#47 The Context: FTX - who was asleep at the wheel?
Regulators, auditors and big ticket investor all face awkward questions
Hi there. There’s a Senate hearing which might shed a little light on FTX which will have started by the time you read this. But for the most part the digging and investigating is being done by journalists, although not everyone has been impressed. The dominoes are likely to keep falling — BlockFi has filed for bankruptcy, while Digital Currency Group is grappling with two of its assets, Genesis Trading and Grayscale Investments. The questions keep coming, of course, including whether this is all a house of cards, and what, really, was FTX?
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. 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).
The team: founder Samantha Yap and Jeremy Wagstaff, formerly of the journalism parish, with Ruby Wu, Sam O’Donohoe, Becky Corbel, Delon Chan, Ewan Brewster and Tiffany Mac Sherry. Your feedback is as always welcome. Ping us at thecontext@yapglobal.com. Old newsletters can be found here.
[tl;dr]
Spotlights are on BlockFi and Grayscale facing problems, but also: is Binance a white knight or a Trojan Horse?
The FTX fallout raises tricky questions for regulators, auditors and even Singapore’s state investment arm.
Not everyone is heading for the exits; in fact even institutional investors see some value in crypto — though perhaps they’ve changed their minds since being surveyed back in October.
[This week’s pain]
It should be a quieter week, given Thanksgiving and the World Cup, but it’s not. Attention is mostly focused on which entities might be next, and whether we know all we should know about the players involved, both white knights and vanquished.
The spotlight has been on crypto lender BlockFi, which went bankrupt in the aftermath of the FTX meltdown and has started laying off staff. BlockFi has up to $10 billion in liabilities, and about $250 million cash on hand. It owes $30 million to the SEC, apparently part of a $100 million fine over allegations it illegally offered a product. (Stories by Kevin Simauchi, Hannah Miller, Vildana Hajric and Muyao Shen of Bloomberg; Liam J. Kelly and Daniel Roberts of Decrypt)
Grayscale Investments has a few headaches of its own while sister company Genesis Global is being investigated by U.S. state securities regulators as part of a wide-ranging inquiry into the interconnectedness of crypto firms. Both companies are owned by Digital Currency Group. (Story by Joe Light of Barron’s)
But there is also some light thrown on the man they call CZ and his Binance: Donovan Choy of Bankless asks, Is CZ Too Powerful? (paywall). The Block writes: Binance’s bailout fund is a welcome backstop for crypto — but questions remain about what it calls the 'consolidator-in-chief’, saying that its $1 billion fund "could further concentrate power in the hands of the exchange" by allowing it to cherry pick which companies survived and which didn’t. More than 150 companies had sought help by November 24, according to Binance. The Block's piece quoted a blockchain expert and lawyer as saying he "wouldn't be surprised if antitrust agencies were to investigate... the reasons why the fund decided to refuse funding [to] specific entities." (Story by Ryan Weeks of The Block)
Most intriguing, perhaps, is the notion that there may be (even) more to FTX than has so far met the eye. Journalists from all corners are digging, uncovering a bank in the middle of nowhere, exploring the connections with Tether, and through that pondering whether Tether and FTX bore a passing resemblance to BCCI. Dirty Bubble Media asks: “If their internal balance sheet is accurate, FTX owes around $6 billion in dollar liabilities to its former customers. Where did these billions of dollars come from? And what parts of the FTX-Deltec- Tether relationship are yet to be revealed?” (Stories by unidentified writers at Protos, Revolver News and Dirty Bubble Media; Stephen Gandel of The New York Times)
[Fallout roundup]
Then there’s that evergreen question: where do we go from here? So far, it yields only more questions, but they’re worth asking.
Is it a House of Cards? The Financial Times' LEX believes that “the sheer interconnectedness of the crypto ecosystem suggests it is now inherently unstable for all participants.” Chris Skinner, a fintech commentator, argues that if the network itself is the ‘government’ (he does not necessarily mean a nation-state, but whatever system of rules, beliefs and trading mechanisms the participants are playing to) of crypto, “when you have things on the network that break the trust of that network, you have a house of cards”. (While sister FT column Alphaville plays the grim reaper in The Crypt, updated collating all the 'fine here; oops, not fine' cases of this year.)
