The entanglement of a Crypto CrisisFinancial Fraud Lawyers investigate
(i)The promising concept of cryptocurrency
The idea of developing digital assets as opposed to a fiduciary system finds roots in the late 1980’s, with DigiCash Inc.’s attempt to create the first global virtual currency in 1989. As per defined by Investopedia, cryptocurrency is “a digital or virtual currency secured by cryptography and based on a network that is distributed across a large number of computers”.
It works through blockchains, “a digital database or ledger that is distributed among the nodes of a peer-to-peer network”. The blockchain system ensures that crypto securities are dispersed when stocked, which makes them more secure and attractive for investors. The initial goal of decentralization was to allow individuals to become their own market makers, without having to rely on a third-party such as banks in order to execute transactions.
Two types of digital currencies were developed. First, crypto tokens, “a digital asset that runs on another cryptocurrency’s blockchain”. The most popular crypto tokens are Bitcoin (BTC) and Ethereum (ETH). Their value has been fluctuating endlessly, but one can wonder what value virtual tokens actually hold. Because they are categorized as speculative investment products, the allocation of any tangible value would be artificial.
To counter this effect, stablecoins were created: “cryptocurrencies whose value is pegged, or tied, to that of another currency, commodity, or financial instrument. They aim to provide an alternative to the high volatility of the most popular cryptocurrencies”. The two most traded and exchanged stablecoins at the time of this article’s writing, are Tether (USDT) and the USD Coin (USDC), both pegged to the American dollar, consequently worth between $0.99 and $1.
There were many actors who significantly played a part in the recent downfall of Crypto. As more and more investigations are being launched and reports are being published, it appears that the crisis’ cause and effect rely on the intertwining of Crypto entities. They were bounded for the most part, which translated into exchanges and trading partnerships to ensure ongoing market value. But how exactly has the relationships between those entities affected the global collapse that occurred throughout this year? As we unravel the situation, we notice the cascading effect that rules the Crypto ecosystem.
(ii)A global downfall for the crypto industry
In hindsight, a large number of well-known Crypto based companies found themselves in the middle of the scandals. Insolvency, creation of artificial value, overall market manipulation… The biggest challenge for crypto players seems to be maintaining fairness: because of the lack of governmental and institutional supervision, it appears that it is easier for crypto giants to take advantage of the ecosystem for their own profit.
Not only does it shatter the public’s trust, but these practices also justify the unsustainability of the digital assets’ development. It proves that the system is not conceived to be equitable, and that the will to transform crypto into the future of finance is unrealistic as it is disadvantageous for the majority. So far, Crypto has enabled a few individuals to become very rich, while it has drained savings from the unsuspecting majority of investors.
According to the Unchained podcast, hosted by crypto journalist Laura Shin, the fact that the industry is evolving so rapidly enables discrepancies, as we lack the necessary distance to observe the market and regulate it accordingly. She noticed that a lot of issues came from the same source: crypto lenders would often offer very high interest rates to encourage individuals to deposit and invest money.
The crypto ecosystem was advertised to be a revolution for individual investors, while as it is currently established, only allows a minority of people to make profits. We read stories about Three Arrows Capital’s founders, buying themselves twin mansions in Dubai, or regarding Terraform Labs’ Do Kwon or FTX’s Sam Bankman-Fried, both accused of committing fraud for personal gain.
All these now bankrupt, dissolved, or liquidated companies were once promising entities in the Crypto industry. They conceptualized a new way of practicing finance, theoretically enabling individuals to free themselves from centralized institutions. However, since Crypto developed independently from government agencies, it evolved and expanded outside of any regulatory framework. This might be the first cause leading to abuses by Crypto actors.
(iii)The entanglement of Crypto players
As investigations blossomed, it appeared that many entities evolving within the crypto industry were related – if not in a legal way, they would be trading partners to some extent. Here is a summary of all the interdependency that publicly occurred in the Crypto ecosystem.
∆ Voyager Digital
Voyager was a private brokerage company founded in 2018 and specialized in cryptocurrency and crypto assets. The company was affected by Three Arrows Capital’s (3AC) financial difficulties, and while implemented strategies to recover, fell victim of 3AC’s bankruptcy filing.
