The Breakdown - The SEC Goes After Crypto VCs

Episode Date: August 14, 2024

Thought Gary was done with crypto? Think again. A group of crypto VCs are in the SEC's crosshairs. Plus, the controversy around wBTC. 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, August 12th, and today we are talking about why the SEC is not done with us yet. 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 in the show notes or go to bit.ly slash breakdown pod. All right, friends, welcome to another week. Today we kick off with a story around the SEC and their continued attacks on crypto. And one would be forgiven for thinking that after all of the Ls that they had recently been

handed, plus the upcoming presidential election, maybe Gensler and his crew would just kind of slink off and try to stop engaging. Well, apparently that is not the case. According to reports from DL News, at least three venture cases, capital firms have been subpoenaed by the SEC over the past year. The first page of the subpoena was viewed by DL News and referred to an investigation into, quote, certain crypto asset offering intermediaries. The subpoenas asked the VC firms to hand over any contracts related to every token deal they have been involved with. One crypto lawyer working at a VC firm that has not

received a subpoena said, it's an overarching fishing expedition and an incredibly expensive one. Others are a little more credulous, with securities lawyer Alicia Cobrae, for example, stating, it's a natural additional enforcement area that the SEC would consider pursuing. The theory of the investigation is assumed to be about VCs acting as, quote, statutory underwriters rather than token investors. A statutory underwriter is a dealer who buys securities with an intent to distribute them to retail traders. At the moment, token deals in the U.S. are largely done using SEC exemptions that allow a crypto project to sell tokens to accredited investors. If VCs are taking deals with the sole intention of selling tokens into the public

market, the SEC might have a case. Essentially, the SEC could claim, that some venture firms are merely standing in the middle to facilitate an otherwise illegal ICO. At this stage, we have no idea which VCs have been handed subpoenas over the past year, but the investigation has been an open secret for the past month. Erie David Paul of Block Tower unpacked the issue on an episode of Unchained in July. He mentioned that some token deals include an expectation to promote the token and actively trade it. Paul said, that is hiring the VC as a marketer, that is acting as a securities dealer.

And from an ethical perspective, you're acting as a pump and dumper very explicitly. At this stage, the investigation doesn't appear to be about VCs who talk their book, but rather the ones that have formalized agreements to distribute tokens to the public. Some crypto lawyers indicate that they saw this coming a mile away. Orlando Cosmi tweeted, I've warned several crypto vCs in token deal negotiations that not only were some of their proposed terms predatory and nowhere near market, but that they increased their legal risk by potentially being underwriters.

They essentially brushed off my arguments as nonsense, implied that only the company would ever have any sort of risk, and had incredible confidence that it wasn't an issue because there were no prior examples of it happening. All of this is entirely unsurprising. Others thought that this was just a continuation of the Gensler Agenda, however, with Lawrence Day of Wildcat protocol tweeting, there are going to be a lot more of these before September. To think, we thought we'd weathered the storm. Tangent co-founder Jason Choi thinks this is a little more tactical, writing, Going after Top of the Funnel Funding is exactly the thing to do if the goal is to cripple and kill an industry. Seems like if you've written a check to a crypto company and talked about it,

Gary may want to have a chat. Of course, there were many looking at this through the lens of the theoretical potential future Democrat crypto reset. Crypto lawyer Ariel Gibner commented, This completely contradicts the narrative of a controlled crypto reset as suggested by some Democratic figures. The SEC issuing subpoenas to prominent cryptoVCs suggest a crack down rather than a gradual restructuring of the industry. They want our trust? This isn't it. Never Trump were in Skybridge capital founder Anthony Scaramucci tweeted, Gensler is on a mission to lose the Democrats the presidential election. It is a shame to watch this happening at such a critical time. Mr. I lose every court case, a man who has destroyed the SEC. Hello, friends. Before we get back to the rest of the show,

I want to implore you to join me at Permissionless. Permissionless is the conference for crypto-natives by crypto-natives, and the reason it's so important this year is that despite regulators' best attempts to push industry founders, devs, and executives out of the U.S., the United States remains the beating heart of crypto. Today, the tide is turning. Policymakers have pivoted from fighting crypto to embracing it. Literally now we are in a major political party's platform, which will lead ultimately to the creation of new financial products,

