The Breakdown - The Crypto Reckoning Continues

Episode Date: January 7, 2023

NLW profiles another brutal week in the crypto computation and cleanup following the disasters of 2022.    He examines:   Celsius ex-CEO Alex Mashinsky sued by NYAG 3AC subpoenaed via Twitter Silvergate laying off 40%  Genesis laying off 30%  And more  Enjoying this content?   SUBSCRIBE to the Podcast Apple:  https://podcasts.apple.com/podcast/id1438693620?at=1000lSDb Spotify: https://open.spotify.com/show/538vuul1PuorUDwgkC8JWF?si=ddSvD-HST2e_E7wgxcjtfQ Google: https://podcasts.google.com/feed/aHR0cHM6Ly9ubHdjcnlwdG8ubGlic3luLmNvbS9yc3M=   Join the discussion: https://discord.gg/VrKRrfKCz8   Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW Disclaimer: DCG is the parent company of CoinDesk.  - “The Breakdown” is written, produced by and features Nathaniel Whittemore aka NLW, with today’s editing by Michele Musso and research by Scott Hill. Jared Schwartz is our executive producer and our theme music is “Countdown” by Neon Beach. Image credit: CSA Images/Getty Images, modified by CoinDesk. Join the discussion at discord.gg/VrKRrfKCz8. 

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. The breakdown is produced and distributed by CoinDess. What's going on, guys? It is Friday, January 6th, and Boyle Boy is the crypto reckoning continuing. We are going to talk all about that today. But before we do, if you are enjoying the breakdown, I would so appreciate it if you would take the time to go subscribe to it, leave it a rating, leave it a review. or if you want to dig 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, happy Friday. It's only the first week of the year and we clearly already need a Friday. Yesterday, Delphi lawyer Gabriel Shapiro wrote, We're looking at an almost total legal and financial wipeout of the crypto kingpins. Ready to rebuild from scratch? And that, I think, is pretty much the state of it. Yesterday was just another ravaging day in the reckoning in crypto cleanup following 2022's crises.

Going in no particular order, we'll start with Celsius. New York State's Attorney General Leticia James has sued, former Celsius CEO Alex Machinsky, for defrauding hundreds of thousands of investors by making false statements about the financial health of the company. Raising allegations dating back to 2018, the state intends to seek a court-ordered ban on Machinsky doing business in New York State, as well as damages and restitution for harmed investors, according to a statement released on Thursday.

The statement alleges that, quote, as the former CEO of Celsius, Alex Mishinsky promised to lead investors to financial freedom, but led them down a path of financial ruin. The AG herself, James, came even harder in her tweets. I'm suing the former CEO of cryptocurrency platform Celsius Network for defrauding investors out of billions of dollars. Alex Mishinsky lied to people about the risks of investing in Celsius, hit its deteriorating financial condition and failed to register in New York. Machinsky tricked hardworking people into investing their life savings into Celsius, promising big financial returns and claiming the platform was safer than a bank.

Instead, Celsius collapsed and New Yorkers were left in financial ruin. I'm suing to get New Yorkers their money back and ban Machinsky from doing business in New York. We will continue to protect people from the risks of investing in cryptocurrency. Now, I don't think anyone is particularly sad to see Michinsky on the receiving end of some serious legal trouble. Mike Dutus, for example, tweeted crypto fraud dominoes falling fast in 2023. Machinsky's day has come, time to pay the piper. But of course, that last line we will continue to protect people from the risks of investing in cryptocurrency, shows just how much all of the fraud is getting caught up with everything in the space that might be legitimate. Now, digging

a little deeper, the allegations claim that Machinsky made false statements relating to the number of users on the platform and the safety of the investments made using customers' money. Celsius claimed that it only lent money to safe, reliable businesses. But that doesn't seem to have been the case. The suit also alleges that Michinsky claimed that Celsius was safer than a bank, but operated without the usual regulatory safeguards associated with U.S. banking. Now, of course, Celsius halted withdrawals in June and ultimately filed for bankruptcy in July as a $1.2 billion hole had appeared in their balance sheet. It later came to light that Mishinsky and his family had withdrawn $44 million from Celsius in the weeks leading up to its collapse.

Just to get a sense of what Celsius was up to, one of the more shocking, revelations about their business practices during the collapse, was that rather than exclusively lending to high-quality crypto firms, as they represented to users, Celsius had in fact given customer funds to one of the highest volume Ethereum defy users, known by his handle 0xB1, to conduct high-risk yield farming strategies. Now, for customers of Celsius, while of course they want to see justice served and are probably not sad to see New York going after Alex Mishinsky, the more pertinent issue for them is, of course, around recovery of funds. On that front, the bankruptcy court presiding over the Celsius case has delivered a significant ruling on the status

of customer assets. The court has found that all $4.2 billion worth of user assets deposited with Celsius into their interest-bearing earned product are legally the property of the Celsius bankruptcy estate. Effectively, in depositing their assets, users transferred ownership in the court's opinion to Celsius for the purposes of Celsius lending out those assets to generate yield. The reason this matters is that Celsius users had tried to claim that they retained ownership of their deposited assets in order to be given preferential treatment over other creditors in the bankruptcy. They basically wanted to be paid back before other creditors had the rest divvied up. Users, of course, still have a claim against Celsius as ordinary unsecured creditors,

but they'll be looking to receive whatever reduced payment is distributed as the bankruptcy resolves. This is an incredibly thorny issue and is coming up in all of these bankruptcy proceedings. Did the people who handed centralized services their crypto surrender ownership of that crypto? It seems likely to me that different courts might come to different conclusions, and that there actually might be different answers for different products, or more specifically different terms of services. If the terms of service says you're effectively entering into an investment contract, that's one thing.

