Unchained - Collapses, Bankruptcies, and Fraud: How 2022 Became the Year of Crypto Carnage - Ep.436

Starting point is 00:00:00 Hi, everyone. In this end-of-year episode of Unchained, I reflect on the rollercoaster year that the crypto industry endured in 2022. From the markets plummeting to the billions lost in hacks, the Ethereum merge, the bankruptcies of FTX, 3-Eros Capital, Celsius, Voyager, BlockFi, and the collapse of Terra Luna, a few of us could have predicted how chaotic and unprecedentedly crazy a year it would be for the crypto industry. Here's Kobe and Chris Berniske in their retrospective on the air. Oh, Chris, who's lost my money this year, me or you? We both lost, but we're both surviving.

Starting point is 00:00:38 It's me, then. Chainalysis demystifies cryptocurrency by providing industry-leading compliance, market intelligence, and investigation support for all crypto assets for organizations like Gemini, crypto.com, and BlockFi. Maximize your potential

Starting point is 00:00:58 with the leading blockchie. data platform by visiting chainelysis.com slash unchained. Minima is a new layer one blockchain designed to run in full on a smartphone. Join over 300,000 Minima node runners on the incentive program today to start earning every month until mainnet launch. Get your node set up at minima.global. Buy, earn, and spend crypto on the crypto.com app. New users can enjoy zero credit card fees on crypto purchases in the first seven days.

Starting point is 00:01:28 Download the crypto.com app and get $25 with the code Laura. Link in the description. DefiSaver is an all-in-one management app for top lending protocols on Ethereum, such as Ave, Maker, Liquity, and Compound. They're best known for their one-transaction rebalancing options and automated liquidation protection features, and you can check them out on Ethereum, Arbitrum, and Optimism Today. January 1st, Bitcoin at $47,650,

Starting point is 00:01:56 ETH at $3,750. This was a brutal year for the crypto industry. Through it all, I aimed to bring you valuable insights and information on the most important news. 2022 will certainly go down in the history books for crypto, and hopefully the industry can take away some good lessons from these challenging events. Just one note, as we present each clip, I'll be noting the Bitcoin and Ether prices from the day that episode was published. Without further ado, let's get started. February 22nd. at $37,800, ether at $2,600.

Starting point is 00:02:32 While researching my book, The Cryptopians, Idealism, Greed, Lies, and the making of the first big cryptocurrency craze, I found evidence that I believe resolves the biggest who done it in crypto. Who hacked the Dow? The day my book was published, I revealed his name. Toby Honish, a 36-year-old programmer who grew up in Austria and was living in Singapore at the time of the hack. I discussed this discovery with Stephen Erlich.

Starting point is 00:02:56 editor of Forbes crypto asset, and here's my take on why the Dow hack was so important. This was the most important event in Ethereum's history. It was the only moment that I would say was an existential crisis for Ethereum. Ever since then, of course, there have been different hacks and different events, but this was the only one where it really caused a massive crisis for the community and resulted in an event that, depending on who you are and where you sit, you might view it as something that sort of delegitimized Ethereum or that, yeah, it was just a blemish on Ethereum's history.

Starting point is 00:03:42 Interestingly, I did find some other people, people read about this in the book, who actually thought the way it got resolved was a sign of maturity. So that was kind of fascinating. to find just a huge range of perspectives in how people viewed it. I also want to give a shout out and thank you to everyone who attended my book readings and talks across the country and in England for my book tour. I loved meeting you all and can't wait to do it again.

Starting point is 00:04:08 March 4th, Bitcoin at $40,800, Eiff at $2,700. On February 24, 2022, we were hit by news outside the industry. Russia had invaded Ukraine. The response to the crypto community was truly remarkable showing that this technology can be of invaluable help in times like this. Tamika Tillamon explains how it was used. I do think that actually this has really showcased some benefits of blockchain technology. So what would you say are kind of the main lessons for some people who are, you know,

Starting point is 00:04:41 seeing blockchain being used in this way for the first time? Well, I'd highlight four big areas where the international community should sit up and and take very close notice. The first is when it comes to moving capital to governments. The United Nations has estimated in the past that in complex environments, you lose roughly 30% of every dollar that's deployed due to malfeasance and corruption. It takes another 15% approximately of every dollar to do auditing, monitoring, and about So before you have done any good at all, before you've helped a single person, bought a single blanket, you've lost 45 cents on every dollar that's deployed using traditional legacy systems. We need to be able to do a lot better than that. And so using Web3 architecture to move capital into complex humanitarian emergencies is the way of the future. This is how it's going to go. And I think governments are going to recognize that.

