New York vs DCG/Genesis and Gemini: Kids, kids, you’re both ugly

By Amy Castor and David Gerard
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The New York Attorney General is suing crypto investment fund Genesis, its parent company Digital Currency Group (DCG), and the Gemini crypto exchange for defrauding customers of Gemini’s Earn investment product. [Press release; complaint, PDF]

Earn put investors’ money into Genesis — where it evaporated.

The lawsuit also charges former Genesis CEO Soichiro (a.k.a. Michael) Moro and DCG founder and CEO Barry Silbert for trying to conceal $1.1 billion in crypto losses with an incredibly dubious promissory note.

New York is asking the court to stop all three companies’ business in “securities or commodities” in the state. That’s all but a death sentence — bitcoin is a commodity in the US.

The SEC was already suing both Gemini and Genesis over the Gemini Earn product because it looked an awful lot like a securities offering. Separately, Gemini sued DCG in July 2023 — and just last week, Gemini also sued Genesis to reclaim missing funds. [Adversary complaint, PDF]

What happened?

Three Arrows Capital (3AC) crashed on June 13, 2022, and blew a gaping hole in Genesis’ loan book. DCG scribbled an IOU to shuffle an imaginary $1.1 billion of value into Genesis reserves.

This financial styrofoam filler didn’t save Genesis, which ultimately halted all withdrawals on November 16, 2022, just days after FTX/Alameda declared bankruptcy. Genesis filed for chapter 11 bankruptcy on January 19, 2023.

The NYAG says that Genesis and Gemini defrauded more than 230,000 Earn investors of more than $1 billion total, including at least 29,000 New Yorkers. New York says that thousands more lost money because of DCG’s actions.

The NYAG claims that:

Genesis and Gemini lied to investors about Earn and Genesis’ credit-worthiness;
Genesis lied to Gemini that it was solvent;
DCG and Gemini lied to the public, including investors, about the promissory note;
Earn is an unregistered security under New York’s Martin Act.

This is a complaint we recommend you read. We all knew some of what went on between Genesis, DCG, and Gemini, but this suit goes into great detail about what happened behind the scenes.

This is a civil complaint, not a criminal indictment — but the NYAG describes several crimes being committed, particularly by DCG, Genesis, Moro, and Silbert.

How Earn worked

Gemini, owned by Tyler and Cameron Winklevoss, and Genesis Capital, a subsidiary of DCG, partnered to launch the Gemini Earn program in February 2021 — just as bitcoin’s number was going up really fast. Crypto was a hot product!

Gemini and Genesis marketed Earn to the public as a “high-yield investment program” — which is just coincidentally a common marketing term used by Ponzi schemes.

Earn promised to pay up to 8% yield. Ordinary investors could deposit their crypto via the Gemini exchange. You could get your money back anytime!

Earn was a pass-through fund to Genesis. Retailers put their crypto in Earn. Gemini then handed the funds off to Genesis, who then lent the money to institutional investors, notably crypto hedge fund 3AC in Singapore. Genesis was substantially a 3AC feeder fund — of which there were many.

When Earn investors wanted to withdraw their funds, Genesis had five days to return the principal and the interest, minus Gemini’s agent fee.

Gemini earned more than $22 million in agent fees for running Earn, plus more than $10 million in commissions when investors bought crypto on Gemini to put into Earn.

Paper thin

3AC was Genesis’ second largest borrower. 3AC had borrowed $1 billion of crypto at 8% to 15% interest, secured by $500 million of illiquid crypto tokens.

Genesis hadn’t received audited financial statements from 3AC since July 2020. But with interest rates like that, why worry — it’ll be fine, right?

It wasn’t fine. 3AC fell over on June 13, 2022, losing Genesis $1 billion. Babel Finance, another Genesis borrower, fell over on June 17, losing Genesis another $100 million — because in June 2022, everyone was falling over.

Genesis was $1.1 billion in the red — it didn’t have the funds to pay back Earn investors. Between mid-June and July 2022, Silbert and other DCG officers met with Genesis management to work out how to fill the hole in Genesis’ balance sheets — and what to tell counterparties such as Gemini.

One problem was that some of the collateral for 3AC’s loan was GBTC shares, issued by another DCG subsidiary, Grayscale — which Genesis couldn’t sell, due to restrictions on sales of stock by “affiliates” of the issuing company.

Silbert told the board of DCG that Genesis was anticipating a run on the bank if word got out. So DCG began casting about for financing. Silbert also suggested to the DCG board on June 14, 2022, that they “jettison” Genesis.

But DCG and Genesis decided instead to act like everything was fine. On June 15, Genesis told everyone its “business is operating normally.” Two days later, Genesis CEO Michael Moro posted in a tweet reviewed and edited by DCG: “We have shed the risk and moved on.” [Twitter, archive; Twitter, archive]

Everything was not fine. The 3AC hole meant that Genesis’ loss exceeded its total equity, and Genesis couldn’t pay out Earn investors. Genesis hadn’t “shed the risk and moved on” — it still had the gaping hole in its balance sheet. It was not “operating normally” — it was floundering in a panic.

Genesis was unable to find anyone to lend them the money they needed, so they had to find a way to paper the hole before the end of the quarter.

The solution: DCG would make a loan from its right pocket to its left pocket and count the loan as an asset.

(When Tether and Bitfinex tried to pull the exact same trick a few years earlier, the NYAG fined them $18.5 million and kicked them out of the state.)

So on June 30 — the last day of Q2 2022 — DCG gave its wholly-owned subsidiary Genesis a promissory note for $1.1 billion. DCG would pay it back in ten years at 1% interest.

Both Silbert and Moro signed off on the IOU. The note was, of course, not secured by anything.

DCG never sent Genesis a penny — the note was only ever meant to be a $1.1 billion accounting entry so that Genesis and DCG could tell the world that Genesis was “well-capitalized” and that DCG had “absorbed the losses” and “assumed certain liabilities of Genesis.”

None of this was true. DCG wasn’t obligated to pay anything on the note for 10 years. And Genesis was still out $1.1 billion of actual funds.

Michael Patchen, Genesis’ newly appointed chief risk officer, said in internal documents that the promissory note “wreaks havoc on our balance sheet impacting everything we do.”

Genesis directed staff not to disclose the promissory note to Genesis’ creditors, such as Gemini. Many Genesis staff didn’t even know about the promissory note until months later.

DCG’s piggy bank

DCG made Genesis’ problems even worse by treating Genesis like its own personal piggy bank.

In early 2022, DCG “borrowed” more than $800 million from Genesis in four separate loans. When $100 million of this came due in July, DCG forced Genesis to extend the maturity date — and DCG still hasn’t paid a penny of it to date.

A DCG executive told a Genesis managing director on July 25, 2022, that DCG “literally [did not] have the money right now” to repay the loan. Genesis had no choice — the managing director replied: “it sounds like we don’t have much room to push back, so we will do what DCG needs us to do.” DCG also dictated the interest rate for this loan.

Around June 18, 2022, DCG borrowed 18,697 BTC (worth $355 million at the time) from Genesis. It partially paid this back on November 10, 2022 — with $250 million worth of GBTC! — but this still left Genesis with no cash to pay back its own creditors. And it still couldn’t liquidate the GBTC.

It’s hard to consider the deals between Genesis, DCG, and Grayscale as anything like arm’s length — it was a single conglomerate’s internal paper-shuffling.

On November 2, CoinDesk reported that FTX, one of the largest crypto exchanges, was inflating its balance sheet with worthless FTT tokens. The report brought FTX tumbling down, and FTX filed for bankruptcy on November 11, 2022.

Around November 12, 2022, Genesis sought an emergency loan of $750 million to $1 billion from a third party due to a “liquidity crunch.” Its efforts were unsuccessful. On November 16, Genesis halted redemptions.

If you owe Gemini a billion dollars, then Gemini has a problem

Gemini Earn investors were supposed to be able to get their funds back at any time. This meant that those funds had to be highly liquid. Gemini told investors it was monitoring the financial situation at Genesis.

Gemini absolutely failed to do this. They lied to investors, and they hid material information.

Gemini got regular financial reports from Genesis. Gemini’s internal risk analyses showed that Genesis’ loan book was undercollateralized for Earn’s entire operating existence. But Gemini told Earn customers that Genesis had more than enough money to cover their loans.

Starting in 2021, Genesis’ financial situation went from bad to worse. In February 2022, after analyzing Genesis’ Q3 2021 financials, Gemini internally rated Genesis capital as CCC-grade — speculative junk — with a high chance of default.

Gemini also found out that Genesis had a massive loan to Alameda — secured by FTT tokens! The same illiquid FTX internal supermarket loyalty card points that were discovered by Ian Allison at CoinDesk to make up about one-third of Alameda’s alleged reserves.

Even after Genesis recalled $2 billion in loans from Alameda, the crypto lender was still full of loans to affiliates, including its own parent company DCG.

In June 2022, the crypto markets crashed and burned. But Gemini continued to reassure investors that it was safe to feed money to Genesis via Earn.

This was apparently fine when it came to someone else’s money, but according to the complaint:

During this same period, Gemini risk management personnel withdrew their own investments from Earn. A Gemini Senior Risk Associate working on Earn withdrew his entire remaining Earn investment — totaling over $4,000 — between June 26, 2022, and September 5, 2022.

Likewise, Gemini’s Chief Operations Officer [Noah Perlman], who also sat on Gemini’s Enterprise Risk Management Committee, withdrew his entire remaining Earn investment — totaling more than $100,000 — on June 16 and June 17, 2022.

This was when DCG tried to paper over the hole in Genesis’ balance sheet with a $1.1 billion IOU.

Gemini realized things weren’t good at Genesis, but it’s not clear that they realized how bad they were — not helped by Genesis lying to Gemini about their true condition.

From June to November 2022, Genesis would send Gemini false statements on their financial condition — for instance, saying that the DCG promissory note could be converted to actual cash within a year, when in fact, it was a 10-year note.

Gemini didn’t tell investors that Genesis was in trouble. Instead, they thought they’d “educate clients on the potential losses” and “properly set clients’ expectations.”

When the Gemini board was advised of Genesis’ financial state in July 2022, one board member compared Genesis debt-to-equity ratio to Lehman Brothers before it collapsed.

Gemini tried and failed to extricate itself from Genesis. They just could not get the funds back. But they knew that Genesis operated as a closely controlled sockpuppet of DCG, and they wanted Silbert to make good on Genesis’ debt.

As things at Genesis got worse, Gemini worked out how to break the news to Earn creditors.

On September 2, 2022, Gemini finally decided to terminate Earn. On October 13, Genesis formally terminated the Earn agreements and demanded the return of all investor funds.

On October 20, 2022, Silbert met with Cameron Winklevoss of Gemini. Silbert said that Gemini was Genesis’ largest and most important source of capital — meaning that Genesis could not redeem Earn investors’ funds without Genesis declaring bankruptcy.

Gemini quietly granted Genesis multiple extensions to return investor funds.

On October 28, 2022, Silbert finally let Genesis tell Gemini the true terms of the promissory note — just two weeks before Gemini cut off withdrawals.

For some reason neither we nor the NYAG can fathom, Gemini cointinued to take investors’ money and put it into Earn right up to the end!

Customer service

Gemini didn’t do anything so upsetting for Earn investors as to tell them about Genesis’ unfortunate condition — even as Gemini’s own staff closed out their positions in Earn.

One customer wrote to Gemini on June 16, 2022, three days after 3AC collapsed, asking if any of their funds were with 3AC. Gemini didn’t answer the question, but replied with vague reassurances about Genesis’ trustworthiness.

Another wrote on June 27, 2022: “with other exchanges like Celsius and Blockfi I am concerned about Gemini. Does Gemini have any similar vulnerabilities? … liquidity vulnerabilities? … risky investments/loans that would risk my assets or cause Gemini to halt withdrawals?”

Gemini responded: “Gemini is partnering with accredited third party borrowers including Genesis, who are vetted through a risk management framework which reviews our partners’ collateralization management process.”

This investor was sufficiently reassured to send in another $1,000.

