#46 The Context: What can previous crashes tell us?
Expect a slow, but inexorable, legal process
Hi, hope you’ve had a decent week. In this newsletter, we explore the three big questions surrounding DeFi and FTX: what happened, who loses out — and who benefits? Amid the usual suspects, there are a few surprises. We also look at the other players teetering on the brink and explore progress on previous crypto crises and scams, underlining how long a haul we’re in for to get to the bottom of the FTX debacle
The usual disclaimer: This newsletter collates the main themes and headlines of the week in DeFi/crypto/metaverse/web3/NFT land and tries to provide unbiased context. It’s aimed at anyone who wants to keep an eye on the space but isn’t following it too closely, or is on the hunt for story ideas and angles. It’s put together by a team at YAP and doesn’t contain any promotion of our clients (if one is mentioned, we’ll flag that).
This was put together by a team led by founder Samantha Yap, and Jeremy Wagstaff, formerly of the journalism parish. Thanks to Ruby Wu, Sam O’Donohoe, Becky Corbel, Delon Chan, Ewan Brewster and Tiffany Mac Sherry for their contributions. Feedback is as always welcome. Ping us at thecontext@yapglobal.com. Old newsletters can be found here.
[tl;dr]
The FTX debacle has a surprising number of losers, raising questions about the quality of due diligence by investors;
Concern that Genesis may be the next to fall is prompting market giant Binance to consider a helping hand;
Sam Bankman-Fried’s storied parents get drawn into the black hole that is FTX.
[FTX’s three big questions]
Three big questions: what actually happened, who is going to lose most, and who is benefitting?
Understanding who is going to lose out as a result of the FTX crash is one key metric to how long and how far this winter will spread. We're gradually learning more, but still not enough.
FTX owes almost $3.1 billion to its top 50 creditors according to bankruptcy filings.
The FT is reporting that **hedge funds** have been left with billions stranded on FTX. Citing Crypto Fund Research data, it says that up to 150 crypto hedge funds -- up to 40% of the total of such funds -- have some direct exposure to FTX or its FTT token.
Data from CoinGecko on unique visitors to FTX.com suggests that South Korea, Singapore and Japan were the biggest users of FTX. Expect to see more investigations and tighter regulation in those jurisdictions. (Story by Danny Park of Forkast)
VC firms have had to eat a bit of humble pie, amid questions about the quality of their due diligence. Sequoia Capital has apologised to its fund investors, said it was misled by FTX and that it would improve the way it researched potential investments. (Berber Jin of The Wall Street Journal)
If younger investors were burned, that creates another concern: hedge fund CEO Ken Griffin worries FTX’s collapse could shake Gen Z investor confidence, not just in crypto but in TradFi. (Maybe they just do things differently, via side hustles or via innovation within traditional markets, such as the Australian 'CHESS' model, where investors are the custodians of shares they buy, rather than the broker or platform.)
And don't forget those **who left Wall Street** to go into crypto. Sam Peurifoy, a partner at crypto venture capital firm Hivemind, left his job at Goldman Sachs during the pandemic to work in crypto full-time. “There’s going to be a ton of knock-on effects across the crypto market that won't come to light for at least another 30 to 60 days,” he said, especially since some firms were using FTX as their “crypto bank.”
What actually happened at FTX? Some attempts to pull it all together.
Adam Cochran posts an epic 82-tweet thread, calling it his “final piece covering this topic…This was a crime plain and simple and I'll put no more wind in this criminal's sails.”
An excellent data-driven analysis by Coin Metrics' State of the Network, building a heat map of Binance's FTT market as well as a wallet transaction analysis of Alameda and FTX, leading the team "to question their claims to independence and segregation of interests" going back to the middle of last year, and offering some potential clues about the outflow of funds consistent with the 'loans' to FTX executives reported in the bankruptcy document. If only we could see this depth of data analysis before everything blows up.
Reuters (Jeremy’s alma mater) continues to dig up excellent scoops: They discovered that Sam Bankman-Fried's company, senior executives and his parents bought Bahamas properties worth $121 million over the past two years. SBF’s parents, Stanford University law professors Joseph Bankman and Barbara Fried, had been “trying to return” a vacation home with beach access to FTX, according to a spokesman. (Story by Koh Gui Qing of Reuters)
Former auditor Francine McKenna sifts through the filings, noting in a CoinDesk column that red flags that should have been seen earlier, such as the company commissioning two different auditors to audit its 2020 and 2021 statements.
