Top Stories of the Week - 11/25

In the newsletter today we talk about the FTX bankruptcy, trouble at genesis, and an attack on Aave that was mostly thwarted. Subscribe here and receive Galaxy's Weekly Top Stories, and more, directly to your inbox.

FTX Bankruptcy Judge Approves Motion to Redact Identities of Exchange Creditors

During the first hearing in the bankruptcy proceedings of defunct cryptocurrency exchange FTX, the judge approved a motion to redact the names and addresses of both individuals and entities on the exchange’s list of creditors (individuals or entities with assets still on the exchange when withdrawals were halted). The attorneys at Sullivan & Cromwell LLP, which is the law firm representing FTX debtors, argued that the customer list of FTX should be considered a valuable “asset of the estate” that if released for public consumption would harm both the resale value of the company and the privacy of its customers. Representatives from the US trustee argued against the redaction during the hearing, saying that, at the minimum, customers of FTX that are entities, not individuals, should be revealed. “There should be transparency about who those entities are, including [those] on the top 50 list,” said Benjamin A. Hackman, an attorney representing the U.S. trustee. A list of the top 50 creditors in FTX was released on Sunday, November 20th in a court filing submitted to the U.S. Bankruptcy Court for the District of Delaware, but it did not name the identities of those on the list. On Tuesday, November 22nd, Judge John Dorsey of the U.S. Bankruptcy Court ruled in favor of keeping the names of the top 50 creditors and all other smaller creditors redacted from public filings “for now,” adding that he would reconsider his decision during the final hearing.

The next official bankruptcy hearing for FTX will be on December 16, 2022, at 10am (ET). Attorneys from both Sullivan & Cromwell LLP and the US trustee are expected to present further evidence documenting FTX’s collapse and likely revisit this matter of redacting FTX creditor identities at the next hearing. The first official hearing presented no new material information about the exchange and its operations beyond what was already stated in John J. Ray’s initial Chapter 11 bankruptcy filing. The discourse used to describe the timeline of events leading to FTX’s collapse echoed the outrage and shock expressed by Mr. Ray in his initial filing. James Bromley, Partner at Sullivan & Cromwell LLP, said during Tuesday’s hearing, “what we have is a worldwide organization, but an organization that was run effectively as a personal fiefdom.” He continued to say, “we have witnessed probably one of the most abrupt and difficult collapses in the history of corporate America.”

Our Take

The decision to redact the names and addresses of FTX creditors is unusual in the context of bankruptcy proceedings. Normally, bankruptcy proceedings prioritize transparency and full disclosures to the public about a distressed company and the identities of the people directly impacted. In early October, the bankruptcy proceedings for now defunct cryptocurrency lender Celsius Network resulted in the release of more than 29,000 pages of court documents that revealed the identities of hundreds of thousands of Celsius’ customers and their wallet addresses, transaction histories, crypto holdings, and more. “Sealing information such as that sought by the Debtors [Celsius] from public disclosure risks transforming the open and transparent bankruptcy process into something very different, which the Court is loath to do without a strong showing of real and not speculative risks,” said Judge Martin Glenn about his ruling to reveal the identities of Celsius’ customers. 

Based on the norms around bankruptcy proceedings, the decision by Judge John Dorsey to redact the identities of FTX creditors is likely one motivated by an abundance of caution, rather than conviction. The livelihood of millions of people is at risk because of FTX’s collapse and it is unclear whether involuntarily releasing their identities is necessary or beneficial for the sake of court proceedings at least for now. There is a real risk that individuals and entities, who are known or assumed to possess cryptocurrencies (digital bearer assets), could be targeted physically or in cyberattacks when their identities become known. However, as more evidence about FTX and its operations are brought to light during forthcoming hearings, it is likely that the identities of at least a small subset of FTX creditors will be revealed either voluntarily or by a reversal of Judge John Dorsey initial decision. One of the main reasons why transparency about FTX’s creditors, primarily the exchange’s top 50, is so important and worth watching for in the weeks and months ahead is because the contagion from FTX’s collapse cannot be properly assessed without this information. News and headlines about cryptocurrency companies impacted by FTX’s fall continue to rock markets and the ongoing uncertainty about who’s next will continue to fuel greater volatility. A clear picture of FTX’s largest creditors impacted from FTX’s fall would go a long way in helping the markets and industry stakeholders correctly evaluate the state of the industry moving forward, instead of merely react to the industry’s present state. –CK

