skip to content

Top Stories of the Week - 12/16

Weekly Top Stories 121622

In the newsletter today we cover the suits and charges brought this week against Sam Bankman-Fried, congressional hearings about crypto, and the forthcoming opening of Apple’s monopoly on app-stores. Subscribe here and receive Galaxy's Weekly Top Stories, and more, directly to your inbox.

SBF arrested, faces charges filed in parallel by the DOJ, SEC, CFTC

Former FTX CEO Sam Bankman-Fried was arrested on Monday in the Bahamas after the US filed criminal charges and requested for SBF's extradition for trial in the US. Charges were filed in parallel by the Southern District of New York’s attorney’s office, the SEC, and CFTC. The three suits:

  • The DOJ includes 8 counts in the indictment which boil down to 4 main areas of misconduct: (i) defrauding customers as he stole billions from FTX customer funds for his own personal benefit and to cover expenses and debts at Alameda, (ii) defrauding lenders to Alameda as he lied about the source of funds used to repay his debts, (iii) defrauding investors in FTX during the height of the crypto crisis since June, and (iv) campaign finance violations as he made tens of millions of dollars in illegal campaign contributions secretly funded by stolen customer money to impact the direction of public policy in Washington.

  • The SEC complaint charges SBF with securities laws violations (including Fraud in the Offer or Sale of Securities and Fraud in Connection with the Purchase or Sale of Securities) for making false and misleading disclosures to equity investors in FTX. It alleges SBF orchestrated a scheme that, since inception, diverted FTX customer funds to Alameda that effectively provided the hedge fund with an "unlimited line of credit" and were misused to fund undisclosed venture investments, lavish real estate purchases, and political donations. He then lied to investors in FTX about the company's financial position, its risk management practices, and made false representations over the privileged relationship between FTX and Alameda to defraud equity investors in FTX when raising $1.8bn.

  • The CFTC complaint charges SBF, FTX & Alameda with fraud over the misappropriation of customer funds and for making false statements to public, customers, investors, and Congress over how those funds are secured and handled. It alleges at SBF's direction, customer deposits intended to be used to trade digital commodities futures and swaps were not appropriately segregated by FTX, fraudulent use of customer funds were inconsistent with the FTX ToS, and that Defendants created a privileged setup for Alameda that allowed for it to have an unlimited line of credit on the exchange and provided Alameda with unfair trading advantages (e.g., faster execution times and exemption from FTX's auto-liquidation risk management process) - all in connection with commodities like Bitcoin and Ether, which underly derivatives contracts on CFTC designated exchanges.

At the SDNY press conference announcing the charges against SBF, US Attorney Damian Williams thanked the coordination and cooperation between multiple agencies including partners at the SEC, CFTC, FBI, Justice Department's Office of International Affairs, National Cryptocurrency Enforcement Team, and others. SBF remains in custody as he was denied bail. Prosecutors are calling for SBF's extradition, which SBF's legal team is reportedly planning to fight.

Our Take

Given the organizational complexity of the FTX/Alameda scheme, regulatory authorities moved (relatively) quickly in bringing formal complaints and indictments against SBF. The level of detail included in the SEC and CFTC suits suggests senior FTX/Alameda insiders have been cooperating with authorities against SBF – this is speculation at this point but it certainly wouldn't be surprising given the SBF media tour where he has been claiming ignorance and throwing other executives under the bus. In contrast, those other top FTX/Alameda players have been noticeably quiet since the fraud was exposed (note Alameda ex-CEO Caroline Ellison was spotted in NYC prior to SBF's arrest and FTX ex-co-CEO Ryan Salame was just reported to have flagged potential fraud by SBF to Bahamian regulators).

The timing of the arrest was also peculiar as it occurred hours before SBF was set to testify before the House Financial Services Committee (HFSC) in the House of Representatives. However, during the SDNY press conference that announced the charges against SBF, US Attorney Damian Williams clarified that the timing of the arrest was dictated by law enforcement as opposed to other considerations like the congressional hearing. He said criminal charges from the DOJ were authorized Wednesday last week and the grand jury indicted SBF that Friday before the arrest by The Royal Bahamas Police Force was executed on Monday.