Starting point is 00:05:52 Second piece is we can get resources to individuals in need in a way that we have never been able to previously. One of the reasons that Ukrainians are proving so adept in using Web3 tools now is that when they ousted their past leader, who was beholden to Moscow and somebody who was engaged in extensive corruption, you'll remember that many of the Ukrainians on the Maidan would hold up Bitcoin addresses on signs so that people watching from the outside could target resources to them directly because they needed Band-Aids, they needed medical supplies, they needed food, and you could send that help precisely where it was needed to the individual. So that's another huge advantage.

Starting point is 00:06:45 The third thing I would highlight is the importance of decentralization. systems in safeguarding information. When a military rolls in, they're going to do two things. One is destroy physical records and the other, and we know that there were attempts to do this using a bug called WIPER, is to erase digital records. The advent of Web3 platforms like RWeave will provide new frameworks for safeguarding information in the face of military attacks. and that's very consequential and important if you want to be able to rebuild quickly and effectively. You need to know that your land registries are protected. You need to know that your vital records have been preserved, and Web3 tools can help do that.

Starting point is 00:07:32 And the last piece that I would mention, and I alluded to this earlier, is that we need to be using Web3 systems to preserve evidence of war crimes and atrocities. Unfortunately, there are war crimes being committed in Ukraine, and it has been very challenging in past conflicts to ensure that you have a clear chain of evidence regarding the validation of those crimes. And we can now use Web3 tools to have a much higher degree of confidence in the information that's coming out of war zones and ensure that it's protected against future deletion. 2020 has definitely been the year of hacks in crypto, with over $3 billion lost to protocol exploits. The industry went through the $580 million hack on Binances B&B Bridge and the $326 million

Starting point is 00:08:25 wormhole attack. Even though marketmaker Wintermute lost $160 million after their wallet was compromised, Tarun had some choice comments about the team. So Wintermute, by the way, has had a couple fuckups that have been epic. And they generally tend to come from the fact that like, you know, when you look at like, the top tier defy trading firms, like the SVPs of the world, they never make fucking dumb mistakes like this. So I think this is actually Wintermute's sort of technical incompetence. Not, I would not, I would not qualify this as a, uh, it's kind of like, oh,

Starting point is 00:08:56 like we should feel totally bad and like, oh, it was great that they like gave us the truth on Twitter. That's not true. This is incompetence. Like there's a fucking CVEE out. Like you should be like changing your systems and monitoring them. So winter meets first up was when they were supposed be a market maker for optimism, and they didn't initialize the NOSS safe on optimism as they did on Mainnet. And then, like, someone figured out, again, a kind of like a way where, like, you could figure out what the sort of private key was more efficiently, or you deploy to that address and you own it, right? They kind of f*** up on these cybersecurity stuff, like left and right. There's a bunch of examples with them. So like, this is actually them being kind of like

Starting point is 00:09:34 incompetent. Putting to Roon's comments aside, the largest exploit of the year happened in when the Ronan network and Ethereum side chain used by popular Web 3 game Axi Infinity suffered a $624 million loss. Unbelievably, the team didn't even notice that it was missing over half a billion dollars until six days later. Here's Arjun Bipani, founder of Kinext and a bridging expert explaining how it happened. The Ronan network is an Ethereum side chain that is built to host the AXA ecosystem, which is one of the largest, like, played earn games in the world right now. The Ronan chain itself is, like, run by a decentralized set of validators, but then Ronan has its own Ronin bridge, which connects Ethereum to the Ronan chain.

Starting point is 00:10:21 And the hack specifically was a hack of the Ronan bridge, where Ronan bridges, you know, has nine validators and requires a five out of nine threshold signature to be able to, like, complete transactions between chains. and five of those validators were compromised, leading to $650 million being stolen from the bridge itself. Around the same time, Kevin Soh was calling out Tara Luna, saying that UST could depeg and go into a downward spiral. The day this episode came out, Luna was at $105. Senior Ridge-based kind of like supply contraction, supply expansion type of designs that don't have any external backing underneath it. or any kind of external collateral, I think pretty much those will all fail.

Starting point is 00:11:09 One month later, Kevin was proved right. If there's one event that set off the crypto-contasion of 2022, it's that Terra, a blockchain founded by Korean developer, Doe Kwan, and valued it over $60 billion at its peak, collapsed to zero in a matter of days. Here's a sieb explaining what happened. Tara, for those who aren't aware, it's a layer-one blockchain built on Cosmos. and the core asset of Terra is a stable coin called UST.

