Crypto's Ides of March

The Death of Julius Caesar (1806) by Vincenzo Camuccini

“A soothsayer bids you beware the ides of March” – such was the ominous warning immortalised in Shakespeare’s recounting of the fate of Julius Caesar. As it turns out, there is huge controversy around when this warning was actually given, or if it even happened at all. That said, the ides of March in 44 BC was at least historically correct in being the day Julius Caesar was assassinated.

The death of Julius Caesar by no means marked the end of the Roman Empire – in fact, it marked the start of the Empire, and the end of the Republic which the conspiring senators were struggling to save. The Empire itself only really “ended” in 476 AD, more than 500 years after that fateful Ides of March, for very different reasons far removed from Julius Caesar.

For the world of crypto, one cannot help but wonder if this month of March, more than 2 millennia after that infamous day, marks the figurative lining up of the conspiring Roman senators seeking a putative finale to the world of crypto as we know it.

The stabbings have arguably already begun, some with greater severity than others: just this week, the most recent announcement came from the US Department of the Treasury, a risk review of Decentralised Finance and its failings in the realm of AML/KYC against illicit activity, effectively labelling DeFi a national security risk. Earlier in March, we saw the CFTC hand out a massive lawsuit against Binance and its founder CZ, carrying very serious allegations and equally onerous penalties, not to mention the regulatory trickle-down onto every regulated manager under US futures regulation.

Even the “good kid” in the room, Coinbase – ever enthusiastic and proactive about seeking regulatory clarity on crypto – has been served an SEC Wells notice, threatening formal penalties on the basis of (again) offering unauthorised securities on what Coinbase bemoaned was an “undefined” portion of their offering. They blame it on lack of clarity from the SEC, but the SEC doesn’t seem to be interested in giving clarity.

Add to that the shutdown of three banks, two of which were involved in crypto, one of which (Signature) didn’t even seem to have any apparent balance sheet risk, shut down in a manner by the FDIC that some argue seemed inconsistent with its mandate (the FDIC fund took a loss in order to preclude a sale of crypto-related assets that it didn’t need to take – a good op-ed explaining the numbers is here), as well as other smaller but otherwise important regulatory actions against crypto operators (fines on Kraken for staking services, blocking them from accessing USD ACH bank transfers; or shutting down Paxos’ BUSD stablecoin issuance; action against Gemini – another pro-regulation crypto exchange etc) and one thing is clear: the US regulators don’t want crypto to continue in its current form.

To us, the pivotal moment came when the CFTC got involved against Binance. The game has changed, the risks have been raised and most importantly, these risks have become non-linear and very binary.

As a result, we have had to change our approach as well.

Ista quidem vis est!

According to the ancient Greek historian Plutarch, when Caesar took his seat, and Lucius Tillius Cimber grabber Caesar’s shoulders and pulled down Caesar’s toga, these were the words that Caesar cried out, “Why, this is violence!”.

The CFTC lawsuit against Binance is, in our view, the first material move of figurative “violence” against the crypto space.

Of course, regulators have sought fines and penalties against other operators before, but compared to the Binance case, these were mere slaps on the wrist. This is closer to an attempt on the jugular than a light slap.

The CFTC lawsuit sets up a lethal precedent that hits crypto on several fronts at one go.

Firstly, Binance is the largest futures exchange in the world. After the downfall of FTX, the CME (the “official” US futures trading venue) has made great strides in taking market share, and is currently either #2 or #3 (depending on the day) in Bitcoin futures open interest. But that’s still a far cry from what Binance has – Binance handles just over 2x the open interest and volume of its next competitor. Going after Binance for unauthorised futures trading – in particular, alleging that Binance has helped and encouraged traders to circumvent access restrictions and trade futures from within the US – is clearly aimed at taking Binance off the league table in a meaningful way, if not completely.

Secondly, this has regulatory implications all around. It will come as no surprise that in terms of capital pools, the US remains the largest pool of investor capital in the world. Most investment firms, including ourselves, have to comply with US regulations if we have US investors or wish to accept subscriptions from US investors in the future. For the moment, the CFTC hasn’t put out an explicit ban on its regulated firms (via the NFA) preventing them from trading with Binance, but the question is whether an investment manager of any credibility would run the risk of losing their business just to trade with Binance. For us, the answer is a very clear no.

