billion USDC in circulation. The report doesn’t say much other than “US Dollars held in custody accounts are at least equal or greater than the USDC tokens outstanding at the Report Date and Time.”

However, another note on the report states that “US Dollars held in custody accounts are the total balances in accounts held by the Company at federally insured US depository institutions and in approved investments on behalf of the USDC holders at the Report Date.” (Emphasis mine.) 

Apparently, Circle’s boilerplate USDC reserves investment disclosure changed between Feb 28 and March 31, 2020, to add the phrase “and in approved investments.”

So, what are those approved investments? Who approves them? What percentage of assets are in that category? We don’t know, because Allaire won’t say. In an interview with Coindesk on June 30, he completely avoided the question, instead, rambling on about fiduciary responsibility, electronic stored money transmission, etc. (Doomberg transcribed the interview.)

High-interest ‘yield product’

On December 31, 2020, USDC was backed 100% by cash per its financial statements. Now Circle is promoting a high-interest “yield product.” The idea seems to be that you can lend Circle your USDC, and they will in turn lend them to degenerate gamblers who want leverage for crypto margin trading.

“Our Yield services provide a compelling and powerful way for institutions and corporations to access the yields that are coming from stablecoin and USDC-based borrowing and lending markets,” Allaire said in a conference call to investors.

These yield products offer 3% to 7% interest paid monthly, Circle claims — well above a risk-free rate of return. Yet, even Circle doesn’t appear to know how its yield services make money.  

“Our yield product service is an innovative product which is difficult to analyze vis-a-vis existing financial service laws and regulations around the world,” the firm says in its investor presentation. (Emphasis mine.)

Even more concerning, Circle’s business model appears to rest on bitcoin never collapsing in price: “Our yield product is collateralized predominantly by bitcoin and the value of that collateral is directly exposed to the high volatility of Bitcoin.” 

Allaire promotes USDC as the complete antithesis of Tether — the dubiously backed stablecoin that claims to have 50% of its $62 billion market cap in “commercial paper,” but doesn’t say anything about what that commercial paper consists of or where it is held. 

Despite efforts to distance itself from Tether, Circle is starting to look more and more like a similar scheme, only with a different critter on the wildcat banknotes. 

Will we ever get a straight answer from Allaire in regards to what’s behind USDC? Looks like we’ll have to wait till the S-4 comes out — that will be the real measure of transparency. 

In the meantime, I’m reminded of Dan Davies’ Golden Rule from his book “Lying for Money,” which includes a series of case studies on frauds.

“Anything which is growing unusually quickly needs to be checked out, and it needs to be checked out in a way that it hasn’t been checked before,” Davies writes. “Nearly all of the frauds in this book could have been stopped a lot earlier if people had been a bit more cynical about growth.”

* Charles Mackay, Memoirs of Extraordinary Popular Delusions and the Madness of Crowds, Chapter 2. “The South-Sea Bubble.”

Feature image: Bank of Brest five dollar bill. The Bank of Brest in Michigan was one of the most infamous wildcat banks that sprang up in the freewheeling economic environment in the US during the 19th Century.

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News: Kraken sets out to raise millions, Circle is cutting staff, Bitfinex scores another tiny victory in court

Crypto exchanges are struggling. Revenue growth is not what it was during the bubble of 2017, and regulators are cracking down. You can’t just list any old coin anymore without considering, “Is the SEC going to deem this a security?” And the cost of hiring lawyers, responding to subpoenas, and staying compliant is cutting into profits. So what are exchanges doing? They are laying off staff and/or trying to raise more money, while they hold out hope for the big institutional money that will come any day now.

Kraken and Bnk to the Future

Screen Shot 2019-05-24 at 12.12.57 AM

Recently, customers of Kraken got an interesting email offering a “rare, but limited opportunity.” Some folks thought the email was spam, but it was real.

Turns out, the San Francisco-based trading platform is partnering with Bnk to the Future as a way to raise funds by selling preferred shares of its stock. You can own a piece of Kraken for as little as $1,000. (In the US, you need to be an accredited investor, though.) 

The exchange hopes to rustle up $15.45 million. (Originally, it wanted to raise $10.2 million, but lifted the goal.) As of this writing, Kraken has raised $6.2 million from 942 investors. The crowdfund runs until June 20.

In December, Kraken tried to raise money at a $4 billion valuation, and it reportedly raised $100 million early this year, which it used to buy Crypto Facilities, a regulated London-based crypto derivatives exchange.  

In 2016, Bitfinex also used Bnk to the Future when it encouraged its customers to exchange their BFX tokens to shares in iFinex, the parent company of Bitfinex and Tether. BFX was the token that Bitfinex gave to its customers in compensation for funds they lost when the exchange was hacked. The exchange sold $57.39 million worth of iFinex shares in this manner, basically converting stolen funds to shares.

Bitfinex customers didn’t have much of an option. BFX tokens were dropping in value, and they wanted to get their money back.

Bitfinex/Tether and the NYAG law suit

Bitfinex joyously declared another small legal victory on May 22, when New York Supreme Court judge Joel M. Cohen granted a motion limiting the scope of the documents Bitfinex and Tether have to hand over to the New York Attorney General’s office.

The day prior, the companies had filed a motion to dismiss the case outright with three new court docs: proposed order to show cause, a memorandum in support of the motion to dismiss, and an affidavit by their general counsel Stuart Hoegner.

