The Breakdown - Court Orders FTX Independent Examiner

Episode Date: January 23, 2024

Reversing a lower court decision, FTX will have an independent examiner. It also appears the bankruptcy estate has been a major source of GBTC selling. Enjoying this content? SUBSCRIBE to the Podcast: https://pod.link/1438693620 Watch on YouTube: https://www.youtube.com/nathanielwhittemorecrypto Subscribe to 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 Monday, January 22nd, and today we're getting an update in the FTX bankruptcy case. Before we get into that, however, if you are enjoying the breakdown, please go 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 of the show notes or go to bit.ly slash breakdown pod. All right, friends, welcome back to the breakdown.

We have been blissfully free, I have to say, of FTX anything since the end of the Sam Bankman-Fried trial. But we did get a meaningful update that we need to go over. An independent examiner will be assigned to the FTX bankruptcy case after a successful appeal. So, last February, when the process was still in its early stages, the bankruptcy court rejected the need for an independent examiner. They cited additional costs and duplication of work already being done by the incoming executive team to investigate the FTX collapse. At the time, the judge said, I have no doubt that the appointment of an examiner would not be in the best interest of the creditors. Every dollar spent in these cases on administrative expenses is $1.00 less to the creditors.

Indeed, the unsecured creditors committee had opposed the appointment of an independent examiner, satisfied that an investigation led by new CEO John J. Ray III would be sufficiently independent. The decision was viewed by many as strange at the time, as there is a presumption in favor of appointing an independent examiner in all bankruptcies larger than $5 million. Well, on Friday, the appellate court reversed this decision. Judges said this would provide greater transparency to creditors and that an independent report would allow the bankruptcy court to, quote, consider the greater public interest in its rulings. The ruling focused on the issuance of FTT tokens and suggested an independent examiner could scrutinize the broader industry practice of crypto firms using their own tokens to boost enterprise value. concerns were also raised about Sullivan and Cromwell who are providing the bulk of the legal work on the bankruptcy. The firm has already billed over $180 million on the case, equivalent to

around 10% of its revenue from 2022. There are also allegations of conflict of interest considering that Sullivan and Cromwell provided legal advice to FTX prior to the bankruptcy. To be clear, there is no solid theory that S&C have acted improperly. The point being made is that without an independent examiner, this potential conflict and the facts underlying are unlikely to come to light. The court emphasized that an examiner must be truly independent of the current bankruptcy team. They specifically noted that the potential that FTX employees who may have engaged in fraud could still remain at FTX Group. There was an emphasis on making the findings public in contrast to the current internal investigations. Ultimately, the bankruptcy judge will be able to set the budget

and scope for this independent investigation, so could prioritize ensuring the process is not delayed. Now, many had expected this is how this would all go down. James Murphy at Meta Lawman wrote the Third Circuit Court of Appeals has reversed the FTC's inexplicable refusal to appoint an an independent examiner for the FTCS bankruptcy. Not a surprise, it's really unfortunate, it has taken this long. Sunil Kavuri wrote, The appointment of an independent examiner for FTCS is excellent news for FTX creditors. One, reveal FtX insider transactions. Two, propping up Samcoins. Three, mark manipulation. Four, who helped them. Five, liability of many parties, e.g. Sullivan and Cromwell, advisors, etc. could help our FtX lawsuits. Six, debtor spending slowdown. Seven.

