The Impact of Multifunction Crypto-Asset Intermediaries on Market Stability Post-FTX Collapse

The Financial Stability Board (FSB) report, along with other sources, offers significant insights into the impact of multifunction crypto-asset intermediaries (MCIs) and key market events, such as the collapse of FTX in November 2022 and the crypto-asset market turmoil in May/June 2022. These events have underscored the crucial role and potential risks posed by MCIs in the crypto-asset markets.

MCIs are firms or groups of affiliated firms providing a wide range of services and products centered around a trading platform. Many engage in proprietary trading and investment, while some issue, promote, and distribute crypto-assets, including stablecoins. The structural vulnerabilities they can exacerbate in the markets include issues related to leverage and liquidity mismatch. Their vulnerabilities are akin to traditional finance, such as technology and operational vulnerabilities, leverage, liquidity mismatch, and interconnections. Some combinations of functions within a single MCI can amplify these vulnerabilities, especially in the absence of effective controls, operational transparency, and conflict of interest management. The centrality of MCIs in the crypto-asset ecosystem and their concentration and market power pose additional risks. These vulnerabilities could spill over into the traditional financial system through various channels​​​​.

The FSB’s assessment indicates that the threat to financial stability from an MCI’s failure is limited at present, but significant information gaps make this a qualitative assessment. The financial stability implications of MCIs depend on the development of the crypto-asset sector, the evolution of MCIs’ roles, and the implementation and enforcement of comprehensive, consistent global regulations. The global reach of MCIs complicates regulation due to their complex organizational structures, incorporation in crypto-friendly jurisdictions, and potential for regulatory arbitrage​​​​.

The collapse of FTX and other key players in 2022 had a profound impact on the cryptocurrency market, leading to a drop in prices and prompting a regulatory crackdown. This event, along with the earlier collapse of stablecoin TerraUSD, significantly affected Bitcoin and other major tokens. Bitcoin, in particular, lost more than 65% of its value in 2022, plummeting to its lowest since 2020. The overall crypto market also took a hit, dropping from a peak value of $3 trillion in November 2021 to a low of $796 billion in 2022, following the FTX implosion. However, the market has shown resilience, with the value recovering to above $1 trillion in 2023. Venture capital investment in crypto firms also experienced a decline, dropping significantly in the third quarter of 2022 compared to earlier in the year. This decline wasn’t solely attributed to the FTX failure but was part of a broader slowdown that began with the collapse of the TerraUSD ecosystem​​.

The analysis of these developments highlights the intricate interplay between MCIs, market dynamics, regulatory landscapes, and financial stability. The evolution of the crypto market, particularly in light of these recent upheavals, will be critical in shaping future regulatory approaches and market resilience.

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Ex-FTX Execs Launch New Crypto Exchange Backpack

Nearly a year after the dramatic collapse of FTX, several former executives of the defunct cryptocurrency exchange have banded together to launch a new venture in the digital currency space. This new endeavor, named Backpack Exchange, is set to reshape the crypto landscape with a focus on enhanced security and regulatory compliance.

Genesis of Backpack Exchange

Leadership and Vision: The project is spearheaded by Can Sun, previously a lawyer at FTX, with significant support from Armani Ferrante, a former FTX employee who now serves as CEO of Trek Labs, the holding company based in the British Virgin Islands. Trek Labs, a Dubai-based startup, has been authorized to offer cryptocurrency services in the region. Claire Zhang, Sun’s former legal deputy at FTX and Ferrante’s spouse, also plays a crucial role in the team, albeit with plans to step down post-investment round.

Mission and Technology: With lessons learned from FTX’s downfall, Backpack Exchange focuses on ensuring the security of customer funds, a critical aspect FTX failed at. The exchange incorporates a self-custody solution utilizing a multiparty computation (MPC) technique, designed for enhanced security in fund transactions.