Starting point is 00:11:35 And essentially on, I think it was May 9th, over the weekend and kind of going into Monday, the Terra UST stable coins peg broke. The market was more broadly declining due to some macro events that were going on, fear about interest rates. And as the price of Terra started declining, price of Luna, which is the kind of core layer one asset that backs UST, started declining in price, the UST peg broke. And one thing led to another, there was basically what we call a death spiral,

Starting point is 00:12:05 meaning that as the peg lowered, the confidence in the system lowered even further. There was more and more algorithmic minting of Luna and expansion and supply of Luna, which resulted eventually in Luna hyperinflation. Over the period of that time, Luna ended up expanding its supply by 18,000 times. It basically underwent a Zimbabwe-style hyperinflation event. UST ended up cratering to something on like 20 cents or less on the peg. I don't know what it's trading at now. And we saw within the course of a week,

Starting point is 00:12:37 the first time I've ever seen this in crypto, an asset dropped 100.0% in terms of the unit price on coin market cap. Literally the price had gotten so low that from the high of $60 before the unwind, Terra ended up cratering to fractions of a penny such that it had to get delisting. from all of the major exchanges. Nobody, none of the major exchanges anymore, trade terra. The Terra meltdown, due to its size and the fact that so many retail investors were involved with UST, attracted the attention of mainstream media and regulators in Washington.

Starting point is 00:13:13 Alta Andoni, general counsel at Eva Labs, shared her opinion on unchained. The question, how do we regulate stable coins and what we do as an industry after this USC Luna collapse, I think, in my opinion, they're completely distinct and super different from each other. I think that if we're referring to the USC and Luna collapse, probably we have to address, or the majority of the questions should be how can we stop this sort of large-scale financial fraud that is happening in the space. But I think that summarizing the two, probably is not going to be fair for our industry. Tara Luna was the first domino to Next, people became concerned about Celsius, a centralized crypto lending and staking platform.

Starting point is 00:14:01 On June 11th, CEO Alex Mishinsky tweeted, Mike, do you even know one person who has a problem withdrawing from Celsius? Why spread fud and misinformation? On June 12th, the very next day, Celsius paused withdrawals. A month later, it filed for bankruptcy. Here's Mika Hakansalo. I think you have to take a few steps back here, and one of the words being used all the time right now is contagion and how things affect each other. And this problem probably really starts from the

Starting point is 00:14:30 Luna UST debacle. And it's likely that they were quite exposed to that. That means that there's some amount of money that they expected to be tied to the US dollar that simply went to zero. And based on how large those losses are mixed in with some suspected defy loss that they've had over the last year, that's what really put them in a bad position. So it really, it really comes down to risk management within these firms and it's just that this company doesn't seem to have done a good job and and it's really as simple as that all the due diligence for understanding that what the downside case may be with luna and u s t that was available there all the issues that s teeth may have that was all available there is just that i think during the

Starting point is 00:15:17 bull market no one was really doing too much due diligence everyone's just jumping into things and this is the end result when things become adverse and suddenly not everything goes up and you have to really think about what should be the correct price for some of these assets. June 17th, Bitcoin at $20,700 and Eath at $1100. Celsius was followed by another domino as crypto hedge fund Three Eros Capital, also known as Three AC, went bust. The fund was run by two former four-X traders, Kyle Davies and Suu, who were living in Singapore, and turned a single millions fund into billions of dollars. However, its exposure to the Terraluna meltdown hurt the hedge fund significantly. And after losing some high leveraged bets, they filed for bankruptcy.

Starting point is 00:16:02 Hasib explains why the 3A meltdown was bad for the industry. They lost tons and tons of money, but it turns out they didn't just lose their own money. Normally, and I want to make this clear because I think a lot of people don't understand why the three arrow story is so bad. Normally, if you go make a big trade and you lose a bunch of your own money, it's fine. It's not. It's not, a big deal, right? Funds go to zero all the time. If you went to zero, somebody else made the money, people bet against each other. That's how markets work, right? But Three Arrow's was borrowing tons of money from other people. And they were also not telling their counterparties exactly how much leverage they were taking on and exactly who they were borrowing from. And so it turned out,

Starting point is 00:16:39 they borrowed so much of other people's money that they lost so much money that they went into negative equity, meaning that they owed more money than they had. And that is really bad. That is way, worse than going to zero. Because when you go negative, that means that now your losses are on someone else's balance sheet. Somebody else is absorbing the loss that you took by gambling like crazy. And the people who are absorbing those losses are basically the crypto lenders, or you can sort of think of the lenders as the crypto banks. These are people who are basically involved in the act of money creation. And so some of their big lenders include BlockFi, Genesis, Voyager, Uselcius also lender to three euros? Highly likely.

Starting point is 00:17:21 highly, okay, yes, highly likely. And so it turns out that a lot of the money in crypto, a lot of the lenders in crypto, were extending credit to three arrows. And this credit was under collateralized. And so now they're massively in the hole. So when the banks lose money, this is extremely bad because this now means that the banks need to control their risk. And the way they control their risk is because they now realize they're down a ton.