If the terms of service instead affirms that those are your assets full stop, that might be different. Some are wondering about the wider implications as well. Nick Hansen of Luxor Mining says if upheld, the precedent set by the Celsius ruling is incredibly damaging. Any non-bank service which holds customer assets is in jeopardy. What happens if a storage unit facility goes bankrupt? Physical gold, bank deposit boxes. For many assets, self-custody isn't possible.

Now, these questions of how customer assets are dealt with in bankruptcy proceedings was already on the legislative docket, but will be doubly so now. All right, next up, let's turn to beleaguered crypto bank Silvergate. Problems that the bank keep piling up as Silvergate announces that they will cut 40% of their staff, which is around 200 people. Additionally, they're writing off their purchase of technology and assets from defunct Facebook stablecoin project DM. The bank, which is one of the few financial institutions that specifically services crypto firms, purchased the DM technology for $196 million in February in hopes of issuing a stablecoin themselves by the end of last year. That product

has now been scrapped, and Silvergate has faced a series of problems, ranging from regulatory scrutiny around money laundering accusations, to questions about their facilitation of payments to Alameda research in the wake of the FTX collapse. Shares in Silvergate dropped by 46% on Thursday following the latest news and are now down 94% from their high in November of last year. In a press release, Silvergate CEO, Alan Lane said, quote, In response to the rapid changes in the digital asset industry during the fourth quarter, we took commensurate steps to ensure that we were maintaining cash liquidity in order to satisfy potential deposit outflows, and we currently maintain a cash position in excess of our

digital asset-related deposits. Silvergate saw massive, massive outflows in the fourth quarter of last year, $8.1 billion in digital asset withdrawals, which was more than 60% of the bank's deposits. This bank run required Silvergate to sell off more than $5.2 billion worth of debt securities held as reserves to meet customer demands, incurring a $718 million loss in the process. Dave Benoit, a reporter at the Wall Street Journal, said Silvergate's 60-plus percent drop in deposits got me looking for historical context. The average run on the banks in the Great Depression was just 37%. Karen Petru, the managing partner at Federal Financial Analytics, said,

Key here isn't if Silvergate is still liquid, maybe yes, maybe no, but if it's above the critical capital threshold at which regulators are required to shut it down. They usually don't have the guts to do so despite prompt corrective action law, but this time might well be different. Bitwise as Alyssa Chu discusses why this matters for the crypto industry. She writes, Silvergate has long been the crypto industry's bank of choice servicing the largest players. There are relatively few alternatives to Silvergate, as many banks shy away from servicing crypto companies. If Silvergate is forced to close or sell itself, banking relationships could become more difficult for the crypto industry.

Dylan LeClair reaffirms this saying, if Silvergate is out of the game, it's yet another hit to Fiat onramps into the crypto ecosystem. But we're not even close to done yet. Another exchange that banks with Silvergate is also showing signs of trouble. On Thursday, it became pretty apparent that there are problems at Huobi. The Justin Sun backed offshore exchanges rumored to have cut off employees from internal communication channels after previously giving them an ultimatum to accept their salary and stable coins. At the end of December, the exchange committed to reducing headcount by 20%, reportedly triggering a rebellion among staff.

Kate Lee, a spokesperson for the exchange, told CoinDesk that, quote, with the current state of the bear market, a very lean team will be maintained going forward. Quibi's native exchange token has fallen by nearly 11% over the past day, having lost 30% of its value over the past month. According to a report from crypto-quant, Wobie holds about 60% of its reserves in its own token. Also during the past day, exchange volume has dropped by almost a quarter, as traders' concerns about the solvency of the exchange grow. Nansen data shows that the exchange experienced $64 million of outflows on Thursday, bringing the total for the week to $100 million.

There's been a lot of speculation that Hwby is having problems with its banking with Silvergate, which could explain why employees would no longer be offered their salary in U.S. dollars. Speaking of layoffs. Genesis and DCG continue to not provide real information about what the hell is going on, all the while showing signs of being in well, real trouble. Genesis Global Trading announced an additional round of layoffs on Thursday, cutting 30% of its remaining workforce in addition to the 20% layoffs performed in August. This new reduction brings headcount to around 145 employees after cutting approximately 62 staffers.

A source familiar with the situation said the reductions were focused on the sales and business development teams. A spokesperson for Genesis said, quote, As we continue to navigate unprecedented industry challenges, Genesis has made the difficult decision to reduce our headcount globally. These measures are part of our ongoing efforts to move our business forward. We sincerely appreciate the hard work of our talented and dedicated team as we continue to work to identify the best outcome for Genesis' business, clients, and employees for the long term.

