The Breakdown - Why Are a Dead Guy's Crypto Coins Moving?

Episode Date: December 22, 2022

This episode is sponsored by Nexo.io, Circle and Kraken.   Ah, what a perfect way to end a year of fraud, deception and disappointment. Earlier this week, on-chain sleuths noticed that more than 100 BTC were on the move from wallets that were controlled by and theoretically only accessible to former QuadrigaCX CEO Gerald Cotten. The problem? Cotten was supposed to have died in December of 2018.  - Nexo is a security-first platform where you can buy, exchange and borrow against your crypto. The company ensures the safety of your funds and keeps innovating with products like the Nexo Wallet - a non-custodial smart wallet that allows you to create your Web3 identity. Get early access at nexo.io/wallet. - Circle, the sole issuer of the trusted and reliable stablecoin USDC, is our sponsor for today’s show. USDC is a fast, cost-effective solution for global payments at internet speeds. Learn how businesses are taking advantage of these opportunities at Circle’s USDC Hub for Businesses. - Kraken, the secure, trusted digital asset exchange, is our sponsor for today's show. Kraken makes it easy to instantly buy 185+ cryptocurrencies with fast, flexible funding options. Your account is covered by regular Proof of Reserves audits, industry-leading security and award-winning Client Engagement, available 24/7. Sign up and trade today at kraken.com/breakdown. - Cryptowatch is the last crypto app you’ll ever need. Track prices up to two times faster than other apps. Catch market movements as they happen with powerful charting tools and custom alerts. Sync your portfolio and trade across multiple exchanges. And stay in the community conversation with leading influencers on Cryptowatch Social. cryptowatch.app.link/social. - “The Breakdown” is written, produced by and features Nathaniel Whittemore aka NLW, with editing by Rob Mitchell and research by Scott Hill. Jared Schwartz is our executive producer and our theme music is “Countdown” by Neon Beach. Music behind our sponsors today is “Glasgow” by Falls. Image credit: solar22/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 sponsored by nexo.io, Circle, and Cracken, and produced and distributed by CoinDesk. What's going on, guys? It is Wednesday, December 21st. And today we are talking about why a dead guy's crypto is on the move. 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. Also, today I'm excited to welcome additional sponsor CryptoWatch. CryptoWatch

is the last crypto app you will ever need. You can track prices up to two times faster than other apps, catch market movements as they happen with powerful charting tools and custom alerts, sync your portfolio and trade across multiple exchanges. And of course, stay in the community conversation with leading influencers on CryptoWatch social. Get everything you need to gain a competitive edge with the CryptoWatch app by visiting Google Play or the Apple Store to download. All right, guys, so it is Wednesday, December 21st, and that means tomorrow we are starting our end of year series.

Rebuild 20203 is the theme of this year's end of year series. I'm going to be talking to people across the Bitcoin and Crypto space, some really interesting folks. We're kicking it off with Munib Ali from. stacks and trust machines, and then Ryan Selkis talking about Masari's new theses, and it will just go on from there. I will pop back in for a couple episodes, one Longreed Sunday along the way, as well as potentially a little listical to end out the year, but more or less from here we will be in interview mode. So in some ways that makes today the last regular breakdown

of the year. And fittingly, we're talking about something that just shouldn't be a fraud rearing its ugly head once again. As if this year couldn't get any we're let's throw a fraudster coming back from the dead, shall we? So today we are talking about Quadriga. And if you weren't around a few years ago, Quadriga was one of the most bizarre recent stories in the crypto industry. Quadriga was Canada's biggest exchange, but it went bankrupt after its co-founder and CEO Gerald Cotton reportedly died while traveling in India during late 2018. When Cotton died, there were about 250 million Canadian dollars, $190 million worth U.S. or so, in crypto that was owed to about 115,000 customers. And even before Cotton

went missing, according to Chainalysis, Quadriga never actually invested its customer funds into crypto. From a 2019 Fortune article, representatives of Chainalysis are quoted as saying, what we found very quickly was that Quadriga as an exchange actually didn't have those customer funds that were reported in the media to be now lost. Those funds actually never existed. What Quadriga really did with the money that customers gave it to buy Bitcoin remains a mystery. So this is just the tip of the iceberg of the weirdness around this company. Quadriga started in late 2013 and at the beginning we're doing local only trades. Their total volume for all of 2014 was just 7.4 million Canadian dollars worth of Bitcoin.