use of customer funds. We'll take four to six months, so bankruptcy plan can be confirmed before that. Info will be public, so why did the debtors and unsecured creditors committee not wanted at the beginning? Wouldn't have delayed anything. Gives FTX creditors more incentive to fight for a better plan, as any adversary action can be done at the same time. Now, interestingly, FTX also has an intersection with the biggest story from the last few weeks, which is, of course, the launch of Bitcoin spot ETFs. One of the big dampeners on Bitcoin's price following the launch of these ETFs is that investors have sold more than $2 billion worth of GBTC. As it turns out, according to private data coin desk reviewed and two people familiar with the matter, a big chunk of that was FTC's bankruptcy

estate dumping 22 million GBT shares worth around a billion dollars. Now, one of the questions that I've aired before when it comes to how we should look at the GBT outflows over the last couple weeks, is the question of how much these were folks rotating from GPTC into a lower cost option versus people just getting out of GPTC entirely. I think that this matters because the less that it's people just rotating, the more that it means that those other funds are seeing new inflows of a different type of customer, which holds aside the total inflows and outflows is what we want to see. We want these products to be about more people coming into the space. This suggests that at least a meaningful part of this is not just the rotation from one product to another. Now,

interestingly, FTX isn't the only thing explaining the GBT outflows. A JPMorgan report released on Friday said that analysts expect further outflows this week, and the report attributed those outflows to traders who had positioned themselves to harvest the GBT discount and are now closing out their trade. Analysts wrote, it looks like GBT investors who over the past year had been buying the GBTC fund at a significant discount to NAV to position for its eventual ETF conversion, have been taking full profit post-ETF conversion by exiting the Bitcoin space entirely, rather than shifting to cheaper spot Bitcoin ETFs. JPMorgan had previously estimated that up to $3 billion had been allocated to the GBT

discount trade over the past year. If that estimate is correct, then this trade has not yet been fully unwound, but certainly much of it has. The report also noted high fees but said that greater liquidity has given GBTC a continued reason to exist. Analysts wrote, a lot more capital, perhaps an additional $5 to $10 billion, could exit GBT if it loses its liquidity advantage. In an interview on Friday, Anthony Scaramucci of Skybridge Capital also suggested that tax planning might have had a role in unwinding GBT positions.

He noted that GBT began trading at a discount in early 2021, with a 15% discount on the day that Bitcoin hit its all-time high. Investors who scooped up discounted Bitcoin through GBT would now be selling for a tax loss. This means that they aren't allowed to re-enter a Bitcoin position for 30 days, according to wash sale rules, so we could see those investors cooling their heels sidelines before buying back exposure using an ETF in February. Overall, a lot of Twitter was about estimating when they thought all of this was going to end. Mikey Bolito from Blockwork said, My guess is GBT Outflows stopped being an issue in one to two months.

If you assume 30% of the 25 billion in AUM leaves, then at the current pace, outflow stop in two weeks. Then I think the market starts paying attention to net inflows, having, and rate cuts. David Bailey, the CEO of Bitcoin Magazine, wrote, I spent almost an entire year talking to GBT shareholders on a daily basis. In total, roughly 40% of the shares reached out and I worked directly with the top 100 holders or so, probably more to be honest. Hearing from folks this week, we're grinding through some of the big boys.

It'll pass. Today's episode is brought to you by Cracken. For far too long, the whole financial system has been standing still, too slow, only on for certain hours, overly designed for some types of people, but not for others. Crypto, at its best, represents progress. It asks the question, what if? It invites people in instead of leaving them out. It's on 24-7, 365, and moves at the speed of real life. Not everyone believes it. We've got our fair share of detractors, but that's the way it always is when you're building something new. Cracken is a crypto company that has been through the highs and

lows of the industry, facing forwards towards progress throughout. And now they're inviting us to see what crypto can be. Learn more at crackin.com slash the breakdown. Disclaimer, not investment advice. Crypto trading involves risk of loss. Cryptocurrency services are provided to U.S. and U.S. territory customers by Payward Ventures Inc. PVI, BVI, DBA, Krakken. Now, one of the missing pieces from the ETF launch has been a full suite of derivatives surrounding the products. At the moment, institutional players are limited in their choices to arbitrage the new ETFs, with no options or futures contracts currently available. The NASDAQ and the CBOE have both filed applications last week to launch options markets for the new ETFs. The SEC acknowledged these filings on Friday,

opening a public comment period, and starting the clock on an approval deadline. Bloomberg ETF analyst James Safart wrote, The SEC has already acknowledged the 19B4s requesting the ability to trade options on spot Bitcoin ETFs. This is faster than the SEC typically moves. Options could be approved before the end of February if the SEC wants to move fast. At absolute earliest, options still 27 days away. Absolute latest we get a decision is somewhere around September 21st. CBOE Executive Vice President Catherine Clay said on Thursday that options were, quote, the next logical steps on the ETFs. She added,

