Top Stories of the Week - 12/23
In the newsletter today we cover the latest in the FTX saga, a major governance proposal for cosmos, and the ongoing debate over NFT royalties. Subscribe here and receive Galaxy's Weekly Top Stories, and more, directly to your inbox.
SBF Extradited to New York, Released on Bond, Lieutenants Plead Guilty
Sam Bankman-Fried, founder and former CEO of bankrupt exchange FTX, was extradited to New York City this week. After initially opposing extradition to the US, SBF begged out of Fox Hill Prison in Nassau, Bahamas (reportedly one of the worst prisons on Earth) and waived his right to extradition on Wednesday morning. By Wednesday evening, SBF was on route to New York, and as he was in the air, U.S. officials announced that two of his top lieutenants, Gary Wang and Caroline Ellison, had pled guilty to several federal criminal charges and were cooperating with investigators.
On Thursday, SBF appeared before a New York federal court and was released on a personal recognizance bond of $250m. According to the appearance bond document, SBF’s release is achieved by the unsecured cosignatures of 4 "financially responsible persons” (FRP) and further secured by “PARENTS HOME IN PALO ALTO.” Assuming 2 of the cosigners are SBF’s parents, Joseph Bankman and Barbara Fried, that leaves two additional parties unaccounted for. According to reporting by The Wall Street Journal and Matthew Russell Lee, a court reporter covering the Southern District of New York, the other two individuals include “a relative and a non-relative.” At this time, the identity of the other two cosigners is unknown. In any case, SBF is remanded to his parents’ home in Palo Alto where he will remain, with GPS monitoring, until his next hearing on January 3. The prosecutor, Assistant U.S. Attorney Nicolas Roos agreed to the bond package as part of a deal that required SBF waive his right to contest extradition.
Sam Bankman-Fried's next court hearing is scheduled for January 3, 2023. SBF is also facing civil suits from the Securities and Exchange Commission and the Commodities Futures Trading Commission.
Federal prosecutors in New York also charged Caroline Ellison and Gary Wang, and each pled guilty on Wednesday. Ellison pled guilty to two counts of wire fraud and five counts of conspiracy, while Wang pled guilty to one count of wire fraud and three counts of conspiracy. Federal prosecutors announced that Ellison and Wang were cooperating in SDNY’s investigation against Sam Bankman-Fried.
Simultaneously, each was also sued by the Securities and Exchange Commission on Wednesday. In a complaint against the pair, the SEC alleged that they participated in a “multiyear scheme to defraud equity investors in FTX.” The most notable addition in the SEC’s complaint against Ellison and Wang that is not present in the Commission’s complaint against SBF is the SEC’s contention that “from the time of its offering, FTT was offered and sold as an investment contract and therefore a security.” Ellison and Wang each agreed to settlements with the SEC that ban them from the securities industry, require them to disgorge ill-gotten gains, and pay a civil penalty. That settlement must be approved by federal court in New York.
We wrote in the December 2, 2022 edition of this newsletter that Sam Bankman-Fried was attempting to enact “a clear and well-orchestrated media strategy to portray himself as an idiot...” in an attempt to “escape criminal prosecution.” Clearly, that ship has sailed. With Sam now charged with a pile of federal crimes and with his feet firmly on U.S. soil, Sam can only hope his ubiquitous media presence prior to his arrest and extradition will sway a jury pool in his favor. But with two top lieutenants cooperating against him, it’s not looking good. For now, though, Sam is relegated to be a mere former crypto trader living in his parents’ basement, an ironic turn of fate for a man whose recent life was that of a crypto mega-mogul living in a Caribbean penthouse.
