The Breakdown - A Recap of the Prime Trust Saga

Episode Date: June 30, 2023

Today on The Breakdown, NLW catches up on the Prime Trust saga which came to a head this week. He also looks at the latest in Bitcoin ETF applications and Michael Saylor and Microstrategy's latest big BTC buy. Enjoying this content? SUBSCRIBE to the Podcast: https://pod.link/1438693620 Watch on YouTube: https://www.youtube.com/nathanielwhittemorecrypto Subscribeto the newsletter: https://breakdown.beehiiv.com/ Join the discussion: https://discord.gg/VrKRrfKCz8 Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. What's going on, guys? It is Friday, June 30th, and we are finally back in the saddle. Today, we are recapping the Prime Trust saga and more. But before we dive in a quick note, if you're enjoying the breakdown, please subscribe to it. Give it a rating, give it a review, or if you want to dive deeper into the conversation, come join us on the Breakers Discord. You can find a link in the show notes or go to bit.ly slash breakdown pod. All right, friends, hello again.

I hope you have had a good week. And I hope that many of you who tried out the Bitcoin Builders episodes, the Summer Startup Special, enjoyed them. If you did, let me know on Twitter or in the Discord, I would love to hear from you. Now, obviously, having not recorded a show for a few days, we have a lot to catch up on. And today we're going to focus first on Prime Trust.

This is a story that has been percolating for some time, but which really came to a head this week. So, on Tuesday, the Nevada Financial Institution's division, or FID, filed to place Prime Trust into receivership. If approved, a regulator-approved receiver would take over operations at the CryptoCastodian, and current business would be frozen while an audit is conducted. Now, this comes after last Thursday, Bickgo walked away from its planned acquisition of Prime Trust. Later that day, the Nevada FID ordered Prime Trust to cease operations,

stating that the custodian had a, quote, shortfall in customer fund. They said that it had been unable to meet redemption request and was, quote, operating at a substantial deficit or might already be insolvent. Now, by way of background, Prime Trust has been a key firm in the U.S. crypto industry since 2016, providing custodial and money transmission services for large firms, including Binance U.S., strike, and swan Bitcoin. Over the course of this year, customers have been moving away from Prime Trust, leaving them with a short list of remaining clients.

Well, this week's filings had significantly more details on the matter. Well, after weeks of rumors, this week's filing had significantly more details on what was actually going on. The Nevada FID claims that Prime Trust owes clients $85 million in Fiat, but only has $3 million in cash on hand. The deficit in crypto holdings was claimed to be a more modest $900,000. The regulator also alleged that Prime Trust had been operating while undercapitalized, with a $12 million deficit after considering shareholder equity. Now, under normal operating conditions, this kind of hole in customer assets shouldn't have been possible at this type of custodian. Prime Trust operates as a trust company, meaning that it doesn't take ownership of

customer assets for the purposes of putting them at risk. So what happened? Well, the Nevada FID alleged that part of the cause of the shortfall was Prime Trust losing access to what it called quote-unquote legacy wallets. In 2020, Prime Trust entered an agreement with fireblocks to provide management of crypto assets and associated private keys. In 2021, after Prime Trust came under new management, they distributed legacy wallet forwarding addresses to customers in order to work around difficulties with creating new wallets within the Fireblock system. Prime Trust believed that these legacy wallets existed within the Fireblocks platform, but discovered in December 2021 that the wallets were inaccessible. Now, rather than alerting customers, Prime Trust allegedly purchased

additional cryptocurrency using cash deposits held in client Omnibus accounts in order to continue servicing withdrawals. To date, legacy wallets holding customer assets have been inaccessible. Fireblocks released a statement explaining that, quote, after Prime Trust became a Fireblocks customer, new management made a decision to deposit Prime Prime Trust's customer assets in old legacy wallets. Once management moved those assets to the legacy wallets, the customer assets were not recoverable. These legacy wallets were not Fireblocks Wallets. Now, of course, if this is actually what happened, it speaks to dangerous levels of mismanagement at one of the most used custodians in the industry. Now, it appears that most major firms removed