By the end of the summer, the two main exchanges in the Crypto industry – Binance and FTX – contemplated a buyout of Voyager Digital, and started bidding against each other. FTX won the auction and was ready to incorporate Voyager, but found itself in the midst of a financial scandal less than two months later. Voyager Digital then faced another unexpected crisis: was there a future for the company and the industry after FTX’s filing for bankruptcy?
Who invested in Voyager Digital?
Alameda Research – undisclosed amount, Key Investor
Digital Currency Group – undisclosed amount
What did Voyager Digital invest in?
3AC – $666M
Alameda Research – $200M
Status: Filed for bankruptcy (July 2022)
∆ Celsius Network
This crypto lending platform was accused by several American states that the securities it would sell were not registered. Victim of the Terra USD crash in May 2022, the company’s main concern was its insolvency. But only two months later, Decentralized Finance’s aggregator KeyFi filed a lawsuit against Celsius Network, invoking alleged market manipulations and failure to implement control systems that would secure the company’s financial state. Celsius Network filed for bankruptcy on July the 13th, 6 days after KeyFi’s allegations. Reportedly, the company was under a $1.2B deficit when it filed for bankruptcy.
Who invested in Celsius?
Nuri – $42M
Tether – $10M
What did Celsius invest in?
3AC – $75M
Status: Filed for bankruptcy (July 2022)
∆ Three Arrows Capital (3AC)
Founded in 2012, the company quickly shifted its strategy. At first it was specialized in arbitrage, meaning that the company would profit from buying assets on one market and almost immediately selling them on another market. It operated on the Forex market, mainly exchanging foreign currencies. Although this ensured a risk-free trade, the profit generated were very low as the assets’ price difference between markets is usually faint. So when 3AC started crumbling from lack of exterior investments, lack of substantial profits and a vanishing support from banks, the founders repurposed the company. In 2017, they applied their strategy to the then emerging Crypto market. After a while though, 3AC started to execute trades from borrowed money instead of its own capital, assuming generated profits would reimburse both the loans and their interest rates.
One of 3AC’s approach to the market was to offer reimbursements with high interest rates instead of putting up collateral. This means that they would not engage their own assets in order to obtain the loans they were seeking. Another approach was to push for less liquid assets put as collateral for loans. Could that actually have been a foreshadowing of insolvency on 3AC’s part?
Who invested in 3AC?
Voyager Digital – $650M
Blockchain.com – $270M
Genesis Global Trading – $2.3B
What did 3AC invest in?
$200M in the Luna token
40M units in GBTC
Status: Filed for bankruptcy (July 2022)
∆ BlockFi
It started as a cryptocurrency lending company with high yields on crypto deposits, with the aim of providing credit services to the crypto market. BlockFi offered USD loans backed by crypto, following the same model as FTX. With a lot of investing in the start-up, cash availability enabled the consideration of new services and implementations. That’s when BlockFi launched its exchange and started to offer trading services.
In March 2020, BlockFi partnered with Silvergate Bank in order to allow users to transfer their liquid assets into digital assets. Last June, BlockFi received a $250M loan from then-giant FTX. Following the collapse of the latter, BlockFi became collateral damage to the financial crumbling of the Crypto market. It was announced in July 22 that BlockFi would not accept shares of the Grayscale Bitcoin Trust as collateral, which meant that the value of GBTC dropped enough to make it risky.
Who invested in BlockFi?
FTX – $275M
FTX.US – $400M
3AC – undisclosed amount
What did BlockFi invest in?
Coin Metrics – $35M
Elwood Technologies – $70M
Status: Filed for bankruptcy (November 2022)
∆ Binance
The Crypto exchange, leader on the market, managed to stay out of the whirlwind when crypto institutions began collapsing. Although it played a part in the FTX rout, social engagement and transparency attempts played in Binance’s favor. But it was since revealed that the American Department of Justice has been investigating Binance’s practices for a while now – from 2018 to be exact – and the crypto giant might face money laundering charges due to a possible lack of compliance with the Law. Like an echo, the UK’s FCA – Financial Conduct Authority – forbid Binance to operate in its region in June 2021, invoking a similar reason. According to the FCA, the company needs express authorization from the governmental institution before offering its services on the territory.