The Genesis Story Awaits a Conclusion

Genesis, one of crypto’s biggest OTC dealers, freezes lending redemptions amid liquidity crunch. On Wednesday (Nov. 16) last week, Genesis Global Capital, the lending unit of Genesis Global Trading, itself a subsidiary of Digital Currency Group, abruptly halted operations, blaming market conditions. Shortly after the announcement Wednesday morning, crypto exchange Gemini announced that delays from its interest-bearing deposit account program, Gemini Earn, relied on Genesis’s lending operations and would also be halted. Some estimates Genesis subsequently hired Alvarez and Cleary Gottlieb to assist in exploring options.

Genesis previously announced that it had $175m stuck at FTX.com as part of its derivatives book, making it one of the largest creditors in the FTX bankruptcy. Bloomberg reported that its parent, Digital Currency Group, owes $575m to Genesis due in May 2023, as well as a promissory note due June 2032. Early this week, Genesis said it had hired Moelis & Company to advise it on possible options including bankruptcy.

Genesis had perhaps the largest loan book in crypto, with Q2 2022 its biggest quarter with more than $44bn in loans originated and a March 31, 2022 active loan balance of $14.6bn. The firm was known for offering lenient loan terms compared to competitors, including offering totally unsecured loans, no doubt contributing to its $1.2bn loss to Three Arrows Capital earlier this year. Despite the lending halt, Genesis says its trading and derivatives businesses remain operational. The Wall Street Journal reported last week that Genesis was seeking “an emergency loan of $1bn,” but on Monday The Block reported it had cut its target raise to $500m.

Digital Currency Group is one of the oldest and largest companies in the cryptocurrency sector, with subsidiaries in mining and staking (Foundry), wallets and custody (Luno), wealth management (HQ), news and media (CoinDesk), and asset management (Grayscale). For its part, Greyscale, whose GBTC vehicle holds 635k BTC and is the largest bitcoin investment vehicle in the world, (and custodian Coinbase) have refused to perform a proof of reserves attestation to confirm the safety of its assets, although Coinbase reaffirmed that Grayscale’s assets are safe and intact.

Our Take

While FTX’s collapse undoubtedly put additional pressure on Genesis, it’s clear that holes resulting from last Spring’s credit crisis played a big part in the current saga. Genesis’s whopping $1.2bn unsecured claim against Three Arrows Capital is likely to be a total loss, or inaccessible for years at best.

But while a Genesis closure would represent the loss of a near ubiquitous counterparty in the institutional crypto trading ecosystem, bigger questions swirl around the state of Digital Currency Group as a whole. Market participants and social media instead have focused intently on Grayscale and assessing any risk that its flagship funds GBTC and ETHE, which collectively have more than $8bn of AUM, could somehow be affected if Genesis contagion spreads to its sister companies or parent DCG. These funds are open-ended grantor trusts which, by SEC regulation, may not offer redemptions simultaneous to creations. Currently, there is no ability to redeem shares of GBTC, leading to a current discount of -40% to NAV. However, prospects for any unwind of GBTC remain low, either due to opening of the redemption window (which would deprive Grayscale and DCG of hundreds of millions in revenue per year), or due to any bankruptcy at the DCG level, which would seek to protect the asset (Grayscale) rather than liquidate it outright.

Barry Silbert, DCG Founder and CEO, wrote to shareholders Tuesday that “DCG will continue to be a leading builder of the industry and we are committed to our long-term mission of accelerating the development of a better financial system.” At the time of writing, DCG and Genesis have yet to announce their next move, whether a successful fundraising or restructuring effort. For now, we can only watch and wait to learn the fate of one of crypto’s true juggernauts. -AT

Notorious Mango Market Schemer Guns for Aave

After exploiting a vulnerability in Mango Markets' risk parameters to the tune of $117mm, Avraham Eisenberg (or ponzishorter.eth as he’s known on the Ethereum Name Service), migrated to Ethereum to test out Aave’s systems. The full scope of his positioning is unknown, but the public details suggest Eisenberg was aiming to get liquidated, leaving Ethereum’s oldest pool-to-peer lender with “bad debt.” Eisenberg, over a week-long period, built up a sizable CRV borrow, acquiring roughly 92mm tokens vs about $60mm of USDC on Aave V2. The CRV was borrowed on leverage as Eisenberg jettisoned his initial borrow for more stables, looping or “folding” his CRV position. While market participants believed Eisenberg was attempting to short CRV, as Tuesday wore on it became clear Eisenberg aimed to short-squeeze CRV, leaving Aave with bad debt.