A third customer wrote on July 24, 2022, asking specifically if Gemini was involved in any of the “drama” around 3AC and if it impacted Earn. Gemini said they weren’t involved in anything regarding 3AC — even as the 3AC crash had in fact blown out Earn.

The consequences

The NYAG is asking the court that all three companies be permanently banned from dealing in “securities or commodities” in New York — e.g., bitcoin.

Some of the press coverage noted this provision — but didn’t notice that it would be a near death sentence for a crypto business. DCG’s profitable Grayscale business would have to leave New York or be sold off. Gemini would be kicked out of the state.

New York is also seeking restitution for the victims and disgorgement of ill-gotten gains.

Also, they all get fined $2,000 each. It’s possible that bit of the General Business Law could do with an update.

Posted on October 30, 2023October 30, 2023 by Amy Castor 0

CoinDesk retracts stories about sponsors, makes implausible excuses

By Amy Castor and David Gerard

Send your sponsorship to the most incorruptible writers in crypto journalism — us. Here’s Amy’s Patreon and here’s David’s. It’s the only workable way!

On two successive days this month, CoinDesk retracted anonymous opinion pieces with weird and spurious explanations. Both stories just happened to be about companies who sponsor CoinDesk. The crypto world noticed, and it’s not happy.

Justin Sun

On August 27, CoinDesk pulled an article detailing Justin Sun’s concerning and questionable practices in the crypto space two days after it was published. The story was titled: “Justin Sun: The Next Do Kwon or Sam Bankman-Fried? The TRON founder has built a crypto empire that would cause collateral damage if it collapsed.” [CoinDesk, article archive of August 26, retraction archive of August 27]

CoinDesk editor-in-chief Kevin Reynolds claims the story was pulled because it didn’t meet CoinDesk standards. He even said that the story “never should have been published.”

This statement is simply not credible. The story was on a topic that was clearly in the public interest. It was extensively cited and backed with data.

The article was written by “awbvious awbvious,” the pseudonym of a “DeFi user and internet artist” — but it was also edited and reviewed before publication by two experienced CoinDesk editors: Ben Schiller (managing editor for features and opinion) and Daniel Kuhn (deputy managing editor for CoinDesk’s Consensus Magazine).

So how does a story that was reviewed by two competent editors suddenly not meet standards?

Reynolds says the story was a personal attack:

… we allow the use of anonymous sources and, from time to time, publish articles written under pseudonymous bylines, but with one very important caveat: we cannot grant the cloak of that identity protection to a writer who launches an outright personal attack against an individual.

The article is built around data-based claims. There are no personal attacks in the story. Reynolds is making statements about the story and its author that are clearly false if you read the actual article text — now safely available on an archive site out of CoinDesk’s control. [archive]

Reynolds claims he was invoking, and links to, CoinDesk’s little-used policy on not outing pseudonymous article subjects. We call this the Scammer Identity Protection Rule, because functionally it is. Marc Hochstein, former CoinDesk editor in chief and current Consensus executive editor, put the rule into place in 2020. [CoinDesk, 2020, revised 2023; archive, 2021]

This rule is mostly ignored in practice at CoinDesk — because it’s obviously stupid. Crypto is an area of finance that’s saturated with fraudsters. Knowing the players’ names is clearly in the public interest. Are you doing journalism or are you doing PR?

But the Scammer Identity Protection Rule doesn’t say a word about articles with anonymous bylines. Reynolds is citing and linking to a rule that doesn’t apply to what he’s just done: retracting an article.

So why did CoinDesk pull the story? The simpler explanation is that the WhiteBIT crypto exchange, controlled by Justin Sun, is one of the few remaining banner ad buyers on CoinDesk — and CoinDesk can’t afford to lose sponsors

CoinDesk may have been concerned that Sun was being compared to two people under criminal indictments. This is a reasonable objection — but the article easily could have been edited to the data-based claims, or to make it clearer that the comparison was in terms of systemic risk.

This would also have avoided a retraction that didn’t make coherent sense — a retraction that made absolutely sure that everyone in crypto read the article.

Chainalysis

The day before the Sun story was pulled, CoinDesk also retracted a pseudonymous op-ed about Chainalysis by crypto Twitter regular L0la L33tz: “Chainalysis Investigations Lead Is ‘Unaware’ of Scientific Evidence the Surveillance Software Works.” [Twitter, archive; CoinDesk, article archive of July 26, retraction, archive of August 26]

Here’s the article summary:

Elizabeth Bisbee, head of investigations at Chainalysis Government Solutions, testified she was “unaware” of scientific evidence for the accuracy of Chainalysis’ Reactor software used by law enforcement, an unreleased transcript of a June 23 hearing shared with CoinDesk shows.

… Bisbee said she was unable to provide the court with statistical error rates for Chainalysis’ Reactor software. She further denied being aware of any scientific peer-reviewed papers or “anything published anywhere” attesting to the accuracy of Chainalysis Reactor. Instead, Chainalysis reportedly judges its software’s accuracy using customer feedback, she said.

This is clearly newsworthy subject matter. It’s a story that makes factual claims about information that the news site saw concerning the administration of justice.

Bitcoin Magazine promptly reprinted the Chainalysis story when CoinDesk pulled it. Yahoo News still has the original CoinDesk version up. [Bitcoin Magazine; Yahoo]

What’s really weird is that CoinDesk retracted the story a full month after it was published.

As with the Sun story, Kevin Reynolds’s retraction claimed that “we cannot grant the cloak of that identity protection to a writer who launches an outright personal attack against an individual.”

Reynolds also claimed: “Given that the very nature of the piece violates that standard — allowing us no way to merely correct the story and be done with it — we are removing the story in its entirety.” [archive]

That’s curious — because when the retraction hit crypto Twitter and the article was reprinted in Bitcoin Magazine, CoinDesk suddenly found the ability to republish almost all of the article! [CoinDesk, archive of 29 August]

After his previous slander of L33tz, Reynolds realized people were watching his behavior and took care to note in his un-retraction: “It was not our intent to besmirch the reputation of the writer, who has for some time used the same pseudonym and built a reputation around it.” Wasn’t that nice of him.

Chainalysis just happens to be a portfolio company of Digital Currency Group, who (as of this moment) still own CoinDesk. Chainalysis also sponsors the 2023 Consensus conference and the CoinDesk GenC podcast. [CoinDesk, archive; CoinDesk]

“If you retract an article while you have such a huge conflict of interest, that’s just not okay,” L33tz told Gizmodo: [Gizmodo]

L0la L33tz told Gizmodo the article was received well by the editor she worked with and that she was encouraged to write more stories like it in the future.

L0la L33tz claims she only discovered the redaction after stumbling upon it online, saying that nobody at CoinDesk reached out to her to suggest corrections to alter the article or even to inform her that the story had been retracted.

There are no respectable media outlets in a crypto winter*

Leaving a story up for a month and then attempting to vanish it — without even contacting the author — is not competent behavior, individually or organizationally.

Reynolds’ retractions seem not only to slander the authors of these articles, but also to imply his fellow editors Ben Schiller and Daniel Kuhn were incompetent.

Whatever the true reasons for the retractions, they clearly weren’t anything to do with protecting pseudonymous article subjects or harsher rules on pseudonymous authors.

CoinDesk was building up a journalistic head of steam again — with amazing successes like taking down FTX, and the reputations of its best writers.

Whoever was responsible for this debacle has trashed the improvements to CoinDesk’s reputation in two days.

This all comes as CoinDesk is being sold to Peter Vessenes and Matthew Roszak’s consortium. (The sale is in the final stages, but hasn’t quite gone through as we write this.) Was this supposed to make the site more or less attractive to the buyers?

CoinDesk has always been a money-loser. The conference business is the only part of the site that makes any money. (DCG is keeping this bit and selling the rest of the site.) This is a precarious position to be in, especially in a crypto winter.

As we lamented about The Block’s troubles, you can’t make money in crypto news without becoming just another cog in the crypto PR machine.

People will always wonder who your funders are and what you’re doing for them — and they’ll be absolutely correct to do so.

We advise that you treat crypto media as ephemeral and subject to the whims of publishers who suddenly realize they’ve said too much. Always keep copies.

The first rule is still: archive everything.

——-

* except us, of course

Posted on August 29, 2023August 30, 2023 by Amy Castor 2

Crypto collapse: Terra judge repudiates Ripple finding, Razzlekhan cops a plea, Binance’s FDUSD stablecoin, CoinDesk sold, smart contracts still stupid

By Amy Castor and David Gerard

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“EXCLUSIVE: IT’S RUMORED THAT GARY GENSLER HAD A BLT FOR LUNCH TODAY. EXPERTS BELIVE THIS IS BULLISH FOR A POSSIBLE SPOT BITCOIN ETF APPROVAL”
— Sean Tuffy

IMPORTANT: Patreon sponsors, please check your pledges!

Patreon changed its billing for this month from California to Dublin. So a lot of banks rejected the transactions as possible fraud.

This would easily be reversible … except that Patreon’s systems automatically wiped all patron relationships where a transaction bounced! [Twitter thread, archive]

If you sponsor anyone on Patreon, not just us: please check your transactions for August, re-send them if they bounced, and rejoin as a patron if you need to. The “retry” link should be located in your billing history. Your creators will be most grateful!

We also have Ko-Fi links where you can send us casual tips — here’s Amy’s and here’s David’s.

Razzlekhan cops a plea

Bitcoin rapper Heather “Razzlekhan” Morgan and her husband Ilya Lichtenstein were arrested in February 2022 for hacking Bitfinex in 2016. They agreed to a plea deal a couple of weeks ago. [DOJ press release; Reuters]

The plea hearings were today, Thursday, August 3. Morgan pleaded guilty to money-laundering conspiracy and conspiracy to defraud the United States. The BBC says that “Morgan masqueraded as a rapper.” [BBC]

Lichtenstein pleaded guilty to money-laundering conspiracy. He also admitted to being the original perpetrator of the Bitfinex hack!

Lichtenstein stashed some of the hacked funds as buried gold coins. Arrr. [Bloomberg, archive; CNBC]

Curve: smart contracts, stupid humans

“Smart contracts” are small programs that run right there inside a blockchain. In enterprise computing, these would be called “database triggers” or “stored procedures.”

You never use triggers or stored procedures unless you absolutely have to, because they’re very easy to get wrong and a pain in the backside to debug. In the real world, you keep your financial data and the programs working on it separate.

So, of course, crypto uses programs embedded in the database for everything and touts the difficulty in working with them as a feature and not evidence of the idea’s incredible stupidity.

A smart contract full of crypto can reasonably be treated as a piñata, just waiting for you to whack it in the right spot and get the candy.

Today’s piñata is Curve Finance, a DeFi exchange used for trading stablecoins and other tokens. Curve was hacked on July 30 due to a bug in the Vyper language compiler. Smart contracts that were using Vyper versions 0.2.15, 0.2.16, and 0.3.0 were vulnerable. About $70 million in funds was drained from liquidity pools whose smart contracts used these versions. [Twitter, archive; Twitter, archive]

Vyper, which is inspired by Python, was supposed to have been an improvement over the hilariously awful Solidity — a.k.a. “JavaScript with a concussion” — that most Ethereum Virtual Machine smart contracts are written in. Unfortunately, the Vyper compiler had a bug that meant compiled code was exploitable. So you could mathematically prove your smart contract program was correct … and the compiled version could still be exploited. This could hit any Vyper smart contract using vulnerable versions. [Twitter, archive]

Some have suggested that the Vyper exploit and subsequent Curve hack were “state-sponsored” — which is quite possible, given that we already know that North Korea actively seeks to launder money using crypto.

If North Korea is caught cashing out from the Curve hack, then we suspect large DeFi protocols may get a call from OFAC soon for the same reasons that Tornado Cash did.

David wrote an entire book chapter on all the ways that smart contracts were stupid back in 2017. He foolishly thought that this would knock the idea firmly on the head.

