Cryptocurrencies - intelligent commentary

[fastupslowdown]

It's an 'and'. Yes, when they take the clients funds, they may be misappropriating client assets, and giving a worthless IOU, but they (FTX) are leveraging their balance sheet. If they make money, they can pay back, and they get away with it.

If the customer was 'staking' their account to earn 8%, the client funds weren't necessarily misappropriated. Because in 'staking' they were lending and had the risk of the borrower not repaying. This is like a margin account with any broker dealer, and you will become a general unsecured creditor against the firm. The question is whether or not, related party transactions were prohibited? This is essentially how Lehman Brothers blew up the hedgefund clients.

There is a lot going on here.

Now let's say I am a black hat. My LLC issued commercial-paper denominated in dollars to Tether for $25,000,000. Now instead of getting $25mm from Tether, I get $25mm equivalent of tether tokens. I deposit the tether tokens at FTX. I buy $25mm of Ethereum. Now FTX goes bankrupt and I have lost access to my Eth. Is my loss $25mm USD or is it whatever the number of Eth tokens I held. And you see how all of my transactions are 100% levered so I created $25mm out of thin air. That is really what is going on in the entire crypto ecosystem.

It's possible because my LLC is a blackhat and tether is willing to pretend I am credit worthy and the commercial paper actually is not worthless.

I still think its misappropriation because of the opacity between FTX and Alameda. As the Wall Street Journal notes, “Using customer funds for proprietary trading or lending them out—without an investor’s consent—is generally forbidden in the regulated securities and derivatives markets.”

While such protections do not exist in the unregulated crypto market, as the Journal points out, FTX’s terms of service explicitly told users that they owned the cryptocurrencies in their accounts; the terms of service document reads: “None of the digital assets in your account are the property of, or shall or may be loaned to, FTX Trading.”

[fastupslowdown]

There are so many moving pieces in this.

With all these questions about actual value, is this going to have repercussions on the general global economy? What, for example, would be the impact on Tether and their secured bitcoin in the above scenarios? Anything?

I suspect FTX was not alone in such behavior and the contagion seems to be spreading. As a society we never seem to learn. When the market's rise we say don't regulate because nobody has gotten hurt, after when the market is dead nobody wants to regulate because the worst behavior is no longer occurring. Companies involved in the same business are seeing similar runs.

[vertical_doug]

There are so many moving pieces in this.

With all these questions about actual value, is this going to have repercussions on the general global economy? What, for example, would be the impact on Tether and their secured bitcoin in the above scenarios? Anything?

No impact on regular economy. However, if you live in a country like El Salvador which wanted to crypto-ize the economy with crypto-bros, you are wiped out and the country will be bankrupt.

Ultimately, the question is how much real fiat currency went into the cryptouniverse versus how much of the valuation where inflated on 'stablecoin' valuations. Since this is fractional banking, I suspect it is like 10 to 1 so actual cash lost is smaller than figures being batted around.

Keep in mine, investors lost $1tr in price declines of Amazon from the top just for a size comparison.

[vertical_doug]

Here's the guy involved with Mt Gox looking for some return :

People Are Already Buying the Depositor Claims on FTX Group
2022-11-17 21:36:27.679 GMT