In an interview that year, Cotton explained their novel system, we'll say, for custodying assets. So we just send the money to them, he said. We don't need to go to the bank every time we want to put money into it. We just send money from our Bitcoin app directly to those paper wallets and keep it safe that way. Effectively, they were using paper wallets in safety deposit boxes as their banking system. In 2015, the Quadriga team had four employees, raised about $850,000 Canadian, but was out of money by June. Everyone besides Cotton quit the company, leaving him as the only director by 2016. However, with him and a couple of contractors, the exchange plotted on, and then 2017 happened.

As Bitcoin rose from 1K to 20K in the course of a year, Quadriga saw $1.2 billion worth of Bitcoin exchanged. Good for the business, of course, but does this sound like a company that was prepared to handle that volume? Absolutely not. In fact, this was a company that didn't have anything resembled. accounting or really bank accounts. It relied entirely on third-party payment processors, so let's actually talk about who those processors were. Well, for one, there was Custodian, but in January 2018, Custodian had $28 million frozen by the Canadian Imperial Bank of Commerce, who said that they couldn't determine who owned the money and couldn't get in touch with cotton or his exchange. Another payment processor Quadriga used was called WB21. The CEO of that

company, Michael Gastur, was sued by the SEC for aiding and abetting the fraudulent sale of $165 million in microcap stocks just a little while after Quadriga folded. And by the way, that wasn't Michael's first run-in with the law. In 2010, he had been given an 18-month suspended sentence in Switzerland for commercial fraud and counterfeiting. The list goes on. Crypto Capital, another of Quadriga's payment processors, was named in an April 2019 suit by the New York Attorney General accusing Crypto Capital of having lost stolen or absconded with

$851 million that had been sent by BitFinex customers to them. And then, of course, there was Quadriga co-founder Michael Patron. Following Cotton's quote-unquote death, the Globe and Mail and Bloomberg both identified patron as originally being named Omar Dinani. Denani was a California resident who pled guilty in 2005 to identity theft and served 18 months in federal prison. Additionally, he played guilty to burglary and grand theft and was deported a couple years later to Canada.

Now, Patron would later show up in the defy community as an anonymous founder going by the username Zero X-Sifu, and ended up deploying some of the most egregious rugs of this past bull cycle. The point of all this is that Quadrigo was dubious from the get. In an ecosystem where innovation is the norm, it's the basics that are in the spotlight. Nexo is a company that has never put the safety of clients' funds in question. With over 50 global licenses, $775 million in insurance, and a real-time audit of custodial assets, Nexo sets an example for security standards in the industry. from keeping their 5 million clients safe,

Nexo has kept building. They've just announced their non-custodial smart wallet. Visit nexo.io. That's nexo.io and sign up today. This episode is brought to you by Circle, the sole issuer of USDC and a leader in crypto that's held to a higher standard. USDC is a fast, safe, and efficient way

to send money around the globe. USDC is always redeemable one-to-one for U.S. dollars and has over $45 billion in circulation as of October 13, 2022. Plus, Circle posts weekly reserve reports and monthly attestations of reserve capital, letting users know that USDA is safe, transparent, and compliant with regulations. Just go to circle.com backslash transparency to see why USDC is a trusted stable coin. Cracken Pro is an all-new, powerful trading experience for advanced traders.

Spot trade, margin trade, and stake, all from a single interface. With customization tools, unlike any other, Cracken Pro lets you see. set up your trading interface in the exact way you want. It's all backed by Cracken's industry leading security and award-winning client engagement teams that are available for support 24-7. No matter how you like to trade, Cracken Pro is built to make it happen. Visit pro.craken.com or download the Cracken Pro app on Google Play or the Apple App Store today. So let's fast forward now to December 2018. Jennifer Robertson, Cotton's widow, claims that on December 8th, the couple who were traveling in India, went to a high.