While the SEC has thus-far sued SBF, Ellison, and Wang specifically for violating the anti-fraud provisions of the Securities Act of 1933 and the Securities Exchange Act of 1934 in relation to the sale of FTX equity (I.e., hiding their alleged fraud from their venture backers), the Commission has also stated that “investigations into other securities law violations and into other entities and persons relating to alleged misconduct are ongoing.” The potential for the SEC’s claims to expand was on display, with the Commission adding language to its complaint against Ellison and Wang arguing that FTX’s native exchange-token FTT is a security, something not present in the Commission complaint against SBF. The repercussions here could be significant, but time will tell.
Another big mystery here is the question of who provided surety to the court to get Sam released on a $250m bond. Here the bond document is extremely confusing. Section 2 of the bond appearance doc says the surety is secured and provided by “PARENTS HOUES IN PALO ALTO,” but that can’t possibly be enough (unless they live here). A lot of people think that only 10% would need to be posted, but we’re told that, in federal cases like this, nothing may need to change hands if the total value of the bond can be provided for by security or the unsecured cosigning of “financially responsible persons.” Assuming the parents’ home in Palo Alto is not worth $25m (10% of the total) and knowing it’s not worth $250m (the balance of the bond), presumably the remainder is comprised by the cosignature of these 4 financially responsible people. According to the Court, one of the 4 is “non-family.” This could be some high-value, white collar, surety firm, perhaps. But if it is an individual that is providing this cosignature, whether for a fee or not, then it is in the public interest to know the identity of that person, whose cosignature we must assume comprises the bulk of the required asset value for the $250m bond. Some of this information may be revealed in the court transcript from the hearing, which we have yet to see. -AT
DeFi, Meet Cosmos
Stables, DEXs, Liquid Staking, and more is coming to Cosmos in 2023. After over a year of discussion and development, a proposal for Interchain Security v1 (ICS) to be implemented on the Cosmos Hub is finally live on the network forum. ICS v1 (or Replicated Security) leverages existing Cosmos tech including the Inter-Blockchain Communication (IBC) messaging protocol to pass on Cosmos validation, security, and liveness to consumer chains. In return, consumer chains will create new, composable DeFi apps based around the ATOM token while also passing inflation and fees to Hub validators.
Once (and if) the proposal passes, code will be added to the Hub that will enable consumer chains to join the Cosmos ecosystem, bootstrapping security from the Hub’s $1.7bn of stake without having to overly incentivize hundreds of early validator partners. In theory, ICS will enable DeFi applications (or dapps) built on alternative Tendermint chains like Polygon and Terra to be built natively on the Hub for the first time. Several projects are developing the necessary code to onboard into the “ATOM economic zone,” including a Liquid Staking solution (Stride), a DEX (Duality), a permissionless CosmWasm-based smart contracting platform (Neutron), and, most importantly, the first ever fiat-collateralized stablecoin in Cosmos, Circle’s USDC. Notably, for ICS v1, at least 2/3rds of validators will need to support the consumer chain.
Ostensibly, ICS v2 will enable the Cosmos Hub to maintain radical minimalism and neutrality while also unlocking faster innovation for the Hub along with greater yield for validators, a cheap but secure launchpad for DeFi incubation, and greater utility for the ATOM token via an IBC native DeFi. ICS v1 is expected to launch with the Rho upgrade in Q1 2023 while ICS v2 (opt-in security) and ICS v3 (layered security) are expected to follow later in the year.
While ICS is a big deal for the Cosmos Hub, unlocking value and utility for users and validators alike, it has bigger implications for crypto overall. ICS, should it go live, will provide the first look at amortizing the cost of a network’s sybil resistance mechanism in PoS. Basically, since inception, developers have looked for 1) more ways to use blockspace and 2) ways to lower validation costs while still maintaining current security guarantees. Early on (and still to this day), Proof of Work (PoW) networks like Bitcoin have experimented with Merge Mining, a dual model where miners receive additional rewards for securing other protocols via PoW mining. To date, Merge Mining has failed to catch on.