client assets from Prime Trust before the events of this week. Both Swan Bitcoin, and strike migrated customer assets to an alternative custodian over the past few weeks, seemingly avoiding the worst of the fallout. However, a smaller Bitcoin-only firm named CoinBits was not so lucky, announcing on Wednesday that their services would be suspended until they develop a solution. CoinBits wrote in a Twitter thread that, quote, The petition seems to indicate that Prime Trust still has enough Bitcoin to honor our members' balances. We are pursuing these assets on behalf of our customers. Now, in another crazy dimension of the story, blockchain analytics firm Arkham Intelligence

did some digging into the crypto remaining under custody with Prime Trust, and found that out of the 68.6 million worth of crypto held, only 7.5 million of that was Bitcoin. The vast majority, on the other hand, around $61 million worth, was held in audio tokens. Audio is a fairly illiquid token that trades mainly on Binance, and the tokens held with Prime Trust represent over 30% of the circulating supply. We'll come back more to that in just a minute. Now, on top of all of this, rumors have been swirling around

that Justin's son affiliated Stablecoin TrueUSD, or TUSD, was caught up in all this madness as well. Prime Trust had been handling some minting and redemption for the stablecoin issuer prior to this month's event. Following the tumult at Prime Trust, TUSD's issuer announced that only $26,000 was held with the custodian. According to the firm's auditors, those funds were not reserve assets, but represented cash redeemed but not yet transferred to customers. Despite the assurances, however, TUSD had a major depegging event on Wednesday, with its tether pair reaching 80 cents on Binance U.S. before recovering. Other exchanges experienced a much less severe divergence of less than one cent, and the peg is now stabilized. So the big question that remains is how customers

will be affected by prime trust receivership and whether any clients that pulled their funds early will be subject to clawbacks. The receivership process is different to bankruptcy. Because trust clients retain legal ownership of their assets, they are generally allowed to withdraw without concern. However, due to the involvement of a state regulator and questions of fairness between different clients, will have to wait for the legal process to play out to know for sure. Swan CEO Corey Clipson appeared on concern, tweeting, quote, the government would have to get rid of all trust companies and a century of trust structure legal precedent to confiscate assets from individuals and companies who had removed their own

assets from a legal custodian. Also, if there were somehow going to be clawbacks, illegal and contra a century of precedent, Swan would just make our users whole. Our share of the assets on Prime Trust was small, and we have plenty of money to cover our share. Now, the response among the community has just been brutal. Pleditor writes, wow, the fraud at Prime Trust was way worse than I could have imagined. They've been massively insolvent since 2021 and have been secretly buying back coins to fill the hole. Patrick McKenzie writes, the trouble with misappropriating customer funds to cover an operational shortfall is then you have to misappropriate funds to cover the misappropriated funds and then you have to dot, dot, dot, dot. Low Strife commented on the audio

token positions saying, wait what? So after losing all the crypto, did they yolo all of the customer USD into some random shit coin in hopes to 100x at all back in one trade? Because that's what it looks like they did. James Murphy at Meta Lawman writes, the Prime Trust debacle step by step. One, lose private keys to customers crypto. Two, panic. Three, use customer money to replace the lost crypto. Four, get caught. And finally, Bitcoin or Magoo summed up one of the best takeaways when he wrote, wondering when people are going to realize the innovation is no counter-party risk. Next topic, let's check in on the latest on all of these ETFs. BlackRock's application for a spot Bitcoin ETF two weeks ago has led to a flurry of

activity among rival asset managers. Last week, Wisdom Tree, Van Eck, Invesco, and Bitwise all revised their ETF filings. On Wednesday, Kathy Woods' Ark Invest joined the ranks amending its spot Bitcoin ETF filing. The amended filings include a version of the surveillance sharing agreement which was included in BlackRock's application, which many saw as the key change which would allow SEC approval. So far, the SEC has rejected all spot Bitcoin ETFs on the primary grounds that Bitcoin markets are rife with manipulation and have insufficient fraud detection mechanisms. Arcs update provided that the CBOE's BZX exchange would enter into surveillance sharing with an unnamed US-based crypto exchange. Though this phrasing has