hospital in Jaipur, where Cotton was diagnosed with a slew of things including septic shock. Apparently, he was having complications surrounding his Crohn's disease, and he ended up dying of cardiac arrest the next day. Keep in mind, he was 30 years old at the time. Now, people were instantly super duper skeptical. Cotton's will had been signed just a couple weeks before, 12 days before his death, in fact. It left Robertson, his widow, his $9.6 million estate, including a plane, sailboat, and multiple real estate holdings. In January of 2019, Quadriga announced that they were going into protection, and, oh, sorry guys, couldn't access any of the customer's money. It was claimed that the exchange's cold wallets were unable to be accessed, as Cotton seemed to operate the exchange

without a proper security setup, trusting only himself to access the wallets. There was supposed to be a dead man switch, which sent that information in the event of his death, but it seems that that was never enacted. So, boom, you have theoretically $250 million worth of customer to posits, just simply gone. Now, of course, this made people think that, one, Quadriga was a scam from the get-go, and two, many took the additional leap of suggesting that Cotton faked his own death. Now, as to that second point, authorities never really weighed in on it. But as to the first point, in June 2020, the Ontario Securities Commission did officially conclude that Quadrigo was a fraud in a Ponzi scheme. In a report they issued, they said that Cotton opened accounts under aliases,

He credited himself with fictitious currency and crypto balances, and he traded with those fictitious balances. The Securities Commission report said, quote, what happened at Quadriga was an old-fashioned fraud wrapped in modern technology. So anyways, this is a big, fat, juicy story that has been the subject of a Netflix documentary, numerous podcast series, and more all about this. But that's the last we've heard for a while. Until. At 435 p.m. on December 19th, on chain sleuth Zach XPT wrote, Five wallets attributed to Quadriga CX unexpectedly moved 104 Bitcoin on December 17th for the first time in years. Cotton, it seemed, was back from the dead.

Now, the wallets in question were known to bankruptcy estate managers Ernst & Young, but they were believed to be inaccessible to anyone other than the presumably deceased cotton. Ernstyn Young had originally lost the 104 Bitcoin after mistakenly transferring them to the Quadriga cold wallets early on in the bankruptcy process, rather than to a wallet controlled by the bankruptcy estate. Ernst & Young claimed they were not able to access those wallets at the time. After the new moves, Magdalena Grinowska, a member of the Quadriga Creditors Committee, said that Ernst & Young did not move the Bitcoin and went on to say, quote, Bankruptcy inspectors are aware Quadriga funds have moved.

Thank you to blockchain investigators for following flows. We're working to gather more information, and I hope we are able to recover stolen funds. On Tuesday, Ernst & Young put out a statement saying they were aware of the movement of funds. They said that they had, quote, worked with management and others to recover the Bitcoin transfer to these wallets, however, The private keys associated with the cold wallets have not been located despite the detailed review. Both Ernst & Young and the creditors' counsel say they're investigating the matter, but as you might imagine, the strange movement of funds has renewed in a big way

questions around whether Gerald Cotton might have faked his own death in India, as was widely suspected at the time. A media entrepreneur named Stephen Ponswani retweeted Zach XPT and wrote, funny story. We own the only candid interview from Quadriga CX staff on what everyone actually did, what happened right after India and basically the rights to Cotton's life. Story's not even close to Dun. Canada government preferred the narrative one dead person did it, so case closed. Although still my favorite take comes from Lawrence at Function Zero who says, Bear Market's so bad, Gerald Cotton has come back from the dead to top up the commissary card he uses in hell.

Honestly, what a perfect Danu Ma for this fraudulent shi sandwich of a year. Now, speaking of shit sandwich is core scientific, one of the world's largest Bitcoin miners has officially filed for bankruptcy. The financial distress has been widespread across the mining industry this year, but Core Scientific is the first publicly traded minor to declare bankruptcy. According to the filings, Core Scientific has between 1,000 and 5,000 creditors. Its assets are estimated between 1 and 10 billion, as are its liabilities. And importantly, this is a really significant actor in the space. Core Scientific accounts for about 10% of computing power on the Bitcoin network. It operates 143,000 mining rigs and hosts another 100,000.