Thirdly, there is the matter of the scale of the penalties being sought by the CFTC: not only are they looking for fines and disgorgement of gains from unauthorised trading, they are looking for compensation for any traders that have lost money trading in unauthorised futures. To start quantifying the size of that settlement, given all the money that has been lost (presumably traders that have made money won’t need to pay it back) over the years, that’s a “heads I win, tails you lose” situation for Binance. For years, allegations have been levelled against Binance for hunting stop losses of hapless traders, and the CFTC lawsuit alleges significant insider dealing against customers – for us, that’s the risk we take (remember when investment banks had prop dealing desks?) and we account for it by making sure we trade accordingly. But for everyone else, it’s not only open season for recouping losses, but it also makes for good (bad) publicity, bringing public opinion behind such a move (reverse all losses, keep all gains!), and bad economics when those gains have to be paid back.

One might say: well, sure, maybe Binance gets locked out of the US, and maybe it takes some damage, perhaps even big damage, but surely they still have the rest of the world to make money from?

Perhaps, but “rest of the world” is also starting to take sides: Australia just this week also announced that it was cancelling Binance Australia’s futures license. Is it that clear that the rest of the world will tread where the US threatens brimstone and fire? Not at this point.

That’s not the killing blow, though, for like it or not, crypto has one single point of failure which is squarely in the control of the US regulators.

Et tu, Brute?

Again, this famous line could well have been another Shakespearean invention. The same recount of the event by Plutarch instead claims that Caesar merely pulled his toga over his head when he saw his protégé Brutus among the conspirators, presumably in resignation that even his friend had turned on him.

There is no Brutus in Crypto’s current story – there is no protégé that might change his or her mind and turn against the current system, at least not willingly. But there is a cornerstone on which the entire system has been built, a cornerstone that has been gradually eroded down by the powers that be: United States Dollar (USD) stablecoins.

Like it or not, crypto operates in USD. No one thinks about the Bitcoin or Ether price in EUR, GBP, CHF, HKD or JPY. It’s all in USD. All-time highs in JPY? Who cares, only the ATH in USD counts. The establishment of USD stablecoins, most prominent of which is Tether (USDT), had arguably ushered in the golden age of Crypto. For once, the base was stable – coins didn’t need to be traded against an unstable base of BTC or ETH, they could go into USDT and back, and at some point those profits could be turned back into real USD which could pay for cars, boats, houses, food, holidays, school and whatever else people desired.

Running stablecoin issuance is great business: you take in USD fiat, and you issue 1 USD stablecoin in return, while depositing that 1 USD into a money market fund to pick up a nice yield. Funny enough, that arbitrage didn’t really matter in a world of near-zero rates, and to be honest, most of the crypto crowd didn’t even mind getting arb-ed out of that trade. There was more money to be made in crypto trading.

USDT is no stranger to controversy: multiple accusations (and counting) of having more USDT in issue than assets available to back its $1 value have been levied, and while Tether itself has settled its dispute with the NYAG with an agreement not to operate in NY state and a (tiny, in our view) US$18.5m fine in 2021, the veracity of its claims around actual value backing its tokens remains rather indeterminate.

That said, it never really mattered, at least so far. While USDC (operated by Circle, and which at least has shown through its episode with Silicon Valley Bank that it does have cash reserves that could get stuck and subsequently recovered) is typically known to be the “safe” stablecoin, USDT remains the popular one, perhaps driven by the fact that it was one of two stablecoin assets accepted as collateral at Binance (remember, #1 futures trading venue in the world), the other being BUSD which is now being wound down. There is no alternative to USDT - and that’s a single point of failure for the system.

When numba goes up, everyone closes their eyes to the risk that the base isn’t 1. Furthermore, Tether’s defence, substantiated by large institutions that appear to have successfully withdrawn from those reserves, albeit with some degree of accompany controversy, is that if big institutions can withdraw, then small ones can too, as long as you have the banking wherewithal to do so.

Therein lies the problem. Tether’s USD reserves, however much they may have, are mostly offshore. The problem with offshore banks is that when it comes to USD transactions (including for withdrawals and redemptions), they can’t process these payments alone – they require a correspondent bank, typically the likes of an onshore bank like JPM, Citi, Northern Trust or Signature. And that’s their weak spot: Signature et al are gone now, the rest of the banks look like they either have no interest in supporting crypto or they’re gradually being "encouraged” into compliance with the idea that crypto is bad.

