Most Wonderful Time... To Be a Prosecutor
I will be off for New Year’s (don’t worry, your subscription will be automatically credited for an extra two weeks) so this will be the last issue of 2022. I feel obligated to cover the ongoing FTX drama, but I’m sure everything will have completely settled down by mid-January and we’ll all go back to creating innovative tools built on top of revolutionary technology. Happy Holidays to all of you and here’s to a better 2023.
🟢 Down Goes Bankman
(Big Idea: SBF Sux)
Crypto Twitter is often a, uh, edgy place with disparate opinions. But I’ve never seen it so unified and joyous as when Sam Bankman Fried was arrested in the Bahamas and then indicted by three different federal agencies on multiple counts of civil and criminal crimes including wire fraud, securities fraud and conspiracy. You’ve probably read much of it, but here are some of the highlights:
SEC: “From the inception of FTX, Bankman-Fried diverted FTX customer funds to Alameda, and he continued to do so until FTX’s collapse in November 2022.”
John Ray III, “[Enron crimes] were highly orchestrated financial machinations by highly sophisticated people to keep transactions off balance sheets. This (FTX)... isn't sophisticated whatsoever, this is just plain old embezzlement."
FTX used QuickBooks. As a former QuickBooks product manager and customer, I can confirm this is a horrible idea.
Alameda could borrow limitlessly, and at zero percent interest (!), from FTX customer funds. FTX referred to this account as “fiat@ftx.com” and was hidden internally.
Alameda was exempt from FTX’s “auto-liquidation” risk engine functions. This exception was hard coded into FTX’s system.
“Because its own FTX trading account was able to maintain a negative balance of billions of dollars, unbacked by sufficient collateral, Alameda was able to divert billions of dollars in FTX customer assets. Alameda did just that in 2022.”
Senior execs at FTX reportedly formed a chat group called "Wirefraud" and used it to send secret information about operations in the lead up to the company's implosion.
It seems pretty clear that Bankman Fried bought BlockFi and Voyager so that he could raid those company’s customer deposits as well.
Ryan Salame, co CEO of FTX Bahamas (he of the mere $55 million loan), reportedly tipped off Bahamian regulators that FTX used customer funds to cover losses at Alameda. There is speculation that Caroline Ellison, CEO of Alameda and Bankman-Fried’s ex, is also cooperating with the Feds.
While many thought that Bankman-Fried was avoiding arrest because of his prodigious donations, the one month turnaround from blow-up to arrest is actually very quick. For example, it took over a year for Bill Hwang to get arrested after the Archegos blowup.
Some took solace that the Bahamas only prison is considered one of the worst prisons in the world. But apparently, a) Sam is being held in the infirmary where he still gets his daily Zyrtec and Adderall and b) the prison is “no longer infested with rodents.”
Bankman Fried is still actively maintaining that all was fine and dandy and he should have never filed for bankruptcy and it is all John Ray III’s fault. And Mr. Wonderful claims that it was all Binance’s fault.
🟦 FTX Fallout
(Big Idea: Contagion)
While still keeping an eye out for further contagion, nothing dramatically fell apart in the last two weeks and all eyes have now turned to Binance. Even before FTX blew up, Binance was, by far, the largest global exchange, but it’s always been a bit “shadowy” for a lack of a better term. The company has no headquarters and does not operate in the U.S. Still, reports came out this week that the DOJ has been investigating Binance since 2018 and is split on pressing charges for money laundering and violating sanctions. Honestly, this wouldn’t be all that shocking a charge and would put Binance in elite company with Credit Suisse, Deutsche Bank and HSBC.
Investors, however, have been worried that Binance might be the next FTX and have been pulling their money out just in case. At times, Binance was processing $800 million in withdrawals per hour. They hit $6.8 billion of withdrawals in 48 hours. If you run a bank, that might be a problem, but if you’re running an exchange where you actually hold assets for users, this shouldn’t be an issue. Unlike FTX, it has not been a problem so far.
We talked last time about Proof of Reserves and how crypto, uniquely, can create clear attestations that institutions hold the assets that they claim to. Binance had recently released the addresses of some of their largest crypto wallets. They show, for example, that Binance holds 584,600 Bitcoin worth around $10 billion and $35 billion of Ethereum.
Binance also published a Proof of Reserves audit by Mazars last week which immediately came under fire as incomplete, largely because it omitted liabilities. Then, this morning, Mazars announced it was getting out of the crypto auditing business, adding another layer of doubt.
Fear has trickled into the world of “Inverse Cramer.” People started freaking out when CNBC’s Jim Cramer said that he was bullish on Binance three days ago. But then, Binance stans were relieved this morning when Cramer Tweeted, “I would trust my money more in Draftkings than i would binance.”
If I were betting, I suspect that Binance is fully or mostly collateralized and will likely be fine. But I also wouldn’t eff around with a 10% chance that it doesn’t survive and I would have bailed weeks ago (recall that U.S. residents are unable to sign up for a Binance account).