Now, interestingly, some have pointed to the fact that they're continuing to mine while they restructure, which means that there won't even be relief for others in the sector around the punishing hash rate. On Tuesday, Green Ridge another miner reached a debt restructuring deal with Nideag to allow it to continue operating, and in September, compute North, which operates data centers that host miners, filed for bankruptcy as well, leaving some of its customers owed tens of millions of dollars in refunds of deposits in advance of receiving hosting services. Speaking of bankruptcies, the Informal Genesis Creditors Committee forms. by Gemini has put forward a proposal to resolve liquidity issues at the massive crypto lender. Gemini co-CEOCEO, Cameron Winklevoss said in a tweet,

Today, Hulahan Loki presented a plan on behalf of the creditor committee to resolve the liquidity issues at Genesis and DCG and provide a path for the recovery of assets. This plan is based on information received from Genesis DCG and their respective advisors to date. Creditor committee expects an initial response this week. Earlier reports stated that Gemini is owed $900 million by Genesis out of a total of $1.8 billion owed to the creditors group overall. BlockFi is also moving ahead with its bankruptcy. Bankrupt crypto under BlockFi has asked the court to allow it to distribute funds held in individual wallets to customers. BlockFi claims that the funds belong to customers and that the company has, quote, no legal or equitable interest in funds

that were frozen when the company halted operations in November. The point of how individual customer wallets and accounts are treated under bankruptcy has been a contentious topic during this year's crypto-institutional failures. With no legislation in place to categorize customer funds as segregated and not the property of bankrupt custodians, crypto firms are left arguing the matter before the courts. In an email to BlockFi users, the lender said, quote, It is our belief that clients unambiguously own the digital assets in their BlockFi wallet accounts.

It seems this argument, however, only applies to customer funds that were custodied only, rather than those lent out to earn yield. The court will determine this matter at a hearing on January 9th. Meanwhile, the FTX bankruptcy continues to sound like an absolute dumpster fire. Newly appointed executives appeared at a procedural hearing on Wednesday to report progress, on locating assets held by the company. FTX's new chief financial officer, Mary Sillia, told the court, quote, we are reaching out to all of those banks and changing the signatories on the accounts so that we can get access to the accounts and move the cash as much as we can

to authorize depository institutions. So far, FtX has over a billion dollars in cash deposits has been found across international and U.S.-based financial institutions. Of that money, $130 million is being held in Japan, with local regulators safeguarding funds to help repay Japanese creditors. 423 million is being held with U.S. institutions that are not authorized to hold the bankrupt estate's funds by the DOJ and will need to be transferred, and 485 million is already being held by authorized U.S. depository institutions. The efforts to locate crypto assets owned by FTX is ongoing. FTX has not filed a statement of assets or of its financial position as required by bankruptcy law, and Siliah said this is estimated to be possible by April. Wasey lawyer was

tweeting the hearing and came away frankly sort of disgusted, saying, quote, seems pretty useless apart from comedy value, to be honest. Sounds like not much progress made. Maybe because the dumpster fire was too large, or maybe because the FDX advisors and new board don't get crypto that well. Maybe both. Finally, as of the time of recording, Sam Bagman-Fried had arrived in the magistrate's court in Nassau, Bahamas, to sign a final set of documents allowing for extradition. According to Bloomberg, he is expected next to be brought to a private air facilities where U.S. authorities will take custody of him. The question now is what assurances, if any, has he got from prosecutors in the U.S.

There has been much scuttle about whether there was a deal for Sam to get bail when he arrived in the U.S. But of course, ultimately, that will be left up to a judge. Either way, it seems like the next phase of this story will take place on U.S. soil. All right, guys, there you have it. Last normal breakdown of the year, and what a year it's been. Holding everything else aside, I really can't thank all of you enough for taking the time to listen to this show every day or frankly whenever you do. It is the place where I get to share frustration, excitement, agony, annoyance, and ultimately in spite of myself, optimism about what a different sort of financial future might look like. And I appreciate all of you guys for being here

and participating in that conversation however you do. So for now, I want to say thanks again one more time to my sponsors for supporting the show, nexo.io, circle, crackin, and crypto watch. And thanks, most of all, to you guys for listening. Until tomorrow, be safe and take care of of each other. Peace.