CoinDesk on the block

The bankruptcy of Genesis left Genesis owner Digital Currency Group scrambling to sell off the silverware. DCG’s news site CoinDesk was rumored in January to be up for sale. CoinDesk is now being bought for $125 million by an investor group led by Matthew Roszak (Tally Capital) and Peter Vessenes (Capital6). [WSJ]

DCG bought the failing media outlet in 2016 for $500,000. It’s been shoveling money into CoinDesk ever since. DCG wants to keep the CoinDesk conference business, which is the only part of the site that makes any money.

Bitcoin old-timers will remember Vessenes from the Bitcoin Foundation of the early 2010s. He was the CEO of CoinLab, which was functionally a US agent for the Mt Gox exchange. CoinLab and Mt Gox sued each other repeatedly over alleged contractual breaches. After Mt Gox went bankrupt, CoinLab escalated its claims against the dead exchange from $75 million to an amazing and implausible $16 billion. [Bitcoin Magazine, 2013; Cointelegraph, 2019]

We don’t know what Vessenes wants with a media outlet that only loses money, even from a commercial propaganda perspective. We suppose he could alienate the site’s expensive hires of the past couple of years.

A Ripple in the war on Terra

Terraform Labs issued the TerraUSD and Luna coins, which triggered the crypto crash of May 2022, which popped the 2021 bubble.

We were surprised to hear that Terraform is not dead! It has a new CEO, Chris Amani, who was previously the firm’s COO and CFO. Amani’s hot plan is to revive the Terra blockchain. Amani says that Terraform won’t be launching a new stablecoin. Founder Do Kwon, who is in jail in Montenegro, is still Terraform’s majority shareholder. [WSJ]

The SEC’s case against Terraform proceeds. Terraform filed in May to dismiss the SEC’s complaint, using similar arguments as Coinbase and Ripple. Terraform recently filed that the bizarre July finding in the Ripple case supports dismissing the SEC complaint.

The SEC responded to Terraform and confirmed that it’s appealing the Ripple ruling because it’s nuts: “Ripple’s reasoning is impossible to reconcile with all of these fundamental securities laws principles … SEC staff is considering the various available avenues for further review and intends to recommend that the SEC seek such review.” So we can look forward to that appeal in Ripple. [Doc 29, PDF; Doc 47, PDF; Doc 49, PDF; case docket]

Judge Rakoff concurred with the SEC and got quite pointed about the very dumb and bad ruling in Ripple: [Doc 51, PDF]

Howey makes no such distinction between purchasers. And it makes good sense that it did not. That a purchaser bought the coins directly from the defendants or, instead, in a secondary re-sale transaction has no impact on whether a reasonable individual would objectively view the defendants’ actions and statements as evincing a promise of profits based on their efforts.

… Simply put, secondary-market purchasers had every bit as good a reason to believe that the defendants would take their capital contributions and use it to generate profits on their behalf.

We don’t expect the Ripple ruling to stand.

4

Crypto trading is illegal in China — technically, anyway. The Wall Street Journal says that Binance users coming in from China still trade $90 billion a month — it’s “Binance’s biggest market by far,” with over 900,000 users. [WSJ]

The importance of China is “openly discussed internally.” In fact, “the exchange’s investigations team works closely with Chinese law enforcement to detect potential criminal activity.”

Binance denies the reports, with the very specific wording: “The Binance.com website is blocked in China and is not accessible to China-based users.” Good thing nobody in China uses a VPN, hey. The WSJ says that Binance directs its Chinese users to “visit different websites with Chinese domain names before rerouting them to the global exchange.” [Cointelegraph]

Binance CEO Changpeng “CZ” Zhao responded “4” — meaning that it’s all FUD. [Twitter, archive]

Fore!

The US Department of Justice is considering charges against Binance, but worries about causing a run on the exchange — or so says Semafor, which says the DoJ is considering fines or a deferred prosecution agreement instead. We think that any Binance user who hasn’t already priced in yet more US government action against Binance, particularly an indictment, just doesn’t want to be told. [Semafor]

Binance is cutting employee benefits, citing a decline in its profits — which suggests its customers are running away screaming. The non-US employees laid off in June were offered severance of two months’ salary paid in BNB tokens. [WSJ]

If Binance has a drop in profits, it’s likely the large institutional traders — Binance’s “VIPs” — jumping ship while they can. Where can they be going? Is there a good casino left for the VIPs with an ample supply of suckers to milk? Or was Binance the end of the line?

CZ has filed a motion to dismiss the CFTC complaint against him. He holds that Binance just doesn’t do business in the US, so the CFTC doesn’t have jurisdiction. Also, the securities aren’t securities, apparently. [Doc 59, PDF]

CZ wanted to just shut Binance US earlier this year because of the regulatory heat, two people told The Information. The BAM board voted, but the lone holdout was Binance US CEO Brian Shroder. CZ also considered selling Binance US to Gemini or a sovereign wealth fund. Binance told Cointelegraph that it was “not commenting” on this issue. [The Information, paywalled; Cointelegraph]

In June, the SEC Nigeria ruled that Binance Nigeria had to stop operating in the country. Binance claimed that “Binance Nigeria” had nothing to do with them. SEC Nigeria has now reiterated that they really do mean binance.com. Nigeria has also told all other crypto platforms to desist: “all platform providers, making such solicitations, are hereby directed to immediately stop soliciting Nigerian investors in any form whatsoever.” [SEC Nigeria]

Everybody gets a stablecoin!

On July 26, Binance listed a new coin, FDUSD — a “1:1 USD-backed stablecoin issued by First Digital Labs. Reserves of FDUSD are held by First Digital Trust Limited.” Its trading pairs are BNB, USDT, and BUSD — with zero fees. [Twitter, archive; Binance]

Binance has been going through the stablecoins lately. Binance’s own BUSD has shut down, Binance doesn’t seem to be on such solid terms with Tether, and it tried pumping out a few billion questionably backed TrueUSD after that coin’s main custodian, Prime Trust, had collapsed. First Digital — previously known as Legacy Trust — just happens to be the remaining custodian for TrueUSD.

FDUSD was launched on June 1. Data Finnovation wonders why millions of dollars of deposits to and minting of FDUSD started a week before its supposed launch. “If you believe these are strongly linked to real usd you deserve what you’re gonna get.” [press release; Twitter, archive]

Vincent Chok, CEO of First Digital, has a storied history in business. Before Chok’s move to Hong Kong, he was selling real estate in Canada with Platinum Equities in 2014 — a company that was sanctioned by the Alberta Securities Commission for fraud (though Chok wasn’t named). Chok’s previous company was Intreo Wealth Alliance in Calgary. [press release]

None more stable

Wyoming is trying to do a stablecoin again with their Stable Token Commission! The total budget for the initiative: $500,000. We wrote before about Caitlin Long’s crypto bank Custodia and what a disaster that was. Custodia also hoped to launch a national stablecoin backed by the Fed, but the Fed was having none of it. So good luck, guys. [Wyoming Truth]

Michel de Cryptadamus notices that Tether’s attestations show its actual cash on hand is getting quite low. On December 31, 2022, they claimed to have $5.31 billion in cash. On March 31, 2023, they claimed $481 million. On June 30, 2023, they claimed just $90 million. This is as the issuance of tethers keeps going up. But we’re sure it’s all fine. [Twitter, archive]

The New York Fed wrote about “Runs on Stablecoins” — concerning the Terra-Luna collapse of May 2022. David Rosenthal contextualizes the New York Fed paper: “Note in particular that traders don’t actually believe that USDT is safe, it is just that its size makes it convenient for traders to use USDT unless, like Wile E. Coyote, they look down at it as they did last May.” [NY Fed; blog post]

The White House has told Rep. Patrick McHenry’s stablecoin bill to go away, at least according to McHenry. [The Block]

Coinbase: not so keen on regulatory clarity

Coinbase wants regulatory clarity. The SEC was happy to give it to them. Brian Armstrong of Coinbase told the Financial Times that prior to the SEC suing Coinbase in June, the commission told them to delist all cryptocurrencies other than bitcoin. [FT, archive]

The SEC told CoinDesk that “SEC staff does not ask companies to delist crypto assets. In the course of an investigation, the staff may share its own view as to what conduct may raise questions for the Commission under the securities laws.” [CoinDesk]

Coinbase told CoinDesk that the FT report “lacks critical context” but was somehow unable to also say what the context was.

This is pretty rich given that it was literally Armstrong who told this to the FT, presumably hoping to gin up the crypto crowd — which he certainly did.

Coinbase concurred that the SEC did not, in fact, formally tell the exchange to delist everything except bitcoin.

We strongly suspect the actual conversation was Coinbase asking “Well how can we absolutely avoid breaking any laws then, smart guy?” and then the SEC fellow suggesting the very safest possible option.

Good news for bitcoin

Kyle Davies from Three Arrows Capital (3AC) has gone sovereign citizen. Davies holds that renouncing his US citizenship in October 2020 means that he can’t be held in contempt of court for not responding to 3AC liquidators Teneo in their US action. Davies’ lawyers also claimed that he hadn’t been properly served, as if he could claim not to know about the proceeding while arguing it in court. [Doc 106, PDF; Doc 107, PDF; case docket]

The SEC suggests that crypto “attestations” that aren’t audits might be a worry … for the accountants. Subheadings in the SEC’s statement on “The Potential Pitfalls of Purported Crypto ‘Assurance’ Work” include “The Accounting Firm’s Potential Liability for Antifraud Violations.” The footnotes mention that “liability for fraud may extend to “attorneys, engineers, and other professionals or experts.” This means that the SEC will look at what the developers were doing. [SEC]

Swift is running a pilot program that lets you make instant payments across different currency zones! So what backend do you need to use for instant remittances across currency zones? It turns out the answer is: a database. [FinExtra]

Kuwait has banned cryptocurrency for payments or investments. The National Committee for Combating Money Laundering and Terrorism Financing says it’s doing this to implement FATF requirements. Crypto mining is also banned. Securities under the Central Bank of Kuwait or Capital Markets Authority regulation are exempt. [Arabian Business; Al Jarida, in Arabic]

FedNow, the Federal Reserve’s real-time retail settlement system, has gone live, dragging US retail banking kicking and screaming into the 2000s. This puts a Fed CBDC into the trash can, as the White House had already noted. The hard part is getting thousands of banks to sign up. But the Fed has its ways of asking for things. [Federal Reserve]

Media stardom

David told the Moscow Times — who are not fans of Mr. Putin and who are currently banned in Russia — that a CBDC ruble wouldn’t do anything new to help evade sanctions that Russia can’t already do with rubles: “The problem is that nobody wants rubles.” [Moscow Times]

Posted on August 3, 2023August 4, 2023 by Amy Castor 1

Crypto collapse: Fahrenheit buys Celsius, DCG may be broke, Hong Kong cracks down, Binance commingling, how Bitfinex was hacked

By Amy Castor and David Gerard

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Temperature drop

Fahrenheit has officially won the bid for the bankrupt Celsius Network’s assets — pending approval by the court, which is near-certain, and by regulators, which is less so. A $10 million deposit is due by Monday. [Doc 2713, PDF]

Fahrenheit is a consortium that includes VC firm Arrington Capital, miner US Bitcoin, investment firm Proof Group, former Algorand CEO Steven Kokinos, and Seasons Capital CEO Ravi Kaza.

The new deal is an adaptation of the previous NovaWulf proposal. A “NewCo” will be created to take ownership of Celsius’ remaining DeFi tokens, its loan portfolio, its venture capital investments, its bitcoin mining operation, and $500 million in “liquid cryptocurrency” (not specified, but presumably Celsius’ remaining BTC and ETH). US Bitcoin will manage Celsius’ bitcoin mining operation.

Holders of Earn claims, some holders of Convenience claims, Withhold claims, and Borrow claims will receive equity in NewCo, pro rata. NewCo will endeavor to get a public stock exchange listing for the equity. Earn claimants will also get a distribution of the liquid cryptocurrency and any proceeds from litigation.

If you’re a Celsius creditor, the plan contains lots of important details. Read it and discuss this with your fellow creditors.

As with the original NovaWulf proposal, we think this is a Hail Mary pass that can only work if number goes up. On the other hand, it’s doing something and not just liquidating what little remains. Also, Alex Mashinsky won’t be involved.

