Molly White's Citation Needed - Issue 58 – Threats to the stability and integrity of Ethereum

Episode Date: May 19, 2024

The Justice Department worries about the stability of Ethereum, DCG tries to bilk their subsidiary's creditors, and Biden threatens a crypto veto. Originally published on May 18, 2024.

I'm Molly White, and you're listening to the audio feed for the Citation Needed Newsletter. You can see the text version of the newsletter online at citation needed.news. Issue 58. Threats to the stability and integrity of Ethereum. The Justice Department worries about the stability of Ethereum. DCG tries to bilk their subsidiaries creditors, and Biden threatens a crypto veto. This issue was originally published on May 18, 2024. It's time for your regularly scheduled cryptocurrency industry update. Behind the scenes, I've been hard at work on a pretty cool project that I'm excited to share with you all soon,

so stay tuned for that. I've also got a post in the hopper about the recent Tornado Cash verdict in the Netherlands, which should be in your inboxes in the next few days. But until then, in the courts, tornado cash. Alexei Pertsev, one of the developers and operators of the Tornado Cash Cryptocurrency Mixing Service has been sentenced to 64 months or over five years in prison in the Netherlands. I have complicated feelings about it. I think this case, along with similar ongoing litigation in the United States and elsewhere, is one of the most important cryptocurrency-related cases to watch, even though it hasn't

gotten nearly the press coverage of some other cases like FTX. Because of this, and because my thoughts on this case are pretty lengthy, I'm going to be covering it in a separate issue in the next few days. FTX. We're coming up on the sentencing of the first FTX executive besides Sam Bankman-Fried. Ryan Salem was the CEO of FTX Digital Markets, which was the Bahamian portion of the business. He pleaded guilty to one count each of conspiracy to operate an unlicensed money. transmitting business and conspiracy to make unlawful political contributions and defraud the Federal Election Commission in September 23, just before Bankman Fried's trial began. He was the only co-conspirator

of the four to not plead under a cooperation agreement, and he did not testify at Bankman Fried's trial. His charges carry a maximum sentence of 10 years in prison. Salem has just submitted his sentencing memorandum, in which he argues that he should be sentenced to a maximum of 18 months imprisonment. As he might expect, he downplays his role in the wrongdoing at FTX, laying most of the blame on Bankman Freed, the other co-conspirators, and others at FTX, including Dan Friedberg. According to the memo, Salem, quote, had absolutely no knowledge that the four people at the center of Alameda and FTX had conspired to lie and steal from their customers. He stole from no one. He did not lie to customers, and he was duped, as was everyone

else, into believing the companies were legitimate, solvent, and wildly profitable. Salem also argues that his charitable work and family commitments should be considered in his sentencing, and the fact that he was abusing substances, alcohol and unspecified drugs, while working at FTX, but has since achieved sobriety. Along with Salem's wife, child childhood friends and neighbors, the conspicuously absent Sam Chibuco was kind enough to submit a character reference. As a part of his plea agreement, Salem agreed to forfeit $1.5 billion, which he says, quote, will leave him with no remaining assets. He is scheduled to be sentenced on May 28. MEV bot exploit. Two brothers were charged with an attack on Ethereum MEV bots,

various types of automated software that sift through pending transactions that are waiting to be added to the Ethereum blockchain and try to insert their own profitable transactions using a technique called maximum extractable value, or MEV. MEV itself is a somewhat controversial practice, mostly because the profits from such a technique come from the losses of people who are just trying to use the blockchain, but who end up losing money to bots that front-run them or otherwise cause their trades to have worse outcomes. Some think that code is law, and if it's possible to do something within the confines of the code, it should be allowed. Others think that this adversarial profit extraction harms users in the long run, who are often at a disadvantage against the sophisticated bots. In this particular case, the brothers were able to exploit the bots themselves,

by learning their trading techniques and exploiting a flaw in software called MEV boost to get access to private information about upcoming blocks that allowed them to essentially profit from the profiteers. Perhaps the most notable thing about this lawsuit is the level of technical familiarity the prosecutors seem to have developed with the issues at hand. The indictment navigates a technically complex web of topics, including Ethereum's system of validators, relays, M-EV and M-V bots, and presumably the prosecutors are confident in their ability to walk a jury

through it all as well. One thing that stuck out as a little odd to me, though, was the prosecutor's apparent concerns over protecting the integrity of the Ethereum blockchain. In the indictment, they wrote, quote, tampering with these established M-EV-Boost protocols, which are relied upon by the vast majority of Ethereum users, threatens the stability and integrity of the Ethereum blockchain for all network participants. Everything else. Aidan Pluterski, the 25-year-old Canadian self-described crypto-king,

who managed to convince people to give him 40 million Canadian dollars, or over 30 million U.S. dollars, has been arrested and charged with fraud and money laundering. He was sued in 2022, forced into bankruptcy later that year, and then allegedly kidnapped and beaten in 2023 by angry investors. But now he's facing criminal charges as well. Even after the bankruptcy proceedings and kidnapping incident, Patersky had continued to flaunt his supposed wealth online.