Other interesting points from the three suits filed against SBF include:

  • The DOJ indictment was the shortest document with the fewest details provided, but it also has the broadest scope of charges, recognizing various victim groups (incl. FTX customers, FTX investors, lenders to Alameda, those who accepted money from SBF not knowing they were criminal proceeds).

  • The scope of the SEC's charges was much more limited compared to the DOJ, only alleging fraud against equity investors (at least for the time being) for private securities offerings in FTX. The SEC noted in its press release that “investigations as to other securities law violations and into other entities and persons relating to the alleged misconduct are ongoing,” but the capacity for the SEC to add other charges over specific crypto tokens and trading venues is currently bounded by what is deemed a security. Recall, Gary Gensler has long called for the SEC to be granted broader authorities to regulate the crypto industry.

  • On the other hand, the CFTC claimed in its complaint "certain digital assets are 'commodities,' including bitcoin (BTC), ether (ETH), tether (USDT) and others" – somewhat interesting, but perhaps too dramatic since the CFTC has said this for years (e.g., in its complaint filed against Tether). However, it is also noteworthy that the CFTC complaint was the only one that named SBF, FTX, and Alameda as Defendants (the DOJ & SEC suits only name SBF as the sole defendant) given the CFTC regulates BTC & ETH derivatives trading on regulated exchanges.

Still, questions remain about the possible length of SBF’s prison term should he be found guilty (5 of the 8 criminal charges carry maximum sentences of 20 years), what other charges could be brought against SBF/FTX/Alameda and others, how much of the misused funds are retrievable to repay creditors (including from political contributions), and which FTX assets/businesses will be available to creditors. Answers to these questions won’t be clear for some time and will depend on further investigation as well as the level of cooperation from Sam and his legal team. That said, one thing that is clear: Sam will need a better defense than “I fucked up.”- CY

Congressional Hearings on FTX take place without testimony from SBF

SBF's arrest came one day before he was due for testimony in front of the US House of Representatives over the collapse of FTX (House Financial Services Committee hearing was held on Tuesday 12/13 and Senate Banking Committee hearing titled "Crypto Crash: Why the FTX Bubble Burst and the Harm to Consumers" was held on Wednesday 12/14).

At the HFSC hearing, opening statements from Chairwoman Maxine Waters (D-CA) lamented the timing of SBF's arrest, which prevented him from testifying (note: a copy of SBF's planned testimony was leaked). However, the Committee still heard testimony from John Ray, the newly appointed CEO at FTX. Key themes in the questions posed by Committee members included:

  • FTX governance failures and mismanagement. Ray's testimony claimed "there were absolutely no internal controls whatsoever", calling out unacceptable management practices at FTX including: (i) the privileged access by senior management to systems that stored customer assets without security controls to prevent them from redirecting assets, the commingling of assets and the ability of Alameda to borrow funds at without any effective limits, the absence of complete documentation for investments made with FTX funds and assets, the absence of audited/reliable financial statements, lack of personnel in risk management functions, and absence of independent governance throughout the FTX Group. He also noted instances such as employee invoicing/expenses were handled over Slack, the company relied upon Quickbooks (accounting software fit for SMBs rather than for a multi-billion-dollar company).

  • Asset recovery and investigation. Ray noted that asset recovery efforts to date had secured over $1bn in assets, but the recovery process would likely take months. Contrary to SBF's repeated assurances, Ray noted there was no distinction between FTX US and FTX Int'l: “What we’re seeing now is that the crypto assets for both and for FTX US were housed in the same database." However, Ray acknowledged Ledger X, an FTX derivatives-trading subsidiary is regulated by the CFTC, had segregated customer funds and was still solvent.