Starting point is 00:17:43 They need to start recalling their loans to other people because they don't know who else got hurt. They don't know who else is down. So they start recalling loans everywhere. A bunch of people suddenly start getting margin called. and these people are getting margin called, they might not have the cash on hand. So they need to start selling some assets

Starting point is 00:17:55 in order to meet the margin call or to go repay the loan. And in this situation, you get a bunch of people selling at the same time. And not only that, but liquidity is worse because the market makers who are managing the liquidity and keeping markets liquid, they're also getting their loans recalled.

Starting point is 00:18:09 They also have less money, so they can't keep markets liquid, and the end result is just a meltdown. And so that's what we saw over the last couple of weeks. We saw this massive fear around exactly how bad was three hours. in negative, how much money did the banks lose, how much of these loans are getting recalled, and how long is the selling going to take? And that's caused an absolute wreckage in the crypto

Starting point is 00:18:30 markets, where at times we actually saw Bitcoin and Ether sell off more than the alt, which is extremely rare. And that's a sign basically that what's happening is forced. It's not a people have lost confidence in Bitcoin and Ethereum. It's that something really bad has happened in the market, and now you have forced selling. Three AC's implosion also had some contagion effects. In fact, Voyager Digital had to halt withdrawals as well, and subsequently file for bankruptcy after 3AC failed to repay a $650 million loan. What's the most important thing about crypto? It's not transactions per second. It's not convenience, and it's not even smart contracts. It's decentralization to achieve censorship resistance so we can all be free. Minima is a new

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Starting point is 00:21:13 Eager to make more informed decisions around crypto using data you can trust? Chain Ellis is here to help. help. Chainalysis demystifies cryptocurrency by providing industry-leading compliance, market intelligence, and investigation support for all crypto assets for organizations like Gemini, Cryptna.com, and BlockFi. Gain unparalleled visibility and maximize your potential with the leading blockchain data platform by visiting Chainalysis.com slash unchained. D5Saber is an all-in-one management application for a number of decentralized finance protocols on Ethereum, Arbitrum, and Optimism.

Starting point is 00:21:53 The app has dedicated dashboards for lending protocols such as Ave, MakerDAO, Liquity, and Compound, as well as integrations that allow quick access to yield earning protocols such as YERN, convex, M-stable, and the newly released chicken bonds from the Liquity team. Some of their most notable features include quick, one-transaction rebalancing, and automated liquidation protection of collateralized debt positions. On top of that, they also have tools for collateral swaps, debt swaps, and instantly moving positions between different protocols. Once you load up the app at defysaver.com,

Starting point is 00:22:25 make sure to enable the simulation mode first so you can freely test all available features before diving in further. August 18th, Bitcoin at $23,000, ETH at $1,800. Another big story this year was the sanctions by the U.S. Treasury Department on Tornado Cash, a decentralized virtual currency mixer

Starting point is 00:22:44 that enables private transactions. Crypto advocates protested, since the authorities did not ban a particular group or address, but instead banned an entire smart contract. Last week, we saw Treasury and the Office for Foreign Asset Control, also called OFAC, they issued the first ever sanctions against a smart contract. So it was not tornado cash to the company. It was not the people who are involved in tornado cash,

Starting point is 00:23:08 but rather the sanction entities include tornado cash, quote unquote, which is not a legal entity, it's just the name of a project. And then specifically the list of a certain number of contracts in Tornado Cash, which are mostly on Ethereum. Now, Tornado Cash actually has other contracts on other chains. So Tornado Cash exists on BSC. It exists on Arbitrum. They were apparently not sanctioned, but the Ethereum contracts itself were sanctioned.

Starting point is 00:23:32 The sanctions also highlighted how a lack of clear regulatory framework as well as regulation by enforcement hurt the industry and kicked off a debate about whether the government overstepped its bounds. Jerry Brito explains. I think OFAC made a mistake. here for several reasons, right? So one reason I think is that they may have overstep their authority, as I was just saying. So number one, OFAC is authorized by statute and executive order in its own regulations. It's authorized to designate

Starting point is 00:24:03 persons and entities, you know, and add them to the SDN list. And what an entity is is defined in their regulations. And then once you've designated a certain person or entity, their property is blocked or frozen. Without going to too much detail, because we'll do that in our extensive analysis, it may be the case, and I think it's a very good case, that these immutable smart contracts that make up the tornado cash application are not an entity, right? So they're not subject. They can't be added properly to the SDN list.