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There will be links to register for the conference, and again, you can use code Breakdown 10 to get 10% off. We will, of course, keep you posted as we get more information about this. But for now, let's move over to the other big thing that everyone has been chattering about, which is controversy swirling around a major change to the structure of wrapped Bitcoin on Ethereum. Since its launch in 2019, WBTC has been the dominant standard for using Bitcoin on the Ethereum network. Around $9 billion worth of Bitcoin has been wrapped for use as a convenient on-chain trading pair and solid collateral across D5 platforms. The token has also been bridged

to multiple other layer 1 and layer 2 networks. Until now, Bitco was the single provider of WBTC, accepting Bitcoin from customers and issuing WBT tokens. The Bitcoin was held by Bitcoin using their multi-sig custody system, but private keys were concentrated in the United States. Bitcoin has provided continuous proof of reserve since 2019, and there has never been a major question about the assets that backed WBTC. The change is being presented as a way to diversify jurisdictional risk. Control of WBTC will be passed to a new partnership in joint venture called BitGlobal. BitGo is a minority shareholder in the new venture, but its custody system will remain in use. Private keys will now be distributed across Hong Kong and Singapore as well as the U.S. The transition will take place over the next 60 days.

The catch for many and the source of the controversy is that the new joint venture is a partnership with Justin's son and the Tron Network. These scandals are real and imagined surrounding Sun over the years are too numerous to get into, but in this case, the most relevant is a previous attempt at a Wrapped Bitcoin product. In 2021, Sun-owned exchange, Polonex, launched their own version of Wrapped Bitcoin for the Tron Network. Proof of reserves have never been published despite being promised. In April of this year, the product depegged from the price of Bitcoin and was subsequently delisted from Polonex. There are still around 115,000 wrapped Bitcoin tokens circulating on Tron. A similar fate struck Huobie's wrapped

Bitcoin product, HBTC. This version didn't see much on-chain use, but was the main Bitcoin trading pair on the centralized exchange for a few years. That product violently depegged in February and is still trading at an 80% discount to Bitcoin. As a legal note, Sun has consistently denied rumors that he owns a majority stake in Wobie, which was renamed to HTX last year. In other words, for many, there is more than enough reason for people to be uneasy about Sun getting involved with a systemically important asset for Ethereum Defi. For their part, both BitGo and Justin Sun have attempted to calm concerns. Bitgo's CEO Mike Belchie has been quite responsive on Twitter, but seems somewhat limited in the answers he can provide.

In response to Defi researcher Ignis, Belchie said, Yes, everyone should take a close look at the new setup. It's why we did a 60-day announcement to allow sufficient due diligence time. We recognize the community wants to know about Justin's involvement in anything, even though he doesn't have the ability to move funds. That's why we made sure to be very clear about his name. Note that WBTC.network will remain online on an ongoing basis and will always provide near-real-time proof of reserves. So you'll see if anything changes provably and on-chain. Further, it's the same BitGo technology and we won't sign transactions that don't have the corresponding mint and burn proof. Still offline keys, etc. My main recommendation is

don't jump to conclusions until you've done the diligence. Sun himself also spoke to the controversy tweeting, recently I've heard that the community has some concerns about my involvement in various projects including WBTC. I would like to clarify the following points. There have been no changes to WBTC compared to before. The audits are conducted in real time and can be accessed via WBTC.network. The minting process is entirely managed by the custodians, BitGlobal and BitGo, following the same procedures as before. In simple terms, BIC Global and BitGol will not sign any unaudited transactions. The keys are still safeguarded using the same Bitgo cold wallet technology and offline keys, with backups in multiple countries and regions.

My personal involvement in WBTC is entirely strategic. I do not control the private keys to the WBTC reserves and cannot move any Bitcoin reserves. I would like to discuss the real situation of my involvement in projects in detail so that everyone can better understand me. My level of involvement in different projects varies. But my goal with all these relations, is to promote projects dedicated to decentralization, security protocols, and safety. WBTC is a critical part of the DFI ecosystem, and I look forward to ensuring it continues to be, end quote. While BITCO provided 60-day for DFI participants to perform due diligence, some have already

seen enough. On Saturday, B.A. Labs put forward a proposal to off-board WBTC as a collateral asset within the MakerDAO ecosystem. Currently, WBTC is around 10% of the collateral base for Maker Stablecoin die. In their proposal, B.A. lab said that they, quote, infer that Justin Sun will have significant influence or control over the joint venture managing WBTC. The post continued, This bears some similarity to the previous situation concerning control of the TUSD stable coin.

