Top Stories of the Week - 6/30
This week, we write about Prime Trust, criticism of Azuki’s new NFT drop, and Robert Leshner’s new venture. Subscribe here and receive Galaxy's Weekly Top Stories, and more, directly to your inbox
Prime Trust placed into Receivership
Nevada financial regulator files to place Prime Trust into Receivership. After issuing a cease-and-desist order last week to Prime Trust to halt all deposits and withdrawals, the Nevada Financial Institutions Division filed on Monday a petition to place the Nevada-licensed crypto custodian into receivership. Insolvency concerns at Prime Trust were confirmed after BitGo called off its acquisition of the rival company on June 22. The latest court filing by the Nevada financial regulator provides new details into how the custodian amassed a shortfall in customer funds.
Per the filing, Prime Trust had lost access to some wallets holding customer assets starting in December 2021. Upon discovery that it was unable to access the customer funds within these wallets, the company then allegedly resorted to purchasing additional crypto assets to meet withdrawal requests using fiat funds from its omnibus customer accounts. This practice likely deteriorated the company's financial position even further. Prime Trust now reportedly faces a customer shortfall of ~$83m ($85.7m in cash liabilities vs. $2.9m of cash on hand, and $69.5m in digital asset liabilities vs. $68.6m in digital assets on hand).
Prime Trust's inability to fulfill customer withdrawal requests has resulted in market concerns around stablecoin TUSD, whose issuer relied upon Prime Trust for custody and as banking partner. As of writing, TUSD trades at a small discount to its peg after a reserve report revealed just $26k of funds held at Prime Trust, while other customers like Swan Bitcoin moved custody over to Fortress as an alternative solution. However, further details around impacted customers and bankruptcy proceedings are yet to be known.
Our take
Prime Trust’s failure showcases the difficulty in custodying crypto assets and highlights deficiencies in the regulatory market structure. Compared to custody of traditional financial assets, custody of crypto assets has much higher technical requirements with key management and how the pairing works with BLS signature schemes. Management at Prime Trust may have realized they needed greater expertise to custody digital assets when they decided to outsource some of the work to Fireblocks (good business decision), but if that is the case, then they bungled their handling of the situation. The team likely would have been in a better financial & legal position if it had simply disclosed upon initial discovery the loss of customer funds. But by reportedly attempting to fraudulently cover up the shortfall by misappropriating customer funds crosses an ethical line that should result in consequences.
Qualified custodians need to be held to the highest security standards, but regulators have failed to outline adequate requirements for transparent safekeeping of assets. Nevada's state licensing structure did not succeed in preventing Prime Trust's failure, while obtaining a federal license to custody digital assets is currently impossible. – Charles Yu
Botched $38mn NFT Drop
Azuki, the seventh most valuable NFT collection by market cap, launched its eagerly-awaited "Elements" collection, a release met with widespread disappointment by the community. The creators behind Azuki, Chiru Labs, set the initial minting price at 2 ETH, or approximately $3,800. To facilitate an equitable and organized distribution, holders of Azuki NFTs were offered a 10-minute presale window to mint the new collection. This was subsequently extended to BEANZ holders, beneficiaries of a derivative project, 10 minutes later. Nevertheless, the entire collection was snapped up within 15 minutes, amassing an impressive $38mn in primary sales. Evidently, the launch failed to provide fair minting opportunities to the broader collector base as the minority share of large Azuki holders seeking a quick profit benefitted the most from the minting guidelines.
Our take
Despite the successful capital raise amidst a bear market, many collectors called the new collection a "rug", a term synonymous with a scam. After the Elements collection reveal, collectors discerned that the new offerings were strikingly similar to the original Azukis. Critics took to Twitter to shed light on the apparent art reuse by Chiru Labs with only minor alterations. Further exacerbating the situation was a technical glitch during the minting process where minters discovered their NFTs shared the same metadata, leading to multiple NFTs featuring identical imagery. Although the issue seems to stem from outdated event logs from a data provider, Chiru Labs is swiftly working towards a resolution. Acknowledging their shortcomings via Twitter, Azuki's admission did little to prevent a significant drop in market value for Azukis, Beans, and Elements by 35%, 50%, and 20% respectively.