Much to the indignation of the creditors in his bankruptcy, he has continued to regularly livestream himself gambling online for hours, spending $150,000 on Legos and driving luxury cars. Now he's out on $100,000 Canadian dollars bond, or around $75,000 U.S. dollars, thanks to his parents. The group responsible for monitoring Binance's compliance has been appointed, and it's not Sullivan and Cromwell, as once seemed likely. Instead, forensic risk analysis, or FRA, will be the group making sure the company abides by the terms of its plea agreement. The SEC has filed two responses in its ongoing legal cases with Coinbase, which has been trying to get the courts to force the SEC to write bespoke rules for the cryptocurrency industry.

Over in the Third Circuit, where Coinbase is appealing the SEC's denial of Coinbase's petition for rulemaking, the SEC is submitted a filing urging the appeals court to uphold its decision to, quote, take a more incremental approach to applying the longstanding security. framework to crypto assets, rather than, quote, build a new regulatory framework from the ground up, as Coinbase has requested. Over in the district court for the Southern District of New York, the SEC has opposed Coinbase's motion requesting they be allowed interlocutory appeal in the civil case from the agency. The SEC writes that Coinbase's basis for the appeal is unsound, and that, quote,

Coinbase continues to insist, as grounds for interlocutory review, that, quote, the digital asset industry labors under an intolerable cloud of uncertainty or under a, quote, cloud of legal uncertainty. But the court's crystal clear order, others like it, and the decades of legal authority they are based upon provide that certainty. Coinbase just does not like the answer. Having made the weather, Coinbase cannot now complain that it is raining. Two people have been arrested for laundering at least $73 million in pig-butchering proceeds through Deltech Bank in the Bahamas. If that bank name rings a bell, it's probably because of its close ties to the cryptocurrency industry, particularly to tether, but also to FTX and Alameda Research.

Remember that surreal period when every big brand decided they needed to stay hip by embracing crypto and launching NFT projects. Budweiser, Pepsi, and Porsche all decided they should give it a try. McDonald's launched McRibb NFTs, luxury clothing and accessories brands like Louis Vuitton and Tiffany tried to introduce Fidgetal into the lexicon by pairing physical items with digital copies that a person might one day be able to wear in a metaverse somewhere. Even the Charmin Toilet Paper brand launched NFTP. Most reasonable people wouldn't be surprised to hear that these gimmicky projects didn't have much staying power. At least one person was surprised, though. Luke Brown has filed a class action complaint against luxury fashion brand Dolce and Gabana for its DG family NFT flop. Dolce and Gabana had

promised that its NFT holders would regularly receive some combination of digital wearables, physical clothing items, access to live events. Many people spent around $1.2 Ethereum, or around $3,500 at the time, for a random tier of what was essentially a loot box, and some high rollers were given private access to pay $40,000, or around $120,000 for a guaranteed top-tier box. However, the rollout was full of snags, including the weird decision to manually fulfill NFT rewards one by one, shipping issues and high customs fees for people receiving physical items, and a lackluster experience in Decentraland, which is described in the lawsuit as, quote,

a metaverse platform with barely any users. Brown contends that he spent $6,000 on the NFTs, but that the items distributed in turn were only generously worth $20 to $30. Secondary market sales also quickly plummeted, making it challenging for holders to recoup much of the most. money they'd spent. Brown accuses Dolce and Gabana of rug pulling by failing to follow through on what he describes as false advertising. In bankruptcies, FTX. Headlines have once again been going around claiming that FTX customers will not only be repaid in full, they'll receive their money back