Lawyers for the companies argued the Bitfinex platform does not allow New Yorkers to trade (putting it outside of the NYAG’s jurisdiction), the Martin Act doesn’t apply to them (because tether is not a security or commodity, they said), and the document requests were too onerous. The NYAG has seven days to respond, and the judge scheduled a hearing for the motion to dismiss on June 29. 

According to Hoegner’s affidavit, which I read late one evening, you can’t actually redeem tethers 1:1 unless you bought them directly from Tether, which means if you got them on an exchange somewhere, too bad. You won’t be too surprised to learn then, that I can’t find a single person who claims to have either bought or redeemed tethers via Tether Ltd.

The Block got hold of a court transcript from the Bitfinex court hearing on May 16. “Tether actually did invest in instruments beyond cash and cash equivalents, including bitcoin,” a lawyer for Bitfinex told the court.

Wait, what? Bitcoin? Tether invested in bitcoin?

The entire purpose of tether is to be a stable asset that traders can use to escape market volatility. Yet, Tether is taking its reserves—money that it was supposed to keep an eye on, so that tethers always remained fully backed—and investing it in a highly volatile asset. What if bitcoin crashes? What then of the stablecoin? 

We learn something new about Tether everyday, it seems. According to CoinMarketCap, every 24 hours, the entire $3 billion supply of tethers changes hands 7.5 times, but not really, because most of that volume is fake.

The Block analyst Larry Cermak posted a graph of exchanges that trade tether, and some of the ones with the highest volume are obscure platforms nobody has heard of. “If I were to make an educated guess, at any given time, only a maximum of 15% of the total Tether volume is real,” he tweeted. In other words, it is all wash trading, i.e., trading bots simultaneously buying and selling tether to create the appearance of frenetic activity.

As far as I can tell, tether’s actual value is on par with horse manure—giving true meaning to the word “stablecoin”—just not as good for the roses. 

Circle and Poloniex

Circle, the Boston-based company that bought crypto trading platform Poloniex in February 2018, is laying off 30 people—10 percent of its workforce. The company blames the layoffs on an “increasingly restrictive regulatory climate.”

Last week, I mentioned that Poloniex geofenced nine altcoins, meaning people in the US will no longer be able to trade those coins on the exchange after May 29. Circle said  recent guidance from the SEC was a trigger for the move. I took another look and realized that one of the coins was Decred—a fork of bitcoin. Why Decred?

It’s possible the project’s premine and governance structure look a little to shareholdery, and Circle, which is backed by Goldman Sachs, is not in a position to risk listing any coins on Poloniex that might be construed as securities.

QuadrigaCX

I finally got around to writing up QuadrigaCX Trustee’s Preliminary Report. Ernst & Young basically says the money is all gone. Also, it adds that Quadriga’s financial affairs were a complete mess, and they’ll probably never sort everything out properly.

Remember the photo of 1,004 checks sitting on a stovetop? EY finally deposited those into a disbursement account on April 18. What a surprise for this trader to learn the money was freshly sucked out of his bank account two years later!

Also interesting, Black Banx (formerly WB21), the third-party payment processor allegedly holding $CA12 million in Quadriga funds is now issuing Visa cards without Visa’s consent. Antony Peyton, the finance journalist who had a thug show up on his doorstep last time he wrote about them, has been researching the company.

Cryptopia

New Zealand crypto exchange Cryptopia went belly up on May 14. Turns out, for the last nine months—since before the January hack that put it out of business—Adam Clark, the exchange’s former founder and programmer, has been building a new crypto exchange. According to his LinkedIn profile, he’s been working on Assetylene since September 2018. So, if you lost your money on Cryptopia, you can try again on Assetylene. I’m sure they’ve got their security issues sorted out by now.

Meanwhile, the funds that were stolen from Cryptopia are on the move. Whale Alert, who has been keeping on eye on the transfers, says funds from Cryptopia recently went to Huobi, where they were likely traded for other coins. Whale Alert also noted 500 ETH going to decentralized exchange EtherDelta.

Elsewhere in cryptoland

Facebook is getting ready to launch its GlobalCoin cryptocurrency payments system in 2020. They probably want to do something like PayPal combined with social media. David Gerard asks: “Why are on earth are they doing this as a cryptocurrency?” As he explains, nothing about putting this on a blockchain makes any sense whatsoever.

Bestmixer.io, one of the largest crypto mixers and tumblers, was shut down by Dutch authorities with the help of Europol and Luxembourg law enforcement. According to Europol’s press release, it was responsible for $200 million in money laundering.

Well, this is a shocker. The SEC has again delayed the VanEck bitcoin ETF proposal. Here is the order. The new deadline for the SEC to make a decision is August 19, and it can delay one more time for a final deadline of October 18, Jake Chervinsky tweeted. It’s been eight years, and the SEC has yet to approve any bitcoin ETFs in the US.  

Bitcoin is set to overtake the existing financial system—or maybe not. In a recent report, the European Central Bank says crypto poses no threat to financial stability in the euro zone. A “very low” number of merchants currently allow buying of goods and services with bitcoin, and there is no “tangible impact on the real economy.”

The IRS is planning to publish new tax guidance for crypto holders and traders. The last time it issued guidance was November 2014, back when it said crypto would be treated as property and you had to report earnings as capital gains.

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