DCG: When your left pocket can’t pay your right pocket

In the Genesis bankruptcy, Genesis’ parent company Digital Currency Group missed a $630 million payment to Genesis due earlier this month. Note that that’s a payment from themselves to themselves, and they still failed to make it.

This failure to pay was noted by Gemini, which has a tremendous interest in getting that money so Gemini Earn investors can be paid back. Gemini Earn’s retail customers are the largest creditor of Genesis. [Gemini, archive of May 25, 2023]

Gemini Earn was an investment product where Gemini customers put their money into Genesis to earn unlikely interest rates. Gemini’s customers were not so happy at the prospect of their money being stuck in the Genesis bankruptcy for months or years.

So in February, the creditors worked out an “agreement in principle” — not, you’ll note, an actual deal — whereby they would get money back from DCG, as the owners of Genesis. [press release]

In April, the creditors got sick of DCG messing about and upped their demands. This led to a bizarre statement from DCG on May 9 that they were “in discussions with capital providers for growth capital and to refinance its outstanding intercompany obligations with Genesis.” They didn’t have the money to pay themselves. [CoinTelegraph]

Gemini also plans to file a reorganization plan of its own. This is likely why Genesis has filed asking for its exclusive right to make reorganization proposals to be extended to August 27. The court will hear this motion on June 5. [Doc 329, PDF]

Either DCG is trying extremely hard to screw over Genesis customers … or, despite all the millions and billions with dollar signs in front in their accounts, and “$200 million” a year in Grayscale management fees, DCG is broke — at least in actual money — and has been pretending not to be broke. And we’re pretty sure Gemini is pushing this point this hard because they can’t cover their customers either. Imaginary assets are great — until you have to pay up.

Binance is outraged at Reuters catching them out again

Reuters has caught Binance at it again. This time, Binance was commingling customer funds and company revenue on the order of billions of (actual) dollars in their Silvergate accounts in 2020 and 2021. Controls? What are controls? [Reuters]

Binance told Reuters that this was money being used to buy BUSD and this was “exactly the same thing as buying a product from Amazon,” per Brad Jaffe, Binance’s VP of communications since August 2022.

This explanation is at odds with Binance’s previous claims to customers that dollars they sent to Silvergate were “deposits” that they could “withdraw” as dollars. Jaffe said that “the term ‘deposit’ is a communication term, it’s not an indication of the technical treatment of the funds.” Oh, a communication term — you mean like when words mean things in a context?

Reuters didn’t find any misappropriation of customer funds in the documents they saw. But commingling is a massive red flag for incompetence (as it turned out to be with FTX) and fraud — such as moving money around to evade regulatory scrutiny. Reuters includes a complex diagram of the international flows of Binance’s cash in the report.

Binance PR person Patrick Hillmann dismissed the story as “1000 words of conspiracy theories” and said that Reuters was “making stuff up.” Though Hillmann never stated at any point that Binance hadn’t commingled funds at Silvergate. Hillmann also decried “the xenophobia behind consistently mentioning @cz_binance’s ethnicity without noting that he’s been Canadian since the age of 12” … which the Reuters story didn’t do at all. [Twitter, archive]

Hong Kong brings some regulatory clarity

The Hong Kong Securities And Futures Commission (SFC) has finished its consultation on virtual asset trading platforms opening to retail investors. The rules allow licensed exchanges to offer trading to the public in tokens that are highly liquid and are not securities.

The rules are strict — no securities, no lending, no earn programs, no staking, no pro trading, and no custody. Unlicensed crypto exchanges are not allowed to advertise. Hong Kong very much wants to avoid the sort of embarrassment that comes with a large exchange like FTX failing.

Exchanges will be required to assess the failure risk of all tokens they offer trading in. Tokens are required to have a 12-month track record. Exchanges will need to get smart contract audits where appropriate. 98% of client assets must be in cold wallets (offline); hot wallets must not hold more than 2%.

Margin trading is not yet allowed even for professional investors, but the SFC will issue guidance on derivatives in the future.

The guidelines take effect June 1, which is when exchanges can begin to apply for a license. [SFC; Consultation Conclusions, PDF]

Regulatory clarity around the world

Japan will be enforcing FATF rules on crypto from June. This went through with no objections because Japan learned its lesson from Mt. Gox and regulated crypto exchanges early. [Japan Today]

FATF tells CoinDesk that it didn’t actually demand that Pakistan not legalize crypto. “Countries are permitted, but not required, to prohibit virtual assets and virtual asset service providers.” [CoinDesk]

The International Organization of Securities Commissions is putting together recommendations on crypto. Service providers need to address conflicts of interest, separation of functions, and accounting client assets, and this has to work across borders. Get your comments in by July 31. [IOSCO, PDF; recommendations, PDF]

Huobi gets kicked out of Malaysia for failure to register. Not registering is a violation of Malaysia’s Capital Markets and Services Act of 2007. The Securities Commission Malaysia said Huobi has to disable its website and mobile apps on platforms including the Apple Store and Google Play. [Securities Commission Malaysia]

The CFTC is talking about all the fraud in crypto, says it’s on good working terms with the SEC on these matters, and warns the crypto industry that it’s not going to be a soft touch. [Reuters]

The SEC has changed the disclaimer that commissioners say before speeches — probably in response to William Hinman’s comments saying ether wasn’t a security being cited in the Ripple case. [blog post]

Molly White put up Rep. Sean Casten (D-IL) questions at May 18, 2023, stablecoin hearing, and it’s a lovely five minutes. This guy understands precisely how Web3 was fundamentally a venture capital-funded securities fraud. [YouTube]

Bitfinex: whoops, apocalypse

The Organized Crime and Corruption Reporting Project obtained an internal report on the August 2016 hack of the Bitfinex crypto exchange — the hack that led to the Tether printer going wild and the 2017 crypto bubble.

The report was commissioned by iFinex and prepared by Ledger Labs. It was never released, but OCCRP has obtained a draft.

Bitfinex kept transaction limits secured by three keys. It looks like someone made the mistake of putting two of the three keys on the same device. This is how the hacker was able to raise the global daily limit and drain the accounts.

One key was associated with a generic “admin” email address and another linked to “giancarlo,” which belonged to Bitfinex CFO Giancarlo Devasini. The report does not blame Devasini for the hack.

Ledger Labs thinks the hacker came in from an IP address in Poland. [OCCRP]

Tether’s issuance is up — but its usage is through the floor. The trading volume is at its lowest in four years. Most of the tether trading happens on Binance, which is where the majority of all trading volume happens, and where USDT is accepted as being worth a dollar. We mentioned last time that volume was down, but Kaiko has the numbers. [Kaiko]

More good news for bitcoin

Do Kwon’s bail has been scrapped. He’s back in jail in Montenegro, awaiting his local trial on charges of forging documents, specifically the ones he was using to try to get out of Montenegro to his next bolt-hole. [Reuters]

Glassnode tells us that hodling has never been more popular! 68.1% of BTC hasn’t moved in the past year! Now, you might think that this is because most people who bought in during the bubble are still underwater. But “baghodler” isn’t yet a word. [Glassnode]

Shaquille O’Neal was finally served in the FTX class action suit against the exchange’s celebrity promoters — at the former FTX Arena. [Washington Post]

Openfort is scraping up the very last of the Web3 gaming venture cash — they just got $3 million to do an online crypto wallet for blockchain games. You know, that gigantic current market that anyone has the slightest interest in. Openfort doesn’t appear to have a customer as yet. [VentureBeat]

Coinbase has a new TV ad! We know you lost all your money — but crypto is like the early Internet, really. [Youtube]

Solana is so thoroughly out of ideas that they’re adding a ChatGPT plugin. Presumably, it can write tweets for them. [The Block]

Crypto fans make up new justifications for the importance of their magic beans all the time. David Rosenthal takes us through a few. [DSHR Blog]

Video: The problems with Crypto Currency. Max Silverman wanted to do an animation, so asked David for 90 seconds of audio. It came out great! [YouTube]

Posted on May 26, 2023 by Amy Castor 0

Crypto collapse: Coinbase rattles sabres at the SEC, Voyager sale collapses, Terra-Luna, Binance

By Amy Castor and David Gerard

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“All financial complexity is a footnote to ‘don’t hand all your money to some random guy promising high returns.’”
— Matt Levine on Celsius Network

Coinbase takes on the SEC

Crypto bitterly resents any possible regulation. It’s an industry of proud scofflaws. This presents some difficulties to regulators, who are used to financial firms that listen to them.

Coinbase keeps demanding “regulatory clarity.” What this means is that they want special permission to do things that are presently just illegal.

FTX blew up spectacularly in November, and its CEO and top execs were indicted for fraud. In the wake of FTX’s collapse, the SEC has the political backing it needs to get much more serious about making crypto exchanges comply with rules that have always been there.

In the meantime, the SEC’s lack of jackbooted statist enforcement over the last decade has allowed Coinbase to grow larger and larger — which means that Coinbase has bigger guns to challenge the regulator with.

In July 2022, Coinbase petitioned the SEC to make a clear framework for crypto asset trading. Coinbase handwaved that putting unregistered securities on a blockchain was “a paradigm shift from existing market practices, rendering many of the Commission rules that govern the offer, sale, trading, custody, and clearing of traditional assets both incomplete and unsuitable for securities in this market.” [Petition, 2022, PDF]

The SEC didn’t respond — because this claim is just stupid — and in the time since have stated repeatedly that they think the Howey test of what is a security in the US is just fine.

In March, the SEC sent Coinbase a Wells notice saying that they were going to file an enforcement action. Coinbase promptly filed a petition for a writ of mandamus to try to force the SEC to respond to their July 2022 letter. [CNBC; Writ of Mandamus, PDF]

The petition pounds on the table and cites an extensive range of blog posts as legal authorities. The introduction sets the tone:

“Contrary to the prior actions and statements of the Commission and its officials, the SEC Chair now claims that it is ‘clear’ the securities laws already apply to digital assets and platforms.”

Never mind the DAO Report from 2017, let alone the past century of judicial precedent that securities laws apply to what you do, not what you call the assets you are trading. A security is a security is a security.

And the SEC has been very clear — it’s saying that most crypto tokens are securities. There are rules for trading in those securities, and Coinbase needs to comply — or stop trading in them.

As Gary Gensler’s latest dad joke video puts it: “Many crypto platforms are just pretending that these investment contracts that they offer are more like goldfish … It’s not a lack of regulatory clarity.” [Twitter, video]

Coinbase pivots to video

Coinbase has also put up its response to the SEC’s Wells notice. [Response, PDF]

The exchange claims that the SEC approving the company’s S-1 filing to go public surely constitutes approval of all its possible business lines — a claim that crypto pumpers have been promoting heavily. This theory is, in legal jargon, on crack.

Coinbase also confidently asserts that none of what’s listed on the exchange is a security. None of it! Coinbase’s theory is that a given asset is a security only if and when it’s determined in court to be one — despite extensive legal precedent that something can be a security before it’s registered or has come to the SEC’s attention.

It’s just not possible to run a digital assets exchange trading in securities that follow SEC rules, Coinbase pleads. Apparently, this is a problem for the SEC, not for the violators.

Coinbase has threatened the SEC with a scorched earth legal battle: “if the Commission pursues this matter, it will face a well-resourced adversary that will necessarily be motivated to exhaust all avenues” — much as Ripple has been. We think this is unlikely to get the SEC to back down.

So confident is Coinbase in its legal position in the Wells notice that it’s making videos to reassure its user base that all is well. This just makes Coinbase look desperate and clownish — winners don’t make promotional videos for their legal filings. [YouTube]

Why is Coinbase so insistent on trading unregistered securities? Because Coinbase’s business is in deep trouble. Trading volume on the exchange is through the floor — it’s dropped to $26.8 billion so far in April. March was $49 billion in total. This is the lowest volume on the exchange since the crypto crash. [FT]

The Voyager sinks

Binance US pulled out of its $1 billion purchase of Voyager Digital. On Tuesday, April 25, Binance sent Voyager a letter canceling the sale. [Twitter; Doc 1345, PDF]

Voyager will now proceed to liquidation — as it probably should have when it first declared bankruptcy in July 2022 — and give the creditors whatever’s left.

