The Breakdown - Tornado Cash Sanctions Upheld In Court

Episode Date: August 19, 2023

One of the legal challenges to the Department of Treasury's putting Tornado Cash on the sanctions list has been defeated. NLW also does a broader crypto legal roundup. 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 Saturday, August 19th, and that means it's time for the weekly recap. 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. Now, today we are catching up on a ton of legal updates that have happened this week. This continues to be the big theme of this bear market is legal cleanup, legal proceedings, legal, blah, blah, blah.

Which, unfortunately, is just sort of part of the phase that we have to get through before we get to the exciting stuff like, you know, usage and excitement and whatever, anything that isn't just legal stuff, but here we are. However, I want to start with something that is a little bit more on the market structure side, given the dump that we had on Thursday. So in the middle of the week, the block started reporting that yet another cryptocurrency marketmaker was pulling back. Apparently, long-time crypto market maker, GSR, has been scaling down operations during the bear market. Now, this is a firm that has been active in crypto order

book since 2013. They had already conducted two rounds of layoffs and appeared to have also lost multiple executives and department heads. The firm's chief financial officer Jonathan Hugh has been the highest profile departure. He joined the firm in 2021 and helped build out the company's finance department. Anonymous sources speaking with the block criticized the firm for expanding too rapidly during the height of the bull market. GSR brought on scores of traditional financial professionals to help expand the firm. In 2020, the firm had just 25 employees, but the number went up to more than 300 at its peak. One source said, quote, The executive team is mostly friends, and I think it threw off a lot of the momentum GSR built in the

previous cycle. They hired a lot of corporate Wall Street executives that came in at the top with the bull market, which ended up costing the firm dearly. Another source said, quote, some of the leadership is out of touch with true crypto. Now, a spokesperson for GSR said, our business operations and strategy have evolved naturally to respond to changing market conditions, and there has been no restructuring. GSR President Rich Rosenblum took this even farther. On Wednesday, he wrote, regarding the blocks reporting yesterday, we worked with a reporter in good faith, but it's clear the story was always intended to be a negative one regardless of the facts. Here is some additional color on GSR.

GSR's business is strong. We have navigated three volatile bare markets successfully without raising outside capital. The firm has a solid balance sheet. We continue to be profitable and increase our market share regardless of market conditions. The article tries to suggest that departures over 18 months are more than bare market norms. We've had many personnel changes over the last decade, but juxtaposing it alongside strategy changes in a bare market to write a sensational piece is irresponsible. We aren't going anywhere and we continue to be very bullish. We are one of the longest operating in one of the best funded companies in the space. We stand stronger and better position now than at any other point in our history. Now, obviously this has gotten very quickly into a he said she said, but mostly why

it's worth paying attention to, at least with a little bit of side-eye, is what Noel Atchison wrote, more market-maker scalebacks is not great for crypto-market liquidity, which is already low. With that, though, let's move into the legal stuff. First, a group of investors and developers have lost a lawsuit which challenged the legality of the tornado cash sanctions. The litigation, which was funded by Coinbase, claimed that the U.S. Treasury had exceeded its authority in dealing with tornado cash using sanctions law. In coming to their decision in a district court in Texas, the judge found that tornado cash itself was sufficiently coherent in operation to be considered an entity capable of being sanctioned. The Treasury Department can only sanction entities such as

individuals, companies, or unincorporated associations. The judge found that the Treasury had identified an entity when it designated tornado cash as including the developers and the Dow which governed the operation of the mixer. The judge wrote that, quote, the Dow is an entity unto itself that, through its voting members has demonstrated an agreement to a common purpose. As the government notes, the structure is not unlike that of stockholders of a corporation who may not intend to vote in a shareholder meeting without this affecting the structure of the entity. They ultimately found that adding tornado cash to the sanctions list was, quote, not plainly inconsistent with its regulations. The judge also rejected the argument that there was no property which could be the subject of

sanctions. Litigants claim that the tornado cash entity, whatever that constituted, does not have property rights in the smart contracts identified by the Treasury. Sanctions can only prohibit U.S. citizens from transacting with sanctioned entities in relation to property, so they're used to prohibit interacting with a smart contract was a novel application of the law. The litigants also made an argument that the sanctions violated First Amendment rights to free speech. The tornado cash sanctions were somewhat unique in that they prohibited U.S. citizens from transacting in a privacy protected manner. The Treasury is not allowed to sanction U.S. individuals, so there was an argument that prohibiting them from using tornado cash was unconstitutional.

Now, the tornado cash sanctions drew widespread criticism from the industry when they were put in place last August. The measure was taken ostensibly to deal with North Korean hacking group Lazarus, however, critics said the sanctions were too much of an impingement on privacy and crypto. CoinCenter have filed their own legal challenge to the sanctions which is yet to be heard. Next up, the SEC has been allowed to move forward with an appeal in the Ripple case. The regulator is attempting to appeal the parts of the case which were decided against it, namely that the programmatic sales of XRP tokens and distributions to employees and contractors were not to be considered the sale of securities. The SEC requested leave to file a motion to

appeal last week, to which Ripple objected, claiming that, quote, there is no extraordinary circumstance here that would justify departing from the rule requiring all issues as to all parties to be resolved before an appeal. The judge has now granted this leave to file the motion. Once filed, the court can either accept or reject the SEC's reasoning to appeal the decision. If successful, the appellate court would also need to agree to hear the case, and then determine whether the SEC is successful in their appeal. Bill Hughes tried to sum up some of this extreme legal complexity, saying, the court has not granted leave to appeal. It granted leave to file a motion for leave to appeal. The court just decided, yeah, we can deal with this issue. Again, guys, this is the kind of minutiae that we're dealing with right now.