Who is benefitting?
Oddly, AWS could be argued to be a beneficiary. Firstly, it decided not to get involved in any direct investment, but it has provided some of the tools, such as a blockchain-as-a-service product Amazon Managed Blockchain. There's no date on this report, but research suggests that quite a few big players in the US and UK have been using the service. A story from Pandaily says that AWS may have been “conducting secret business in the Chinese cryptocurrency field. (Thanks to The Blind Spot for the links.)
And whoever was behind the $600 million “exploit” of FTX is still moving their gains around using ether and renBTC via a cross-chain bridge that has been accused of facilitating “at least $540 million in proceeds of crime”. (Story by Shaurya Malwa of CoinDesk)
Meanwhile, astride all this chaos sits Binance and its CEO Changpeng Zhao (CZ), possibly the largest potential beneficiary. There seems little question about it surviving the mayhem, and more likely it will emerge vastly stronger. Indeed, CZ told Bloomberg TV that he was amassing a $1 billion fund to buy distressed DeFi assets, and said he was in talks with Genesis Global (see below). (Story by Ben Bartenstein and Anna Irrera)
[Ripples and Reapers: the FTX fallout]
Beyond the immediate, what should we be worrying about? Some big names are looking a bit shaky. And the debate about regulation goes full circle: don’t regulate because you don’t want to encourage bad behaviour by making investors think it’s a regular investment class.
Genesis Global:
Facing a liquidity crunch after the collapse of FTX, Genesis has warned of bankruptcy if they can't raise $1 billion (later reduced to $500 million), and if that were to happen it “would be a monumental event in crypto, with enormous downstream exposure," according to Molly White, who runs the Web3 is Going Just Great website. Genesis has $175 million locked in an FTX trading account.
In its latest update, Australian crypto investor Apollo Capital notes that some of Genesis’ associated entities are “already feeling the squeeze. Gemini Earn, a crypto lending product from the centralised exchange Gemini, once offered depositors 8%. Due to liquidity issues from its exposure to Genesis, it has now been forced to pause redemptions for all depositors. A company that also sits under DCG is Grayscale. Grayscale’s Bitcoin Trust, a product that offers bitcoin exposure through a listed trust structure, is now trading at its lowest level below net asset value at a 45.2% discount.”
Grayscale has said it won’t share proof of reserves, citing ‘security concerns’. “But panic sparked by others is not a good enough reason to circumvent complex security arrangements that have kept our investors’ assets safe for years,” Grayscale said. (Story by Stephanie Murray of The Block)
The FT observes the Crypto Reaper come a-calling for Genesis, but notes it surveys a "target-rich environment, with even stronger players looking a little pallid." Cue Coinbase logo, whose market cap now sits at $10 billion, compared to an IPO valuation of $76 billion last year. (Story by Robin Wigglesworth)
Solana, tied to FTX through the latter’s investments in several Solana-related projects, has seen Tether, issuer of the USDT stablecoin, convert USDT it had on Solana to the Ethereum blockchain, a Solana competitor. Solana, weeks ago in the top 5 cryptocurrencies by market cap, has now sunk to 16th, and has lost 95% of its value from a year ago.
Schadenfreude and handwringing: The regulation issue trundles on, and it’s unlikely there won’t be a barrage of new rules at some point. But is this the right way to go? Both crypto lovers and haters suggest not, albeit for different reasons.
The FT says U.S. regulators are wrong: Don’t regulate crypto as finance, argues Robert Armstrong, because we don't yet know whether crypto assets are investment assets and if we regulate them that way, that's what they will become. Instead, if they have to be regulated, it should be in the same way as smoking and gambling are - in other words, to protect consumers. (This might not be such a bizarre idea: see NFT section below.)
And a few private commenters suggest that Armstrong's claim that “finance is all about trust” might not withstand much scrutiny. The whole point of crypto was to circumvent the failure of the trust-based system that is Wall Street.
A fairer take can be found in the Australian Financial Review, where wealth editor Aleks Vickovich writes that Crypto sceptics are reading the wrong lesson from FTX. “As many as one million customers (and an estimated 30,000 Australians) lost money in the FTX collapse. They knowingly invested in highly volatile assets via a platform subject to few rules and vulnerable to cybercrime. Next time they might want to think twice about who they trust and the security of their holdings. But they deserve better than being the butt of jokes among those with more market experience. And they’re not wrong to dream of a better financial system.”