Voyager’s lawyers said in a Wednesday hearing that they were surprised by the letter — Binance was still talking with them about the deal up to the previous Friday. Likely recoveries for Voyager creditors are in the range of 40% to 65%. [CoinDesk]

Imagine how much creditors’ money Voyager could have saved on expensive bankruptcy professionals if they’d just gone straight for liquidation nine months ago. Recoveries would have been on the order of 70%.

The ongoing good news for Terra-Luna

Terraform Labs has answered the SEC’s February suit, which claims that the collapsed UST stablecoin and its free-floating twin LUNA were offered as securities. The SEC’s case asserts that UST was part of Terraform’s Anchor Protocol investment scheme because you had to first buy UST to get into Anchor.

Terraform wants the suit dismissed on the grounds that digital assets can’t be securities — good luck with that one, guys! — and even if they can, UST was a stablecoin, and therefore can’t be a security. Terraform’s motion appears to be written in crayon. [Notice of motion, PDF; Memorandum, PDF]

Crypto VC firm Paradigm submitted an amicus brief in support of Terraform’s very stupid theory. Paradigm argues that SEC’s premise for treating stablecoins as securities would “radically and impermissibly” expand the definition of a security. [Amicus, PDF; Docket]

Terraform Labs co-founder Daniel Shin was finally indicted in South Korea along with nine others. Shin is facing charges that include violating capital markets laws. Do Kwon, the other co-founder of Terra, was arrested in Montenegro last month. [YNA; Bloomberg]

All the good news for Binance

The legal net around Binance tightens. Last month the CFTC filed a civil suit against them. A long-running criminal investigation is being led by the Justice Department’s Money Laundering and Asset Recovery Section and prosecutors in the US attorney’s office in Seattle. The SEC is conducting a parallel investigation.

Binance and CZ have lawyered up and are in discussion with regulators and the Justice Department: [NYT, archive]

“In February, Patrick Hillmann, its chief strategy officer, revealed the exchange was in talks with regulators about a settlement to resolve the various legal investigations with a fine or some other penalty. He said the company was ‘highly confident and feeling really good’ about the discussions. A month later, the C.F.T.C. filed its lawsuit.”

David Silver thinks Binance is screwed: “The truth will come out,” he said. “And Binance will be held culpable.”

Binance has resumed its support for Russian-issued credit and debit cards after Russian cards were cut off for the past year. Payments go via Qiwi. The withdrawal limit is 200,000 RUB (about $2,486). [Meduza]

Other good news for bitcoin

The FBI has searched the Washington, DC, home of former FTX executive Ryan Salame on the morning of Thursday, April 27. It’s not clear what they were looking for. Salame was the first FTX insider to turn on Sam Bankman-Fried. [NYT]

Gemini wants to set up a non-US crypto derivatives exchange. Their first product would be BTC-GUSD perpetual futures, with ETH-GUSD to follow. [Bloomberg; Gemini]

The US Justice Department has charged North Korean bank official Sim Hyon Sop for his role in two crypto laundering conspiracies. “The IT workers gained employment at U.S. crypto companies using fake identities and then laundered their ill-gotten gains.” [Press release; Sop indictment, PDF; Sop et al indictment, PDF]

Digital Currency Group subsidiary Genesis is bankrupt. Creditors have noticed that DCG is substantially cashed-up compared to Genesis and are insisting that DCG put more money toward the bankruptcy estate — particularly given how much control DCG clearly exercised over Genesis. So Genesis has filed for mediation over the amount that DCG will need to contribute to the reorganization. [CoinDesk]

Bloomberg writes about Celsius Network creditors and how they’re feeling. Their money is just gone, and it’s not coming back. Mashinsky et al. stole some of it and set the rest on fire through ineptitude. All the creditors have left is hope. Celsius really should have liquidated rather than declared Chapter 11. [Bloomberg]

David Rosenthal has written a marvelous summary of his decades in the world of blockchains: “Crypto: My Part In Its Downfall.” [blog post]

Image: Coinbase CEO Brian Armstrong. Photo by Steve Jennings (Getty Images for TechCrunch) enhanced for (regulatory) clarity.

Posted on April 29, 2023April 29, 2023 by Amy Castor 1

Crypto collapse: Crypto.com’s shadow bank Transactive, US banks and crypto, Binance not so good with actual money

By Amy Castor and David Gerard

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“funds are safe. we’ve done a risk assessment and found that 100% of hacks happen when someone has access to their coins, so we’re revoking that access to make them even safer”
— Boxturret

Transactive: Lithuania shuts down a money laundromat

Crypto exchanges have trouble finding stable gateways for actual money. Proper banks won’t talk to them, so they turn to shadow banks, which cater to high-risk clients and use lots of tricks to skirt the traditional banking system.

Sometimes the exchanges just lose their gateway — and your money.

We wrote earlier about how Crypto.com customers’ euro deposits were seized by the Lithuanian government as part of an anti-money laundering enforcement action against the exchange’s payment provider, Transactive Systems UAB. Cryptadamus has a great post explaining what happened. [Substack]

If you had EUR on Crypto.com before this, it’s gone. The “EUR” you see in your account is unbacked. Work out what you can do to extract value from your outstanding balance, while Crypto.com gives you the runaround.

Transactive was also the payment channel for crypto lender Nexo, whose Bulgarian offices were recently raided by authorities. Transactive has an office in the UK as well — Transactive Systems Ltd. [Transactive]

After getting authorization from the UK Financial Conduct Authority and the Bank of Lithuania to act as an electronic money institution (EMI), Transactive grew astonishingly quickly in just five years — thanks to its clientele in crypto, gambling, and forex, and whoever else they were processing money for. [Bloomberg, archive]

Given Transactive’s sordid history, it’s amazing that the FCA authorized them at all.

Transactive emerged from the rubble of PacNet Services, an international payments company that started in Vancouver. PacNet was forced to wind down after the US Treasury sanctioned it as a “transnational criminal organization” — specifically, being the middleman for mail-fraud scam artists. Several PacNet executives were charged with fraud and money laundering. [US Treasury, 2016; DOJ, 2019]

A CNN investigative report from 2016 details how PacNet employees moved large piles of money around the world. PacNet set up bank accounts in the names of shell companies, they sent packages of cash labeled “legal documents,” they bribed Russian banking officials, and they even used a private plane to ferry cash to customers. [CNN, 2016]

So the money launderers left PacNet and moved over to a totally legitimate new business —Transactive, co-founded by convicted healthcare scammer Scott Roix.

In February 2022, the Bank of Lithuania fined Transactive 20,000 EUR for commingling customer and company funds. Transactive had also misreported its customer balances and its equity capital. [Lieutvos Bankas, in Lithuanian]

In January 2023, the Bank of Lithuania accused Transactive of massive money laundering and froze the company’s funds. It ordered Transactive to stop servicing clients in finance, forex, and crypto, pending a review. [Lietuvos Bankas, in Lithuanian]

Transactive notified clients about this trivial hiccup and said their funds were being “safeguarded” — a word meaning “you’ll never see your money again.” If an investigation discovers any of the money was dirty (if!), the government will seize the funds. [Reddit]

Crypto.com has told its euro-using customers that their SEPA (Single Euro Payments Area) transfers are being migrated to a new provider. Now the exchange has to find a new provider.

Here are Crypto.com customers screaming into the void to get their funds back. Crypto.com has yet to tell them what actually happened to their money. [Twitter, Twitter]

Unless Crypto.com had euros stored somewhere other than Transactive Systems UAB, they are likely insolvent in EUR and will have to start from scratch, paying withdrawals with new deposits until they can somehow fill the gap — or not.

US crypto banks are out of favor

In the US, Crypto.com still banks with Silvergate, which allows their institutional clients to transfer USD from their bank accounts to the exchange. This channel may have problems in the near future, due to Silvergate’s dealings with FTX.

The US Federal Reserve really, really hates banks touching crypto and is not putting up with it even a bit — especially after Silvergate needed a $4.3 billion bailout. The Fed issued a policy statement on January 27: [Federal Reserve; Federal Reserve, PDF]

“The statement makes clear that uninsured and insured banks supervised by the Board will be subject to the same limitations on activities, including novel banking activities, such as crypto-asset-related activities.

In particular, the preamble would provide that the Board would presumptively prohibit SMBs from holding most crypto-assets as principal, and also would provide that any SMB seeking to issue a dollar token would need to demonstrate, to the satisfaction of Federal Reserve supervisors, that the bank has controls in place to conduct the activity in a safe and sound manner, and to receive a Federal Reserve supervisory nonobjection before commencing such activity.”

That second paragraph directly addresses Silvergate’s plan to revive Diem (née Facebook’s Libra) and do their own private stablecoin for retail customers. Yeah, no. Silvergate says it’s written off its Diem investment after previous regulator refusals to let them print private money, but the Fed evidently thought it was still worth emphasizing their “no.”

The US Department of Justice is investigating Silvergate over its FTX and Alameda Research dealings. FTX customers were wiring money to Alameda and to Alameda’s dubious subsidiary North Dimension via the bank, thinking that money was going directly to FTX. The DOJ wants to know what Silvergate knew, and when they knew it. [Bloomberg]

Binance: increasingly freed from the chains of filthy fiat

In the UK, the Binance crypto exchange should have no access to pounds, ever. After the Financial Conduct Authority warned in March 2022 that “in the FCA’s view, Binance Markets is not capable of being effectively supervised,” UK banks cut off direct deposit to Binance immediately. [FCA, 2022]

But Binance knows you can’t keep a dedicated gambling addict down, so they keep trying to weasel their way back into the UK’s Faster Payments network, most recently through payments processor Paysafe. Sometimes this works. Binance recommends UK customers send money in and out via Visa — but even that’s being cut off by the banks. [Twitter; CoinDesk]

Cryptadamus traces Binance’s Visa connection — Binance owns crypto debit card issuer Swipe, which it bought in 2021! Swipe also issued a crypto debit card for FTX. [Twitter; Binance; FX Empire]

Australian users also report payment issues with Binance — even via Visa. [Twitter]

In the US, Binance users say they can’t withdraw funds in amounts of less than $100,000 from American banks. Binance says that’s fake news and everything is fine. Cryptadamus has been documenting the difference between Binance’s official statements and what customers report. [Reddit]

When Bitfinex was cut off from banking in 2017, users would buy bitcoins just to get their funds out of the exchange. This drove the price of bitcoin up and may have helped trigger the 2017 crypto bubble. So all of this is good news for bitcoin!

FTX in bankruptcy

At the next FTX bankruptcy hearing on February 6, Judge John Dorsey will hear arguments for and against appointing an examiner. FTX and the Unsecured Creditors’ Committee are against hiring an examiner, but the US Trustee and various state regulators want one. John Reed Stark thinks it’s absolutely necessary. [Agenda, PDF; LinkedIn]

Brian Glueckstein of Sullivan & Cromwell for FTX filed a declaration in support of FTX’s objection to an examiner. It’s 3,855 pages of mainly exhibits. But the US Trustee wants it stricken from the record because the deadline to file was January 25, and Glueckstein filed on February 3, one business day before the hearing. Oops. [Declaration, PDF; Doc 617, PDF]

FTX is suing Voyager for repayment of $446 million of loans. After Voyager filed for bankruptcy in July, it demanded repayment of all outstanding loans to FTX and Alameda. FTX paid the money back for Alameda — but because they paid it back so close to FTX’s bankruptcy filing, FTX wants to claw it back again. [Complaint, PDF; Reuters]

In the legal case against Sam Bankman-Fried, Judge Lewis Kaplan has barred Sam from using Signal or Slack and from contacting any former FTX employees without lawyers present until February 9, when he’ll hear arguments. He wasn’t impressed when Sam reached out to a key witness, who we assume is FTX US counsel Ryne Miller, to “vet” things on the phone. [Order, PDF]

SBF’s bail conditions required two more sureties. These are now in, with their names redacted: $200,000 and $500,000. Judge Kaplan has agreed to unseal the names, but they’ll remain redacted pending possible appeals. [Bond, PDF; Bond; PDF, Memorandum Opinion, PDF]

Digital Currency Group

The second day hearing in the Genesis bankruptcy is February 22. No agenda yet. We wonder if anyone will attempt to go after Genesis’ owners, DCG. [Notice, PDF]

The Gemini crypto exchange implied to its Gemini Earn customers in 2022 that their deposits were protected by FDIC insurance, and customers took Gemini’s statements to mean they were protected by the FDIC from Genesis failing. But Gemini didn’t technically say that! So it must be fine, right? [Axios]

DCG’s crypto news site CoinDesk claimed to have prospective buyers approaching them unsolicited and offering hundreds of millions of dollars for the site. The new rumor is that the prospective buyers are looking at buying only parts of the site — the conference business or the media outlet — and certainly not at paying hundreds of millions of dollars. [Twitter]

Other good news for bitcoin

Coinbase was fined 3.3 million EUR (USD$3.6 million) by De Nederlandsche Bank for not registering as a money transmitter in the Netherlands. [Reuters]

Coinbase bragged about having proper registration in September 2022. But the violation occurred in the years prior when they weren’t properly registered. [Coinbase, 2022]

MicroStrategy posts another loss. This is its eighth straight quarterly loss in a row. Before former CEO Michael Saylor started to amass bitcoin in 2020, the company had $531 million in cash. Now it’s down to $43.8 million in cash. [Bloomberg]

MicroStrategy is one of the loans that Silvergate is particularly worried about. In March 2022, MicroStrategy borrowed $205 million in a three-year loan from Silvergate. The loan was collateralized with bitcoin — and Silvergate will need to worry about that too.