Ultimately, it's important, but I don't think any of us will be sad for the days when we get to focus on other things. Speaking of other things, the Federal Reserve has brought an enforcement action against Farmington State Bank, which used to be known as Moonstone Bank. Now, Moonstone was the tiny bank in rural Washington, which accepted an $11.5 million investment from Alameda Research in March of 2022. The thing that made that investment notable and weird was that it was more than double the bank's entire net worth at the time. Moonstone also had ties to Deltech bank executives, which is the Bahamas Bank that notoriously dealt with stablecoin issuer tether as a customer. Moonstone was one of the smallest federally charted banks in the country, indeed last year

photos circulated of its headquarters, which appeared to be a farm shed with a pickup truck parked out in front. In January, the microbank announced that it would be stepping away from plans to offer banking services to digital asset and cannabis companies, but apparently unimpressed with this In session, the Fed has now ordered the bank to, quote, wind down in a manner that protects the bank's deposit insurance fund. Farmington has also been prohibited from distributing any dividends or assets without approval from regulators. Caitlin Long writes, Wow, Moonstone Bank, aka Farmington Bank, is liquidating after the Fed issued a cease and desist today. This will chill multiple attempts at charter strips, i.e. buy a small existing bank and chain business plan, currently underway by

crypto or crypto-adjacent companies. Bitcoin or TBH joked, both residents of Farmington are quite concerned about this turn of events. Caitlin Long again responded and said, that's what happens with charter strips. Companies search for tiny banks, acquire them, and change the entire business plan thereby skirting all the requirements of starting a de novo bank. Fed policy favored charter strips by holding them to a far, far lower standard than de novo's.

Now, speaking of Alameda and FTX, FTCS and Genesis have reached an agreement on lending arrangements between the two firms and the disposal of collateral. Genesis will pay $175 million to Alameda research to settle their claims. Genesis lawyers wrote in a court filing that, quote, The settlement will, among other things, significantly smoothed the path to confirmation of the Genesis debtors Chapter 11 plan of reorganization, as well as eliminating the risks, expenses, and uncertainty associated

with protracted litigation among the FTX debtors. Now, FTX had originally filed the claim for $4 billion in May, Genesis counterclaim stating that they had $175 million stuck on FTCS after it collapsed. In other words, both firms had outstanding loans with each other at the time of their respective bankruptcies. Genesis Interim CEO Dararazim said, The terms of the settlement agreement provide significant and near-term benefits to the Genesis debtors and their creditors, in contrast to the uncertainty and expense of fulsome litigation of the FTX claims and Genesis claims.

Now, this settlement will extinguish all claims between the firms, which is potentially problematic given that they are significantly less than FTX had originally claimed from Genesis. Adam Cochran wrote, Barry paid $175 million on a $4 billion debt position, and it means that Genesis claims from FTX are settled and can't go back to DC and Grayscale, this is a damn good deal for DCG, but horrible deal for FTX creditors. And indeed, FtX creditors are not happy.

At AFTX creditor on Twitter says, FTX asked court to settle Genesis dispute for a $175 million Genesis claim, the release of 175 million customer claim and near worthless Alameda claims. Down from first $3.9 billion to $2 billion asserted, this must be the worst deal to date, especially in the light of the new DCG Genesis DOJ investigation. Genesis claims are currently worth more than FTCS's, even as Genesis lender balances are inflated by the interest they earn from lending, among others, to Alameda. Genesis was repaid by Alameda, quote-unquote, with billions of FTX customer funds in 2022.

Coins they hold may be directly traced to FTX customer deposits. We expect the UCC to object to this, quote-unquote, deal. Now, there is, of course, a different interpretation than just Barry negotiating a great deal. Nap Jenner tweets, again, my timeline is way off here. Everyone is raging at the FtX estate. I mean, basically, FTCS is not going to settle for that little unless Genesis is truly cooked. Barry Silbert is in big trouble. Now, obviously, we don't know the answer to that, but it certainly doesn't look good and feels like a pretty reasonable open question. Lastly, today we'll end on a little bit of a positive note.

Coinbase have been granted approval to offer crypto futures to U.S. customers. Nearly two years after applying, the National Futures Association granted a license to Coinbase, which will now be authorized to operate CFTC regulated futures markets. Coinbase joins the CME and the recently approved CBOE in offering the products legally onshore. Andrew Sears, the CEO of Coinbase Financial Markets, said, Offering U.S. investors' access to secure and regulated crypto futures is key to unlocking growth and enabling broader participation in the crypto economy. CFTC Commissioner Christy Goldsmith-Ramero said,

I've been vocal about the benefits of bringing appropriate crypto activities into the regulated space in order to protect customers but in a way that supports oversight, accountability, transparency, and risk management. J.P. Morgan analysts said the license will open up new revenue operations, opportunities and demonstrated, quote, the staying power of crypto markets in the U.S. They estimated that futures trading could represent hundreds of millions in new business to Coinbase. Coinbase product executive Greg Tussar said, we believe this is a watershed moment to be able to bring regulated crypto products to U.S. customers. Where regulations are clear and sensible, we

will work with regulators to receive the authorizations needed to offer products that align with our purpose of using crypto to update the financial system to advance economic freedom and opportunity. Congrats to Coinbase on that license, and thank you to them for giving me something to close the weekly recap on. That isn't just a legal decision. Anyways, guys, hope you are having a great late summer weekend. Enjoy it. Soak it in. I know for many of you, summer is the best. For me, it's always all about fall. So with that, I leave you to go grab some old painting from a goodwill so that I can do the ghost painting trend on TikTok with my family this weekend. Until next time, be safe and take care of each other. Peace.