plus interest. However, these claims are still based on the price of cryptocurrency assets at the time of FTX's bankruptcy, which were in part because of FTCS's bankruptcy. Which were, in part because of FtX's collapse, lower than they had been in a long time. I think some are dismissing creditors' complaints that they're not receiving back the current price of their Bitcoin or other crypto assets, almost seeing them as entitled for wanting to be able to cash in on the gains Bitcoin has enjoyed in the time since. But to put a number on it, if a customer held one Bitcoin with FTCS, the estate is considering that Bitcoin to be worth about $16,800. But many of customers put far more money into FTX than that. If a person decided to buy one Bitcoin when they

saw the Super Bowl commercial that promised FTX was a, quote, safe and easy way to get into crypto, they would have spent $42,000 on it. Some bought in at even higher points when Bitcoin prices were as high as almost $70,000 and are receiving about a quarter of that original money back. Today, Bitcoin is back around that $70,000 mark, but, but, you're receiving about a quarter of that $70,000 mark, but the people who bought a Bitcoin for that amount and put it on FTCS will be repaid something around $20,000 and are stuck reading headlines about how they're so lucky. That's not to say there aren't people trying to pull one over on the FTX estate, though. Recent bankruptcy filings show that people have filed a combined $27.3 quintillion in claims.

My guess is there are a lot of people trying to claim their illiquid shit coins are actually worth their paper values. Genesis The bankruptcy judge has approved Genesis' plan to return about $3 billion in cryptocurrencies and fiat to its creditors. Though the way the recovery is being calculated in this case is much more friendly to creditors than in the FTX case, Genesis customers are still estimated to receive only around 77% of their assets back. Genesis's parent company, Digital Currency Group, or DCG, tried to argue that, like FtX, Genesis should only repay creditors what the crypto was worth at the time Genesis filed

for bankruptcy in January 2023, when Bitcoin was priced at around $21,000. This would have made recovery substantially less for creditors, though it would have also allowed DCG to claim that its subsidiary's customers had been repaid in full. DCG had seemed to hope that if the bankruptcy judge approved their objection and required the company to return a smaller portion of the company's remaining assets to its customers, there would be more left over for DCG at the end. However, the judge pointed out that there is still nowhere near enough money to pay the $32 billion in outstanding claims, including some fines by federal and state regulators, which would come before DCG was left to pick. at any scraps. In Governments and Regulators. The big crypto topic over at Capitol Hill recently is the SEC's Staff Accounting Bill 121, which the cryptocurrency industry and some banks have been pushing hard to overturn. Opponents of SAP 121, a rule which requires banks to report

crypto assets as a liability on their balance sheets, argue that it unfairly prevents banks and other financial institutions from getting into crypto by making it extremely expensive. Many are also upset over the procedural side of things, arguing that the SEC was inappropriately setting policy via an SAB instead of through its more formal rulemaking process, or by seeking new legislation from Congress. Supporters, on the other hand, argue that SAB 121 is a perfectly reasonable stance by the SEC, taken in response to the serious risks posed by cryptocurrency assets, and that repealing it would undermine the SEC's ability to regulate the cryptocurrency sector.

One such supporter is President Biden, who has stated he will veto the bill if it gets to him. It looks like it will come to that, as the Senate has passed a resolution to overturn the policies 60 to 38, enough to pass, but not the two-thirds majority that could overcome a veto. Meanwhile, the House is set to vote this week on the Financial Innovation and Technology for the 21st Century Act, abbreviated to Fit 21, a bill that has received strong support from the cryptocurrency industry. Most notably, it would make the CFTC the primary regulator of the cryptocurrency industry, something the industry has been clamoring for for years, mostly because it is a smaller agency than the SEC with fewer resources, and a historically less aggressive

approach to the sector. Unsurprisingly, around 60 cryptocurrency companies and industry lobbying groups, including Coinbase, Circle, DCG, Gemini, and Cracken, signed on to a letter in support of the bill. The Treasury Department released its annual report on combating terrorist and other illicit financing. The report calls out, quote, the ongoing trend in virtual asset investment scams, and recommends updating regulatory requirements. around anti-money laundering and terrorist financing to account for cryptocurrencies. Elsewhere in Crypto The Wall Street Journal published an investigation into Binance's internal handling of market

manipulation among its VIP customers, or, more accurately, its lack thereof. According to the journal, after Binance investigators received a complaint that their customer, trading firm DWF Labs, was manipulating markets, the investigators' discovered that DWF had manipulated token prices and performed more than $300 million in wash trading. However, after those investigators submitted their report recommending that DWF be removed as a customer, a finance executive in charge of handling the company's VIP clientele complained to company leadership. A subsequent investigation of the investigations team found insufficient evidence that DWF had intentionally

manipulated markets, and alleged that the head of the investigations team had collaborated too closely with the DWF competitor who had submitted the complaint. That person was fired soon after, and over the course of the next few months, several other investigators were laid off for cost-saving reasons. That version of events might be more believable if the journal hadn't also dug up a report from DWF to one of their own customers, which outlined how they had created a massive amount of artificial trading volume for that customer's token, and were trying to make the trading patterns look, quote, believable. The people behind the scam as a service software known as Pink Drainer have announced their retirement after they, quote, reached their goal. Altogether, their