Since TUSD was placed into Justin Sun's control, it has seen market deterioration in operational processes and transparency, including the resignation of the previous management team, suspension of real-time proof of reserves, and several significant defects caused by interruptions and redemption service. On the whole, we find that Sun's involvement as a controlling interest in the new WBT joint venture presents an unacceptable level of risk. B.A. Labs also referred to the recent failed acquisition of Bicco by Galaxy Digital. They wrote that these issues, quote, may be indications of financial distress within Bicco,

and reflects negatively on BitGo's counterparty risk. While some of the risk factors are somewhat speculative, it makes sense to err on the side of caution given the critical role WBT collateral plays within DFI. Mike Belshe commented on the Maker-Dou proposal stating, These guys are asking good questions. They should figure out how to do good diligence. And it's going to require some novel creative ways to figure that out.

and I think in the end, people are going to realize this is a big nothing burger. Curve, meanwhile, is still promoting that they support WBTC, while AVE haven't signaled a position on the issue. Hasu, the strategy lead for FlashBot suggested that offboarding is probably the right call, tweeting, sad because WBTC is a significant revenue driver for Maker and without a real alternative for defy users, but offboarding is likely the right choice. Later in the weekend, he noted,

the most interesting part of this isn't actually the changing custody model of WBTC. It's that BitGo clearly wanted to exit WBTC and Coinbase didn't acquire it. What the hell happened here? This is not only terrible for Defy, it's even more terrible for Coinbase. No one either BitGo or Coinbase has spoken directly to this point, but there is some room for inference. BitGo is still a private company, so they aren't bound by the SEC's accounting bulletin, SAB-121. That controversial guidance, of course, forced public companies to place custody crypto assets

on their own balance sheet that made it impossible to offer bankruptcy remote custody within a public company. While BitGo weren't accounting for the WBTC collateral in this manner, SAB-121 may have been a blocker for an acquisition or a competing product from Galaxy or Coinbase. The other issue is that RAPT tokens could represent a regulatory risk for U.S. firms. In the Terraform Labs case, the SEC successfully claimed that RAPT tokens are securities in some cases. It's not a solid precedent, but no one in the U.S. is looking to give the SEC additional ammunition at this point. Zero X NGMI from Defi Lama questioned whether this event should just be used as a clean break, tweeting, I don't get why so many people are calling for a Coinbaseback

WBTC alternative. Why replace a centralized custodian with another one when alternatives exist? A few interesting projects exist with more decentralized designs, but none have achieved anywhere close to the scale of WBTC. WBTC. WRApped assets don't just need trust in the collateral. They also need liquidity and wide acceptance to function properly. In other words, scale matters, which makes replacing an asset as dominant as WBTC a tall order. Lastly, since we started with the SEC, let's also close with the SEC. Something seems to be going on at the SEC regarding options on Bitcoin ETFs. With the CBO withdrawing and refiling their application. The lack of Bitcoin ETF options more than six months after

the launch of products went live has so far gone unexplained. Most ETFs have options approved within weeks or even days, usually completely without controversy. For the Bitcoin ETFs, though, the SEC has been dragging their feet for months, and we haven't really heard a good theory as to why. Of course, the lack of options on the ETFs isn't a major impediment for trading, particularly for institutions. There are already a multitude of options products that track the price of Bitcoin and can stand in as a proxy. This makes the delay even more perplexing. last week, the CBOE and several other small options venues withdrew their applications. The CBOE immediately replaced theirs with an updated filing. Bloomberg ETF analyst James Safark commented,

what does this mean? The original filing was only 15 pages. This new one has a lot more meat to it at 44 pages. To me, it looks like the SEC likely gave some sort of feedback, which looks like it was related to position limits and market manipulation concerns. No way to know for certain if SEC is engaging with the CBOE on this. One downside here is I think this restarts the clock. so deadline would move to sometime at the end of April, April 25th-ish. But if the SEC is engaging, the deadline might not actually matter, time will tell. His colleague Eric Belcunis agreed, adding, just as comments from the SEC was a good sign in our ETF approval odds, we think this is a good sign here too, because if they were just going to deny outright,

why bother engaging at all? Meanwhile, ETF store president Nate Garassi is simply baffled by the SEC protecting investors from plain vanilla spot Bitcoin ETF options. He pointed to the list of 13 Bitcoin futures ETFs that already have options available, including the numerous levered inverse and call writing strategy products. Grassy pleaded, make it make sense. That is going to do it for today's breakdown. Appreciate you listening as always. And until next time, be safe and take care of each other. Peace.