On The Brink with Castle Island - Weekly Roundup 03/03/23 (Silvergate in trouble, Oasis hacks back, Regulation by Blog Post) (EP.402)

Episode Date: March 3, 2023

Matt and Nic are back for news and deals of the week. In this episode:  Is Yuga Labs' NFT collection on Bitcoin genuine? Will the environmentalist attacks on PoW move to other industries? FTX' Nishad Singh pleads guilty Ramnik Aurora maxed out donations to George Santos Silvergate is in trouble Why concentration risk makes it difficult for smaller banks to bank crypto firms UK banks are curtailing their crypto exposures Oasis returns $140m stolen from Wormhole to Jump NY Mag's piece on Arthur Hayes Gensler continues to make vague threats against the crypto space Gensler's regulation by blog post Greyscale's case against the SEC is moving to oral arguments Can Bitcoin just change the code and move to PoS?

Brought down by bad mortgage investments, Lehman, which has 25,000 employees, will be liquidated. The federal government loans American International Group, AIG, $85 billion. This is a different kind of market, and the Fed is asleep. The federal government is stepping it to stabilize Fannie Mae and Freddie Mac, the two mortgage giants that have been threatened by the housing crisis. The Bank of England has pumped 75 billion pounds more into Britain's ailing economy with a new round of Concentive Easing. You print a couple trillion dollars, and all of a sudden, people start to worry. So out of this worry, we have something called a Bitcoin. Welcome to On the Brink. I'm Matt Walsh.

And I'm Nick Carter. And what a week. It's actually not that busy. The deal pace was pretty slow. So I don't know why I said what I'm going. Yeah, no, it was just kind of a normal week. Just a normal week. Busy week. Everyone's in Denver. That's the problem. So nothing's happening this week. Are you, I mean, I guess I know you are paying attention.

but this Bitcoin Ordnals thing is taking off big time. Ugalabs. Ugal Labs, the biggest NFT company, aside from OpenC, I guess, are now minting? Or are they? Are they or aren't they? Are they not? So they did announce their intent to mint a generative NFT collection on Bitcoin. Those images started to appear on Bitcoin.

However, we don't know. if it's actually them or someone, the images were leaked somehow and some third party did it. We don't know yet if those are the authentic ones. Interesting. I don't know. I'm just basing this on people in my orbit that are talking about it. And there's a ton of people talking about it. There seems to be a lot of startups getting off the ground. And I just think this is going to be a thing. Yeah, completely. We have another Ordinoles podcast coming up actually with another. I just recorded. I just recorded. I I haven't even told you this.

I just recorded a podcast with Rob Hamilton and just got done like 10 minutes ago. And we talked a lot about Orders. Yeah, Rob has been all over it. We have another one, actually on top of that with one of the mining pools that are involved in Ordinals, which is a wealth of Ordinance content. Yeah, I mean, I'm seeing some high quality projects. So the problem is most of the original first Ordinals, mints were just derivative or pretty generic. But now there's actually new original content, which is coming to Bitcoin. I can't wait until IBM hears about this and they start tagging lettuce on the Bitcoin blockchain.

That's where we're going. That's what NFTs are for. So we had a awesome podcast this week. Ria set down with Matt from Block Native, Matt Cutler. That was his second time on the podcast, talked about MEV, block building. A lot going on in that space. Always extremely big brain to when Matt Cutler comes on the show. Matt Cutler is a Boston guy.

lives out on the West Coast, but Boston guy, big brain Boston guy. You're claiming him. And unfortunately, we were just talking about this. No zany or weird happenings happened to us this week. So there's sort of not that much to report. Yeah, no like weird stuff happened, huh? I mean, just knock on wood. On the political front, I am hearing there will be further agitations against proof of work coming up.

That old chestnut. Wow. What else is new? Yeah. So, okay, here's my theory around that. I think the issues that certain members of Congress or others, the administration have with brief of work, that's just a prelude to a broader campaign to attack other industries that consume a lot of energy. So let me ask you, what is a highly touted industry that consumes a lot of energy? that has kind of a dubious social purpose to it.

