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The Institutional Risk Analyst

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Crypto Collateral Damage Mounts

January 9, 2023 | We caught up on a lot of reading over the holiday, particularly the growing pile of losses due to crypto fraud and other schemes fueled during a decade of quantitative easing (QE). The excesses displayed by our colleagues on the Federal Open Market Committee are of course massive, but the childish naiveite and ignorance displayed by American investors, their advisors and bankers, and public officials is equally monumental.


“Creditors of the bankrupt cryptocurrency lending platform Celsius Network suffered a setback on Wednesday after Judge Martin Glenn determined that user funds trapped on Celsius’ Earn product belong to the debtors’ bankruptcy estate,” reports William Farrington of Proactive Investors. No dear readers, this ruling was neither shocking not disappointing. It’s just the law and it tracks the recent experience with another famous fraud, Bernie Madoff.


“This is totally unsurprising,” notes our friend Fred Feldkamp, one of the fathers of the “true sale” in the 20th Century and retired partner at Foley & Lardner in Detroit. Fred muses: “In short, the judge found that investors in crypto owned by Celsius are, by contract and in law, just unsecured creditors of Celsius, the institution that owned the crypto.”


There is no claim possible on the non-assets in the various crypto frauds, proof positive that there was never any substance to these electronic beanie babies. Collectibles at least qualify as "assets." The court ruling in the Celsius bankruptcy tracks the earlier finding that Madoff investors had general claims against the Madoff firm, not rights to specific assets, real or imagined.


As unsecured creditors they will collectively challenge any secured creditor of Celsius, especially any insider claiming to be a secured creditor, under fraudulent transfer law. Unsecured creditors also will likely force any money insiders received to be repaid --to the extent the insiders are solvent. In other words, those residual claims on crypto issuers that have been trading at pennies on the dollar may have no value whatsoever.


“If the bankruptcy is run as well as was the Madoff case, there may still be some recovery,” Fred concludes.


The big question of course if how state and federal regulators, as well as elected officials in both political parties, did not see that the entire construct of crypto currency was at best a form of money laundering and at worse outright fraud. There was no segregation of accounts, no internal controls, none of the consumer protections that are already part of existing law and regulation. The crypto craze was merely a repeat of the chicanery and get rich quick schemes of the Roaring Twenties portrayed in the Great Gatsby with a tech veneer.



Fitzgerald portrays 1920s America as a world where speculation and gossip about the latest investment scheme spread rapidly, often based on no actual knowledge of the situation. Fractional interests in Florida real estate and distant oil wells were just some of the come-ons of that era. In the 1920s, Charles Ponzi created a vast scheme from the simple beginnings of postage receipts. Most participants lost everything.


Sound familiar? The era of the 2010s looks remarkably about the "single window" worldview in Gatsby. To expect Celsius or FTX or any other crypto scheme to end up differently from near 100% loss for the unfortunate “investors” would be unreasonable. But we live in the age of unreason, the age of the dilettante where one regulator or politician is more ignorant of the law or markets than the next.


Washington is filled to the brim with articulate incompetents, conflicted agents who always put their own interests first and foremost. And federal bank regulators are still months behind the curve in terms of how the collapse of crypto could impact insured financial institutions. We expect a number of small banks to fail or be acquired as a result of crypto losses, but this is only one aspect of the crypto collapse.


The losses borne by crypto investors are instructive for professional investors, particularly those foolish enough to purchase “participations” in various types of real and surreal assets since 2008. The same harsh rule imposed on victims of crypto fraud also applies to investors that buy standard “participations” in loans, mortgage servicing rights or other assets The investors think they own prior rights to the “participated” assets when, in fact, they are merely unsecured creditors of the participation “seller.”


In the early 1980s, the collapse of Penn Square Bank proved that participations are often unenforceable, as we wrote in American Banker in 2016. Whether the investor faces a bank or a nonbank issuer, the likelihood of collecting on participations post-default is nil. In effect, buyers of crypto tokens issued by a corporate entity face precisely the same situation as the general creditor of a failed bank or nonbank.