Strategic Location and Regulatory Compliance

Dubai as a Crypto Hub: The choice of Dubai as the base for Backpack Exchange is strategic. Dubai’s progressive stance towards virtual assets and the regulatory framework established by the Dubai Virtual Assets Regulatory Authority (VARA) offers a conducive environment for crypto ventures. Backpack has obtained the Dubai Virtual Asset Service Provider (VASP) license, enabling it to operate within one of the world’s emerging financial centers.

Product Offerings and Launch Timeline: Backpack Exchange plans to commence operations with spot trading, featuring state-of-the-art features like zero-knowledge proof of reserves and low-latency order execution. Exclusive early access is set for November 2023 for existing Backpack and MadLads community members, followed by a broader public launch in early 2024.

The Road Ahead: Transparency and Market Integrity

Commitment to Transparency: In a bid to instill greater trust and compliance in the crypto industry, Backpack Exchange adheres to VARA’s stringent regulations. This commitment is seen as a major step towards the institutionalization of cryptocurrency trading in Dubai, enhancing investor protection and maintaining market integrity.

Dubai’s Regulatory Framework: The decision of Dubai to regulate and license exchanges like Backpack reflects a positive approach towards embracing blockchain technology, with a focus on creating a regulated yet thriving environment for crypto-assets.

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SEC Chair Gensler Open to Lawful Revival of FTX

During a CNBC interview at DC Fintech Week, SEC Chair Gary Gensler discussed the potential revival of the bankrupt cryptocurrency exchange FTX, emphasizing the importance of operating within legal boundaries. The context for this comes in the wake of FTX founder Sam Bankman-Fried’s recent fraud conviction and the company’s bankruptcy last year.

FTX, founded by Sam Bankman-Fried, was once a cryptocurrency exchange titan, known for its innovative approach and rapid growth in the crypto world. However, its reputation nosedived following revelations of financial mismanagement and legal violations, leading to a bankruptcy filing in late 2022. This downfall highlighted the risks and regulatory loopholes in the burgeoning cryptocurrency market.

Gensler’s remarks followed reports of Tom Farley, ex-president of the New York Stock Exchange and founder of digital asset exchange Bullish, being a top contender in the bankruptcy auction to purchase FTX. Gensler advised anyone considering entering the crypto exchange market to focus on earning investor trust, ensuring proper disclosures, and avoiding conflicts of interest, such as trading against customers or misusing their assets.

The conversation pivoted to Sam Bankman-Fried’s conviction on charges including fraud and money laundering. FTX, once a leading crypto exchange, was revealed to have inappropriately channeled customer funds to its sister hedge fund, Alameda Research. Alameda, a market maker for FTX, enjoyed unfair advantages such as a significant line of credit without collateral and leniency in trading positions, unlike other customers. Sam Bankman-Fried, the young entrepreneur behind FTX, experienced a dramatic turn of events with his recent conviction on multiple counts, including fraud and money laundering. 

Gensler reinforced the SEC’s commitment to applying existing securities laws to the crypto industry, stating their compatibility and robustness. He highlighted the challenges of global compliance in the crypto space, particularly with entities like Binance facing allegations from U.S. regulators for evading rules. Gensler’s comments also touched on the need for stricter adherence to international sanctions and anti-money laundering laws in the cryptocurrency sector.

The SEC, under Gensler’s leadership, has been actively pursuing legal actions in the crypto space, with over 150 cases in the past six years. High-profile cases include those against Ripple and Grayscale. The SEC’s stance remains firm on the necessity for companies, including major players like Coinbase, to comply with U.S. laws, with Gensler asserting the undesirability of non-compliant or fraudulent actors in the market.

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FTX Former CEO Sam Bankman-Fried Grilled in Court Over Exchange’s Risk Management Measures

FTX CEO Sam Bankman-Fried (SBF) found himself in the hot seat during a recent court proceeding regarding the exchange’s risk management measures. The hearing, documented by BitMEX Research, shed light on a catastrophic event stemming from a flawed risk engine in 2020, the subsequent code change titled “Allow Negative,” and its implications on FTX’s operations.

