Crypto Observer: Week of October 16th 2023

Crypto News Watch

The Securities and Exchange Commission (SEC) will not appeal a recent court ruling that determined the agency had acted "arbitrarily and capriciously" in rejecting Grayscale’s proposal to convert its Bitcoin Trust (GBTC) into an Exchange Traded Funded (ETF). On Tuesday, August 29, 2023, the DC Circuit Court of Appeals made its ruling and ordered the SEC to review its decision and provide a clear rationale for its treatment of different types of Bitcoin-related products.

The SEC decision to not appeal the loss potentially opens the door for the Grayscale Bitcoin Trust Product, which trades under the ticker GBTC, to be converted into a more investor-friendly ETF. The SEC decision, however, does not mean that GBTC will be immediately converted into an ETF. The next stage is likely the appeals court issuing a mandate specifying how its decision should be executed.

The Appeals Court’s initial decision was driven by the SEC’s inconsistent approach to regulating crypto products. Historically, the SEC has been reluctant to approve spot Bitcoin ETFs, citing concerns over market manipulation, liquidity, custody, and investor protection. The SEC has, however, approved several ETFs that are underpinned by Bitcoin and Ethereum futures contracts, which are derivatives that track the price of Bitcoin indirectly.

The basis for the Grayscale appeal was arguing that the SEC had violated the Administrative Procedure Act by approving futures-based ETFs while rejecting spot-based ETFs without providing a reasonable explanation.

The SEC is now in a difficult position and will have to find a new rationale to reject the Grayscale ETF conversion application and others like it if they do plan to reject it again.

Blockfi CEO testifies in SBF trial reflects on billions of dollars of losses because of FTX and Alameda research

On Friday, Zac Prince, the CEO of failed crypto borrowing and lending firm Blockfi testified in the trial of SBF, the disgraced former exchange head and founder of the hedge fund Alameda Research.

SBF’s trial commenced on October 3rd and is scheduled to last for six weeks. SBF is in jail after being charged by the SEC in December 2022 with violating the anti-fraud provisions of the Securities Act of 1933 and the Securities Exchange Act of 1934. The commission says he orchestrated a long-running fraud on FTX, the giant global cryptocurrency exchange SBF was the CEO of. They say he committed the fraud by diverting FTX customers’ funds to his crypto hedge fund, Alameda Research LLC, without disclosure and concealing risks tied to FTX’s exposure to Alameda’s inflated, illiquid assets like FTX-affiliated tokens, amongst other malpractice claims.

Over two days of testimony, Prince explained how his firm’s involvement with FTX and Alameda led to its bankruptcy. He said Blockfi began lending to Alameda in late 2020. After initially robust loan agreements, Prince said he accepted Alameda’s request to borrow significantly more after conversations with SBF.

In 2022, after Blockfi suffered losses following the collapse of the Terra/Luna blockchain protocol, the lender attempted to call back loans made to Alameda which by May 2022 amounted to more than US$1 billion. Prince says Alameda paid back the loans in full, after which Blockfi then allowed the crypto hedge fund to borrow another US$850 million. During this period FTX also ‘rescued’ Blockfi and had the option to fully purchase based on performance targets being hit.

At the time of Alameda and FTX’s collapse, according to Prince, Alameda owed Blockfi amounts between US$800-850 million because further loans were issued in the short period “maybe at the end of July but more likely probably in the August or September time frame is when we started making the new loans to Alameda.” During this time it appeared Blockfi, FTX, and Alameda were all heavily involved with each other. BlockFi was a customer of FTX and had US$350 million of customer funds on the exchange when it collapsed in November 2022. Prince said that at the time that FTX and Alameda collapsed they both, in total, owed Blockfi over US$1 billion.

When asked about assurances made by Alameda that they would pay back the loans, Prince said that they were provided with multiple quarterly balance sheets that showed that the firm was solvent and had a large amount of liquid assets. He also said that Alameda posted significant collateral in the form of FTT tokens, GBTC shares, and shares in popular stock trading software company Robinhood.

