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Always a Bull Market Somewhere

Familiar faces turn up for new projects to help shape the mess they created.

Markets appeared to be moved by macroeconomic news this week as prices responded to economic data and the musings of policy makers.

Wednesday brought a slew of economic statistics and comments by central bankers.

The day started with the release of Euro Area HICP inflation data which came in, as forecast, at an eye-watering 9.2% year-over-year. Investors somehow found something to like in the data as German 10-year bonds prices rose after the release, with the yield eventually bottoming out at 1.97%. This is a full 0.40% below the German 2-year rate.

It bears repeating that this indicator of severe economic distress has never occurred since the launch of the Euro.

ECB President Christine Lagarde cautioned in a speech at Davos that:

“Inflation is way too high.” and that the ECB will “…stay the course with rate hikes.”

Markets do not believe her and are forecasting a Euro Area economic downturn followed by a rate cut by year-end.

Policymakers in the U.S. have been subject to nearly the same scorn.

Despite bullish economic data releases, markets were lower Wednesday after St. Louis Fed President James Bullard repeated his hawking stance on interest rates in a broadcast interview by the Wall Street Journal.

But by Friday, investors seemed more inclined to follow the lead of Fed Governor Christopher Waller, who, in a speech at the Council on Foreign Relations, clearly advocated a 0.25% rate rise by the Federal Open Market Committee (FOMC) at their meeting on January 31st. This would signal a continued deceleration from the 0.75% increment rate rises in 2022, a shifting stance by the FOMC, and indicate the Fed is nearing its terminal policy rate for this cycle. Markets for risk assets rose sharply.

Oh Jamie, boy

Crypto markets responded to macro developments similar to other assets, despite the best efforts of JP Morgan CEO Jamie Dimon, the new “Jim Cramer of Crypto”

In an interview at the glorified gabfest known as the World Economic Forum in Davos, Switzerland, Dimon once again put his nuanced understanding of crypto on display: “Bitcoin itself is a hyped-up fraud, it’s a pet rock.”

When asked to comment about JP Morgan’s peers making blockchain infrastructure investments, he responded:

“That’s different. Blockchain is a technology ledger system that we use to move information. We use it to move money…”

He must be referring to Morgan’s Onyx “permissioned” blockchain that select depositors can use to transfer JPM Coin to each other. It would be interesting to hear him explain the reason for using Onyx and not an ordinary database or, indeed, the bank’s regular online portal.

Bitcoin seemed to respond to his comments by shooting through the $22k level and then continuing an orderly rise.

Joining in the bullish sentiment this week was FTT, the token of the bankrupt crypto exchange FTX. This follows comments by new CEO John J. Ray III that FTX could possibly re-launch. In an interview with the Wall Street Journal, he said, "There are stakeholders we're working with who've identified what they see is a viable business."

Although the FTT token does not represent ownership in FTX, any utility, or a claim on assets or profits, the token is trading 160% higher in 2023 with a market capitalization of over $700 million. I guess this is what a journey toward normalization looks like in crypto.

Oh, Kyle and the Boy Named Su

FTX is not the only crime scene hosting a comeback story. Kyle Davies and Su Zhu, co-founders of bankrupt crypto fund Three Arrows Capital (3AC), are reportedly seeking funding for a new crypto exchange. The tentatively titled GTX would initially be a venue for trading asset claims from crypto bankruptcies and, eventually, other assets.  

With Davies and Zhu currently in non-extradition countries avoiding subpoenas related to the collapse of 3AC, howls of outrage splashed across crypto media. The confluence of events coming full circle in this mess is only fit for a crypto circus. The risk potential is beyond comprehension.

3AC was founded in 2012 ostensibly to trade foreign exchange arbitrage, pivoting to crypto in 2017. 3AC rode the wave of the 2021-2022 bull market with increasingly leveraged positions to a peak net asset value somewhere north of $10 billion.  

In 2022, 3AC’s leverage bit back, starting with an ill-timed $200 million April investment in the Luna Foundation Guard which was written down to zero the next month. Things did not improve.      

The Luna collapse caused a contraction in crypto lending and cascading collateral liquidations.  Among the 3AC bad debts outstanding were over $1b each to crypto lenders BlockFi and Voyager Digital, which subsequently forced both firms into bankruptcy.  