Well, it's probably not the one you're thinking of, but I think cloud providers and social networks consume a ton of energy. Well, they do, but everyone uses those. So they kind of escape that kind of level of scrutiny, I would argue, because there's enough perceived social utility there. Here's what I think. Okay, they're coming after Christmas lights. Probably.

but here's what's going to happen, AI. You know, I think there's going to be a move against the big AI data centers, which many of them are actually repurposed crypto data centers. And the same arguments you see leveled against Bitcoin mining, you'll see leveled against these big data centers that are doing AI stuff all day.

Especially because AI is getting very politicized. You know, if it's like the wrong kind of AI, like you all, Apparently Elon is creating now like a non-woke AI. I saw that. I saw that. So that's a way to create enterprise value without having to actually build anything. Just say you're doing AI.

Yes. But to Elon's credit, he was one of the co-founders of Open AI. He was back when it was a nonprofit. And then now he doesn't like it anymore. It went woke, right? And so now he regrets that. And he's going to create the opposite. the equal and opposite AI.

And I bet you anything, once these new AIs emerge that are, maybe they don't adhere as much to, you know, the defined social perspective, then I think you'll start to see, like, the Elizabeth Warrens of the world writing the same exact letters that they write to the miners, they're going to write those letters to these other GPU hosting companies and basically demand that they justify their electricity consumption. So that's kind of my warning to people is it's not just going to stop with Bitcoin. You know, I think it'll go broad base. It'll be a broader effort to control what companies spend electricity on. So everyone should care about it. It's too bad that we're starting to get entrepreneurs come in and talk to us and just say, well, you know, in two years, things will be better.

And just looking towards the end of this administration. it's hard to underwrite to that plan because it might not be better in two years for certain categories. It might be four more years. Yeah, look, we have no, there's no, you know, it's not a guarantee that the administration's going to change in two years. So that's kind of a, that's a pretty weak plan if that is the plan. I said to someone who said that to me yesterday, I said, well, so you're banking your business on the fact that, like, Joe Biden has a sex scandal here? Like, what's, what actually are you talking to me about? Yeah, I mean, and even if he doesn't run again, like maybe it'll just be Pete Buttigieg, you know, I don't think he's going to be positively disposed towards crypto either.

Well, we'll see. I think some of these infrastructure developments with the SEC could be positive if interpreted the right way. So there are some green shoots potentially. Why don't we hop into the deals of the week? All right. Let's start. First up, we have portal labs. They're a blockchain infrastructure company. They raised 5.3 million in a round led by slow ventures. Next one up is Orange Comet. This is also an NFT company. They raised 7 million from new and existing investors. Then we have Hashnote, an institutional defy startup.

They raised 5 million from Cumberland Labs. They also hired Christine Sandler. So congrats to that team. That's a great hire. Christine's a rock star. Next up we have blockchain founders fund. They're cryptophiles. They raised $75 million for their second fund.

And the last one is Redeemed. This is an NFT company that is building SMS functionality. They raised $2.5 million from Kinetic, CMT, and others. So not a crazy deal week. Last week was nuts. Last week there was probably four times as many deals announced. Yeah, I guess you don't announce deals during September. Well, let's queue up the crime syndicate.

Cue the music for the crime syndicate. All right. So we've got Nashad is officially, he's played guilty. So last week we said, you know, a lot of rumors that he was pleading. It looks like he's been in tux for some time. So he pled guilty to a bunch of those charges, mostly fraud. He had some campaign finance stuff. Basically, what was revealed here is that he was just in on it the whole time. And he was actively defrauding investors. And there was interesting nuggets in all of these indictments. It looks like he was pulled into some of these investor meetings, so head of engineering, not surprising, I guess. And he actively defrauded them. One interesting nugget was that Sam asked Nashad to make it look like FTX had an

additional 50 million in revenue because he wanted to show that they had $1 billion in revenue per year. And so Nasad went back and backdated a bunch of things related to a defy transaction to make it appear that FTX was getting paid to support a certain token. So active fraud there to show that they were, you know, doing more revenue than they actually were. He engineered the back door. You know, he's just a bad dude here. There's kind of no other takeaway. Yep. And then our other favorite member of the FTX crime family, a certain Mr. Ramnik Aurora, FTCS head of product, slash corporate development slash M&A slash head of toy ventures

apparently maxed out his campaign finance donations to a certain Mr. George Santos. What is the story here? So Romnik is, first of all, he's got $30 million in a slush fund as heading up Toy Ventures from FTX. He's the head of product. He's the head of Corp Dev, head of M&A. He's the one that's out there trying to convince