I think you're going to start seeing all sorts of hedge fund players in the Bitcoin ETF option space. Folks that might not have been traditionally speculating on crypto directly in the crypto ecosystem are now going to have something to play with. Clay's point was that options would offer, quote, cost efficiencies and increased hedging strategies. Still, although it would be a logical step, Clay was not confident in the SEC's actions, stating, we're really in this holding pattern to see what the regulators will do with our filing and other exchanges filings as well. It's really difficult to know if we will even see

approval. Now, many people have been watching Ethereum closely in the wake of the Bitcoin ETF approvals to see if that might be the next domino to fall. Gary Gensler has tried to tamp down on that, but that doesn't mean that people aren't still paying attention. Well, interestingly, the correlation between Bitcoin and Ethereum price action has hit its lowest level since early 2021. According to Kiko data, the 60-day correlation between the two largest cryptocurrencies has now fallen below 70%. Bitcoin and Ethereum have been highly correlated since late 2018. Aside from a brief dip in April 2021 when Bitcoin crossed 50,000 for the first time, the correlation has been strong over the past five years. During recent months, this correlation

has been consistently trending down and is now below long-term averages. The two assets are not uncorrelated, but this change in market structure indicates that they are moving more independently have in years. Kyko suggests this decoupling was related to idiosyncratic narratives becoming more important in crypto markets. They wrote, It is no coincidence that this occurred on the day that the Bitcoin's bot-etop ETF started trading. For months, the two crypto assets have been diverging in price activity as Bitcoin benefited from the ETF hype and speculation, while ETH experienced a relatively sluggish rally. Kiko noted that Ethereum has been struggling to find a clear narrative tailwind stating, since the merge, Ethereum has had a bevy of narratives. Deflation and

ultrasound money, layer 2s, liquid staking derivatives, restaking, and now ETFs, with dank sharding on the horizon. Despite all of these competing narratives, it appears that the potential approval of spot ETFs is the strongest narrative right now. Even though the ETF launch produced negative price action for Bitcoin, Ethereum has seen renewed trading interest. Kiko noted that spot Ethereum volumes on centralized exchanges reached their highest level since the FTCS collapsed over the past week. Yet despite the emerging narrative of Ethereum ETFs, derivatives markets at least are not yet showing a bullish bias. Price is also a little limp with Ethereum. falling by 6% for the week. At the same time, this drawdown hasn't wiped out early outperformance,

with ETH up 9% year-to-date compared to Bitcoin falling by 2%. If Ethereum ETFs are launched, they would most likely be approved in May. Analysts are pretty mixed on that likelihood. Bloomberg are handicapping approval at 70%, while J.P. Morgan thinks the odds are closer to 50-50. Kiko wrote, while ETFs were one of the most catalyzing narratives in Bitcoin's history, it remains to be seen whether ETH will be able to replicate this. Speaking of handicapping, Bloomberg senior litigation analyst Elliot Stein walked out of last week's hearing with the feeling that Coinbase has a good chance of winning their lawsuit. Stein wrote, I went into the SEC versus Coinbase hearing thinking that Coinbase would, on this motion,