Starting point is 00:24:41 September 16th, Bitcoin, $19,600, ETH, $1,500. While this year brought no shortage of bad news, bankruptcies, and hacks, one event brought momentary relief in crypto. Following years of hard work, Ethereum successfully transitioned from using proof of work to proof of stake, and what was for many people, one of the most important technological achievements in the short history of crypto. Justin Drake explains the significance. So the fact that the merge was successful for one second is already a huge break. breakthrough. The fact that it was successful, one minute is a huge breakthrough, 10 minutes, a whole day, a whole week, a whole month, a whole year. And I think if it can survive the next few days,

Starting point is 00:25:21 the next few weeks, next few months, this is high, high confidence that, you know, this is reliable. I must also highlight that the proof of stake chain has been running for a very long period of time. It's been running for, you know, over a year and a half now. It's the most secure blockchain in the world now. It has $20 billion of economic security. And also, unlike proof of work chains, it has the ability to recover from 51% attacks, thanks to slashing, the ability to identify and remove attackers if and when there is an attack. The merge going seamlessly was a major milestone for Ethereum. With the additional changes in ETH's monetary policy, many said ETH could challenge Bitcoin as digital goals. Arthur Hayes disagreed.

Starting point is 00:26:07 I think people, in my opinion, don't understand what Ethereum actually is. Ethereum is not money because money has no use. Ethereum has use. You use it to power the applications on its network. Bitcoin has no use. It's just money. It's like the dollar has no use. It's just money.

Starting point is 00:26:24 And that's why it's a good form of money because its value cannot be conflated with actual utility of other stuff. And so because the Ethereum's goal is to be this decentralized compute for, you know, this digital existence, let's say that the deflation gets so severe that it becomes so expensive that nobody uses it because gas prices is too high because of the inflation rate. Well, guess what's going to happen? They're going to change the inflation rate because it doesn't, it contradicts the goal of Ethereum being an essentialized computer that people can actually use. October 18th, Bitcoin at $19,600, ETH at $1,300. In October, six months, After the blowup of Terra, Doe Kwan came on unchained to discuss his legal case, whether he was

Starting point is 00:27:11 sorry or not, the moment of the US DPEG, what happened with all the crypto held by Terraform Labs and the Luna Foundation Guard, and why he doesn't want to talk about his location. This clip is from a trailer we released of the interview. A South Korean court has issued a warrant for your arrest and even said that Interpol issued a red notice for you. Why have you not returned to Korea? I haven't been living in South Korea, so it wouldn't be accurate to say returning to South Korea. So these tweets would seem to imply that you're still in Singapore. Are you in Singapore or are you not? It's not in the interest of, let's say, being on the

Starting point is 00:27:48 run or something like that that I don't want to disclose where I live. And this is what he had to say when I asked him about his arrogant tweets. So I think I got too much carried away with interacting with other people on crypto Twitter. So like the industry lingo for this is called shit posting. Right. So I think in retrospect, I should have held myself to sort of a more stringent standard. So, you know, just because there's anonymous cartoon characters that are, shall we say, more liberal with the words that they're using, does not mean that I should have followed suit. In the Tara wipeout, thousands of people lost their life savings and at least one person committed suicide. While many believe that Doe Kwan was responsible and is also a fraudster,

Starting point is 00:28:34 it could also be argued that Tara Luna simply failed. Still, Kwan offered an apology. Whether you believe him or not is up to you. So you said that you take full responsibility. I didn't hear words like, I'm sorry or I apologize, but do you want to offer an apology? Oh, yes, I am sorry. I think, and it could seem, you know,

Starting point is 00:29:00 with the way that we've been responding to allegations and use reports and things like that that we're being defensive or something like that, but that is absolutely not the case. I believe in the stability of UST, and I do understand that my beliefs and statements about how stable and safe UST would be led a lot of, you know, traders and, you know, holders without the tools to understand the complex economic mechanisms underpinning UST to gain confidence in a system that ultimately failed. And I do apologize and I do own up to, you know, the full responsibility of that. The only thing that we are attempting to do is that in the process of people dealing with this grief, there's been a lot of people making allegations like, you know, it was a fraud,

Starting point is 00:29:52 or Doquan probably shorted UST, or there was theft or embezzlement going on. While it is easy to think this entire thing crashed because it was a scam or to point fingers to, you know, somebody and just assume there was some theft going on or something like that. That was absolutely not the case. November 1st, Bitcoin at $20,500 and ETH at $1,600. This fall, we saw a trend of NFT marketplaces eliminating creator royalties. In October, Magic Eden, the largest NFT marketplace on Solana, announced it would give buyers the option to pay creators, however much

Starting point is 00:30:30 they wanted in royalties. The decision kickstarted an interesting debate on whether creators should earn royalties on secondary sales and whether it's even possible to enforce that on Ethereum NFTs. Lee Jin spoke for the pro-royalties side. I think the raison d'etre of NFTs in general is to support the creator economy. NFTs were very much envisioned as this new monetization method for the creator economy that allowed creators to tap into digital, digital scarcity for the first time ever and to be able to monetize based off of something that could actually be scarce. And so it's like the entire market's appeal has been to creators, to independent creators, because of this. And I think undermining creator royalties is kind of like biting the