Lightspeed to put money into FTC. is defrauded countless people and came in all those rounds and he's out there making max contributions to George Santos of all people. What possibly could they have been collaborating on? This is like the fraudsters themselves getting defrauded. Do you think they knew that George Santos

had falsified his resume or were they themselves tricked? The George Santos thing is really puzzling to me. Is George Santos like an FTX employee? This guy just, there's no rhyme or reason to this. This guy's just a, is he just a criminal? It's genuinely one of the oddest stories I've come across ever. And how is he still in Congress?

I guess so if you got elected and it turns out the whole thing was, your entire resume was made up, you just get to stay there? He just lied about everything. Nothing that George Santos has ever said is accurate, which I guess you could say the same thing for all these FTX frauds. Yeah, it's kind of a birds of a feather here. So I don't know, they'll probably do their time and come back and start an exchange together.

George Santos will be like the face of it. So that's it for the crime, that very light week for the FTCS crime family too. Well, there's a lot of, there's a lot of interesting things going on behind the scenes here. So obviously they're, they're just amassing this case against Sam. The only people that were very high up in that organization

that seemed to not have been pulled in in charge yet, or Romnik and Sam Truvugo. So you wonder if they're just going to start to grab a few more of these folks that can testify against Sam. And at this point, what are you doing if you're Sam? I mean, I guess you're going to go to trial because the alternative is to just take life in prison, so you kind of have to. But there's no way he's going to win this. Yeah.

What's he going to do between now and October? I mean, like prepare the case. It looks pretty hopeless, though. I just don't know how you can, every single one of his lieutenants by October is going to be, turned on him and it's pretty cut and dry. I mean, this is the easiest case to win, I would think, if you're a federal prosecutor. So there was one other thing somewhat related, which is now certain members of the Senate are going after Binance saying that their structure in Binance U.S. was eerily similar to FTX and FTX US, which is kind of probably the case.

I mean, having the onshore entity, making it look more respectable, maybe to deflect attention from the offshore entity. Yeah, I guess. I mean, I don't know. It's hard to tell, right? It certainly seems like it doesn't seem like there's outside investors in finance US. I know they tried to raise a round at one point when Brooks was there, but I don't think that ever happened. So it seems like it's owned by Binance. Has anyone heard from Catherine Coley?

I feel like I haven't heard from her in years at this point. No, I don't think so. But she was quoted, I think, or there was some mention of her in that article a couple weeks ago that came out about finance in the market makers that were on the platform. It's impossible to even speculate what's going on right now with finance. Unfortunately, Silvergate appears to be in extremely dire straits

on the banking side. not entirely sure that their current predicament is survivable. No, I'd say at this point, this has deteriorated materially. So we're recording this at 2.30 Eastern on Thursday. Yesterday on Wednesday at Close a Business, Silvergate came out and said that they were not releasing their 10K. And there was questions about them being a going concern. Today, this morning, basically every crypto company has dropped them. So no longer servicing Coinbase, FalconX, Galaxy, Crypto.com.

So I, to me, this looks really bleak. I mean, especially about it because they were one of the few banks that had reaffirmed their commitment to their crypto clients, whereas virtually everyone else that we know of is pulling back or increasing the disclosure standards for clients. So overall, I would say not a great development for cryptoform. that are looking to be banked. Yeah, and this creates sort of this cascading issue of concentration for small banks. So if you're a small bank and you see crypto companies as a good growth area,

which historically they had been, you start to bank them and then they start to get large and you have this issue around deposit concentration. And that also creates a cold start problem when you look at a map that doesn't have Silvergate on it potentially, when you just have a signature and a couple other smaller banks. that kind of means that those banks can't go out and just run the table on grabbing all of the exchanges and the brokerages because they would just have that deposit concentration. So you kind of have to have a bigger bank step into this, which there just aren't any that have the appetite for it yet. I think eventually there will be. But you don't have that yet.