Either way, no correspondents = no USD payments. No USD payments = no USD redemptions, regardless of how much reserves Tether has. And the common knowledge of no redemptions means that assumption that 1 USDT = 1 USD becomes 1 USDT = ??? – that’s bad news.

The single point of failure for the system has a single point of failure that is one decree away from being triggered by the very establishment that system aims to supplant.

Because what happens to all of those billions of dollars’ worth of futures open interest measured against USDT as the base of the pair? Do they go up because the denominator is lower? Do they go down because the denominator is broken? Who knows? The only guarantee is chaos, and it takes just one directive to trigger that chaos.

As an aside, some in the industry are titling this entire series of events “Operation Choke Point 2.0”, a reference to the original Operation Choke Point that sought to de-bank businesses deemed unsavoury by the Obama administration, including Payday lenders and arms dealers. The law firm Copper & Kirk LLP has put out a fascinating paper outlining their thoughts of Operation Choke Point 2.0 that is well worth a read, considering they were the firm that also successfully sued the banking regulators (namely the Fed, the FDIC and the OCC) and put an end to the previous Operation Choke Point.

Liberty! Freedom! Tyranny is dead! Run hence, proclaime, cry it about the streets!

These were the words proclaimed following Caesar’s assassination, as the conspirators took to the streets to celebrate what they thought was freedom from Caesar’s tyranny.

As it happened, they were met with silence. The citizens of Rome, upon hearing rumours of what had taken place, had locked themselves in their houses. The noble act, undertaken by these senators, was meant to restore the Roman Republic. Yet, they merely precipitated the end of the Roman Republic, leading to the rise of the Roman Empire following the Liberators’ civil war and eventually the Principate period of the Empire.

It’s unlikely that the stabbing of crypto’s modern day Caesar, in the form of the system as we know it, rather than any individual player regardless of size, can be averted.

The Balaji bet of Bitcoin’s price heading to $1m appears to be an assertion that these very actions of regulators, designed to shut down crypto in its current shape and form, could well precipitate the rise of something unforeseen: taking into consideration the liabilities in the US banking system, the global reliance on the USD and the need to maintain solvency of the entire system, the premise – ideological as it may be – that he is taking is one of the doors being shut to prevent value from flowing out into a system (crypto) that is beyond the control of US regulators.

We don’t claim to know what will come next, but it is clear that neither side will go down without a fight. Fights are messy, and when in the business of managing risk, it is typically unwise to hold on to an ideology through a fight – regardless of whether it turns out right in the end.

Our immediate response to all of this was to take our assets off Binance, where we were trading futures. We crystallised unrealised losses by trading at a time that was far from optimal. But the risks had fundamentally changed, and so did the game. And it is far preferable to take a trading loss than lose entire chunks of collateral.

More importantly, we needed to remove ourselves from the scene in order to best assess the rapidly changing lay of the land.

Where do we go from here? We find it unlikely that the US authorities will fail to shut down USD involvement in crypto, at least in its current form. Maybe a Fed-issued CBDC comes eventually – after all, the groundwork seems to be being laid, with the likes of NASDAQ going for digital asset custody. The US wants crypto, but only if it’s under its control and purview. It currently isn’t, so it has to change – and that’s probably bad news for all the crypto incumbents. The mismatch of ideology, regardless of who is right, is likely to produce outcomes in regulators’ favour.

But therein lies the potential twist in the story: if the “tyrant” Binance is shut down, subverted by the dismantling of the USDT system, does the value flow back to the traditional system, into the hands of US banks? Or does it flow even further out, into BTC and ETH, arguably the only two “digital commodities” as defined by the CFTC (through the NFA) in this circular to members?

The Balaji bet goes for the latter, the US regulators are going for the former.

So, when freedom from tyranny – from the thieving exchanges that hunt your stops and trade against you, from the money launderers and tax evaders that pollute decentralised liquidity, from the pump and dump YouTube influencer schemes and Discord channels – is proclaimed, the question is whether the people will rejoice with greenbacks or lock their doors with digital commodities, leaving the streets in desolate silence before an oncoming storm.