Image: PacNet’s part owner Don Davis (on the left) posted on LinkedIn. Airplanes are great for moving piles of cash.

Posted on February 5, 2023February 6, 2023 by Amy Castor 0

SEC sues Genesis and Gemini, Genesis owes $3 billion to creditors

By Amy Castor and David Gerard

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Kids, kids, you’re both ugly

There’s a huge conflict between the Gemini crypto exchange and the Genesis crypto investment firm over the Gemini Earn product — and what happened to the money.

Fortunately, the SEC has stepped in to clear things up — they’re suing both of them! [Press release; Complaint, PDF; Docket]

The charge is that the Gemini Earn program, which offered retail investors up to 8% return on crypto they lent to Genesis, was an unregistered securities offering. This is because it was really obviously an unregistered securities offering.

Genesis had hitherto only dealt with accredited and institutional investors, which is fine. But starting in February 2021, Gemini Earn gave Genesis access to money from ordinary retail investors. Somehow, this didn’t set off the “Howey test” alarms for anyone at either company.

(Coincidentally, February 2021 is when the GBTC premium dried up. Did someone need money quickly?)

The SEC says: “Both Defendants were integral to the operation and success of the Gemini Earn program.”

Retail customers suffered hugely — they are out $900 million — as Gemini froze withdrawals without warning in November, after Three Arrows Capital (3AC) collapsed in July, then FTX collapsed in November. The SEC has actual harm it can point at.

Gemini terminated the Earn program on January 8, when it pulled the plug on its Master Loan Agreement between Genesis and Gemini.

The SEC is getting out there and just busting unregistered crypto securities now that the government and public are onside.

Here’s Gary Gensler, explaining in a video what the SEC just did in very small words. [Twitter, video]

The SEC complaint

The SEC’s complaint outlines how Gemini Earn worked.

Genesis was founded in 2018. It marketed its services to institutional and accredited investors — and that was more or less fine.

With Gemini Earn, however, Genesis got into soliciting retail investors, via Gemini — and selling to retail requires companies to file paperwork with the SEC and make important financial disclosures, so the public can make an informed decision about what they are investing in. Of course, neither company bothered with that part.

Earn investors agreed they were sending their cryptos to Genesis. Gemini acted as the agent in the offer. In the first three months of 2022, Gemini received about $2.7 million in agent fees from the Gemini Earn program, according to the complaint.

Gemini Earn took in billions of dollars worth of cryptos — mostly from US retail investors. Both companies widely marketed Gemini Earn by promoting its high interest rates.

By November 16, 2022, when Genesis froze withdrawals, it was holding $900 million in Gemini Earn investors’ cryptos, from 340,000 customers, mostly in the US.

The SEC holds that Gemini Earn is an investment contract, per the Howey Test:

Gemini Earn involved the investment of money;
in a common enterprise;
and investors reasonably expected to profit from the efforts of the defendants.

If you want to sell such an offering to retail investors, you have to file the paperwork. Or the SEC can bust you.

Prayer for relief

The SEC asks that the defendants don’t offer unregistered securities ever again, that they be enjoined from offering Gemini Earn and any similar offering in the future, and they disgorge all ill-gotten gains — that includes interest and all profits associated with Earn — and pay civil penalties.

Most SEC suits never go to trial, they just end in a settlement. There is no settlement as yet.

By the way, investors will likely be able to claim the right of rescission — if you buy something that’s found to be an unregistered security, you can just demand all your money back. Section 12(a)(1) of the Securities Act says “Any person who — (1) offers or sells a security in violation of section 5, … shall be liable, subject to subsection (b), to the person purchasing such security from him”

If the SEC prevails, investors will be able to demand their money back from Gemini as well as from Genesis — the SEC considers both companies were offering Gemini Earn, even as their internal agreement said Gemini was just acting as Genesis’ agent. After all, one of these two companies appears to be solvent.

Former SEC chief of Internet Enforcement John Reed Stark tells us:

An SEC victory would take disgorgement and penalties and perhaps deposit it all in a FAIR fund for investors. The sole priority of the SEC staff filing the action will be to give those investors their money back who hold the $900M of Earn that is now worth nothing. Any remedial steps would typically entail hiring a law firm to create and manage a distribution plan, working feverishly towards that goal of helping investors who incurred losses.

That the SEC seeks disgorgement of profits and penalties to make investors whole is good news for Gemini’s Earn investors. Given that Gemini has the assets to satisfy a judgment, there is cause for some optimism, as opposed to other situations involving bankrupt entities where angry customers are more likely stuck last in line as unsecured creditors.

It’s an outrage!

Tyler Winklevoss of Gemini has responded to the SEC’s action: [Twitter]

It’s disappointing that the @SECGov chose to file an action today as @Gemini and other creditors are working hard together to recover funds. This action does nothing to further our efforts and help Earn users get their assets back. Their behavior is totally counterproductive.

Fortunately, there’s a remedy: the suit demands that Gemini and Genesis give everyone’s money back — $900 million — out of their own pockets, which the Winklevosses are entirely capable of doing because they still sit atop a mountain of bitcoins.

Tyler further pleads that “the Earn program was regulated by the NYDFS and we’ve been in discussions with the SEC about the Earn program for more than 17 months.”

That’s great! Were the SEC discussions along the lines of “you really need to register this stuff before we shut you down”? Perhaps Tyler could clarify.

Also, the SEC complaint notes specifically that New York didn’t regulate anything about how Gemini Earn operated. One of the points of the SEC complaint is that there was no other regulator.

The Daily Beast spoke to former Gemini employees about the Earn program. They had boggled at the terms and conditions — deposits were uninsured and crypto was lent out on an unsecured basis, meaning Genesis wasn’t putting up any collateral. “We were like, ‘Holy sh-t, are you f-ing kidding me?’” [Daily Beast]

The SEC had previously gone after BlockFi for failing to register its crypto-lending program, and they stopped Coinbase from launching its crypto-lending program, so they are getting serious about ending this sort of nonsense.

Current unconfirmed rumor: Gemini will get only this SEC charge and will settle with a fine — and disgorgement. But the Department of Justice and the US Attorney’s Office for the Eastern District of New York are coming quickly for Genesis and its parent company Digital Currency Group (DCG). [Twitter, archive]

Genesis is in hock for $3 billion

Genesis owes more than $3 billion to creditors, according to sources who spoke to the Financial Times. DCG is looking for silverware to sell to plug the gap. DCG has a huge venture portfolio it’s looking at dipping into. [FT, archive]

DCG had been trying to raise capital — about $1 billion — after 3AC blew up Genesis’ books. But it couldn’t get any takers. So now DCG’s only option is to try to sell what it’s got.

DCG’s portfolio includes 200 crypto companies — and most of them are illiquid because crypto is a losing business right now.

Some direct customers of Genesis — not Gemini Earn customers, but Genesis’ accredited and institutional customers — are claiming that Genesis lied to them to get them to reinvest after they pulled out: [Protos]

He says he was lured back in by reassuring emails from Genesis salespeople and the delivery of monthly balance sheets that seemed to show in late summer and early fall that the firm’s financial position was stable. The creditor now says those financial documents were inaccurate and hid the firm’s growing financial problems.

Media stardom

David went on Blind Spot Markets Live on Friday morning. The transcript is up now. Izabella Kaminska talked to David about FTX, Nexo, Genesis vs. Gemini, and US banking for crypto companies. This episode was sponsored by Big Nocoin, the Federal Reserve, and the Pentagon. [The Blind Spot]

Image: They fired 10% of their staff and went on tour. Instagram.

Posted on January 13, 2023January 13, 2023 by Amy Castor 3

Crypto collapse: DCG’s problem is Grayscale, FTX Bahamas agreement, DeFi trading arrest, Silvergate Bank, Huobi, Binance

By Amy Castor and David Gerard

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Oh, what a tangled web we weave, when first we practice to deceive!
— Sir Walter Scott, 1808

DCG: Congratulations, you played yourself

The Department of Justice’s Eastern District of New York and the SEC are looking into money flows between Barry Silbert’s Digital Currency Group and its lending subsidiary Genesis, and what investors were told about the transfers. [Bloomberg]

DCG has been playing all the same games as the rest of crypto — trying to create the illusion of money where there is no money, to keep the party going a little bit longer.

Genesis should have declared insolvency in June when Three Arrows Capital (3AC) blew a $2.4 billion hole in its accounts — but DCG purchased 3AC’s defaulted loan from Genesis and financed the purchase with a promissory note of $1.1 billion, to be paid back over 10 years.

That is: DCG and Genesis counted an internal IOU as money, to claim Genesis was still solvent.

The catch with the promissory note is that if the 10-year loan is “callable” — meaning DCG would have to pay Genesis the full amount immediately in the event of a liquidation or bankruptcy — then it could give Genesis creditors a claim on DCG itself, and take all of DCG down with it.

“The Promissory Note is like a noose wrapped tight around the neck of DCG. If Genesis goes over the cliff, it drags DCG with it,” said Ram Ahluwalia, the co-founder of Lumida, an investment advisory firm that focuses on crypto. [Twitter]

In a letter to shareholders in November, Silbert disclosed that DCG borrowed another $575 million from Genesis — due in May 2023. The funds were used for “investment opportunities” and buying back shares of DCG stock from outside investors. [Twitter]

A creditor committee that includes crypto exchange Gemini presented Genesis and DCG with a plan to recover the assets. Silbert had until January 8 to respond. Cameron Winklevoss threatened that “time is running out.” [Twitter; Twitter]

We think Gemini will try to force Genesis into involuntary chapter 11 — they just need three creditors to file a petition with the bankruptcy court. The judge then holds a hearing and decides if the matter will go through. [11 U.S. Code, section 303]

Gemini Earn, Genesis, GBTC, and 3AC

As is usual in crypto, DCG screwed itself by greed. DCG also owns Grayscale, which operates the Grayscale Bitcoin Trust (GBTC) — DCG’s cash cow. Grayscale collects a whopping 2% annual fee on its assets under management — currently, 633,000 BTC.

GBTC traded above the face value of the bitcoins in the fund up to early 2021 — then it dropped below net asset value (NAV).

Genesis took the crypto it got from Gemini Earn customers and lent those funds out to institutional investors and crypto hedge funds — such as Three Arrows Capital.

3AC was one of the biggest investors in GBTC, taking advantage of a lucrative arbitrage opportunity. They would borrow bitcoins from Genesis and swap those for GBTC shares at NAV from Grayscale. After a six-month lockup, 3AC could dump the shares on retail for a handsome profit. Rinse and repeat, and when GBTC was trading at 20% above NAV, they could make a 40% profit a year that way

This GBTC arb played a big role in keeping the price of bitcoin above water in 2020, setting the stage for the 2021 bitcoin bubble.