Ultimately, the rushed launch of the Elements collection appears to have undermined the collector base and diluted the value of the main Azuki collection. This scenario highlights a broader issue with NFT studios that take on venture capital backing. Notably, Chiru Labs secured $30mn in funding in September 2022 to expand their brand. The Elements release seems to be a consequence of pressure on Chiru Labs to generate returns for investors in a period where the broader NFT market is experiencing historic lows in activity, making it difficult for NFT studios to generate revenue. Additionally, the lack of revenue from creator royalties due to marketplaces no longer enforcing them is applying more pressure on top NFT studios. Chiru Labs’ tainted reputation will leave collectors questioning the value of future developments within their ecosystem. Overall, we hope that the hasty Elements release serves as a cautionary tale for other NFT studios that reinforces the importance of prioritizing collectors' interests and not underestimating their ability to publicly scrutinize quality. - Gabe Parker
Robert Leshner steps down as CEO of Compound and announces new fund, Superstate Trust
On Wednesday, June 28, Robert Leshner announced that he would be stepping down as CEO of Compound Labs. Leshner is a pioneer in the decentralized finance (DeFi) ecosystem, being the founder of Compound Finance, one of the earliest and most popular DeFi lending protocols that first launched on Ethereum back in September 2018. Leshner is moving on from Compound to start a new company, Superstate, that will exclusively manage traditional finance assets, that is short-term government securities. Superstate is a mutual fund that plans on buying short-term U.S. government debt and other government-backed instruments, keeping record of fund activities through a traditional transfer agent such a trust company or bank, and keeping a secondary record of fund activities for additional data integrity on one or more public blockchains.
Superstate filed a draft prospectus with the U.S. Securities and Exchange Commission (SEC) for their short-term government bond fund on Monday, June 26. According to the filing, Superstate may extend the functionalities of its fund to one day take advantage of its secondary record of fund activities on the blockchain for more efficient peer-to-peer transfer of values. The filing states: “In the future, the fund's shares may also be available for purchase, sale, or transfer from one shareholder to another shareholder (or potential shareholder) 'peer-to-peer' on a blockchain by utilizing Secondary Blockchain Records." In other words, the fund may enable shareholders to hold their fund shares in a blockchain wallet, alongside stablecoins and other cryptocurrencies.
Superstate has raised $4mn in an equity funding round from ParaFi Capital, 1kx, Cumberland Ventures, CoinFund, and Distributed Global. The newly founded company led by Leshner will not invest in any assets that rely on blockchain technology. However, over time, the company may increase its reliance on blockchain technology for record-keeping, transferring assets of value, and interoperability. Leshner tweeted on Wednesday, “The primary limiting factor to DeFi is that crypto-native assets are the only interoperable assets. But eventually, hundreds of trillions of 'offline' assets will find their way onto blockchains. We plan to facilitate that migration. … This is the first step on a long journey to upgrade financial markets.” Jayson Hobby, previously VP of Product for Compound Labs, will be taking over in place of Leshner as CEO.
Our take
Despite the excitement around Superstate’s short-term government bond fund and its potential to enable shareholders to purchase, sell, and transfer assets on-chain directly from their blockchain wallets, it’s important to highlight the initial approval of the fund will not mean shares can be custodied on-chain. Initially, the fund will primarily record-keep assets through a traditional transfer agent and only rely on a blockchain, namely Ethereum, for secondary record-keeping purposes. Superstate’s strategy in filing its draft prospectus to the SEC with minimal, almost non-existent reliance on anything crypto or blockchain is meant to act as a first baby step among many towards reaching the fund’s broader vision of bridging traditional finance assets to the world of DeFi. It is a Trojan horse strategy. Superstate’s first product at face value appears to be a relativley harmless, conservative, and approachable traditional mutual fund in the eyes of U.S. regulators. However, if approved, Superstate’s mission would be to develop this product in such a way that it increasingly opens the door for more blockchain innovations to revolutionize how traditional financial assets are custodied and managed.
It is difficult to tell whether Superstate’s strategy will be the winning strategy to take DeFi to a new level of institutional and retail adoption. This not only because of the clear and costly regulatory battles that will inevitably need to be fought in order to progress Superstate’s true DeFi-focused mission but also because it remains unclear what exactly DeFi’s main value proposition is in the long-term future. Leshner is betting on the fact that DeFi’s value proposition will be the superior efficiency of purchasing, selling, and transferring regulated traditional financial products on-chain, as opposed to off-chain, and on behalf of a permissioned set of KYC/AML’d users. Others may argue that DeFi’s longstanding value proposition must go further and be the superior accessibility of on-chain financial services as a result of the permisionless and censorship-resistant nature of the underlying blockchain technology, as well as the growing adoption of native crypto assets. Both strengths of DeFi are not mutually exclusive by any means but how the DeFi industry evolves in the future depends heavily on what takes precedence. Can the accessibility of DeFi be compromised for wider levels of adoption and still retain value? There is no doubt some form of permissioned DeFi applications and services like the ones Superstate plans on building in the future will exist but their value relative to permissionless DeFi applications that favor accessibility over integration with traditional financial products remains a matter of debate. – Christine Kim
Other News
Fidelity rejoins rush to spot bitcoin ETF with fresh filing
Ether to bitcoin ratio futures coming via CME Group, pending review
New UK financial law includes 'crypto hub' provisions and web3 rules
Sotheby's forms partnership with Artblocks
MicroStrategy buys another 12,333 bitcoins for $347 million
Warner Music, Polygon Labs launch blockchain music accelerator
HSBC Hong Kong launches support for Bitcoin and Ethereum ETFs
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