By Joe Weisenthal
(Bloomberg) -- It looks like some traders who have money
stuck on the fallen cryptocurrency exchange FTX are already
selling their claims in over-the-counter trading.
Thomas Braziel, the founder of 507 Capital, who has been
active in past crypto bankruptcies, says he’s currently seeing
claims being sold “between 5 cents and 8 cents on the dollar” in
private offerings.
Braziel, who says he has purchased one $8 million FTX
deposit at a price of 3 cents on the dollar, says there are a
few key factors right now that help determine how much a
theoretical FTX depositor can get on their claims.
One is that larger claims can fetch more for smaller ones.
So given the overhead and administrative costs associated with
pursuing claims in bankruptcy, it’s more economical to buy out
the claims of larger institutions, rather than individuals with
a small amount of money stuck at the exchange. Also dealing with
institutional entities is more appealing than dealing with
individuals, in part due to the quality of documentation on the
claim itself. Depositors in jurisdictions with clear and robust
legal systems, such as US or Europe, can also theoretically
fetch more than FTX depositors in countries where bankruptcy law
is less mature.
Even if the total dollars made by purchasers is modest, he
says a situation like this is a scenario “where people can make
careers” basically by looking smart in the event of a big
eventual recovery.
To Braziel, the math behind a good scenario would look
something like this: If you figure there’s something around $10
billion of total stuck deposits, the hope would be that the
venture-capital portfolio ends up at around $1.5 billion in
value, the liquid crypto portfolio hits $1 billion, and
creditors are able to claw back $1 billion from individuals and
related entities. Lop off, say, $500 million for legal fees and
expenses, and you’re left with $3 billion, which would price
deposits at roughly 30 cents on the dollar.
Over the past several years, Braziel made a roughly 18-fold
return on his purchases of Mt. Gox depositor claims in 2017.
He believes the downside is that you basically get your
money back, but it takes five years to do so.
Interestingly, there is also kind of a liquid, crypto
version of this type of distressed trading. As DMT Capital notes
on Twitter, there’s a market for so-called wrapped Bitcoin,
which is essentially Bitcoin that’s held in custody by FTX, and
reissued to the depositor as a token that can be traded on the
Solana network.
Of course the holders of these wrapped Bitcoin can’t
actually redeem their wrapped token for the real thing so the
tokens are trading at an extreme discount to actual Bitcoin.
Earlier in the month, as you can see, it was trading at 1-1
against Bitcoin, per CoinGecko. Today it’s trading around 0.06%
of a Bitcoin. This is roughly in the ballpark of where Braziel
is seeing deals in the private market. Of course, how a holder
of Wrapped Bitcoin is treated in some kind of restructuring is a
different question.
To some extent, the whole trade is itself something of a
crypto bet, since payouts will be a function partly of what the
VC or crypto book ultimately looks like.

[fastupslowdown]

***Interesting points about mis-use of company funds, borrowing the following from John Hempton***

When you sign up to a margin account in almost all cases you pledge your securities to the broker with the ability for them to repledge. 

The reason to broker-dealer must be able to repledge is that it needs to finance the loans to you – and to reduce the cost of that financing it needs to offer collateral. 

So, when I take my million dollars worth of securities to the broker and borrow 100K on my margin account it looks like I have pledged a million dollars to a broker who might be questionable in order to get 100 thousand worth of financing.

There is one word for this. Dumb. They can – on face of it – take your assets and pledge them to finance their risky business.

If you do not believe it is dumb have a look at my post on Opes Prime, a small broker-dealer that went down in Australia taking something near a billion in client assets with it. It involved organised crime, guys that killed hitmen and all sorts of other colourful characters. There ain’t no way I would want to lend my securities to these guys and wind up an unsecured creditor.

The US had huge problems with broker-dealers in the 1930s. They folded and lots of people lost their entire fortune by not understanding their credit arrangements. 

Enter the US Securities Exchange Act of 1934. This is one piece of depression era legislation that survives and thank the Good Lord for that.

What the broker dealer act does is (a) ring fence the US broker dealer and (b) limit the amount that the broker dealer can borrow against your securities and the amount of collateral it may take. 

I am hardly a lawyer – so take the bush lawyer caveat – but the way it works is that the broker dealer may not borrow against your securities to finance their own business, only client business. So Lehman Brothers US broker dealer could take collateral of securities and if they had 100 million out on client margin loans the most that they could raise using client securities is 100 million and not a brass razoo more. This is really important because it meant that client assets were not used to finance Lehman’s disastrous commercial real estate and other businesses. 

Moreover when you deposit a million dollars at the broker dealer and give them the right to repledge those securities they can only rehypothecate 140 percent of your outstanding balances.

If you have 1 million deposited and you have 100 thousand borrowed then only 140 thousand can be rehypothecated and the rest must sit in a segregated client account. [If your broker wants to steal from the segregated client account there are precious few defences – but…] You can not contract out of this requirement. 

**however per a coindesk article**

But the exchange’s terms of service states that none of the crypto in customer accounts are “the property of, or shall or may be loaned to, FTX Trading,” and that the platform “does not represent or treat Digital Assets in User’s Accounts as belonging to FTX Trading.” In other words, FTX cannot use the funds for purposes other than just holding them on customers’ behalf.