At the end of 2020, 3AC was the largest holder of GBTC with a position worth $1 billion at the time. After February 2021, the GBTC premium dried up, and GBTC began trading on secondary markets at a steep discount to NAV.

3AC had hoped the discount would be reversed when the SEC approved Grayscale converting its bitcoin trust to an ETF. But the SEC rejected the application, and the GBTC discount continued to widen. [Bloomberg]

When 3AC defaulted on its $2.4 billion loan to Genesis, Genesis seized the collateral backing the loan, including 17.4 million shares of GBTC, and filed a $1.1 billion claim against 3AC — a claim that is now on DCG’s books. [Coindesk; Affidavit Russell Crumpler, PDF]

Class action against Gemini Earn

Gemini partnered with Genesis for their Earn program. After Genesis lost $175 million in FTX in November, it froze withdrawals. Gemini Earn froze withdrawals in turn. Now Gemini Earn customers are out $900 million.

In an effort to get those funds back, three Gemini Earn customers are seeking class arbitration against Genesis and DCG.

Gemini and Genesis had a “master digital asset loan agreement,” which Gemini Earn customers entered into — when you became an Earn customer, you agreed you were lending money to Genesis.

The complaint alleges that Genesis breached this agreement by hiding its insolvency through a “sham transaction,” whereby DCG “bought” the right to collect a $2.3 billion debt owed to Genesis by 3AC with the aforementioned $1.1 billion promissory note. The plaintiffs also claim that the Genesis loan agreement created an unregistered sale of securities. [Press release; Complaint, PDF; Master Digital Asset Loan Agreement]

The master loan agreement states that: “Each Party represents and warrants that it is not insolvent and is not subject to any bankruptcy or insolvency proceedings under any applicable laws.”

This is why Silbert keeps insisting that Genesis has a liquidity issue and not a solvency issue — even as those are functionally identical in crypto. If Genesis was found to be insolvent and took customer funds in, it would be in violation of that contract. (As well as promptly calling that promissory note from DCG.)

Amidst all of this, Larry Summers, the former US Treasury Secretary and World Bank Chief Economist, has quietly left DCG — going so far as to remove all mention of DCG from his own website. Summers joined DCG as a senior advisor in 2016, a year after the company’s founding. [Protos]

Silvergate Bank

Moody’s has downgraded Silvergate Bank’s long-term deposit rating to Ba1 from Baa2 after the crypto bank announced that its customers — who are almost entirely crypto firms now — withdrew $8 billion in deposits in Q4 2022: [Moody’s]

The negative outlook reflects Moody’s view that the bank’s profitability over the near term will be weak along with the risk of further declines in deposits from crypto currency centric firms further pressuring profitability. In addition, the negative outlook reflects the increasing regulatory and legal risks that the firm is currently facing.

Silvergate’s other customers are worried about the bank’s solvency and about the regulatory heat coming its way. Silvergate was key to FTX/Alameda having access to actual money — they helped funnel money to FTX from accounts in the name of Alameda and of Alameda’s dubious subsidiary, North Dimensions.

If Silvergate are found to be complicit in FTX’s fraud, they will be fined. But if there was money laundering and sanctions busting, they could be shut down. They will at the very least be fined. We would guess some individuals will also get a bar from being bankers. Here’s a list of enforcement actions on Federal Reserve member banks. [Federal Reserve]

Silvergate’s 8-K SEC filings this year are full of bad news. We noted Silvergate’s layoffs and writing off its Diem investment last time. [SEC 8-K; SEC 8-K; SEC 10-Q]

FTX

After a series of knock-down-drag-out filings — and the hilarious revelations of how FTX Digital Markets (FTX DM) was functionally Sam Bankman-Fried’s Bahamas partying fund — the US and Bahamas bankruptcies are working together now. John Jay Ray III and his team met in Miami with the joint provisional liquidators (JPLs) handling the FTX DM liquidation, and they’ve reached an agreement. [press release; agreement, PDF]

The Bahamas JPLs will handle everything to do with FTX DM, and the US administrators will handle everything to do with all the other FTX companies. The JPLs will handle the Bahamas real estate and the cryptos being held by the Securities Commission of the Bahamas. (This doesn’t mean that the Bahamas will handle the disbursement of the crypto they have under their control — only that FTX is fine with them holding the funds for now.) The parties will share information. FTX DM’s chapter 15 foreign entity bankruptcy in the SDNY will continue.

We suspect it was clear the US side would win in court, and the Bahamas liquidators realized they weren’t being paid enough to damage their reputations this way. The agreement is subject to approval by the courts in the US and the Bahamas, but it would be surprising for them not to allow it.

The Department of Justice has put out a call for victims of “Samuel Bankman-Fried, a/k/a ‘SBF.’” That’s his rapper name now. [Justice]

Huobi’s real-time meltdown

Huobi has always been a dodgy crypto exchange — even before it was run by Justin Sun from Tron. Huobi has $2.6 billion in reserves, and 40% of that is its own HT token. If you don’t count its own internal supermarket loyalty card points, Huobi is insolvent. [Twitter]

Huobi is desperately searching its pockets for spare change. On December 30, Wu Blockchain reported that Huobi was canceling year-end bonuses and planning to slash half its staff of 1,200 people and cut the salaries of senior employees. Sun denied the rumors. [Twitter; South China Morning Post; Twitter]

Other unofficial reports from small accounts on Twitter said that Huobi was offering to pay its employees in stablecoins — USDC and tethers — instead of actual-money yuan. If they objected, they would lose their jobs. [Twitter]

Employees revolted at being paid in magic beans — so Sun cut off internal communications. On January 4, Bitrun said that “all communication and feedback channels with employees” had been blocked. [Twitter]

Here’s the unofficial details on how Huobi is treating its employees. Those who quit because they’re getting paid in tethers get no severance pay either. This is what a doomed company does. [Twitter]

After initially denying Huobi was cutting staff, Sun finally admitted that Huobi was indeed laying off 20% of its employees in the first quarter of 2023 — after rumors swirled that half of all employees would be let go. [FT]

Huobi users rushed to get their funds off of the exchange. Blockchain analytics platform Nansen noted a wave of withdrawals on January 5 and 6. Following the withdrawals, Peckshield reported a wallet associated with Tron moved $100 million in stablecoins — USDC and tethers — into Huobi. [Twitter, Twitter]

In a lengthy Twitter thread, Sun assures you that your funds are totally safe. We fully expect the exchange to blow up at any moment. [Twitter]

Binance

US prosecutors for the Western District of Washington in Seattle are sending subpoenas to hedge funds for records of their dealings with Binance. John Ghose, formerly a Justice Department prosecutor who specialized in crypto and now a lawyer at compliance vendor VeraSafe, thinks this is about money laundering. [Washington Post]

We noted previously that “BUSD” on Binance is not the BUSD issued by Paxos, which claims to be backed by actual dollars in Silvergate Bank. Binance “BUSD” is a stablecoin-of-a stablecoin, maintained internally. This is the sort of arrangement that’s fine until it isn’t.

It turns out that Binance has been issuing uncollateralised “BUSD” on its own BNB blockchain. Data Finnovation looked at the Ethereum and BNB blockchains and saw that Binance has a history of minting fake “BUSD” internally on BNB. At some points in 2021, there were $500 million to $1 billion of fake dollars circulating on BNB. They’re caught up now, though — so that’s all fine, right? [Medium]

Dirty Bubble thinks Binance US isn’t meaningfully separate from Binance.com, if you look at how the cryptos flow. But that shouldn’t be news to anyone here. [Dirty Bubble]

Reuters is still on the Binance beat. Here’s a special report on Binance’s accounts, as far as can be told. Reuters calls Binance’s books a “black box.” Private companies don’t have to disclose their financials, especially if they’re operating outside all effective regulation — but even Binance’s former CFO, Wei Zhou, didn’t have full access to the company’s accounting records in the three years he was there. We’ve noted previously how regulators have a heck of a time getting the most basic information out of Binance. [Reuters]

John Hyatt from Forbes notes how Binance is spending tens or hundreds of thousands of dollars sponsoring Politico’s Playbook newsletter to reach politicians and bureaucrats. Worked great for FTX! [Twitter thread]

DeFi: Go directly to jail

Discussions of crime on the blockchain hardly ever point out that almost all of what goes on in DeFi was always just straight-up illegal under US law.

Pretty much every token was always an unregistered security. The sort of market manipulations that are standard practice in the DeFi trash fire have been illegal under Dodd-Frank since 2010. And that’s before we get to the rugpulls, hacks, and “hacks.”

The authorities are finally moving in. Every DeFi trader should consider themselves on notice.

Hotshot DeFi trader Avraham “Avi” Eisenberg was arrested in Puerto Rico on December 27 on a Department of Justice (Southern District of New York) indictment for commodities fraud and commodities manipulation in the $110 million trade that took out Mango Markets. [indictment, PDF; case docket]

Mango Markets is a decentralized exchange that runs on Solana. Users can lend, borrow, swap, and trade on margin. The exchange is overseen by a DAO, made up of people who hold MNGO — the native token of the exchange.

On October 11, someone drained the project of $110 million by manipulating the platform’s price oracle. After others had traced it to him, Avi Eisenberg came forward and explained the trade.

Eisenberg sold MNGO perpetual futures from one account he controlled to another account also under his control. He then bought large amounts of MNGO, which had the effect of increasing the value of his large holding of MNGO perpetuals. He then borrowed against these holdings and withdrew $110 million in assorted cryptocurrencies.

This also rendered the Mango platform insolvent. Eisenberg himself explained that the insurance fund in place was “insufficient to cover all liquidations.” He gave back some of his trading profits. [Twitter; Bloomberg]

Eisenberg tweeted: [Twitter, archive]

I believe all of our actions were legal open market actions, using the protocol as designed, even if the development team did not fully anticipate all the consequences of setting parameters the way they are.

Eisenberg’s lawyer will likely explain his client’s erroneous legal reasoning to him.

Eisenberg wasn’t just arrested, he was denied bail as a flight risk — he has significant ties outside the US, he already left the US for two months just after the alleged offense, he likely has crypto stashed away somewhere, the charge carries a heavy penalty, and his background could not be checked. (Compare Sam Bankman-Fried’s release on bail.) [Order of detention pending trial, PDF]

It’s not clear why prosecutors went after Eisenberg in particular. We’d guess the CFTC and DoJ were looking for someone to make an example of. The bit where Eisenberg tweeted a complete confession probably helped, much as SBF’s confession tour of the press helped get him indicted.

What Eisenberg did to Mango was not remarkable at all. DeFi traders pull this nonsense all the time. Perhaps you don’t think DeFi trading shenanigans should be crimes, and that’s nice for you that you think that.

As Avi tweeted on October 19: “What are you gonna do, arrest me?” [Twitter, archive]

Posted on January 8, 2023January 16, 2023 by Amy Castor 1

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.

Posted on November 25, 2022 by Amy Castor 0

Welcome to Grayscale’s Hotel California

If you happen to be taking Amtrak and pass through Penn Station or Union Station, you will notice something unusual: every available ad space has been taken up by Grayscale.

“We care about crypto investors,” the crypto asset manager says in its ads. Grayscale is urging the public to write to the Securities and Exchange Commission and convince them to approve the first spot bitcoin ETF in the U.S.

Grayscale wants to convert its Grayscale Bitcoin Trust (GBTC) into a bitcoin ETF after flooding the market with shares. GBTC is trading 25% below its net asset value, and investors are rightfully pissed off. Grayscale wants them to be upset with the SEC, but the regulator isn’t really to blame. If anything, the SEC should have warned the public about GBTC years ago.

Over the last eight years, Grayscale has been telling investors to buy shares of GBTC, advertising the fund as a way to get exposure to bitcoin without having to buy bitcoin.

Accredited investors plowed dollars (or maybe bitcoins) into the fund all through 2020, looking to take advantage of an arbitrage opportunity. They could buy in at NAV, and after a 6 to 12-month lockup, sell on the open market for a premium. All through 2020, that premium was around 18%, on average.