So I think we might be going back to 2016, 2017 banking infrastructure, unfortunately. The battle days. Yeah, that is one of the most insidious things about choke point. 2.0 is it basically discourages most banks from servicing crypto and then you get, as you say, a few smaller ones that fill the gap, but they also don't want to have all the deposits be entirely correlated with the swings in the crypto market. So that, you know, and the established ones are pulling back their crypto practice as a consequence because you just can't have all your deposits be from crypto firms. And, you know, it's tough. It is a,

phenomenal opportunity for a larger bank to come in. If you can get comfortable with the risk, if you want to be the bank that supports a coin base, that can be just an unbelievably great business. You want to be doing some of these loans that Silvergate's done. So this loan that they did to micro strategy, for instance, which is collateralized, way over collateralized with Bitcoin. If you're a banker, you want to be doing that type of lending all day long. So then you have the the send network, right? These like post-trade settlement networks that signature and Silvergate have built out, those are valuable infrastructure pieces. So I don't know.

I think, you know, if there's a bank executive that's really smart and knowledgeable about this stuff, they'll see this asset as something worth owning, I would think. But it's hard to say how this unfold. For what it's worth, I am actually hearing from certain banks that they do see this as an opportunity and are looking to onboard the crypto clients that are being dropped. So it's not all one way. Although if you look across the pond, it's the same thing. that's happening. I think just today or yesterday, it was announced that UK banks are also

curtailing their exposure to crypto clients. It's not just a U.S. thing. Yeah. So it'll be interesting. By the time this podcast comes out, there'll probably be new news on Silvergate, but we'll keep an eye out on it. I did want to get your take on this jump crypto thing. What a crazy story. So to set this up, Jump Crypto, which is the crypto subsidiary of Jump Capital, they lost ton of money in this wormhole bridge attack last year. It was upwards of $200 million, I think, of their capital that was drained by an exploit. And the hacker, you know, obviously these are public blockchains, you can see where their funds go. So the hacker had money on this Oasis platform, this, this Oasis Decentralized Exchange network. And what appears to have happened here is

Jump has recovered 140 million of these funds by essentially hacking the hacker. And the way that they did this was there was a court order from the high court of England and Wales that basically said to this OASIS team that they need to reconfigure their multi-sig configuration to steal money from this hacker to give it back to jump. So did I get that right? Yeah, that appears to be right. I find this to be a little worrisome, actually, because on the one hand, you know, clearly these were illicit funds. and it's good that the theft has been undone.

On the other, you're making DFI participants worry that their funds ostensibly held in a non-custodial way on these DFI platforms are now vulnerable to court orders. I mean, especially from offshore jurisdictions. I mean, this was a UK court that asked for this. So it a little bit undermines the premise of DFI, I think, and it does. It does remind people that if the funds are held in a multi-sig that's controlled by a single administrator or fairly centralized multisig configuration, the funds are not ultimately yours as the user of the platform.

So I think it actually attacks the value proposition of defy to a certain extent. Yeah, I think this is, so I would agree with that. I mean, I think if you are running this OASIS network and a high core. can come in and tell you to change the configuration and move money, you look an awful lot like an exchange to me. That looks like a centralizing vector that can be regulated. I don't actually even see how that is defy. Yeah, I mean, that is one of the unfortunate realities of defies. Most, not all of these smart contracts are governed by certain multisigs and in some cases, just singular entities. There's a few people that are.

sound the alarm about this. Chris Black in particular, I think is a point. A lot of this stuff isn't Defi if you're really just beholden to the activities of a small number of people. Yeah. So, you know, I think more to come probably on this, but if you were a regulator looking to get aggressive, this would be something that you'd be studying, I would think. So there's an interesting piece from one of our favorite journalists, Jen Vietchner in Nymag. about Arthur Hayes. The cover image is him holding an octopus plush toy with his tosy-wozy-woes right there in the foreground.