On the regulatory front, however, there was some good news this week or really, the absence of bad news. In the past, the SEC in particular has used individual charges to simultaneously strafe crypto and establish precedent. When they charged a Coinbase product manager for front-running, they included the premise that nine of the crypto assets sold were actually securities. This meant, implicitly, that a single individual, a mid-level product manager, would need to defend a momentous and complicated designation that would have implications for the entire industry.
In this week’s charges filed by the DOJ, SEC and CFTC against Bankman Fried, however, crypto itself mostly dodged potential bullets. 1) The CFTC called Bitcoin, Ethereum and Tether “commodities,” a relief to some people that have been worried that they may be regulated as securities. 2) The SEC itself focused on fraud in the entities (i.e. VCs as aggrieved parties) vs. fraud in the coins or any securities designations. 3) The DOJ used crypto assets on FTX for commodities charges, reasserting the commodity vs. security designation. In each of these instances, the charging authorities could have used FTX to reach some broader anti-crypto conclusions so there is so relief that this did not come to pass.
◆ Trump That NFT
(Big Idea: NFTs as Status)
Given that Donald Trump has affixed his name to steaks, airlines and universities, it should really come as no surprise that he has now launched his own set of NFTs. The launch video is well worth watching. It starts with Trump revealing a six-pack under his suit (who knew?) while shooting laser beams from his eyes and comparing himself favorably to Lincoln and Washington. It mellows out after the first 10 seconds though.
He compares the NFTs to a baseball card or other collectibles and, frankly, this is pretty accurate: the vast majority of baseball cards and collectibles aren’t worth anything. My Franklin Mint civil war chess set is still in its box, but I’m starting to sense it may not have been my best investment. I mean, even Trump says in his video, “Each card comes with an automatic chance to win amazing prizes like dinner with me. I don’t know if that’s an amazing prize, but it’s what we have.”
We’ve talked in the past about Starbucks and Reddit doing cool, real-world things with NFTs. Despite having some pretty broadly different opinions from our former President, I do acknowledge there have been times that I agree with him. It’s definitely not my can of Diet Coke, but despite what I read on my feed, I don’t really have much against it. The art is pretty bad, low budget and repetitive, but the people that are paying $99 for these NFTs are probably pretty darn clear about what they are getting and, unlike Starbucks’ NFTs, it has actually launched.
Most “rugs” in NFTs happen where a project launches, promises all sorts of future benefits and enhancements and then slowly fades away, keeping the money that they claimed they would use to build. Here, the future promises are pretty limited and even the former President who has been known to exaggerate once or twice admits that the prizes are pretty crappy. Now if they don’t follow through with the round of golf, that is a different issue, but given that Trump liked to cater athlete’s dinners with McDonald’s and Chick fil-a, I would limit my expectations if I won the Mar-A-Lago dinner.
Technically, this project is very similar to the others and is also run on Polygon. As talked about before, Polygon is a Layer 2 network that sits on top of Ethereum and has an absolutely killer biz dev team who is crushing it right now signing up everybody. You can buy these NFTs with a form of ETH or you can just use a credit card and have a wallet set up for you by Torus, obfuscating away the technical backend.
In fact, all 45,000 NFTs sold out in about 12 hours, netting $4,356,000. Because all of this is onchain, we can see exactly how it is coming along. You can track the underlying smart contract and using that data someone has put together a Dune dashboard that analyzes some of these numbers (I believe the calculation for “First Polygon NFT” is incorrect, however):
And now that the collection has sold out, we can also watch all of the secondary sales (which earn the creators a 10% royalty on each sale). In one hour this morning, almost 1,000 of the NFTs were sold at an average of double the purchase price so take that you snowflakes!:
There’s also an interesting legal wrinkle. One of the cool things about NFTs is that you can use them to enable some secondary action or privilege. For example, owning a specific set of Adidas NFTs might allow you early access to a new drop. Here, the Trump Cards offer 8 different “prizes” from dinner, to a round of golf to a 20 minute Zoom with 2,000 fellow NFT owners. It would be technically possible to assign each of these prizes along with the “minting” (aka generation) of the NFT, but the Trump Cards are doing that as part of a separate sweepstakes. The NFT itself gets you an entry into the sweepstakes which will happen later and also has all of the normal sweepstakes language as protection. Baby steps, I guess.
Also, in a refreshing amount of clarity, Trump never claims that this is for his campaign or to save America or really anything other than a money grab. In fact, all proceeds go to NFT INT LLC which “uses Donald J. Trump's name, likeness and image under paid license from CIC Digital LLC.” I’m sure NFT INT LLC (say that fast 5 times) just paid Trump, what, maybe, $5 million upfront to do the video, a few events and use his image.
Moving forward, I think we will continue to see all sorts of variations of this model, targeting different niches with different benefits. Most will be worthless, lots will be outright scams, a small number will become truly valuable, but over time they will evolve and develop and we will be shocked at where it ends up in 10 years.
This Week's Freezing Cold Take
Bankman-Fried had declared earlier on Monday, “I don’t think I will be arrested,” saying he was more worried about paparazzi.
As always, thanks for reading. Send me questions and please share with your crypto curious friends.