Oct 21, 2023

The Crypto Industry's House of Cards Collapses as Legal Authorities Investigate Widespread Fraud

Bitcoin Macro

The crypto market crash of 2022 has exposed rampant misconduct across the industry's highest flyers. As regulators and bankruptcy courts sift through the wreckage, a tangled web of fraud and unethical behavior is coming to light.

At the center of this web lies FTX, whose collapse triggered contagion throughout crypto. FTX founder Sam Bankman-Fried faces criminal charges for misusing client funds, but the issues run deeper. Testimony alleges Bankman-Fried improperly diverted billions in FTX customer assets to invest, donate to politicians, and buy back FTX shares held by rival Binance.

However, FTX's problems extend beyond just its founder's malfeasance. Details emerging from FTX's bankruptcy proceedings reveal a complex shell game used to prop up sister trading firm Alameda Research. To repay loans to lenders like Genesis, FTX reportedly diverted client funds to Alameda in violation of terms of service. This raises legal questions around firms that received FTX customer money under false pretenses.

Chief among them is Binance, whose CEO Changpeng Zhao received $2.2 billion from Bankman-Fried for FTX equity. Testimony traced $1.2 billion of this to FTX customer accounts, not the full $2.2 billion. While Zhao has brushed off returning funds, bankruptcy law provides avenues for the FTX estate to claw back these assets.

Beyond Binance, major crypto lenders now embroiled in bankruptcy proceedings may also hold FTX customer funds received improperly. Genesis, Voyager, Celsius, BlockFi - their Chapter 11 cases now face new complexities as investigators untangle FTX's web.

In fact, Genesis is FTX's largest unsecured creditor with $226M in claims. BlockFi CEO Zac Prince blamed FTX and Alameda's collapse for his own firm's bankruptcy. He testified that BlockFilent $1.1 billion to Alameda without knowing FTX was improperly using customer funds. Prince said BlockFi would not have made the loans had it known Alameda's balance sheets were false. He said $650 million was still outstanding when FTX failed, precipitating BlockFi's bankruptcy.

Prince testified as prosecutors near the end of the second week of Bankman-Fried's trial, in which the former FTX CEO faces fraud charges over allegedly misusing billions in customer funds.

The complications stretch even further as legal action mounts against other major industry players. Crypto exchange Gemini is now engaged in lawsuits on multiple fronts related to the implosion of its Earn lending program with Genesis.

Gemini faces direct legal action from regulators including the New York Attorney General, who recently filed a complaint against Gemini and Genesis. The complaint alleges the companies made false assurances and concealed risks regarding the Earn loans. It provides evidence Genesis misled Gemini about overcollateralization of loans and hid its shaky financial position tied to Three Arrows Capital's collapse.

Genesis itself is under further scrutiny, now facing a court order to comply with an SEC subpoena related to TerraUSD'scollapse. A New York judge gave Genesis just 5 days to respond after determining it failed to provide requested documents previously. The subpoena is part of the SEC's lawsuit against Terraform Labs and Do Kwon over the dramatic 2022 implosion of the TerraUSD algorithmic stablecoin.

Beyond regulators, Gemini is also embroiled in civil lawsuits against Genesis itself and parent company Digital Currency Group. Gemini alleges Genesis parent company DCG concealed its financial troubles and $1.1 billion hole due to Three Arrows Capital with an undisclosed promissory note.

The complaint supports claims that DCG CEO Barry Silbertallowed Genesis to hide its losses right up until withdrawals were halted. The legal issues involving Gemini and Genesis reflect how the 2022 crypto crashes continue to have ripple effects as lawsuits and investigations unfold. Revelations in these cases stand to implicate other major players as the aftermath is untangled.

As authorities investigate, major figures like Silbert and Bankman-Fried may still face reckonings. Though painful, the lawsuits and charges aim to root out unethical actors and fraud that flourished in crypto's unchecked boom years. For the industry to move forward on sounder footing, this regulatory and legal purge of bad behavior may be necessary medicine.

Bitcoin Macro

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