Arthur Hayes, man, he, in comparison here, this guy looks like a hero compared to some of the rogues that we've dealt with this year. I mean, he never stole customer money. He did get federally indicted and sentenced to probation for running an offshore, unregistered exchange, and had those Bank Secrecy Act violations, but it's all a matter of comparison, right? Yeah, I mean, given what happened to other executives of major crypto platforms,

it seems like not the worst outcome. I mean, I think the probation is over now. People in crypto still really like Arthur. He's still riding his really good trade missives. And yeah, he seems to be living his best life now. You know, Bitmex still exists, which is the other interesting thing. It wasn't like a shutdown. I don't know that they could have shut it down, I guess.

I suppose now they just don't service U.S. customers, and they operate still under a foreign jurisdiction. So they continue to operate, and he seems to still have control of it. Yeah, he seems to have come out the other side of this ordeal, reputation intact, which is nice to see. Did you see Gensler came out today and said that crypto exchanges, that might say that they're qualified custodians might not be qualified custodians. So that's a little bit of who are you talking about here? Yeah, it's the old regulating by blog post.

It seems like he just wants to stochastically instill fear in the industry, even if he's not actually taking actions that often that follow his statements, it seems like cultivating a culture of fear is actually the objective here to just chill activity. in crypto.

Yeah. And so the obvious question here is just, all right, are you talking about Coinbase? And then you start to get into, okay, so walk me through what you're talking about. And maybe Coinbase will come out and just clarify this. But my understanding is that they have a New York trust company distinct from the exchange. And so maybe there's like a flow of funds issue that could be pointed to. But I don't think anyone would come out and say, hey, our exchange is a qualified custodian. they would probably say our custodian is a qualified custodian. So that's a question, but it goes

back to what we talked about, I think, last week around some of these entities that have custodians and also have exchanges. If you're moving assets from the custodian onto the exchange, I think that might end up being problematic. And certainly the exchange itself, if it's in a different legal entity and it doesn't have the same protections and controls as what you would need to be a qualified custodian, obviously it wouldn't be. And then you just get into, okay, well, how do you deal with that? And the obvious beneficiaries there are going to be prime brokerage businesses and over-the-counter bilateral trading businesses. So what you'd want is a prime broker to extend you credit so that you can trade on the venue while keeping your assets in custody. You'd be looking at like a hidden road

style business model. Or you'd be looking to just keep your assets with the custodian, not trade on exchange, just go bilateral and use smart order router, order management platform like a Talos to connect to various pools of liquidity. So I think both those work, but if you're just like moving assets from a custodian onto an exchange, that clearly doesn't work. So I don't know what to think of his comments other than I think he's probably going to find out who's doing it the wrong way.

and try to go after them. Yeah, I mean, his comments were met with a lot of pushback from crypto folks just because it seems like he's just making assertions without actually backing it up with enforcements or formal guidance. So I can see why people find it enervating. Well, did you see this general counsel at Ripple, which, you know, they're still, I think that case is coming to a head here pretty soon, but Stuart Alderati.

So he said, PSA, Chair Gensler has again proclaimed that every cryptocurrency except for Bitcoin is an unregistered security. He must now recuse himself from voting in any enforcement action that raises that issue since he has prejudged that outcome. And that is apparently a Eighth Circuit case called Antonew versus the SEC in 1989. So that'll be interesting. I mean, they might just be a new vector here to attack. your ripple. So there's another case to watch, which is grayscale versus the SEC. So those oral

arguments are coming next week. In their case about GBDC, they're contesting the SEC's decision to deny the conversion of GBDC into an ETF. Leading up to that case, the GBDC discount is at a tremendous low of 46%. So the markets are not pricing in a favorable outcome there. I'll be very interested to see what happens, though. I'm not pricing in a favorable outcome either. I think there's a world where they win, where they win this case. And then the SEC says, all right, back to the drawing board, resubmit,

and then they deny it based on the spot market surveillance sharing agreements. They just say, all right, well, show me a proper regulated spot market. and you can't really do that because 80% of the volume is on finance. So this discount is just shy of the all-time lows from December. So the market is really just not optimistic about GBDC's conversion right now. I will say it's not exactly a clinic on how to run a closed end fund. They haven't been helped by the securities regulators. No, they haven't.