The next day, the Senate Banking Committee included testimony from four witnesses: (i) Law Professor Hilary J. Allen at American University Washington College of Law, (ii) Mr. Kevin O’Leary, FTX Investor, (iii) Ms. Jennifer J. Schulp of Cato Institute, and (iv) Mr. Ben McKenzie Schenkkan, actor and author. (Note: SBF had reportedly refused to appear before the Senate Banking Committee.) Following the Senate hearing, a new bipartisan bill—the Digital Asset Anti-Money Laundering Act—was introduced by Senators Elizabeth Warren (D-MA) and Roger Marshall (R-KS), which, among other things, calls for blockchain developers and node operators to register with FinCEN where they would be obligated to perform KYC checks, and prohibits this new class of crypto infrastructure financial institutions from handling, using, or transacting business with any anonymity-enhancing technologies.

Our Take

Post-FTX, there has been an uptick of legislative interest to oversee crypto. However, the House hearing was clearly more productive than the Senate—particularly relative to the FTX debacle—and the Senate hearing, while billed as a “FTX” hearing, was rooted more in reflexive personal opinions than fact or keen observations on FTX’s demise. Even without the presence of SBF, John Ray led a more focused dialogue that presented new useful fact-based information, whereas the Senate witness lineup was more uninformed and self-serving in their testimonies, in our view:

  • Hillary Allen, when voicing criticisms of decentralization benefits enabled by crypto technologies, falsely claimed, "Bitcoin is controlled by a few core software developers - fewer than ten - and they can make changes to the software, and then that software is implemented by mining pools and there are just a few of them," adding that "the few people pulling the strings" are "unidentified and unregulated." In reality, core devs and miners do not control Bitcoin (e.g., Bitcoin Core cannot force users or miners to run their specific implementation of Bitcoin) and many core devs/ mining pools are known/using real names and not anonymous. Furthermore, the failure of miners to achieve a block size increase in 2017, despite near unanimous miner support, empirically demonstrates their limited powers to control protocol development.

  • Kevin O'Leary, TV personality who revealed last week on CBNC that he was a paid endorser of FTX (receiving $15m to act as a spokesperson), presented a theory that Binance was to blame to FTX's fall: “I have an opinion, I don’t have the records. These two behemoths that own the unregulated market together and released incredible businesses in terms of growth, were at war with each other. And the one put the other one out of business, intentionally.”

  • Ben McKenzie was an actor popularized by his role on "The OC" and has no known expertise on cryptocurrency, finance, or technology. He told Bloomberg, “I got high one day and I decided that I should write a book about crypto and fraud.”

From the participating Members of Congress in the hearings, we heard the usual rhetoric from members such as Brad Sherman (D-CA), who continued with his anti-crypto sentiments, but added some zingers like “SBF or should I say inmate #14372” and characterized crypto as a “garden of snakes” or “an electronic pet rock to invest in”; pro-crypto Congressman Tom Emmer (R-MN) had specified that FTX's collapse was "a failure of centralization and business ethics, not of technology,” adding that open, permissionless blockchain technology solves the problem of centralization. However, a notable development from the HFSC hearing were the criticisms directed at SEC Chair Gary Gensler, led by Ranking Member Patrick McHenry (R-NC) (recently selected to be Chairman of the HSFC in the new Congress), who noted “the SEC’s regulation by enforcement approach is not going to stop bad actors.” Congressman Ritchie Torres (D-NY) opened an investigation last week into how Gensler “fundamentally failed as a regulator” over FTX’s collapse. From the Senate Banking Committee, Ranking Member and crypto advocate Sen. Patrick Toomey (R-PA) is retiring and will be replaced by Sen. Tim Scott (R-SC), whose stance on crypto is still somewhat unknown.

Looking ahead, particularly in the short-run, the possibility for significant legislation to pass becomes more difficult. Members of Congress and policymakers throughout the broader DC-policy scene are still struggling to understand blockchain technology, fundamentals about Bitcoin and Ethereum, and much more about the broader ecosystem. While divided government has at times presented the opportunity to advance bipartisan legislation, legislators (in a bipartisan manner) who are supportive of the sector will have to double down on their efforts to convince their colleagues to take up and pass legislation. And, they need to accomplish that while sifting through the FTX mess, which includes potential campaign finance law violations The SBF-endorsed Digital Commodities Consumer Protection Act (DCCPA), and other similar efforts will likely fail to advance during the rest of this year and will have to be reintroduced next Congress. Sen. Elizabeth Warren’s (D-MA) newly introduced bill is a reactionary, poorly thought-out piece legislation that is not only misrepresented as a solution to prevent another FTX collapse (does not address corporate control issues demonstrated by FTX), but one that effectively forbids Americans from accessing permissionless blockchains (as argued by Coin Center). We are hopeful that bipartisan legislation will advance that could be more effective in preventing another FTX without putting more users at risk and doesn't blatantly attack the individual privacy rights of Americans. - CY