win dismissal of SEC's primary claims concerning trading, but maybe not staking in broker claims. I left thinking Coin would win full dismissal. Stein is now given Coinbase 70% odds of winning the case overall, although not necessarily at the current early stage. He noted that the judge was looking for a limiting principle to the SEC's definition of an investment contract, which would not sweep in collectibles. The SEC was entirely unable to present one during the hearing. Stein suspects that if the case survives until trial, it could end up in the Supreme Court on appeal. He thinks the Supreme Court decision in this case would restrict the Howey test, severely undermining the SEC's scope for crypto enforcement. Now, Stein has been

early and correct in his read on other crypto cases. Immediately after oral arguments in the grayscale lawsuit, Stein predicted the firm would win their case against the SEC. He expects a ruling on this motion by next quarter at the latest, noting that this judge is extremely efficient and could provide a decision much sooner. Now, over in another case, Terraform Labs have voluntarily filed for Chapter 11 bankruptcy protection in Delaware court. The Singapore-based company, which launched Terra, USD, and Luna, has claimed between $100 million and $500 million in both assets and liabilities in preliminary filings. Documents listed to Scraised founder, Doe Kwan, as the 92% shareholder in the firm. Chris Imani, CEO of Terraform Lab, said in a statement,

the Terra community and ecosystem have shown unprecedented resilience in the face of adversity, and this action is necessary to allow us to continue working toward our collective goals while resolving the legal challenges that remain outstanding. We have overcome significant challenges before and against long odds the ecosystem survived and even grew in new ways post-DPEG. We look forward to successful resolution of the outstanding legal proceedings. Now, the Chapter 11 process could allow Terraform to restructure its debts and relaunch if a suitable resolution could be found to satisfy creditors. Otherwise, the liquidation of the company would be the default outcome. The firm said they intend to honor financial obligations to employees and vendors

during the process. It do not require additional financing to do so. Still, as stated by Amani, Terraform still has a host of legal issues in front of it. The firm is being sued for securities fraud by the SEC, with an early ruling going against them and a full trial scheduled for March. The judge has already ruled that TUSD and Luno were sold as unregistered securities as part of a broader investment scheme. The remaining issue is whether Terraform used this scheme to defraud investors. Terraform is also facing a class action lawsuit in Singapore, and Terraform's founder, Doe Kwan is still locked up in Montenegro. He has been battling extradition to the United States for months, but recent legal filings imply he could soon be handed over to the DOJ. Quan will likely face criminal fraud

charges once U.S. authorities have him in custody. Lastly today, Colorado state regulators have sued a local couple, claiming that the pair have cashed out $1.3 million from a crypto scheme to spend on extravagant personal expenses. Denver pastor, Ellie Regalado, and his wife allegedly launched a token to sell to their online congregation. Regalado admitted to launching the currency but said the allegations that the tokens are worthless were based on the fact that there is, quote, no exit for people who have bought. In a nine-minute-long explanation video, he claimed, we launched an exchange, the exchange technology failed, things went downhill, and from that point forward we've been waiting on the Lord literally for a miracle. Regalado confirmed that he withdrew

1.3 million from the scheme, but claimed, quote, half a million dollars went to the IRS, and a few thousand dollars went to a home remodel that the Lord told us to do. The CFTC has alleged that the prophets were also spent on a range rover, jewelry, luxury handbags, cosmetic dentistry, and snowmobile adventures. Regarding the failed platform, Regalado said that he asked the Lord where the liquidity was going to come from, quote, and the Lord said, trust me. He said, we were always under the impression that God was going to provide that the source was never ending, that God was doing a new thing and we had nothing to worry about. Coin Telegraph reporter Tom Mitchell Hill said, this is truly a next-level breed of grifter.

After being charged with fraud, online pastor Ellie Regalado admitted to using several hundred thousand in investor funds to finance home renovations. More simply, Hawkward wrote, and the Lord told us to rug liquidity to install hardwood flooring. Crazy times out there, friends. Watch out and stay safe. One more big thank you to my sponsor for today's show, Cracken, go to crackin.com and see what crypto can be. And of course, until next time, be safe and take care of each other. Peace.