Re-staking, which again utilizes PoS Sybil resistance, provides a new avenue for experimenting with amortizing the network’s primary security cost while also unlocking possible new use cases for blockchains. Development on re-staking is already underway on Ethereum which could possibly reshape crypto’s middleware layer, unlocking fast finality and enhanced transaction inclusion guarantees for rollups plus ways to mitigate MEV (minimal extractable value). For Cosmos more broadly, ICS v1 provides a faster and safer avenue to implement long-demanded but contentious and challenging applications which mutually benefit both users and validators.
Perhaps most importantly for the Hub, because ICS is an opt-in service solely servicing apps that pass a rigorous governance process, Cosmos will maintain its neutrality and hence minimize the amount of MEV its new apps introduce into consensus, something that a permissionless network cannot control. While there are no guarantees ICS v1 will work better than Merge Mining, it inarguably provides both those in and outside of the IBC world a live look at something entirely novel. It's a key development to watch in 2023, as it could provide insight into how to fight against today’s abundance of blockspace via new designs while also helping mitigate MEV’s threat to decentralization via Cosmos-specific features like permissioned blockspace. -WJS
NFT Marketplaces Struggle to Define Royalty Policies
NFT marketplaces appear to have inconsistent opinions on royalties. The spotlight on the royalty debate motivated top NFT marketplaces to rapidly take a stance on the subject. Consequently, NFT exchanges appear to have implemented critical platform updates without evaluating the NFT ecosystem's developing viewpoints on royalties.
Earlier this month, OpenSea announced that it will alter its previous aggressive stance on enforcing royalties. Prior to OpenSea's latest announcement, the platform required all projects released after November 8th to use an open-source smart contract that prohibited interactions with 0% royalty marketplaces. OpenSea's new creator smart contract preserves royalty rights through blacklisting smart contract addresses associated with 0% royalty marketplaces; transactions made to these addresses automatically fail. OpenSea is effectively enforcing royalties on their marketplace at the smart-contract level by enclosing their ecosystem exclusively to royalty supporting entities.
Following criticism for this stance, the marketplace recently laxed their stance on royalties. Now, starting January 2, 2023, projects on OpenSea will have the option to opt out of using the royalty enforcing smart-contract and be able to set royalties that are optional for collectors to comply with. However, although royalties are no longer mandatory on OpenSea, the platform clarified on twitter that they are still firm believers in royalties for creators.
At the same time OpenSea changed their stance on royalties, Magic Eden also shifted their stance on NFT royalties. Magic Eden, which previously followed an optional royalty model, released an open-source royalty enforcement tool on top of Solana's SPL token standard called Open Creator Protocol (OCP). Like OpenSea's royalty enforcement smart-contract, Magic Eden's version (OCP) will also enforce royalties through blacklisting contracts associated with 0% royalty marketplaces. New entrant X2Y2 also switched to mandatory royalties this year.
The recent decision from OpenSea and Magic Eden's to give creators the option to blacklist royalty-free marketplaces is a win for the royalty-supporting camp. Our October 2022 report accurately predicted the adoption of creator smart-contracts that restrict an NFTs interaction with 0% royalty marketplaces. This new approach to enforcing royalties on-chain was first explored by Tyler Hobbs, a prominent NFT artist, for his QQL Mint-pass NFT project. Presumably, Tyler's success in protecting royalties for his project motivated OpenSea and Magic Eden to take the same approach.
But protecting royalties through blacklisting royalty-free marketplaces appears to lack long-term viability due to the emergence of new NFT marketplaces. In 2022 alone, three popular royalty-free marketplaces launched (X2Y2, Yawww, SudoSwap). But the royalty question is contentious and the constantly shifting marketplace policies make forecasting here unpredictable.
Despite OpenSea and Magic Eden blacklisting 0% royalty marketplaces, the continued emergence of royalty evading NFT marketplaces will present an on-going issue for NFT creators who support royalties. Overall, the issue will not resolve until the NFT community develops a new standard to enforce royalties at the smart-contract level that is not reliant on blacklisting contract addresses. -GP
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