The Crypto Ice Age, Part 2

"Resistance is futile." -- the Borg hive mind, Star Trek (1989), et seq.

Credit: Paramount Pictures

Since I began working on crypto, we’ve seen formal bankruptcy filings from BlockFi, FTX/Alameda, Voyager, Celsius, et al. I keep thinking I can just bolt down and ship, and BOOM: Another one goes to meet their Redeemer.

With one exception: Binance.

It’s the crypto exchange that is located everywhere but nowhere, and it remains. Changpeng Zhao is the head organism at Binance. As far as I know, he was born in China, has a Canadian identity, and is supposedly a “permanent resident” of Singapore. But he’s hanging out in Dubai. Of course.   

Dubai Creek is just the right place for CZ. And CZ is avoiding the problem of a failed exchange. But how?

Well, while CZ gives lots of recorded interviews on video (etc.), none of these (as far as I know) appear to be conducted before a court that can enforce perjury laws.

Just saying.

However, there is a Swiss/cloud/Hong Kong-based litigation group, called Liti Capital, whose partners have told me about their proceedings against Binance. These are taking place at the Hong Kong International Arbitration Centre. 

One of the partners, Jonas Rey, told me, “Under Hong Kong arbitration law, you can select which legal regime you would like to use. We chose U.S. law. Why? Because of double damages. Our goal is to maximize returns, [so under U.S. law] we can go for punitive damages.”

Why the Hong Kong International Arbitration Centre? Because under Binance’s terms and conditions, proceeding can only happen through the Centre. And the Hong Kong International Arbitration Centre has a steep cost barrier. You must have legal representation in Hong Kong and pay fees up front. According to Jonas Rey of Liti, Binance is represented by serious Hong Kong counsel. 

Liti Capital’s counsel is White & Case. In particular, they have Abby Cohen Smutny, a well-reviewed partner at the firm in Washington. I asked Liti Capital if I could interview her, but the interview was postponed.

According to Jonas Rey of Liti Capital, Binance has pulled the plug on their exchange(s), allegedly during periods of high volatility in the crypto markets. Exchanges are turned back on (allegedly) after volatility goes down, when prices are lower and execution is slower. 

Here’s an important question: Why is Liti Capital asking only for $37 million USD in damages from Binance? 

According to Jonas Rey, the initial outage in 2021 created losses of $37 million dollars for the 77 Binance users who are participating in Liti’s suit. At the time of this event, the traders were trading futures and other complex derivatives on Binance. 

Rey says that typically, during times of high volatility, traders want to sell or un-margin in order to avoid forced liquidation. 

But because of the outage, they were unable to do so. According to Rey, Binance is blaming technical issues and overloaded servers. 

Rey posits another explanation. To paraphrase Rey: The day of the cited outage, the Binance site did not have high traffic. The number of users was average. There was no reason for a crash. 

“I cannot prove it,” Rey says slowly. “Were they about to enter a death spiral that would have resulted in them going bankrupt and killing the cryptocurrency market forever? I think that. Because the outage on the website started much earlier than [stated] in the official postmortem on the website.

“And the other reason I think that is because in the cryptocurrency world, when you make a trade, you don’t always have a counterparty on the other side. So if you’re short bitcoin, there is not necessarily, on the other side, [someone] who is long bitcoin. [It’s not like] a traditional stock exchange, where there is a central bank that is the ultimate counterparty.” (A central bank here is referring to a clearinghouse or centralized depository.) 

“So, the exchange had to run shorts and longs, and it was beyond the capital they had.” 

Later on in the conversation, Rey notes: “They tried to compensate at ten cents on the dollar, and that was obviously insufficient. Now they’ve created a billion-dollar insurance fund. It’s self-insurance, so we don’t know how big it really is. They publish the cash value of the fund at the end of each day, but they never say what’s on the balance sheet. So, okay. Without knowing what cryptocurrency they have in the cash position, it’s meaningless. Because if you have a billion in cash in different crypto, that’s different. But without looking at the balance sheet and knowing you have a net exposure on maximum leveraged products, that cash position is [also] meaningless. If you have a net exposure of $10 billion, like FTX did, and a cash position of $1 billion, it’s irrelevant. But if you have $100 million in liabilities and a billion dollars in cash, then you’re in pretty good shape. Nobody audited them.

“There were other exchanges that had similar issues, but they were not as bad. For example, Coinbase. It’s a U.S.-listed exchange, fully SEC regulated. They had an outage of one or two hours, but they fully compensated all the users that were affected. They communicated very practically. But because Binance is regulated nowhere, they don’t have to provide any further [explanation]. They said, ‘oops, sorry!’”  

Back to the tech issues.

On another level, I personally like the approach. If there is not enough cash or collateral in my USD checking account or the securities held by a registered custodian, I simply inform my creditors and counterparties that “tech issues” are preventing me from transacting on time. 

Because in this instance, I am everywhere but nowhere, and it could be made to work.

Abracadabra! 

In my mini-universe within the multiverse, though, it helps to have some background reading. I informed the Liti Capital people that they should read Manmohan Singh’s book, Collateral and Financial Plumbing, and the latest edition of Dermot Turing’s book Clearing and Settlement. Those ones are lots of fun! 

It does not appear that the crypto crowd has heard of these. They shouldn’t feel bad, though. The partners in Liti Capital may not have heard of them, either.

I am professionally neutral in Liti Capital’s arbitration proceedings against Binance. And, anyway, I am not licensed anywhere, in anything.

And, notably, the Liti team is not anti-crypto. Jonas Rey tells me they have most of their capital in crypto, except for the $7 million USD they need for costs like Abbey Cohen’s billings and fees to the Hong Kong International Arbitration Centre. 

Jonas Rey also adds, “It’s too late for the central banks to take control of the system. The system is decentralizing now. Plus, if you are going to regulate bitcoin, who are you going to call?” [He laughs.] “The future failure of exchanges could discredit exchanges that don’t use central bank digital currencies, for sure. And that’s why I think this behavior from FTX and the others will provide a massive setback for the global crypto industry. If they want to do more adoptions, people need to feel safe in this space.”

I pretty much believe that. Kind of. 

You see, major powers, like the U.S., China, and even the European Union, are working on quantum cryptography. Supposedly, it might be capable of cracking codes like blockchain, and doing so quickly. 

In a few years, we’ll see. In the meantime, I am grateful to move on to other topics, which are fun-er for me than the trials of the crypto bros and crypto gals. Not to get too binary about it.