Everybody was happy until February 2021, when the Purpose bitcoin ETF launched in Canada. Unlike GBTC, which trades over-the-counter, Purpose trades on the Toronto Stock Exchange, close to NAV. At 1%, its management fees are half that of GBTC. Within a month of trading, Purpose quickly absorbed more than $1 billion worth of assets.

Demand for GBTC dropped off and its premium evaporated. Currently, 653,919 bitcoins (worth a face value of $26 billion) are stuck in an illiquid vehicle. Welcome to Grayscale’s Hotel California.

The plan all along, Grayscale claims, has been to convert GBTC into a bitcoin ETF. On October 19, 2021, NYSE Arca filed Form 19b-4 with the SEC. The regulator has until early July to respond.

In all probability, the SEC will reject the application, just as it has every single spot bitcoin ETF application put before it to date.

Bitcoin’s price is largely determined by wash-trades, whales controlling the market, and manipulation with tethers. SEC Chair Gary Gensler knows this. He taught a course in blockchain and money at MIT Sloan before his appointment by the Biden administration.

This is Grayscale’s second time around. It applied for a bitcoin ETF in 2016, but withdrew the application during the 2017 bitcoin bubble because “the regulatory environment for digital assets had not advanced to the point where such a product could successfully be brought to market.” Meanwhile, the trust’s assets under management grew as did Grayscale’s profits.

Closed-end fund

“Inflation is rising, we need to diversify!” a panicked woman tells her son over the phone in the middle of the night. “I’m buying crypto!” She hangs up. Her son rolls over in bed. The scene is from a series of TV commercials Grayscale ran in 2020 to convince the public that GBTC was a sound investment.

Digital Currency Group is the parent company of Grayscale. Both firms were founded by Barry Silbert. DCG is invested in hundreds of crypto firms. It owns crypto outlet CoinDesk, which essentially functions as a PR machine for the entire crypto industry.

Initially called the “Bitcoin Investment Trust,” GBTC launched in September 2013. It was promoted as an investment vehicle that would allow hedge funds and institutional investors to gain exposure to bitcoin, without having to deal with custody. Coinbase has been the custodian of the fund since 2019 when it bought Xapo, the previous custodian.

Legally, GBTC is a grantor trust, meaning it functions like a closed-end fund. Unlike a typical ETF, there is no mechanism to redeem the underlying asset. The SEC specifically stopped Grayscale from doing this in 2016. Grayscale can create new shares, but it can’t destroy shares to adjust for demand. Grayscale only takes bitcoin out to pay its whopping 2% annual fees, which currently amount to $200 million per year.

In contrast, an ETF trades like a stock on a national securities exchange, like NYSE Arca or Nasdaq. An ETF has a built-in creation and redemption mechanism that allows the shares to trade at NAV via arbitrage. Authorized participants (essentially, broker-dealers, like banks and trading firms) issue new shares when the ETF trades at a premium and redeem shares when they trade at a discount, making a profit on the spread.

How it all works

Grayscale periodically invites rich investors to pledge money into the fund in private placements at its discretion. The minimum investment is $50,000. Grayscale uses the cash to buy bitcoin and issues shares of GBTC in kind.

Investors can also pledge bitcoin directly — a great advantage if you happen to be a large holder who wants to unload your BTC without crashing the market. (More on this later.)

After a lockup period, investors can sell their GBTC on the open markets. Anyone can buy and sell GBTC on OTC Markets Group, the main over-the-counter marketplace, or via a brokerage account, like Schwab or Fidelity.

Up until early last year, GBTC has typically always traded at a premium on the open market. That premium occasionally soared to over 100%. During the 2017 bitcoin bubble, GBTC traded as high as 130% above NAV.

Why would anyone pay the premium? Many institutional investors can’t buy bitcoin directly for compliance reasons. And there are a lot of individuals who don’t want the headache of figuring out how to set up a bitcoin wallet. GBTC was initially the only option for getting exposure to BTC, without having to buy BTC, at least until bitcoin futures came along. However, bitcoin futures contracts came with their own risks, costs, and headaches. GBTC was easier.

In early 2020, GBTC became an SEC reporting company. This allowed investors who purchased shares in the trust’s private placement to sell their shares in 6 months instead of the previous 12 months. You could now make more money faster!

Unsurprisingly, the trust went into overdrive in 2020. Starting in January 2020 up to Feb. 23, 2021, Grayscale filed 35 reports with the SEC indicating that it sold additional shares to accredited investors, according to Morning Star’s Bobby Blue.

The trust’s holdings doubled from roughly 261,000 BTC in January 2020 to 544,000 BTC by mid-December 2020, per Arcane Research.

The @Grayscale Bitcoin Trust has attracted new investors throughout the year, leading to a doubling of Grayscale's BTC holdings from approx. 261k BTC in January to 544k BTC by Dec 12th.

The holdings of GBTC is just below 3% of the total circulating BTC supply. pic.twitter.com/3y00yMYzEk
— Vetle Lunde (@VetleLunde) December 14, 2020

Red flags

Harris Kupperman, who operates a hedge fund, explained in a November 2020 blog post how GBTC’s arbitrage opportunity created a “reflexive Ponzi,” responsible for sending the price of bitcoin hyperbolic.

There were several versions of the arb. You could borrow money through a prime broker. You could use futures to hedge your bet. You could recycle your capital twice a year.

Every version involved Grayscale purchasing more bitcoin, thus increasing demand, widening the spread in the premium, and pushing the price of bitcoin ever higher. Between January 2020 and February 19, 2021, the price of BTC climbed from $7,000 to $56,000.

“When the spread is 26% wide and liquid to the tune of hundreds of millions per week, you can bet the biggest guys in finance are all over it,” Kupperman said. “As you can imagine, everyone big is putting on some version of this trade.”

Kupperman wasn’t the only person to raise alerts about the fund, which mainly benefited wealthy investors. As soon as GBTC launched, skeptics voiced their concerns.

“You can put a nice wrapper around a turd, and present it in a very well-manicured product to investors that you say is safe,” Barry Ritholtz, a wealth manager and founder of The Big Picture blog, told Verge. “But at the end of the day, it’s still crap.”

In September 2017, Citron Research called GBTC “the widow maker” and “the most dangerous way to own bitcoin.” Citron’s Andrew Left accurately predicted GBTC’s collapse:

“Citron believes that as new methods become available for investors to gain exposure to bitcoin — including traditional ETFs — that money will move to these regulated instruments and out of the uncertain waters of GBTC, which we believe can fall by 50% easily.”

Who holds GBTC?

The press has repeatedly credited Grayscale as a massive buyer of bitcoins, and evidence of institutional money entering the cryptoverse. This may not be the case.

Even though Grayscale states its holdings in dollars, it accepts deposits of bitcoins. A whale, or a good friend of Grayscale, can trade in their BTC for shares of GBTC, which they can flip six months later at well above the actual price of bitcoin.

The last time Grayscale broke out the numbers in Q3 2019, they said that the majority of deposited value into their family of trusts was in crypto, not dollars:

“Nearly 80% of inflows in 3Q19 were associated with contributions of digital assets into the Grayscale family of products ‘in-kind’ in exchange for shares, an acceleration of the recent trend, up from 71% in 2Q19.”

Grayscale stopped breaking out the percentage of crypto deposits into its trusts after 2019, and just stated everything in dollars. They may want to break out the numbers again, as this is something the SEC might be interested in.

Crypto lender BlockFi’s reliance on the GBTC arbitrage is well known as the source of their high bitcoin interest offering. Customers loan BlockFi their bitcoin, and BlockFi invests it into Grayscale’s trust. By the end of October 2020, a filing with the SEC revealed BlockFi had a 5% stake in all GBTC shares.

Here’s the problem: Now that GBTC prices are below the price of bitcoin, BlockFi won’t have enough cash to buy back the bitcoins that customers lent to them. BlockFi already had to pay a $100 million fine for allegedly selling unregistered securities in 2021.

As of September 2021, 47 mutual funds and SMAs held GBTC, according to Morning Star. Cathie Wood’s ArkInvest is one of the largest holders of GBTC. Along with Morgan Stanley, which held more than 13 million shares at the end of 2021.

Such a lovely place

Grayscale was happy to take investor money during the bitcoin bull runs of 2017 and 2020-21 and saturate the market with shares of GBTC. Anyone sitting on GBTC now is forced to take their losses, or hold out in the hopes Grayscale will do something to fix this.

Investors, many of whom are regular folks with GBTC in their IRAs, have every reason to be upset. Meanwhile, Grayscale is pointing the finger at the SEC as the reason we can’t have nice things.

Michael Sonnenshein, Grayscale’s chief executive, told Bloomberg he would even consider suing the regulator if Grayscale’s application to convert GBTC into a bitcoin ETF is denied.

Sonnenshein argues that because the SEC has approved bitcoin futures ETFs, it should also approve a bitcoin spot ETF.

This makes absolutely no sense. The two investment vehicles are totally different animals.

A bitcoin futures ETF indexes a bitcoin futures contract on the CME. It is a bet in dollars, paid in dollars. Nobody touches an actual bitcoin at any point. In contrast, Grayscale’s spot bitcoin ETF application represents an investment that is backed by bitcoins — not derivatives tied to it.

A spot bitcoin ETF is good for bitcoin, because it means more actual cash flowing into the cryptoverse. Crypto promoters are pushing hard for this. Bitcoin is a negative-sum game that relies on new supplies of fresh cash to keep it going.

But what happens if the SEC doesn’t approve Grayscale’s application?

Grayscale can issue more buybacks. In the fall of 2021, DCG began buying back over $1 billion worth of GBTC. In March 2022, it announced another $250 million in buybacks for Grayscale trusts. The effort had little impact. GBTC continued to trade well below the price of bitcoin.

As Morning Star points out, Grayscale has the power to make this right. It can redeem shares at NAV and simply return investors their cash or bitcoin. That is, if Grayscale really does care about crypto investors.

Grayscale offered a redemption program before 2016. However, the SEC issued a cease and desist order because the repurchases took place at the same time the trust was issuing new shares, in violation of Regulation M.

The situation is different now. Grayscale stopped issuing new shares in March 2021. That leaves the door open for it to pursue a redemption program and bring GBTC closer inline with the price of bitcoin.

I doubt this will ever happen. Grayscale is sitting on a cash cow. As long as it can redirect investor anger at the SEC, why change?

“There is no obligation to convert to an ETF,” David Fauchier, a fund manager at London’s Nickel Digital Asset, told me in a tweet. “If things stay as they are, they will print money into perpetuity basically, it’s a FANTASTIC business if BTC doesn’t zero.”

Ha. No, the status quo is to keep the trust as is. There is no obligation to convert to ETF. If things stay as they are, they will print money into perpetuity basically, it’s a FANTASTIC business if BTC doesn’t zero
— David Fauchier (@dfauchier) April 18, 2022

Fed by stimulus money, tethers, and a new grift in the form of NFTs, the price of bitcoin reached a record of nearly $69,000 in November 2021. Bitcoiners rah-rahed the moment.

However, the same network effects that brought BTC to its heights are working in reverse and can just as easily bring it back down again. At its current price of $40,000, amidst 8.5% inflation, bitcoin is not proving itself to be the inflation hedge Grayscale hyped it up to be.

It’s worth noting, that Barry Silbert left Grayscale in August 2021. Incidentally, Jeff Skilling jumped ship at Enron in August 2001, shortly before disaster hit, for some reason.

Submit your comments!

I encourage anyone reading this to submit your comments to the SEC regarding Grayscale’s application for a spot bitcoin ETF. Jorge Stolfi, a computer scientist in Brazil, has provided an excellent example, and so has David Rosenthal, also a computer scientist. You can submit your own comments here.

Did you enjoy this story? Consider supporting my work by subscribing to my Patreon account for as little as $5 a month. It’s the cost of a cup of coffee! Or, if you’re feeling generous, you can buy me a pound of coffee beans.

Posted on April 19, 2022January 16, 2023 by Amy Castor 3

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