Who invested in Binance?
Vertex Ventures – undisclosed amount
Limitless Crypto – undisclosed amount
What did Binance invest in?
Forbes – $200M
Twitter – $7.2B
Skynet EGLD Capital – $40M
Status: Active
∆ FTX
FTX was a crypto hedge fund and exchange that rose to prominence within the industry, before making the news when investigations revealed that its sister company Alameda Research had most of its assets in FTT, FTX’s virtual currency. This meant that the value of FTT was artificially enlarged, and that both companies were economically relying on this worthless token. For more information, our network dissected the FTX downfall here. The founder of FTX, Sam Bankman-Fried, was arrested last week and will face wire fraud conspiracy, securities fraud conspiracy and money laundering charges.
Who invested in FTX?
Genesis Global Trading – $175M
Binance – undisclosed amount
Sequoia Capital – $1B
What did FTX invest in?
Limit Break – $200M
BetDEX – $21M
Status: Filed for bankruptcy (November 2022)
∆ Digital Currency Group (DCG)
Private company managing virtual assets, owner of two major players in the Crypto economy:
Grayscale Bitcoin Trust (GBTC)
The fact that Grayscale is a trust fund means that the company is allowed to hold assets for individuals or organizations. Its purpose is to promote the Crypto market by facilitating investments in digital currencies. Since Grayscale has become regulated by the US’ SEC – Securities and Exchange Commission – in 2020, it has an obligation to a certain transparency, although it appears complicated to find relevant information regarding investments from and to Grayscale Bitcoin Trust.
Grayscale Bitcoin Trust sued the SEC in the summer of 2022, because of the latter’s refusal to turn GBTC into an ‘ETF’ (an Exchange-Traded Fund). GBTC even defined the refusal as being “arbitrary, capricious and discriminatory”. Although GBTC does not seem to be in an advantageous position with the SEC, this occurrence proves that Crypto makers feel entitled to conduct business the way they seek, which explains why the definition of a regulatory framework is so necessary as well as complicated to implement.
Who invested in Grayscale?
3AC – undisclosed amount
Grayscale Ethereum Classic Investment Trust – $10M
What did Grayscale invest in?
Undisclosed
Status: Active
Genesis Global Trading
The company specializes in crypto assets lending. It had a good reputation in the ecosystem, so much in fact that Genesis became a trading partner with FTX. About $175M of its assets were on the FTX exchange when it collapsed. Genesis used to be a consequent liquidity provider in the global market, and because of the FTX downfall, blocking some of Genesis’ assets, the company could not pay back the loans it contracted. At the same time, depositors wanted to withdraw their money in light of the crypto crisis, which created a liquidity problem for Genesis. Its parent company, DCG, decided to lend it money to ensure a fallback. While this is reassuring for crypto investors, as this means Genesis might survive the current crisis, it also implies that DCG is now completely tied to the lender’s evolution within the industry. If one collapses, so will the other.
Who invested in Genesis?
DCG – undisclosed amount
What did Genesis invest in?
DCG – $575M
FTX – $175M
3AC – $2.3B
Status: Active
∆ Terraform Labs
This start-up initially had the purpose of developing a blockchain for cryptocurrency exchanges. Terraform Labs created a crypto asset, called Luna, and a stablecoin, Terra USD. Since the crypto token Luna and the stablecoin Terra USD were linked together, and because the start-up had difficulties keeping the stablecoin to its fixed value, both currencies collapsed. It is important to note that the failure of this stablecoin represented a hard blow on the industry and its followers: there was now a legitimate reason to doubt Crypto as being the balanced future of our economy.
No one knows what this would effectively mean for cryptocurrencies. The summer of 2022 saw many players fall victim to their own practices, revealing the intricacies that rule the market. The FTX collapse shredded global confidence in the industry, at a time of general disbelief that crypto would be, in fact, the future of decentralized economy. Major entanglement in the Crypto ecosystem provoked a failure cascading effect, for which only time will tell if the industry has a chance to recover.
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