In 2020, FTX’s risk engine was beleaguered by an overwhelming growth, falling behind in real-time monitoring due to inadequate computational resources. A minor liquidation event spiraled out of control due to the delay, causing a position worth thousands to escalate to trillions within minutes. The risk engine’s delayed responses led to a ping-pong effect of continuous erroneous liquidations and buybacks. This glitch pushed Alameda’s account underwater, risking a platform-wide socialization of losses. The event rendered FTX inoperative for an hour, underlining a systemic risk to the entire exchange and its platforms.

Post-catastrophe, SBF entrusted Gary and Nishad to rectify the risk engine’s deficiencies. They introduced a feature, retrospectively identified by SBF as “Allow Negative.” However, during the cross-examination, SBF claimed his unawareness of the feature’s specifics, a statement the prosecutor found incredulous given SBF’s dedication and the event’s severity.

The court also delved into FTX’s client acquisition strategy and growth trajectory. Initially, FTX garnered clients through industry connections, evolving from trading a few million dollars daily to $10 to $15 billion per day by 2022. The 2019 blog post, “Our Liquidation Engine,” was cited, highlighting FTX’s proactive stance on minimizing clawback probabilities, learning from predecessors like Okex and Bitmex.

The intertwined operations of Alameda and FTX were dissected, focusing on Alameda’s borrowing from FTX, managed by margin traders’ funds. The hearing also touched on the transition of Alameda’s leadership to Caroline Ellison and Sam Trabucco, following SBF’s stepping down.

SBF’s romantic involvement with Caroline Ellison and personal loans from Alameda were discussed, alongside allegations of SBF instructing political donations by FTX employees. Additionally, the CEO’s intent behind inflating 2021 revenue to surpass $1 billion was scrutinized, painting a complex picture of professional and personal intersections.

The court session unveiled the challenges FTX encountered in managing systemic risks, reflecting on the multifaceted responsibilities of SBF as the CEO. Amid rapid growth, ensuring robust risk management protocols and transparent operations remains pivotal for FTX’s sustainable progression.

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Sam Bankman-Fried Dodges Questions on Alameda Debt Repayment Risks

In a recent social media exchange, Sam Bankman-Fried, the former CEO of FTX, found himself amidst a whirlpool of questions regarding the potential risk transfer from Alameda Research to FTX. The core issue revolved around the use of FTX customer funds to settle the debts of Alameda’s lenders, a move seen by some as transferring risk onto FTX customers.

The Social Media Confrontation

On October 31, 2023, a tweet from BitMEX Research illustrated a back-and-forth between an interviewer and Bankman-Fried. The interviewer probed into the risks assumed by FTX when it was agreed to use its resources to pay off Alameda’s lenders. Despite the straightforward questions, Bankman-Fried’s responses were noted to be evasive, especially when queried about his understanding of the risks at the time of the decision back in June 2022.

Bankman-Fried, when questioned about his awareness of the risks this arrangement posed to FTX, veered the discussion towards margin trading instead of directly addressing the question. His reluctance or inability to provide a clear answer to whether he understood the risks involved in repaying Alameda’s lenders using FTX customer money was conspicuous.

Implications and Reactions

The evasion witnessed in the social media interaction raises questions on the transparency and risk management practices at FTX. The responses from Bankman-Fried left the door wide open for speculation on the real risks faced by FTX customers and the integrity of its management in safeguarding customer interests.

Reactions to this exchange varied, with Eric Wall and Outsider_Trading making light of the situation on Twitter, hinting at a potential courtroom drama unfolding in the near future. The humorous take by the Twitter users underscores a potentially serious issue of financial ethics and risk management.

Analyzing the Risk Transfer

The concern arises from the perceived risk transfer from Alameda to FTX, especially given that customer funds were involved. The decision to use FTX’s resources to cover Alameda’s debts, if seen as a risk transfer, could affect the trust and reputation of FTX among its users. This incident, though wrapped in a light-hearted social media exchange, carries a serious undertone of financial accountability and corporate governance.