But I think if this lawsuit doesn't win, we should be starting. to talk about alternatives, including tender offers. So there was a low light of the week in the press, courtesy of the MIT Technology Review, and a certain Amy Castor, I don't know why anyone listens to her, she wrote a piece saying, Ethereum moved to proof of stake, why can't Bitcoin?

This piece was abominable. I don't recommend it. I may write a rebuttal if I can find the energy, but anybody that's even roughly familiar with the proof of work debate, should be able to find the arguments themselves. So the premise is just, hey, Bitcoin moved to proof of stake? Eith moved to proof of stake, so Bitcoin can, according to her.

And she says it's just a social issue, not a technology issue. If that's true, I'd love to see the code. She's written to soft fork or hard fork Bitcoin and turn it to proof of stake. I'd love to see the code. I mean, Bitcoin could move to proof of stake if everyone wanted it to. I'm sure there would be a way. It's not, it'll never happen. It's a little bit like saying, well, you know, there's no technological barriers for the U.S.

to become a constitutional monarchy. It's just a social or political issue. I agree. It's just that's true. It's just that kind of an issue. But it's also not a very practical thing. I don't even know if it's worth getting into the fundamental distinctions between proof work and proofsick. There's one thing I'll say about this, though.

my worry around proof of stake was always that the exchanges would end up controlling a lot of the stake because people tend to deposit coins on exchanges and then the exchange would have undue power over the network because they would be the largest stakers and they're actually our case studies of exchanges changing protocol rules based on them having a lot of coins. However, the recent an SEC settlement with Cracken actually worked against that because now exchanges are less motivated to stake on behalf of their clients. So weirdly, the SEC did something which actually really helped decentralize proof of steak if you think about it. That's probably what they're going for. Yeah. I'm sure they're like, well, how can we make a theorem as robust and anti-fragile as possible?

So, but yeah, that's a weird bright side for Eith's decentralization there. you got to kind of put yourself in Gensler's shoes here and just think about what is the end game here? So if you, you know, he came out last week and he said everything's a security except for Bitcoin. Okay, so then there's over a trillion dollars of market cap on non-Bitcoin cryptocurrencies. And so what are you going to do? You're just going to go one by one and just try to enforce against all these things. And how much money, how much taxpayer money is that actually going to take? and Ripple's been fighting this thing

for like two plus years and so you go after CoinBiss that's go ahead but they're going to fight you and they're going to be fighting you for more than two years I would imagine so it just seems like a total waste of taxpayer money to have the SEC just go after these projects one by one

there's hundreds of these things there's actually thousands of these projects that you'd have to go after so we clearly need an act of Congress here to just force the regulatory to just come up with a framework. So, you know, fall back on something like Hester Persis' Safe Harbor proposal, put some clear disclosure standards in place. Like, that's the only way that this thing gets done

in a way that doesn't just bleed taxpayer money indefinitely. And just stunt capital formation while you're doing it. It's just crazy. Yeah, meanwhile, other jurisdictions are becoming hubs of blockchain startup activity. Totally. I mean, there are certain categories of startups are just, it doesn't make sense to start them in the United States right now.

You'd be a crazy person to start certain types of businesses here when you can just go start them elsewhere and you can have the regulator with a very defined framework and you can start the business, you can hire people, you can get all your accounts set up and you can start to employ people. I don't know why we're missing this.

All right, so I think that's it. A short one this week. We're up against the clock here, but I think we'll have more news next week. Sounds like there's a bunch of deals that'll be announced early in the week, as well as probably some updates here on the banking situation. So I guess we'll leave it there. Okay. Hope everyone in Denver staying warm.

A safe and healthy weekend, and we will see you on Monday.