So 3AC blew up Celsius, Voyager Digital, and BlockFi, each of whom had hundreds of thousands of customers.  It indirectly blew up Gemini Earn with over 340,000 customers. Party to the contagion was FTX, with over 1 million customers. That is a lot of bankruptcy claims.  

It should also mean a lot of enemies for Davies and Zhu. And with the bankruptcy of 3AC as the proximate cause of cascading bankruptcies in the crypto space, the knives were also out on Twitter. But this is crypto, and the fun hasn’t stopped at 3AC. 

Who is willing to trust these guys anyway? Well, partnering up with Davies and Zhu are the CoFounders of the crypto exchange CoinFLEX: Mark Lamb and Sudhu Arumugam.  

CoinFlex is restructuring itself after over $80m in derivatives losses on the platform sustained by an individual customer understood to be Roger Ver. Yes, that Roger Ver, AKA Bitcoin Jesus. Ver denies it and has lodged a counterclaim against CoinFLEX.  

And I looked at him and my blood ran cold

And I said, "My name is Sue, how do you do?

Now you gonna die", that's what I told him - Johnny Cash

But Oh Boy, It’s Complicated.

Now Davies, Zhu, Lamb, and Arumugam are seeking $25 million in seed capital to launch an exchange to trade tokenized claims on bankruptcies. And I’m not making this up: Davies and Zhu are on the list of claimants in the 3AC bankruptcy.  

Beyond the operatic Twitter histrionics and hysteria, the idea of an exchange for trading such assets has a history.

In 2016, crypto exchange Bitfinex fell victim to a hack and theft of BTC 119,756 worth approximately $72 million at the time. Unable to cover the shortfall, the exchange socialized the losses, reducing customer balances by about 36% and crediting them an IOU token, BFX, for the rest. The exchange subsequently listed the token for trading, allowing customers to either take a haircut on the claim by selling the token below par, or speculating that the exchange would make good on the debt. Ultimately, all the tokens were redeemed at par, eliminating the liability.

While some customers took a hit, others speculated on the viability of Bitfinex and profited when the tokens were redeemed at par. Controversially, Bitfinex itself was among the buyers of BFX, which reduced its liability.

The update on the Bitfinex hack is that the DOJ was able to track the Bitcoin (now worth over $2.5 billion) to the “shadowy super coders” Heather Morgan and Ilya Lichtenstein and arrest them after they tried to launder it through, among other things, Walmart gift vouchers and PlayStation consoles.  

Objectively, the idea for the exchange has legs. There are competitors out there, such as Xclaim and ClaimsMarket. But neither of them runs open order books on tokenized claims in the way Bitfinex did and that GTX proposes.  

The addressable market is substantial. There is real opportunity here.

Adding up Celsius, Voyager, BlockFi, Genesis, Gemini Earn, and FTX makes for millions of claimants on $billions in assets. Those claims are going to take years to settle. The formation of a liquid market could bring relief to claimants and opportunity to speculators.  That would be worth something. I bet some Mt.Gox claimants from the OG exchange bankruptcy would want in on the action.

Shouldn’t Binance just get in there and list these tokens?

Um.  No.

There is risk. The legal piece of the puzzle is all important. Accepting a claim for tokenization and transferring the settlement to the token holder presents a compliance headache at a moment when crypto exchanges are in the midst of a compliance firestorm. This is not going to be a job for CZ, Brian Armstrong, or Jesse Powell.  

To be clear, I am not advocating for investment in GTX. I hope the project does not find funding and does not progress. But I am advocating for the idea if executed by an ethical management group in a compliant manner.  

Tokenized bankruptcy claims for assets of bankrupt crypto firms have a large addressable market populated with participants familiar with crypto. They might not be as in love with crypto as they used to be, but at least there is a basic understanding of tokens. It is a market niche needing to be filled. Moreover, it will advance the progression of asset tokenization. Melding on-chain transactions with an established legal framework will move the space forward. As much as anarcho-capitalist crypto bros might despise it, we live in a world of laws.  

Get the VCs on the blower. This can work.

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