And Stephen Diehl, an author and articulate critic of DeFi, acknowledged in a recent interview that the problem has less to do with crypto’s founding principles and more to do with the fact that it's being taken over by Wall Street (Story by Moya Lothian-McLean of Novara Media)
After a blizzard of profiles of SBF and his companions, the spotlight has shifted to the other side of the table, including Gary Gensler of the SEC. (Story by David Yaffe-Bellany of The New York Times)
[Remembrance of crises past]
Meanwhile, the legal process behind previous debacles grinds on — reminding us how long we’re going to be hearing about FTX etc as it grinds its way through the courts.
The Celsius collapse may feel like ancient history but may provide a foretaste of what is to come: A blog post, Celsius’s Interim Examiner Report, by Amy Castor, offers some insight. Things to look for: what can it tell us about how crypto companies work? What actually caused Celsius' implosion, and how much did Celsius' own systems contribute to its collapse? Did regulatory heat help the situation or worsen it?
And not to forget Tornado Cash, the DAO-driven tumbler that was blacklisted in early August by the U.S. Treasury, which accused it of laundering more than $7 billion. Dutch authorities have ordered Tornado Cash developer Alexey Pertsev to remain in jail after prosecutors announced money laundering charges and a court deemed him to be a flight risk. Many on Twitter have pointed to the different treatment experienced by the dramatis personae in these episodes. (Story by Jack Schickler of CoinDesk)
A reminder of how far we’ve come in terms of crypto scams (and how long they take to investigate): Two people were arrested in a massive $575m cryptocurrency 'Ponzi scheme'. The business was started in 2013 and closed its doors in August 2019. The arrests were made on November 20. (Story by Jessica Lyons Hardcastle of The Register)
[Don’t mention the jargon]
Nike has launched a web3 platform Dot Swoosh, suggesting that quiet and well-thought-through strategies are one way to navigate beyond the crisis engulfing DeFi. As Seyi Taylor puts it: “Basically, NIKE has launched a brand-safe NFT marketplace with easy onboarding with all the technical jargon obfuscated.” (Story by Pet Berisha)
Another part of this is working with regulators: NFT fantasy gaming platform Sorare has tweaked its product at the request of the French National Gambling Authority (ANJ). The talks have been going on since March 2021, over the ANJ's desire to protect the public from excessive gambling.
That’s not to say there aren’t problems brewing: with the World Cup playing out in Qatar, fans are asking about the future of all the football fan tokens and whether they’ll still be relevant after the World Cup. While it's not likely that fans will want to sell their tokens, their utility beyond voting for "a minimal scope of less critical decisions” is open to question.
[Reading]
El Salvador’s Bitcoin ‘revolution’ is failing badly, according to Bloomberg. “Almost no one in the country is using Bitcoin, and the few who bought after Bukele made it legal tender would’ve lost big: Bitcoin has dropped 61% since September 2021.”
[Events]
EthVietnam | November 25th - 27th 2022 | Ho Chi Minh City, Vietnam
Miami Web3 | November 28th - 30th 2022 | Miami, USA
DCentral Miami | November 28th - 29th 2022 | Miami, USA
EthDownUnder | December 1st - 4th 2022 | Sydney, Australia
EthIndia | December 2nd - 4th 2022 | Bengaluru, India
EthTaipei | December 2nd - 4th 2022 | Taipei, Taiwan
[DeFi Definitions]
An occasional segment exploring one particular aspect of DeFi.
This Week: “Quadratic Funding” by Mia Grodsky
Quadratic Funding is a mechanism used to determine whether or not a project is worth funding. Projects that are more valued, meaning they have more individual supporters, will receive a higher proportional amount of funds.
In the Ethereum white paper, Vitalik Buterin initially described Quadratic Funding as a mechanism for individual projects to keep track of the funds they are raising. At the end of a raise, the mechanism calculates a payment to each project.
Pioneered by Gitcoin’s Grants program in 2018, quadratic funding is a way for public goods projects to use a combination of individual donations and grant money to increase the amount raised. It is the mathematically optimal way to fund public goods in a democratic community where the number of contributors matters more than the actual amount funded.
With quadratic funding, the number of contributors matters more than the amount funded. For example, if there are two individual projects seeking grants and they both raise $100, the project with more individual donors will receive a higher amount in quadratic funding than the project with fewer donors. More donors signal that there is a higher demand for this project, and Quadratic Funding in practice uses a matching pool to grant projects with more individual backers more funding.
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