My conclusion: This will be litigated and the folks at FTX better lawyer up. -Mike G

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***

I am hardly a lawyer – so take the bush lawyer caveat – but the way it works is that the broker dealer may not borrow against your securities to finance their own business, only client business. So Lehman Brothers US broker dealer could take collateral of securities and if they had 100 million out on client margin loans the most that they could raise using client securities is 100 million and not a brass razoo more. This is really important because it meant that client assets were not used to finance Lehman’s disastrous commercial real estate and other businesses. 

Moreover when you deposit a million dollars at the broker dealer and give them the right to repledge those securities they can only rehypothecate 140 percent of your outstanding balances.

If you have 1 million deposited and you have 100 thousand borrowed then only 140 thousand can be rehypothecated and the rest must sit in a segregated client account. [If your broker wants to steal from the segregated client account there are precious few defences – but…] You can not contract out of this requirement. -Mike G

[QUOTE=fastupslowdown;1087486]*

The mistake in your logic is FTX and Lehman Brothers were not broker dealers. Part of Lehman Brothers was a US Broker Dealer, but their Prime Broker business which financed hedge fund clients in London was not. It was in the London entity which was Lehman Brothers International. The hedge funds became unsecured creditors to LBI. Now as I wrote earlier, LBI transferred all their extra cash on Friday night to Lehman Brokers Broker Dealer. This is why Bob Diamond at Barclays bank bought the US broker dealer so quick. He knew where the cash was. Once Barclays bought LBNY, LBI had no recourse. Everything rolled up to a holdco. This is the devil in the details, and as the old saying goes- possession is 9/10's of the law.

The 140% margin is easy to circumvent, because that is if you only think in cash products- equities and bonds. If you throw in currencies, swaps, futures you are only posting initial margin, and can lever way beyond 140%. Hence GS is levered anywhere from 12-14x . As you would say, google it.

Also, firms will be netting positions, so when a counterparty goes bankrupt, you lose what ever netting offset you have and your leverage can balloon even more. This is essentially how the Lehman contagion ripped through global financial markets. The sunday night lehman went bankrupt, that is what most derivative traders were doing, checking counterparty and offsets so figure out their risk.

Now go back to the FTX org chart. I have no idea which counterparties in which jurisdictions are involved in what parts of the fraud.
Johnny 3 is going to try to bootstrap jurisdiction over the bankruptcy, but different country's regulators will not want to give up jurisdiction, and depending on where clients are onboarded, some should sue to prevent that because it will disadvantage non-US accounts.

https://help.ftx.com/hc/en-us/articl...y%20%28VARA%29.

The FTX US is the broker dealer, but the other entities are not. Now the big questions is which entity had the cash? FTX US is probably an unsecured creditor against one of these. If you read the find print, FTX is not offered to US residents. FTX US offers products and it is not owned by FTX. Oops....

[fastupslowdown]

related parties but who were they?


At the core of FTX Trading Ltd.’s financial statements was a series of related-party transactions. But the company didn’t say who those parties were. 

The lack of detail echoes past scandals. Enron Corp., in its 1999 financial reports, didn’t disclose that its related-party transactions involved its chief financial officer, Andrew Fastow, only describing the person as a senior officer of Enron.

https://www.wsj.com/articles/ftx-dis..._copyURL_share

[j44ke]

rehypothecate - is that even a word? The lingo of finance is its worst feature. It is like the swirling sediment as you try to retrieve your expensive wrist watch from the bottom of an otherwise crystal clear lake.

[vertical_doug]

rehypothecate - is that even a word? The lingo of finance is its worst feature. It is like the swirling sediment as you try to retrieve your expensive wrist watch from the bottom of an otherwise crystal clear lake.

It's a repo. You clean up your balance sheet at quarter end to make your risk look smaller and more profitable....
Classic account scandal.

Yamaichi Securities did it in Japan too....

I will state these people had no clue what they were doing. They jumped into the deep end and drowned. I thought SBF knew what he was doing as a former market maker at Jane Street which is a good shop. I guess the value was the chair and not the person in it.

[fastupslowdown]

rehypothecate - is that even a word? The lingo of finance is its worst feature. It is like the swirling sediment as you try to retrieve your expensive wrist watch from the bottom of an otherwise crystal clear lake.