Prince quite frankly stated when questioned, that Blockfi declared bankruptcy directly because of FTX and Alameda.

During the cross-examination, the SBF defense team questioned the due diligence process and the lawyers involved during BlockFi’s legal process. Prince clarified that his firm’s general counsel, three deputies, and their teams were all involved in reviewing Alameda’s loan agreements.

This week, all eyes and ears will be on the testimony of Nishad Singh, FTX’s CTO and one of SBF’s closest associates. He is widely believed to have been the approachable, ‘nice guy’ who often communicated with FTX employees, in comparison to SBF who was described as standoffish.

Token watch

Mega Cap (Market Cap >US$10 Billion)

Bitcoin (BTC) – 27,208.98 (down ~2.33% in the last 7 days)

Bitcoin, despite being red so far this week, enjoyed a short period of gains following signals that the SEC would not appeal its loss in its ETF case against Grayscale. There has also been some hype around BitVM, a new proposal that will open the door for Bitcoin applications without requiring a fork.

BitVM was proposed on October 9th by Robin Linus of ZeroSync, a group founded to help scale Bitcoin by using zero-knowledge proofs.

BitVM requires no change at all to normal Bitcoin consensus, with most processes and logic occurring off-chain with onchain computation only needed when it is disputed that a party has been dishonest.

There have been question marks around the amount of code needed to allow BitVM to operate, Reddit user oproski says “The conclusion is this is a nifty party trick Bitcoin is capable of but is completely unfeasible for anything even remotely resembling the simplest smart contract, never mind even ERC20 tokens.”

It remains to be seen whether BitVM will begin a smart contract revolution on the Bitcoin chain, but for the time being it is creating hype for the network.

Large Cap (Market Cap between US$4billion – US$10 billion)

Toncoin (TON) -US$1.93, (up ~42.78% in the last 90 days)

TON is the native token of ‘The Open Network’ a high-performance, decentralized blockchain founded by messaging giant Telegram in 2018. The blockchain is noted for its rapid transaction processing speed.

The token has shown exceptional alpha in the last 6 months, currently making it one of crypto’s most exciting asymmetric bets. On the TON chain users do not need to cover chain operation costs like gas fees, instead, smart contracts require TON token holding and ongoing rent payments to the chain. The chain is set up for application managers to handle gas costs, making use similar to a traditional Internet application. Free-to-use decentralized applications have been appealing during crypto’s bear market.

The token gained further momentum thanks to a partnership announcement at the Token2049 conference, with Russian messaging giant Telegram.

Telegram’s CEO Pavel Durov has endorsed TON and backed new integrations with the network and Telegram. “Starting this November, the TON Wallet will be included in the settings and attachment menus for all of our users outside the U.S. and some other countries,” Durove announced.

Medium Cap (Market Cap between US500 million – US$4 billion)

Aave (AAVE) – 64.12, (up ~17.53% in the last 30 days)

Aave has surged in the last month thanks to optimism surrounding a new governance model “Aave governance v3”. The new governance structure will push protocol decision-making onto a new platform built on Polygon and Avalanche, both fast and cheap smart contract platforms. The Aave DAO will further subsidize the costs of users participating in governance.

There will also be a new Cross-chain communication model called a.DI (Aave Delivery infrastructure) and now all infrastructure in the Aave ecosystem will be managed by the Aave DAO.

Regulation Watch

New Crypto license regime is set to be launched in Australia

It was reported today, at the Australian Financial Review Crypto Summit, Assistant Treasurer and Minister for Financial Services, Stephen Jones will announce the Australian government’s long-anticipated regulatory regime for crypto exchanges and the Digital Asset Sector. It is reported that this new regime signals a shift where Australia will regulate crypto at an exchange level and not by setting rules for specific digital assets.