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FTX Announces Proposed Settlement and Amended Plan in Chapter 11 Cases

On October 17, 2023, FTX Debtors made a significant announcement regarding their ongoing Chapter 11 cases, marking a major milestone in their efforts to resolve complex customer property disputes. After extensive discussions involving key stakeholders, including the Ad Hoc Committee of Non-US Customers, the Unsecured Creditors Committee, and class action plaintiffs, FTX Debtors have reached a proposed settlement.

If approved by the Bankruptcy Court, this settlement will result in the creation of a special “Shortfall Claim” designed to benefit customers. This concept was initially proposed by FTX Debtors in July. The primary goal is to facilitate an offer to eligible customers, allowing them to settle their customer preference exposure at an agreed-upon amount. All creditor representatives involved in the negotiations have agreed to support a related amended Plan of Reorganization, which is expected to be filed by December 16, 2023.

In a related development, the Official Committee of Unsecured Creditors of FTX expressed its support for the proposed settlement and the amended Plan Term Sheet. The Plan Term Sheet represents a compromise between various parties, including the Committee, the Debtors, the ad hoc customer committee, and other representatives. It addresses a range of issues that aim to balance the rights of customer and non-customer creditors across the U.S. and foreign debtors.

The Committee believes that the amended Plan Term Sheet will expedite the Chapter 11 cases and the timeline for creditor and customer recoveries, although they acknowledge that significant work remains to be done. They remain committed to safeguarding the interests of customers and creditors throughout this process.

FTX Debtors, in their official announcement on October 16, 2023, detailed their proposed settlement and amended Plan of Reorganization. The settlement, known as the “Customer Shortfall Settlement,” is expected to resolve customer property disputes and pave the way for the Amended Plan, to be filed by December 16, 2023. If approved, this settlement will bring resolution to the customer property litigation filed against FTX Debtors and expedite the confirmation of the Amended Plan in the second quarter of 2024.

The Customer Shortfall Settlement addresses the assertion that customers of and FTX US have property interests in certain assets, rather than an unsecured claim. It provides customers with an unsecured claim that has an equitable priority to certain segregated property.

The Amended Plan divides FTX Debtors’ assets into three pools and provides Shortfall Claims for customers of and FTX US. Customers are estimated to receive over 90% of distributable value worldwide if the Amended Plan is approved. However, it’s important to note that full payment may not be guaranteed for all customers.

The proposed settlement also includes an opportunity for eligible customers to resolve preference exposure related to their claims. The FTX Debtors will offer eligible customers the option to reduce their claim by an amount specified in the Amended Plan ballot. This preference settlement offer is subject to approval by the Bankruptcy Court.

Customers and creditors can access additional information related to the court proceedings and the proposed settlement on the U.S. Bankruptcy Court’s website.

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FTX’s $477 Million Heist: A Trail of Blockchain Clues Unearthed

In the shrouded realm of blockchain, the FTX hack that transpired on November 11, 2022, stands as a glaring testament to the cryptic trails a nefarious act can leave behind. The Bahamas-based cryptocurrency exchange, FTX, fell prey to an unidentified hacker who made off with a staggering $477 million, plunging the exchange into bankruptcy. The maleficent actor was quick to take to the shadows, embarking on a quest to launder the stolen assets through a maze of decentralized exchanges (DEXs), cross-chain bridges, and mixers.

The pilfered assets witnessed a loss of $94 million in the ensuing days, as the thief hastily funneled them through various blockchain services. RenBridge, a service held by FTX’s sister company Alameda Research, saw $74 million of the stolen cache. Yet, the bulk of these pilfered assets lay dormant, only to stir again as the Bankman-Fried trial neared, suggesting a deliberate orchestration.