Apple Plans to Enable Support for External iOS Apps – Opening the Door for Web3

Apple is preparing to allow the integration of third-party app stores on iOS in the wake of the EU’s Digital Market Act. This monumental change to Apple’s app store policy will theoretically enable users to download applications outside of the App Store, either directly from developers or through third party app stores. This would enable mobile iOS apps to avoid the 30% take-rate on in-app purchases. The rollout for Apple supporting third party applications outside of their native app store will initially begin in Europe (Apple's 2nd largest market) through their iOS 17 software update - expected to launch next fall. The timing for Apple's shift in opening their historically strict application ecosystem is a response to the EU's forthcoming legislation that requires tech companies to comply with the "Digital Markets Acts."  The legislation will be enforced starting in 2024 and requires companies with market valuations of at least $80bn, operating in the EU, to permit the installation of third-party applications. Government officials in the U.S and other countries have proposed similar laws in an effort to break up the duopoly structure of mobile application marketplaces on iOS and Android phones. The EU appears to be leading the charge on this front and their efforts may serve as a global framework for other countries to study and potentially implement themselves.

Our Take

Apple's initiative to open their closed app-store ecosystem is significant when considering the company's on-going clashes with the web3 ecosystem. The growing friction between Apple's app-store and Web3 products is largely centered on the nature of in-app purchases. Web3 protocols that power stablecoins, NFTs, and fungible tokens lack the infrastructure to power fiat-based transaction fees required by Apple. Entire web3 business models, like OpenSea’s 2.5% fee on all trades, don’t work when Apple has its own fee that’s more than 10x greater.

Concretely, Apple recently came under fire from the web3 community due to a new policy that banned the use of NFTs to token-gate access to features within apps. This policy was just another example of a legacy, web2 framework that undermined the core value proposition of web3 primitives like NFTs. Lately, iOS apps for NFT marketplaces, such as OpenSea, are forced to completely strip down their mobile experience to browsing. Coinbase recently announced that they had to disable NFT transfers on their mobile wallet due to Apples claim that users would have to pay 30% of any gas fee. Both of these examples underscore the ongoing conflict between Apple’s extractive app-store policies and the ethos underpinning many web3 applications. 

The expected changes to Apple's app-store policies in the EU should open the door for web3 developers to build apps that treat NFTs and crypto as first-class citizens. Conceivably, this policy change could allow Apple to better position themselves in pursuit of building out a metaverse ecosystem as rumors continue to swirl that they’re building AR glasses. If Apple grants its users a path to integrate web3 into their own devices, it's possible that future Apple metaverse products, like an AR experience, would be able to fully support NFTs and fungible tokens out-of-the-box.

Apple’s decision to begin altering their app-store policies in the EU will likely create a domino effect for their policies throughout the western market. This will only help the adoption for web3 applications due to the west being the mecca for web3 adoption while also representing 67% of Apple’s global market share. We foresee that the refined app-store policies will introduce web3 native app-stores for iPhone users. These alternative app-stores will propel user adoption by improving the discoverability for DeFi and NFT applications. From the potential influx of web3 applications on iPhones, user adoption will increasingly arise through mobile interfaces. – GP/SQ

Other News

  • New Bitcoin and Ether Futures ETFs launching in Hong Kong

  • Microsoft bans crypto mining on its online services without permission

  • PayPal partnering with Metamask

  • White House refuses to answer questions about SBF donations

  • MakerDAO relaunches 1% fixed yeld for DAI holders

  • Tron's Justin Sun deploying more capital to stop USDD's slide

  • OFAC-compliant blocks have decreased nearly 10%

  • Binance saw outflows of $3.6bn in the past week