been common across all revised application, we don't know yet which crypto exchanges have agreed to participate in this market integrity program. And indeed, earlier today, the SEC seemed to have responded, or at least Wall Street Journal sources said that they're saying that there's not sufficient information and that these applications are going to have to identify which crypto exchanges are actually participating in this surveillance sharing agreement. Earlier in the week, Eric Balcunas, the senior ETF analyst at Bloomberg, had tweeted, the trick is they have to get the spot exchange to actually enter into a surveillance sharing agreement, potentially the same exchange that BlackRock already has a partnership with. Nate Garassi, the president at ETF store,

said, would BlackRock, who doesn't play, even allow Coinbase to enter into an SSE agreement with another that would help another issuer beat them to market? Now, Arc analyst Yassine Elmandra really wrote the summary of what everyone has been feeling over the last couple weeks when he said, BlackRock's decision to file for a Bitcoin ETF signals that large institutional players are positive on the long-term outlook for the digital asset. Now, on top of all this, after a week of speculation, Fidelity has joined the fray, filing for their ETF on Thursday. Unlike some other proposed funds, Fidelity will be using its in-house custody service. Their ETF also included a surveillance sharing agreement structured in a similar way to other

recent filings. A Fidelity spokesperson said, quote, a meaningful portion of our customers are interested in and own digital assets. Fidelity first filed for a spot Bitcoin ETF in 2021 and was previously rumored to be taking a close look at acquiring Grayscale. Speaking of Grayscale, what's happened with them. Since the filing of BlackRock's application, the Grayscale discount has closed dramatically. Just a few weeks ago, the GBT discount was in excess of 40%. It is now closed to around 30%, which is the smallest discounts in September of last year. Trading has also been robust, with GBT volumes increasing by almost 80% in June after muted volumes in May. Doug Schwank, CEO of Crypto Data Provider Digital Asset Research, said that the bullish sentiment behind GPDC was due to, quote,

BlackRock filing and optimism that the firm may have cracked the code on an ETF. giving hope that Grayscale could also convert and remove the discount. Now, the other interesting Bitcoin event this week is that Sailor has been at it again. On Wednesday, Micro Strategy announced that it had been in the markets in a big way. Since the end of April, the firm has acquired 12,333 Bitcoin for $347 million, a cost basis of a little over $28,000. Micro Strategy now owns $152,333 Bitcoin, worth over $4.6 billion at current prices. Their holdings are now at an average cost base of 29,668.

These recent purchases were funded primarily through the sale of 333.3 million worth of shares under a previously disclosed share sale agreement. There has been some amount of disagreement on how much micro-strategy's buying activity has been a driver of the positive increases in Bitcoin's price. Will Clemente, the co-founder at Reflexivity Research, said, yes, micro-strategy played a role in the recent Coinbase US trading hour premium, but it did not play any role in the $1 billion plus of CME Bitcoin Futures. open interest that was added in the same time period.

Vettley Lunday, a senior analyst at K333 research, said, Micro Strategies' impact last week was probably highly negligible. Now, some people were a little bit skeptical of this, as they always are. Bob Lucas wrote, No idea why so many are cheering this on. This concentration in Honeypot is absolutely horrible for Bitcoin. Definitely applaud his passion and support, though. Still, for most people, all of the speculation was about what this portends for an

ETF and its potential impact on Bitcoin's price. Stack Hodler writes, Micro Strategy bought another 12,333 Bitcoin. It seems 347 million can move the market quite a bit these days. I wonder what happens when hundreds of billions of dollars flow into spot Bitcoin ETFs. All right, friends, I will close there for today. Excited to be back with you.

We've got another update show coming tomorrow and then LRS and then we are back to normal starting next week. I appreciate you listening as always. And until next time, be safe and take care of each other. Peace.