Regulators are in an interesting situation. On the one hand they can argue that the rolling collapse clearly demonstrates the need for regulation. On the other hand it forces their hand: why haven’t they already done so? Particularly when they were already having “many meetings” with FTX, according to Commodity Futures Trading Commission (CFTC) Chair Rostin Behnam. Expect to see the turf war get a little more heated, as each player tries to demarcate their zone. CFTC Commissioner Summer K. Mersinger said this week that any solution would have to involve other agencies, and closer collaboration with national and state legislators, as well as global regulators. Benham and others were due to appear before a Senate committee to discuss FTX on Dec. 1 (Stories by Fran Velasquez of CoinDesk and staff writers at Ledger Insights; Turner Wright of Cointelegraph)
Audits as a Service: What makes an awkward situation worse is that FTX and others were audited, raising not just questions about the quality of those audits, but also whether sufficient scrutiny has been exerted on companies with crypto-related clients. This is sending a few scurrying back to their desks as nervous auditors re-examine their crypto clients. It might also give regulators pause to consider what, actually, constitutes a proper audit. (Story by Stephen Foley of the Financial Times)
Question time: Intriguingly, Singapore parliamentarians are asking solid questions of the government about the country’s exposure to FTX and the roiling seas around it. Singapore is both welcoming to DeFi innovation and conservative about how crypto assets are handled in its banking system, but it is facing awkward questions, inter alia, about how state investment arm Temasek had to write off $275 million because of its stake in FTX. Dubai is also a bit jittery about its association with crypto. (Stories by Ben Bartenstein, Selina Xu and Aradhana Aravindan of Bloomberg)
100% Proof: How useful is Proof of Reserves as a way of measuring the liquidity and health of a crypto company? A few have said ‘not very’; a good explanation here: Merkle Trees and The Simple Problem with Proof of Reserves (tl;dr: PoR merely shows proof of assets. Only with audited liabilities might there be proof of solvency, which is what people are interested in.) Binance released a new site last week explaining its proof-of-reserves system. (Story by James Lavish of The Informationist and Romain Dillet of TechCrunch)
The disappeared: A recurring theme — both sad and worrisome in equal measure — is how many crypto kings (and queens) disappear, sometimes forever. Tiantian Kullander, founder of the Amber Group, died ‘unexpectedly’ at 30, shocking the crypto world and coming a month after the untimely death of MakerDAO co-founder Nikolai Mushegian, 29, in Puerto Rico in late October. (Foul play appears to have been ruled out in both cases.) Metro reported that a third crypto boss, Vyacheslav Taran, died after his helicopter crashed in late November. For prominent figures in hiding, there’s always the prospect of disgruntled investors tracking them down, even casing out the Bahama condo of Sam Bankman-Fried. He eventually, reportedly, got in touch and promised to an interview. The New York Times wrote in a piece based on emails and other documents in the final stages of FTX's collapse that SBF “appeared deluded.” FTX faces an active criminal investigation in the Bahamas. SBF appeared by video link at a New York Times conference to say: ‘Look, I Screwed Up’. (Stories by Sahana Kiran of Watcher Guru, Josh Milton of Metro UK and David Yaffe-Bellany and Stephen Gandel of The New York Times)
[Still life in the old dog yet]
And crypto winter or not, there are still a few indicators that DeFi has life in it.
The new mantra is that if it can't be 100% DeFi, then it needs transparency, WOO Network is attracting some attention as 'The Best of CeFi and DeFi in One Place.”
And, at least until recently, institutional investors have actually increased their crypto allocations during the crypto winter, according to the 2022 Institutional Investor Digital Assets Outlook Survey by Coinbase (it should be pointed out the survey was done in September and October, so predates the FTX débâcle.)
Oh, and pump and dump of sh*t- and memecoins are still a thing. One project tested the limits of cringe by building a $600,000 statue of Elon Musk and delivering it to Tesla HQ. And Dogecoin, occasionally promoted by Musk, surged 16%, apparently because of Thanksgiving-fed cheer (and Elon’s weekend vow to roll out his own smartphone), leading to hope that perhaps Elon would use the token in some way.
And, suggesting that not everyone is heading for the exits, the executive who brought Time magazine into web3 is leaving -- for crypto payments startup MoonPay. Keith Grossman made more than $10 million in profit for Time from web3 initiatives in its first year. (Story by Andrew Hayward of Decrypt)
[Reading]
An extensive read from Bitcoin Magazine's Dylan LeClair and Sam Rule takes a deep dive into the FTX Ponzi - uncovering the largest fraud in crypto history. Worth a read if you haven't been following closely.
The International Securities Lending Association, or ISLA, has published a white paper exploring the legal aspects of digital assets in securities lending. (White paper here; PDF) . It's not light reading, but the ISLA considers it an important first step in using the existing Global Master Securities Lending Agreement (GMSLA) to document transactions involving digital assets. “While there may be uncertainty regarding some of the legal issues identified in this paper, ISLA proposes that the documentation be developed to accommodate transactions involving digital assets so that there are documents available to satisfy market appetite to enter into those transactions notwithstanding the potential lack of legal certainty," the paper concludes.
Annie Lowrey of The Atlantic explores how Black investors have been more heavily impacted by the collapse of crypto currencies which have lost more than $2 trillion in paper value over the past year.
[Events]
EthDownUnder | December 1st - 4th 2022 | Sydney, Australia
EthIndia | December 2nd - 4th 2022 | Bengaluru, India
EthTaipei | December 2nd - 4th 2022 | Taipei, Taiwan
Taipei Blockchain Week | December 12th - 17th 2022 | Taipei, Taiwan
World Blockchain Summit | December 13th - 14th 2022 | Bangkok, Thailand
[DeFi Definitions]
An occasional segment exploring one particular aspect of DeFi.
This Week: “Proof of History” by CJ Cheong
Proof of History (PoH) is a consensus mechanism most notably deployed by Solana, and is an evolution of the Proof of Stake model. As PoH employs Verifiable Delay Functions (VDFs) it is able to incorporate time itself into the blockchain, as a VDF can only be solved by performing a certain set of consecutive steps by a single CPU core.
As no parallel processing is permitted, it is simple to determine how long each step will take, and also calculate the time based on historical occurrences. After analysing these occurrences, a hash function is constructed that can be confirmed by anybody. Every block created by the network has this hash appended to it.
This is unlike traditional blockchains (where gaining consensus on the time a block was mined is just as important as getting consensus on the transactions in that block). While this PoH is drastically able to increase scalability with this method, it is still a relatively newer consensus mechanism that has yet to be as battle-tested.