I would not call rehypothication a repo:

Rehypothecation is a practice whereby banks and brokers use, for their own purposes, assets that have been posted as collateral by their clients. Clients who permit rehypothecation of their collateral may be compensated either through a lower cost of borrowing or a rebate on fees.

A repurchase agreement (repo) is a form of short-term borrowing for dealers in government securities. In the case of a repo, a dealer sells government securities to investors, usually on an overnight basis, and buys them back the following day at a slightly higher price. That small difference in price is the implicit overnight interest rate. Repos are typically used to raise short-term capital. They are also a common tool of central bank open market operations.

[vertical_doug]

I would not call rehypothication a repo:

Rehypothecation is a practice whereby banks and brokers use, for their own purposes, assets that have been posted as collateral by their clients. Clients who permit rehypothecation of their collateral may be compensated either through a lower cost of borrowing or a rebate on fees.

A repurchase agreement (repo) is a form of short-term borrowing for dealers in government securities. In the case of a repo, a dealer sells government securities to investors, usually on an overnight basis, and buys them back the following day at a slightly higher price. That small difference in price is the implicit overnight interest rate. Repos are typically used to raise short-term capital. They are also a common tool of central bank open market operations.

A repo and a collateralized loan are only slightly different. It is all about posting excess collateral for more leverage.

Repurchase agreements are generally considered safe investments because the security in question functions as collateral, which is why most agreements involve U.S. Treasury bonds. Classified as a money-market instrument, a repurchase agreement functions in effect as a short-term, collateral-backed, interest-bearing loan. The buyer acts as a short-term lender, while the seller acts as a short-term borrower.
1

The only difference here is the collateral and the terms. . .It's all about posting collateral to raise cash, and the question is the haircut which is a function of many things.

[fastupslowdown]

Kashkari calls crypto currency "nonsense"

https://www.bloomberg.com/news/artic...to-is-nonsense

[9tubes]

Kashkari calls crypto currency "nonsense"

https://www.bloomberg.com/news/artic...to-is-nonsense

Oh yeah, I remember Neel Kashkari. When Paulson went to Congress and claimed that nobody could have foreseen the 2008 debacle coming and Paulson needed Congress to give him $750 billion with no conditions, direction or strings attached...immediately, right now, no time to wait, it's an EMERGENCY...Kashkari was Paulson's subordinate who wrote a memo eight months before that was a "here's what we do when the market implodes" memo.


.

[fastupslowdown]

Although this is meant to seem like acceptance of responsibility, SBF’s “apology” is actually self-serving.

He thinks he’s helping himself by focusing on mismanagement rather than fraud, but he is just locking himself into a story in the early stages of DOJ & SEC investigations.

ftx_letter.png ftx_letter1.jpg

[fastupslowdown]

https://www.youtube.com/watch?time_c...ature=emb_logo

[fastupslowdown]

excellent Matt Levine article

https://www.bloomberg.com/opinion/ar...crypto-is-hard

[vertical_doug]

Another nice example of a tangle of loans within a crypto group. Originally, the group was making real money from the excessive fees of GBTC and it's restrictive nature but they have pissed away the money on other investments.

-----------------------------------------------------------------------------------------------

Crypto conglomerate Digital Currency Group used funds it borrowed from its struggling Genesis unit to invest in another subsidiary’s products, highlighting the delicate links across billionaire Barry Silbert’s empire.

Silbert wrote to shareholders on Tuesday explaining DCG had borrowed $575mn from its broker Genesis, which is now seeking funds to stave off collapse in an accelerating crisis across the industry.

DCG told the Financial Times that it used some of those funds to buy an investment product issued by Grayscale, another of its businesses, which operates a US-listed trust tracking the price of bitcoin.

DCG lacks the public profile of exchanges such as FTX or Binance, but is one of the biggest and earliest investors in a crypto industry still reeling from this month’s collapse of Sam Bankman-Fried’s FTX. This latest revelation highlights the links across Silbert’s group, which was valued at $10bn last year by investors including SoftBank, Singapore’s sovereign wealth fund GIC and Google’s venture arm CapitalG.

New York-based Genesis Trading halted withdrawals from its lending unit last week, citing “unprecedented market turmoil” and has since been looking to raise cash. It said this week that it was not at risk of an “imminent” bankruptcy but has since hired Moelis investment bankers to help explore “all possible options”.

