Crypto has a problem with spies

Court documents show that the relationships between major crypto firms are complicated and intertwined. This has implications for the stability of the ecosystem and for customers who are owed money.

Last year, mistakes made by a crypto issuer called Terra sent shockwaves through the crypto ecosystem. FTX, a giant in space, was the one that paid the price. This investigation of court records shows how exposures worth millions or even billions of dollars at companies like Three Arrows Capital, Voyager, and Celsius made a small wave grow into a tsunami.

It’s well known that crypto companies are closely connected, but privately owned companies like FTX don’t usually have to reveal their financial secrets. When they were put in the “clear fish tank” of Chapter 11, that changed.

The numbers show a network that was at least interconnected, if not directly connected to itself. Overall, this made the system less strong. The legal process to sort out the mess will take a long time and cost a lot of money, which is bad news for those who want their money back. The people in charge of making sure it doesn’t happen again are already working on it.

On January 30, Alameda Research, which is FTX’s sister trading firm, tried to get back about $446 million it had given to a lender that went bankrupt. Voyager and its creditors said “unfair and fraudulent behaviour” by Alameda had cost them more than $114 million.

But that’s just the beginning of figuring out how the finances of crypto companies like the hedge fund Three Arrows Capital (3AC), Genesis, and the lenders Celsius and BlockFi are connected. (Like CoinDesk, Genesis is a company owned by the Digital Currency Group.)

The 3AC outbreak begins
After the TerraUSD stablecoin and Luna token went down, 3AC lost about $200 million. It was the first company to go down, signalling the start of a new crypto winter.

Voyager, which filed for bankruptcy on July 5, said it gave 3AC a loan of $654 million, which was a huge 57.8% of its total loan portfolio. Genesis Global Holdco filed for bankruptcy, and as part of that, its Asia Pacific unit said it had given the hedge fund $2.4 billion in cash and digital assets. Celsius asked for loans worth $75 million, but only about half of that has been paid back by selling collateral. BlockFi also says that the bankruptcy of 3AC, one of its biggest borrowers, caused it “material losses.”

Even before Bankman-Fried came to save the sector after 3AC, they all did business with the FTX empire. As of July 5, Alameda owed Voyager $377 million. Around the time it filed for bankruptcy in November, BlockFi, which was also the target of Bankman “white knight” Fried’s deals, said it had $671 million in loans to Alameda and $355 million in cryptocurrency that was frozen on FTX.

The FTX exposure for Celsius was also in the billions. An examiner’s report says that as of April, the lender had borrowed $1.5 billion in stablecoins from FTX and had more than $2.5 billion in assets on the platform. Alameda also sent around $520 million of FTX’s native token, FTT, to Celsius. This was supposed to secure $814 million in loans, but its value fell when the exchange did. Genesis owes and its affiliates $226 million, according to FTX’s bankruptcy filings. This makes Genesis the largest unsecured creditor of and its affiliates.
Smaller businesses also lent money to each other. As of July 5, Voyager said it had a $17.5 million risk with another Genesis unit that had gone bankrupt. Celsius has also tried to get back the $7.7 million it gave to Voyager in the three months before it went bankrupt on July 13.

All that money was on shaky ground because of how FTX and Alameda worked together. In November, CoinDesk found that the lines between the supposed separate entities were not so clear. Since then, regulators have said that special lines of credit and improper access to customer funds were used.

Meanwhile, the 56 million shares of Robinhood that FTX founders Sam Bankman-Fried and Gary Wang bought with a loan from Alameda are now in Emergent Fidelity, a shell company that was created just for this purpose and has filed for bankruptcy in both Antigua and the U.S. The assets are now in the middle of a complicated legal fight between the liquidators, the Department of Justice, FTX, and BlockFi.

Moving Markets

Then what?
This kind of interconnectedness in finance is important to regulators because it makes the whole system less stable and reliable.
In 2008, the failure of Lehman Brothers was felt all over the world because of transactions that were hard to understand. Standard-setters now look at how connected banks are to decide if they are too big to fail. If there are too many assets and liabilities in the financial system, more capital needs to be issued.

For now, the crypto virus hasn’t spread any further.

With a few exceptions, like Silvergate Capital, the crypto sector is mostly cut off from traditional finance. But the pattern is being used to make the case for rules.

“The crypto-asset market is highly connected, which could lead to rapid contagion and the spread of stress among crypto-asset market participants,” the Financial Stability Board, an international group that sets standards, said in a consultation in October when it proposed sweeping new rules for the sector.

Banks have strict rules about ownership, capital needs, and how funds can be used again. Crypto companies, on the other hand, only have self-imposed rules that are often broken. A court-appointed examiner says that Celsius went over its own credit limits with big clients like 3AC and Alameda. The bankman’s claim that Fried’s said FTX didn’t invest customer funds now doesn’t seem true.

Alameda was able to borrow from FTX much more than FTX’s clients could.

But there are risks that have nothing to do with money: When things go wrong, it’s much harder to close down companies that are tied together.

Mark Shapiro, a bankruptcy expert, told CoinDesk that if a big company goes bankrupt, like Enron did in 2001, it’s not unusual for other companies in the market to feel a second-order ripple. Crypto could be different, though.

“You don’t see this many different companies connected to each other very often,” said Shapiro, a partner at the New York office of the law firm Shearman.

“All of these companies were more connected than people probably realised,” he said, calling the crypto turmoil the biggest “domino effect” since Lehman Brothers.

Any transaction made up to three months before a bankruptcy is already looked at with suspicion by U.S. law.

Any transactions that are later found to be fraudulent can also be taken back. Now, many judges in different courts in New York, Delaware, and New Jersey will have to sort through the complicated web of transactions and decide who owns what.

Shapiro says that customers who are waiting for their money are out of luck.

“Everything to do with FTX will take a long time,” he said.

People who lost money in Bernie Madoff’s Ponzi scheme had to wait about a decade for a solution.


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