The Federal Government is set to require crypto exchanges to hold a financial services license, issued by the corporate regulator. This will be a part of a new regime with specific obligations to reduce investor risk, while also supporting the growth of the digital asset sector.

Exchanges holding more than US$5 million in aggregate or more than US$1500 for any single user will have to obtain an Australian Financial Services Licence (AFSL) which will be granted by the Australian Securities and Investment Commission. This will require the exchanges to make financial disclosures, submit financial accounts, stick to solvency and cash requirements, avoid conflicts of interest, and generally provide a fair and honest service.

Major Australian exchanges, Independent Reserve and BTC markets, have indicated that they support the licensing regime.

Halving watch

Bitcoin Halving – Brave New Coin

The halving is now estimated to be 154 days away. At block height 840,000, expected to occur in April 2024, Bitcoin’s block reward, for successfully mined blocks, will halve from 6.25 coins to only 3.125. This will continue at the same rate for another 210,000 blocks. Roughly another four years. This system makes BTC a deflationary asset. It has hardcoded scarcity and new supply cannot be arbitrarily created to bail out the network

The Bitcoin halving is also a pivotal moment in crypto markets because of the strong positive effect it has on the price of BTC. Assuming demand stays constant, a cut in the emission rate and the rate of new BTC supply created should lead to an increase in the price of the asset.

A trend we are observing in the lead-up to the 2024 halving is the continual establishment of new all-time highs for Long-term Hodler supply. Glassnode estimates Long-term ‘Hodlers’ or holders based on addresses that have held BTC for more than 155 days. In their latest weekly insights posts, they write that LTH-Hodler net positions are rising and they are vaulting 50,000 more each month. This is making the market more illiquid as more of the ecosystem is becoming less willing to transact.

This may be an indication that leading up to the halving, long-term holders are digging their heels in and come what may, will not sell before the halving.

Hack Watch

Multi-million dollar FTX hacked linked to Russian exploiters

Blockchain intelligence firm Elliptic released research on October 12th detailing an investigation it made into a November 2022 hack of crypto exchange FTX. The exchange was exploited for US$455 million, on November 11th, the day it filed for bankruptcy. The thief, who has yet to be identified, perhaps used the chaos to slip through the cracks. The timing of the hack, however, has led many to believe it was an inside job.

Elliptic notes the possibility of an inside job but writes it is more likely a Russia-linked actor was behind the theft. The report notes that a chunk of the stolen assets can be traced to mixing service ChipMixer where they are then combined with funds tied to Russia-linked criminal groups, including ransomware gangs and darknet markets, before being sent to exchanges. They say this implies that a broker or intermediary with ties to Russian criminal entities was involved in the money laundering process.

There are some other oddities with the case. US$74 million was shifted cross-chain through RenBridge, a service owned by Alameda Research. Additionally, after the initial movements the stolen funds lay dormant for 9 months, and were then moved again on the eve of SBF’s fraud trial. This defied logic as generally, hackers would wait until interest and eyes on a case have shifted away before moving funds, and not just as eyes are returning to a case.

Liquid Indices Watch

Ethereum Liquid Index

Ethereum as measured by the Ethereum Liquid Index has recently touched new 6-month lows. Ethereum remains the largest and most used smart contract network in the world. Data from Google trends, however, indicates that worldwide search interest for the terms ‘Smart Contract’ and ‘Web3’ are both hovering near all-time lows.

Furthermore—

• Ethereum has shown a vulnerability to hacks, particularly cross-chain bridging which involves moving value to and from the Blockchain.
• Ethereum’s invisible tax, MEV, steals value away from everyday users.
• The censoring of transactions is a concern for many freedom-loving Ethereum users. A number of key infrastructures have said they will comply with the US Office of Foreign Asset Control’s wishes to block certain transactions and Ethereum accounts. While these transactions and addresses may be involved with illegal activity, blocking addresses because of a government agency goes against decentralized blockchain principles.

More about the bullish and bearish factors influencing Ethereum here.