One of the first questions that the Federal Deposit Insurance Corp asks new receivers is about rejecting contracts, including loan participations. Trustees in bankruptcy have the same power to reject claims on behalf of the bankruptcy estate, but lack the power of a federal Receiver to pursue third parties. We’d be surprised not to see a Receiver appointed in the FTX bankruptcy and other crypto defaults given the vast array of schemes used to defraud investors.


Even as the Trustee in the FTX bankruptcy rejects claims upon the failed company, they will aggressively pursue those parties that benefitted from the fraud to the detriment of the estate. Politicians that received campaign contributions from Sam Bankman Fried will soon be hearing from the Trustee in the FTX matter, demanding repayment of all funds received.


News reports suggest that federal prosecutors appear to be focusing on possible wrongdoing by cryptocurrency executives, rather than by Democratic or Republican politicians, but the US Trustee is solely concerned with recovering money to the estate of bankrupt firm. Just as Irving H. Picard, a partner in the law firm BakerHostetler, recovered millions for victims of the Madoff fraud as Trustee, the professionals assigned to these new frauds will follow the very same playbook.


Watching clueless politicians in Washington deal with the blowback from the collapse of crypto is likely to be a great entertainment value. Take Senator Kirsten Gillibrand (D-NY), who reportedly “donated” the funds received from the FTX fraud to a nonprofit. The Trustee will seek repayment nonetheless. Indeed, Gillibrand may now cause the charity to be sued by the Trustee as well. Just as Sam Bankman Fried had no right to contribute stolen customer funds to political campaigns, Senator Gillibrand has no right to donate these stolen customer funds to a not-for-profit as a means of redemption. Duh.


The folks at MarketWatch have assembled a handy list of politicians who took money from Sam Bankman Fried. But unlike the Madoff fraud, banks and other Wall Street institutions were forced to cooperate with Irving Picard and even write some big checks that otherwise might not have been written in a less prominent case. The Trustee in the FTX case lacks that larger stage that the Madoff fraud created and Picard played skillfully to recover funds.


Since the folks on the FOMC refuse to allow a true debt deflation to flush the fraud out of the financial system and thereby inoculate investors against acts of ridiculous stupidity like “investing” in crypto tokens, we repeat the old mistakes with renewed fervor. Incredulous members of Congress held hearings about “regulating” crypto as though oversight could make fraud somehow acceptable. And now, as in the early 1920s, new era frauds are unravelling with growing collateral damage to the financial world. Ponder this excerpt from a filing in the FTX bankruptcy in Delaware:


"On December 23, 2022, the Joint Provisional Liquidators filed the Motion seeking, among other things, to have $143 million of funds (the “U.S. Funds”), which are currently being held in bank accounts at Silvergate Bank and Farmington State Bank d/b/a Moonstone Bank (two small fintech banks), transferred to “one or more financial institutions that are better capitalized and/or have less direct exposure to class actions suits or other claims relating to the FTX matter.”

The collapse of crypto illustrates just how conflicted and ineffective supposed “regulators” have become over the past century. Progressives fashioned regulators as a tool to protect consumers from the rapacious behavior of the Robber Barons, who controlled the courts in the 19th Century. Today, regulatory agencies are populated by aspiring politicians who lack any true understanding of how current law already regulates and arguably prohibits crypto tokens.


The stunning failure of regulators and elected officials to prevent the great crypto heist shows that the courts -- not regulators -- remain the last effective institutional protection for Americans. Democrat Representative Maxine Waters (D-CA) even expressed disappointment following the arrest of Sam Bankman-Fried, the former CEO of collapsed FTX. The total failure of regulation to prevent the crypto craze is something to ponder in the weeks and months ahead as the true cost of crypto is reckoned. Fortunately, the US Bankruptcy Court will provide a documentary record of each of these transparent frauds and the victims.



The Institutional Risk Analyst is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

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