Starting point is 00:31:19 hand that feeds you. It's undermining the reason why people are there in the first place. And over the last few years, a lot of Web2 platforms have realized that they need to be more creator-friendly because they realize that the entire value chain of their social networks, of their content platforms, start with creators. If you don't make creators happy, if you don't feel, if creators don't feel like they're being taken care of, then ultimately they turn and that leads to the demand side, the user side, churning as well. And so I think the entire value equation here in the NFT world also starts with creators, obviously. And so we need to do everything in our power to ensure that creators feel like they're playing a fair game,

Starting point is 00:31:59 that they're being taken care of, that the marketplace isn't just skewed towards the incentives of the buy side. However, here Haseeb presents the other side of the argument. The idea of enforcing royalties, it reminds me a lot of, do you guys know, John Deere, the company that builds like tractors and, you know, a lot of farming equipment? So there have been a lot of famous antitrust cases against John Deere. Because John Deere, what they do is they force your tractor to only be used by you.

Starting point is 00:32:25 which kind of destroys the resale value of your tractor. So if you have a tractor, you want to sell somebody, tough shit, like you have to do all the stuff. I believe this is how it works. There's all the stuff that John Deere forces you to do in order to actually resell the tractor, which makes the resale value of the tractor plummet, right?

Starting point is 00:32:41 Because you just can't sell it as easily as you could if it was just an unbranded piece of hardware. This is the exact same thing that empty royalties are. NFT royalties are a way of saying, you cannot buy and sell this freely. If you do, I will extract a tax. Now, if you can enforce that, fair game. Okay, fine, you can enforce it.

Starting point is 00:33:00 But if you can't enforce it, I know exactly where this is going every single time, which is that people will find a way to win out of this pressure that you're putting on them in the market. November 9th, Bitcoin at $16,000, Ethereum at $11,100. As we are approaching the end of the year, things were settling down a little bit. And then came in November 2nd. That day, Coin Desks Ian Allison published a story about, Alameda research, Sam Bankman-Freed's trading shop, which showed that Alameda's balance sheet was quite illiquid. And not only that, but about 40% of it consisted of FTC's token, FTT. After this revelation,

Starting point is 00:33:38 Binance CEO, Cheng Peng Zhao announced he would sell Binance's holdings of FTT, which triggered a bank run on FTCS. And here, I'm using air quotes, since technically a bank run shouldn't be possible on a crypto exchange. Within a few days, Sam Bankman-Freed's crypto empire, collapsed. Essentially, Sam Bank of Fried has two or had two companies. One was the trading firm, Alameda Research, and then the other was the exchange, FTCS. And for the longest time, you know, the last time he was on my show, I did ask him about, you know, this kind of apparent conflict of interest. And he said, you know, there are two separate entities. Yes, I own both, but there's like a wall between them and actually other people that I have interviewed, um, who

Starting point is 00:34:24 interacted with them, like third parties said that their interactions were that FTX and Alameda were very different in their minds. So that was really interesting. Essentially a few weeks ago, CoinDesk reported on the financials of Alameda, and it showed that Alameda's balance sheet was heavily reliant on FTT tokens, which were tokens created by the FTX exchange. They offered kind of like discounts and stuff for activities you would do on the exchange. And, And it was, you know, to the point where it showed, like, basically this is a very illiquid balance sheet. You know, if they were to actually try to recoup what they're showing here, value-wise, on their balance sheet, it, you know, it wouldn't work. And CZ, the CEO of Finance, happened to have $580 million of FTT tokens on finances balance sheet because years ago, he had invested in FTCs.

Starting point is 00:35:20 And once they became competitors, Sam bought him out of his. stake and part of the payment was an FTT token. So CZ tweeted that he was going to be selling his stake and Caroline, the Caroline Ellison, the CEO of Alameda Research tweeted, I will buy your FTT from you at $22. And so of course, because it's crypto Twitter, everyone's like, what's the importance of $22? So essentially, CZ said, no, we're not going to do this in a closed door away, I'm going to sell all the tokens on the open market. And the FTT price kind of held up for a short while, but then it began to collapse. And people became concerned about their funds on FTCS. So there was a bank run. And later, Sam said that it was $5 billion of customer deposits that

Starting point is 00:36:13 were being withdrawn on the Sunday alone, which was Sunday, I guess, November 6th. And he during that time was, seeing things like assets on FTX are fine, the exchange is fine, we're just processing withdrawals, blah, blah, blah. And then we all woke up last Tuesday morning to the news that things were not fine and they actually needed potentially Binance to buy them to resolve their, what at that time, maybe people might have thought were liquidity issues. Then ultimately, after Binance backed out, it became very clear that this was more. much more than something like that.