On Wednesday, the firm issued a letter to clients saying that they would be, quote, reducing costs and driving efficiencies. A letter from their interim CEO also told clients that the firm would need more time. to sort out its financial position after halting withdrawals in November. This has been a common recurring thread. We need more time. We need more time without any sort of commitment to what that timeline is. Obviously, this letter comes on the back of accusations from Gemini co-CEO, Cameron Winklevoss. The DCG CEO, Barry Silbert, was using, quote, bad faith stall tactics in his conduct surrounding the resolution of issues at DCG subsidiary Genesis. This wasn't the only

bad news for the DCG group, as the company has also shuttered its wealth management business. The new division HQ was launched in June and reportedly had $3.5 billion of assets under management. In a statement on Thursday, DCG said due to the state of the broader economic environment and prolonged crypto winter presenting significant headwinds to the industry, we made the decision to wind down HQ. We're proud of the work that the team has done and look forward to potentially revisiting the project in the future. So, as you can see, things are going really well. In fact, given how well things are going, why don't we chuck some new three-erros capital drama in there. Liquidators in the 3AC bankruptcy have gained approval to serve subpoenas to the firm's

founders via Twitter. Proceedings in the bankruptcy have been slow over the last six months, as liquidators complained of incomplete financial records and a lack of cooperation and engagement in the process from founders Suu and Kyle Davies. In October, liquidators requested that the court grant approval for subpoenas to be served by email and Twitter in hopes of compelling cooperation from them. At the time, the court had concerns that service might be ineffective, as neither founder had used Twitter since the collapse of the firm. These concerns, however, melted away as both Sue and Kyle returned to active Twitter users alongside several media appearances in November to comment on the collapse of FTX, an attempt to begin their redemption arc.

Courts in the Southern District of New York and Singapore have now approved the service of Twitter subpoenas. The liquidators said in a statement that although they're attempting to maximize asset recovery for creditors, quote, the founders have unfortunately resisted cooperating in these efforts, and as such, we have received authority from courts in both the the U.S. and Singapore to serve them targeted and comprehensive discovery demands through email and their frequently used Twitter accounts. Castle Islands, Nick Carter writes the irony of the three AC boys trying to tweet their way back into respectability, and having the court okay service via Twitter as a result is really quite exquisite. Pipe down next time, little fellas.

It was clear this was likely to happen since the December 2nd hearing. They didn't engage, so the court had to find alternative means of service. Going on a press tour and tweeting garbage incessantly made it easy. TXMC trades writes, this is absolutely the most bizarre timeline that anyone could have imagined, and I heartily agree. Now finally, it wouldn't be a crypto reckoning day without at least a little of the Sam show. Yesterday news broke that the U.S. government has seized or is in the process of seizing the $460 million Robin Hood stake owned by an FTCS subsidiary as part of its fraud case against Sam Bankman-Fried. The government is also taking control of assets held in bank accounts that are part of the FTX bankruptcy case.

with the DOJ counsel specifically mentioning that assets held with Silvergate were subject to seizure. Now, these Robin Hood shares have been the subject of disputed ownership. BlockFi, the FTX bankruptcy estate, and SBF himself were all lodging claims to ownership of the 7.6 stake in Robin Hood. The shares were purchased via a holding company and held by a brokerage company called Merrick's Capital Markets. The purchase of the shares were linked to loans worth $546 million taken from Alameda research by Sam and FTX executive Gary Wong in Wong's recent plea deal with the DOJ on fraud charges. Now, prior to the DOJ revealing that it was seizing the Robin Hood shares, FTC had filed to bring the stock into the assets of the bankruptcy estate.

On Thursday, lawyers for SBF objected to this application, stating that allowing the shares to be drawn into the bankruptcy would, quote, render it inaccessible to Mr. Bankman-Fried, who is presently facing potential criminal liability. Mr. Bankman-Freed requires some of these funds to pay for his criminal defense. Conversely, the FTC's debtors face only the possibility of economic loss. People have been just, I think, incredulous is the right word, at Sam's argument to keeping these funds. Wassy lawyer sums up,

The people who I stole the funds from are only losing money, but I might go to jail if you don't give me the shares I bought with their funds. This argument is incredible. James A. Murphy met a lawman writes, SBF enters the FTX bankruptcy. Hilarity ensues. SBF has just filed a pleading in the bankruptcy case arguing that the debtors need to keep their hands off his Robin Hood shares. Why? Because, get this. He says he'd legally borrow the money from Alameda to buy those shares. He argued that it's very wrong for the court to assume that everything he's ever touched

is presumptively fraudulent. I believe the technical legal term for this is chutzpah. I wonder where he's getting the money to pay for all these bankruptcy and criminal defense lawyers. Anyways, it continues to be a mess and will likely get messier still from here. But for now, that is the end of our crypto reckoning tale for today. That's plenty for one week, I think you will agree. For now, I am very much looking forward to the weekend.

you are too. As always, I appreciate you hanging out and listening. And until tomorrow, be safe and take care of each other. Peace.