Drainer software has been used to steal somewhere around $75 to $85 million in cryptocurrency in the last year, with the Pink Drainor team taking a cut. In their farewell message, they offered some words of advice. Quote, if you have enough money right now to financially support yourself, we advise you hold on to it and take a step back from the grind and enjoy what this world has to offer. Life is too short to get caught in the perpetual cycle of needlessly spending, going broke and trying to make it back. One wonders what advice they might offer to the roughly 20,000 people who have been scammed with the help of their service.

The Web 3 is going just great recap. There were nine entries between May 8 and May 17, averaging 0.8 entries per day. 124.62 million was added to the Grift Counter. A former employee of Pump.comfund steals $2 million. in an attempt to kill the project. An employee who briefly worked for the Pump. Dot Fund Solana meme coin creation project took responsibility for a $2 million theft they perpetrated with the private key access they had gained by working for the operation.

The employee then began seemingly randomly airdropping the stolen funds to holders of various Solana meme coins and publicly took credit for the attack. In a slew of Twitter posts, the thief seemed somewhat unstable, writing things like, quote, everybody be cool, this is a robbery. I'm about to change the course of history and then rot in jail. Am I sane? Nah. Am I well?

V-much, not. Do I want for anything? My mom raised from the dead and barring that, life without parole. In a later Twitter space's chat, he explained, quote, I just kind of wanted to kill Pump. Fun because it's something to do. It's inadvertently hurt people for a long time. Unlike some cryptocurrency company employees,

the identity of the attacker is known to Pump. Dot Fun, who wrote they would be working with law enforcement. The hacker responded to this announcement in a tweet, Neener, Neiner, Neiner. Sun Finance is the latest to fall victim to the well-known compound bug. A lot of cryptocurrency projects build off of code developed by compound finance. This is good for them in the sense that

it saves them development effort, but it also means that bugs in that code can be passed through to their project. A well-known idiosyncrasy in the compound finance code has been the downfall of a number of projects who failed to properly account for it. The latest in this string is the Sun Finance Lending Protocol, which was hacked for around $20 million. Another $6.5.5,000. $5 million were rescued by various white-hat hackers in operations in which they took the money themselves and then returned it to the project team. Everything else. $2 million was stolen from Alex's X-Link Bridge by a bumbling exploiter, and a cipher contributor

admits to stealing over $300,000 due to a, quote, crippling gambling addiction. Worth to read. I particularly enjoyed a recent piece by Corey Docterow on the, the, quote, Ulysses Pact and twiddling, and the need for platforms to recognize the siren song of twiddling their software in ways that make things worse for the people who use them. The post is called Algorithmic Feeds are a Twiddler's Playground. Albert Bernico, over at Defector, fired a shot across the bow of any would-be, uncritical, hyperpeating tech journalist, and directly into the face of Kevin Ruse.

Previously known for regurgitating the crypto industry's claims about how crypto would revolutionize our lives, Ruse has recently pivoted those impulses towards AI. Bernico's not having any of it in his article titled, If Kevin Ruse was Chat GPT with a spray on beard, could anyone tell? In the news, Julia Anguin prominently quoted my comparison between LLMs and blockchains in her recent guest essay for the New York Times, titled press pause on the Silicon Valley hype machine. If you like the writing I've been doing recently about the web more broadly,

you may like this podcast interview I did on Mike McHugh's dot social podcast, which is all about the future of open social media. We talked about the future of the web and why I'm a web optimist, why I think everyone should be a blogger, digital ownership, and, of course, decentralized social media. It's titled Entering a New Phase of the Web. That's all for now, folks. Until next time, this has been Molly White. Thanks for listening to this issue of the citation needed newsletter. To learn how to support

my work, visit mollywhite.net slash support. If you'd like to read the text versions of these episodes, sign up to receive the newsletter in your email, or support my work on a recurring basis. Go to citation needed.news.