Starting point is 00:36:54 And not only that it was insolvency, but it was likely fraud. Here's what Eric Voorhees and Kobe had to say, as the situation had only just begun to play out. Private parties trying to get good deals and make a profit on the deals with their own property is one thing. And I'm not so concerned about like a conflict of interest between those two firms. There clearly was because they were owned by the same people to a large degree. The problem here is lending out customer money without telling the customers. and then going a step further and acting as though you're not and dismissing others in the industry for doing the same thing that was being done at that moment. That's the egregious behavior here.

Starting point is 00:37:37 It is appalling that Sam would be speaking to regulators about like counterparty risk and the safety of customer deposits while at the same time being insolvent with his own. own customers. That's like sociopathic behavior and is just downright fraud. Yeah. Yeah, I 100% agree with Eric. The other stuff you mentioned, you know, like opening markets so that Alameda or other entities close to FTCs like Friends can hedge these bags that they've got cheaply. They can, you know, effectively proxy sell on perps, kinds that they have locked, and not supposed to sell for four years, to take advantage of, you know, this high FDV type of low float setup

Starting point is 00:38:30 is maybe anti-customer or the markets are much more useful to insiders than they are to, like, retail traders. But it's just a totally different degree of thing than just stealing customer deposits and lying about stealing customer deposits. And part of the reason I would say this, I would have never guessed they were in solvers, is they sort of had the game rigged in their favor, right? So, like, they were able to do these things with these markets that allow them an advantage over any other market participants

Starting point is 00:39:03 such that they should just be printing so much money all of the time. Like, they had the exchange, they owned the venue, they had all the data for people's positions on the venue, they had markets that they wanted to hedge their own positions like a were off venue. And somehow they still managed to lose $10 billion? Like, it doesn't make sense. They must have been the worst traders of all time. FtX then filed for bankruptcy and SBF stepped down as CEO to be replaced by John Ray the 3rd, a restructuring expert who oversaw Enron's bankruptcy instead of FTX.

Starting point is 00:39:41 Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here. Kevin Zoe, founder of Galois Capital, who by the way lost a huge amount of assets on FTX, described warning signs he saw from the very beginning. I'll even share a really kind of random story about when we met Alameda first before they started FTX, sometime in 2018, late 2018 or early 2019. And I actually distinctly remember talking to them about accounting systems. And this is before FTX existed.

Starting point is 00:40:16 So this is just for Alameda's accounting systems. And, you know, what they were saying is that, yeah, you know, at the end of the day, you know, we do our best to try and reconcile. We spend, you know, some time, half an hour or a couple hours. I forget exactly how much time they said. But they spent some amount of time at the end of every day to try and reconcile the records. But then they're like, you know, at the end of the day, sometimes, you know, you just can't get to the right number. And, you know, if it's plus or minus 10 grand, 100 grand, which back in the day was a lot of money, right? they said, well, you know, just move on to the next day, right? So I think, you know, looking back,

Starting point is 00:40:49 there were so many different signs like that that I think in retrospect were sort of clear warning signs and signals for the risk that were to come. But at the time, you know, we didn't really think too much of it, right? So it's just, you know, it's one of those things where hindsight is, you know, definitely 2020. The collapse of FTCS sparked further contagion. One of the firms affected was Genesis and its parent company Digital Currency Group, or DCG. Here's Sam Andrews explanation of the situation. The second problem is with DCG. Now, usually how a company is organized, you have separate entities.

Starting point is 00:41:26 Each one is ring-fest with his own assets and its own liabilities, and that provides some form of security for all these different entities operating. That's how DCG is set up as a parent company with its various assets. However, there's a key problem here, and that is, what was revealed in a tweet from DCG CEO is that there's actually $1.6 billion of loans that went from Genesis to DCG. So that creates another problem is that if Genesis were to go bankrupt, right, which it's potentially on the path of doing, then Genesis creditors enforce on Genesis's assets. The largest asset on Genesis's balance sheet,

Starting point is 00:42:12 is a loan it made, Genesis made, the DCG. So all of a sudden, by enforcing on that asset, DCG gets brought into Genesis' bankruptcy proceedings. That is why these two entities are now intrinsically linked is because if one fall, the other one falls. And that is, I think, critical to understand to how these two entities are now tied together. The doom of one, being Genesis, will impact the fate of DCG. The final big news in the year was the criminal charges against Sam Bankman-Fried and his arrest, which I discussed with the area redboard.

Starting point is 00:42:48 Monday night, Sam Bankman-Fried, the former CEO of FTC, was arrested by Bahamian authorities at the behest of the United States, Tuesday morning, which was the time when SBF was supposed to testify in front of the House Committee on Financial Services, the Securities and Exchange Commission, the Commodity Futures Trading Commission, and the Department of Justice's Southern District of New York, all either unsealed or published their charges against SBF. Can you walk us through all of these charges? I mean, normally we see one of the types of things that you just mentioned, right? We have multiple regulators taking action.