DCG has spent $772mn since March 2021 on open market purchases of units of the Grayscale Bitcoin Trust (GBTC), according to US securities filings. Some of DCG’s purchases were funded by US dollars and by bitcoin that the group borrowed from Genesis Trading, DCG told the FT.

Silbert told investors that DCG had borrowed $575mn from Genesis “on an arm’s length basis” to fund undisclosed “investment opportunities” and buy back DCG shares from non-employee shareholders.

DCG subsequently told the FT that “a portion” of the borrowing from Genesis was used to fund the GBTC purchases, and $300mn was spent on the share buybacks.

DCG declined to comment on whether the loan from Genesis had been secured by assets such as GBTC.


The Grayscale trust units that DCG bought have since dropped sharply in price. The weighted average price of the purchases since March 2021 was $40, according to an FT analysis, but the units closed at $9.23 on Wednesday. DCG said it had other offsetting positions that made its GBTC purchases “market-neutral”.

Until October this year, traders who wanted to deposit bitcoin in the Grayscale trust in return for the more easily traded GBTC units had to use Genesis as the exclusive issuing agent. The Grayscale trust pays an annual 2 per cent fee of its assets under management to DCG-owned Grayscale.

Investing in GBTC had previously generated easy profits for traders because until early 2021 it traded at a premium to the price of the underlying bitcoin asset. The premium had existed because of the demand for bitcoin wrapped in a traditional financial structure.

GBTC now trades at a steep 39 per cent discount to the price of bitcoin. The US Securities and Exchange Commission has repeatedly refused to allow the Grayscale trust to convert into an exchange traded fund structure open to retail investors.

The popularity of GBTC when it traded at a premium, and the ease of trading the units, meant that it was widely used as collateral in crypto lending, including by Genesis itself.

Silbert’s holding company has injected cash into Genesis after a series of high-profile shocks to the industry this year. One came after Genesis lost $1.1bn on a loan to collapsed hedge fund Three Arrows Capital, which pledged GBTC as collateral on the loan. DCG took on Genesis’ liabilities in the process, subsequently owing $1.1bn to Genesis, Silbert said on Tuesday.

More recently, DCG injected $140mn into Genesis hours before FTX filed for bankruptcy. Genesis has since been racing to raise extra new financing and told clients on Wednesday it was working with DCG and exchange Gemini to shore up liquidity.

[vertical_doug]

https://cointelegraph.com/news/the-m...-four-years-on

https://www.reuters.com/investigates...t/bitcoin-gox/

https://cryptonews.com/news/final-an...ion-agreed.htm

This is the original Crypto exchange bankruptcy case which happened in 2014. It is unclear if the trustee has started to payout claims this month on final settlement.
This one was easy compared to FTX.

It also an interesting read with a cast of characters.... There were other side tangents I have excluded like when Fortress Investment Group tried on multiple times to low-ball
bid the claims, etc.

[fastupslowdown]

Funny how the auditors always find religion "after"


Several US firms told the FT that they had elevated some or all of their crypto-related clients to the status of “high risk”, triggering a more thorough audit that will take longer and lead to higher bills.
“When a client is high risk, you significantly expand the scope of the audit, and that translates into needing more resources and more time,” Weiner added. Extra work will be required to check a company’s “systems, controls, the existence of assets, segregation of funds and, of course given FTX, there will be extra scrutiny of related-party transactions”.




https://www.ft.com/content/72c3c6cb-...maUuiqDG3UgPN8

-Mike G

[vertical_doug]

Funny how the auditors always find religion "after"


Several US firms told the FT that they had elevated some or all of their crypto-related clients to the status of “high risk”, triggering a more thorough audit that will take longer and lead to higher bills.
“When a client is high risk, you significantly expand the scope of the audit, and that translates into needing more resources and more time,” Weiner added. Extra work will be required to check a company’s “systems, controls, the existence of assets, segregation of funds and, of course given FTX, there will be extra scrutiny of related-party transactions”.




https://www.ft.com/content/72c3c6cb-...maUuiqDG3UgPN8

-Mike G

The funniest part is the largest stablecoin, Tether, has never had a real audit.
Most stablecoins don't have audits, just attestations.