For context, Aave loans are liquidated when one of two things happens: either the value of the collateral (USDC in this case) falls enough or the value of the outstanding asset (CRV) goes up enough to make the loan fall outside of a pool’s Loan to Value (LTV) ratio. To liquidate loans outside the ratio, Aave relies on liquidator bots that source CRV and exchange it for the collateral atomically. That is to say, all the transactions associated with the liquidation occur all at once or not at all.

Unfortunately for Aave and for the bots, sourcing CRV on-chain proved difficult as most of the CRV supply was on exchange, held privately, or in lending pools. Eisenberg likely chose CRV for this trade due to that lack of liquidity. Liquidators, without a reliable source of CRV, faced slippage which made it quite challenging to profitably execute liquidations. And CRV, thanks to illiquidity, would squeeze high enough that Aave, just like its cousin Mango Markets, would be left with bad debt.

Ultimately, CRV ran from 62 cents to 74 cents over the 40 minutes it took to (partially) liquidate Eisenberg’s position, leaving Ethereum’s Aave V2 with a small debt of $1.6mm that its supporters will need to backstop out of their own insolvency funds or Aave’s treasury.

Our Take

This latest installment of DeFi protocol vs. mercenary trader gives lots of lessons. First, while media outlets, accounts on Twitter, and Aave’s backer (the DeFi modeling outlet Gauntlet Network) all have pronounced the attack on Aave unsuccessful and unprofitable, it's important to note there is no way of knowing where Eisenberg booked the trade and marked his PnL. Calling the scheme unsuccessful from the perspective of trying to break Aave is certainly accurate, as the DeFi lender’s risk system proved robust relative to Mango Markets. But, despite on-chain data suggesting he lost roughly $10mm on the liquidations, where and when Eisenberg booked his exit from his CRV position is unknowable. It’s possible he hedged his position elsewhere (although Open Interest dataon OKX and Binance for CRV suggests hedging did not occur there) or timed his exit to coincide with the short squeeze. Accounts on Twitter were speculating early into the trade what Eisenberg was attempting to do and, if taken at face value, were also positioning their own books around his position. Some, based on comments on Discord, thought he was hunting a Curve developers’ loan on Aave, while others assumed he was betting on bad risk parameters and illiquidity mixed with the launch of Curve’s new stablecoin, crvUSD, on Tuesday. What exactly Eisenberg was doing is still unclear, but an obvious second takeaway is how unwise it is to trade around other people’s positioning, especially when that positioning is itself opaque.

Lastly and most notably, the events that unfolded with Aave this week make abundantly clear how the root of trading and lending for DeFi is not all that different from traditional markets. Mango Markets, like many of the now bankrupt CeDeFi lenders in crypto, failed to employ good risk controls, enabling a mercenary like Eisenberg to walk off with millions of Solana assets. On the other hand, Aave, in part thanks to Gauntlet, minimized its exposure and liquidated a majority of its bad debt despite adverse conditions. In a phrase, it's as true in DeFi as in centralized markets that the key to success and safety is to know thy counter-party, be it a regulated entity with a daisy chain of borrowers and lenders behind it or a cutting-edge fruit friendly DeFi protocol. - WJS

Other News

• Maker Protocol deploys Rocket Pool staked ETH (rETH) as new collateral type

• Maker governance approves new conservative stablecoin vault liquidation parameters

• SBF sends internal letter to FTX employees

• Liquid Exchange paused withdrawals as part of FTX Chapter 11 bankruptcy process

• Deadline for Celsius customers to file claims in bankruptcy case set for January 3

• DCG CEO Barry Silbert addresses shareholders

• Magic Eden integrates with Polygon

• JP Morgan’s application to trademark “JP Morgan Wallet” approved after filing two years ago

• FTX hacker transfers 245k of stolen ether to several wallets that then sell for renBTC

• Coinbase partners with Institutional Investor to publish 2022 Digital Assets Outlook Survey

• Bank of Japan to run CBDC experiments

• Binance U.S files for their own political action committee