The FTX’s hacker initial modus operandi was to swap the stolen tokens for native assets, like Ether, to escape the clutches of centralized authorities. Employing DEXs like Uniswap and PancakeSwap, the thief could swap tokens without fear of seizure. This initial laundering act was the precursor to a more sophisticated ploy: cross-chain laundering. The hacker funneled assets through decentralized cross-chain bridges like Multichain and Wormhole, a tactic to obscure the assets’ trail and facilitate further laundering.

One notable accomplice in this cryptic narrative was RenBridge. The thief, having accumulated 245,000 ETH now worth around $306 million, utilized RenBridge to transfer 65,000 ETH to the Bitcoin blockchain, further muddying the trail. The sinister irony lies in the fact that RenBridge was operated by Alameda Research, a sister company to the beleaguered FTX.

Once the assets were safely harbored in the Bitcoin realm, the thief employed mixers like ChipMixer to cloak their transactions, a tactic often used to thwart tracing efforts. However, as time rolled on, law enforcement clamped down on ChipMixer, pushing the thief towards newer shores like Sinbad, a suspected rebranded version of the sanctioned Blender mixer.

Fast forward to September 30, 2023, the dormant assets awoke once more. The thief, adapting to the closing net, turned to THORSwap for laundering, converting a hefty sum of Ether to Bitcoin. THORSwap, however, soon suspended its interface to stem the illicit flow of funds, albeit to little avail as the thief continued to exploit the underlying THORChain bridge.

Despite the meticulous blockchain trails unraveled by Elliptic Research, the identity of the FTX’s hacker remains shrouded in mystery. Speculations range from an inside job, possibly implicating Sam Bankman-Fried, to external rogue actors linked to North Korea’s Lazarus Group or Russia-affiliated criminal networks. The saga of the FTX hack unveils a sinister dance on the blockchain, leaving in its wake a tale of obscure trails, elusive thieves, and the relentless march of illicit digital transactions.

The unfolding drama around the FTX hack serves as a stark reminder of the continuous evolution within the crypto laundering realm. As the law enforcement and compliance sectors refine their strategies, so do the criminal minds lurking within the blockchain’s cryptic maze. The “State of Cross-chain Crime” report by Elliptic unveils the latest typologies and trends in cross-chain criminality, shedding light on the ever-evolving tactics deployed by crypto launderers.

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Alameda Accused of Misusing FTX Customer Funds in Court

In an unfolding courtroom drama, key personnel from cryptocurrency exchange FTX and its associated entity, Alameda Research, testified, shedding light on potentially damning financial mismanagement and misrepresentation practices. The revelations came to the forefront during the questioning of Gary Wang and Caroline Ellison by the prosecution, with content provided by Inner City Press.

Gary Wang, a former employee of FTX, recounted several episodes where Alameda Research’s financial operations raised concerns. Wang mentioned that on Nov 6, a staggering amount of about $100 million was being withdrawn per hour from FTX, which led to a cumulative shortfall of $8 billion. The discourse also touched upon a ‘Korean friend’ account and allegations about Sam Bankman-Fried (referred to as Sam), the head of Alameda, considering shutting down Alameda due to financial mismanagement.

Further, the testimonies elucidated instances where FTX misrepresented its financial health to customers and investors. Ellison, who had a romantic relationship with Sam, revealed that although FTX marketed itself as safe and well-regulated, it had a line of credit on its platform allowing Alameda to withdraw coins even when they didn’t have them. Ellison also disclosed that FTX funds, to the tune of ten to twenty billion dollars, were deposited into Alameda’s accounts, and were used for various purposes including repaying loans, investments, and stable coin conversions.

The courtroom also saw details emerging about personal ventures being funded through loans from Alameda. For instance, Wang admitted to receiving over $200 million in loans from Alameda for venture investments and buying a house. These loans were apparently signed off without consulting lawyers, revealing a lack of due diligence.

Ellison’s testimony unveiled troubling relationships and ambitions. She mentioned her romantic involvement with Sam and his ambitions to become the President of the United States. Ellison also highlighted a concerning scenario where FTX’s equity value was at risk, with a negative figure of $2.7 billion being thrown into the mix, indicating significant financial instability.

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