Starting point is 00:43:22 You mentioned the CFTC, which really is talking more about market manipulation, you know, the activities that SBF undertook at FTX, you know, what impact did they have on what the CFTC called? the commodities market, right, more sort of the Bitcoin Ethereum ecosystem. Then you have the SEC, which is slightly different, right? The SEC is the securities regulator. So what they're talking about is potential securities fraud. What representations did he make that ultimately defrauded investors and manipulated the securities market? And finally, and in my opinion, you know, having spent a lot of time at DOJ, sort of the most interesting is the criminal indictment that was

Starting point is 00:44:03 unsealed this week that includes eight charges of wire fraud, securities fraud, that talks about actually campaign finance fraud and really sort of lays, starts to lay out what a case here will look like. And one of the reasons I say sort of most interesting is, is a lot of people are sort of wondering, well, how do all these cases happen at one time and how do we deal with this? And the reality is that those regulatory cases, the civil actions, those are about money. They're ultimately enforcement actions about sort of trying to, you know, get restitution for victims or ultimately a fine. Those will take a backseat to the DOJ criminal prosecution because that case involves, you know, potential incarceration, deprivation of liberty, the types of things that sort of go

Starting point is 00:44:47 first. And SBF has constitutional rights. And one of those rights is sort of not to necessarily testify, but that would mean that he couldn't do depositions and couldn't provide interrogatories in the civil cases. So those will take a backseat as these criminal charges, progress. December 20th, Bitcoin at $16,900 and Eth at $1,200. While crypto was still in the depths of a bear market and 2022 was the year of crypto carnage, it's not all doom and gloom. If you are here listening to this podcast, you probably believe that crypto is here to stay

Starting point is 00:45:19 and that all the failures this year will only make the crypto industry stronger. Chris Berniske put it best. Here's a more uplifting note. I was thinking about this earlier. So one thing is the call. of like the lost decade or you know i've seen some people saying it'll be six years until we have a new high or whatever i think those will ultimately be looked back upon as markers of like the sentiment bottom of like how horrible things got i think that the and this is where you know some of my training

Starting point is 00:45:50 comes from kathy wood where like the rate of change that we're seeing in the world is so fast and we kind of forget that but that underlies a lot of the protocols and companies you know within crypto, within AI, within tech at large. And so, like, I don't believe in the lost decade. I don't believe in six years until another boom. So that's one thing I want to say. The other thing is, I think a decent way to stay sane in bear markets is to stop looking at dollar amounts or dollar net worth and look at unit amounts of the crypto assets you care about. And I try to never really fixate unlike dollar net worth. Of course, like how I manage placeholder, I have to like produce results for for my investors. But specific to myself personally, I'm pretty much always thinking

Starting point is 00:46:42 in units of the assets. And that's what I care about. And maybe that's where, you know, I'm just, I drink the Kool-Aid enough where like, like, I'm stoked to be building significant unit position sizes of certain assets. And so then I don't really care what the dollars are. That, that would be my advice, I guess, to people is like, focus on the units you want to get to. If you want to make yourself happy, you can always say, if all these assets got back to their former all-time high, then, you know, these units would be worth, you know, a certain dollar amount. You know, that's like some hopium. Not all assets will get back to their all-time high, but the quality ones will go multiples of their prior all-time high, right? And so that's where you have to pick carefully.

Starting point is 00:47:22 But just focus on the units. Focus on the units and stake, and you'll be fine. And the last thing, sorry, the last last thing, is I very strongly believe that, like, crypto has years for buying and for selling. And so I don't even think about selling this year, next year, whatever. Like, it's just not even an action I'll really take. I just think about buying. And on a year like last year, I don't even really think about buying in the public market that much. I just think about selling. And so, you know, kind of, and that's a very kind of glacial way to move capital.

Starting point is 00:47:55 But it keeps me more sane as opposed to. So like trying to time every single thing. And so it's just like, oh, things go down more, there's even more opportunity. I can stack even more units. And I guess that's one way that I keep myself optimistic and happy in this current environment. Thanks so much for joining us today. And thanks so much for joining us throughout this year. To learn more about what happened this year in crypto, I guess you can just listen to the archive

Starting point is 00:48:20 and check the show notes for this episode. Unchained is produced by me, Laura Shin, without from Anthony Youde, Mark Murdoch, Matt Pilchard, Juanoranovich, Sam Shrebram, Himaimadar, Shashank, and CLK transcription. Thanks so much for listening and Happy New Year, everyone.

Unchained - Collapses, Bankruptcies, and Fraud: How 2022 Became the Year of Crypto Carnage - Ep.436

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