The dark side of the Luno crypto exchan…

On Thursday last week, US-based cryptocurrency lender Genesis Global Holdco filed for bankruptcy, becoming yet another crypto firm to collapse in the aftermath of the FTX fiasco. South African crypto investors are affected by this because SA’s leading crypto exchange, Luno, was bought by the Genesis group in 2020. What exactly is going on here?

You are not going to believe me when I tell you this, but it’s complicated. The first question holders of crypto in Luno have is — of course — whether my bitcoin (or whatever) is still worth anything.  And the short answer is that Luno was not included in the companies of the group that were declared bankrupt. So technically, your bitcoin is safe — for now.

But listen up because there is a question in the market now about whether Luno can avoid at least some of the fallout from the crypto meltdown. On the positive side, it’s important to note that as far as we know now, Genesis did not engage in the same kind of financial shenanigans as FTX. But it does have a different problem.

The root of the problem is simply this: if you invest in crypto, that is your money and good luck to you. The value of your investment rises and falls with the market. The question for crypto intermediaries is: how do they make money? In normal investment finance, the answer would be simple: intermediaries make money because you agree to pay them a fee for the pleasure of investing your money. If they invest it well, they get paid. And this is the joy of the financial services industry: if they invest it badly, they still get paid. Ha! But of course, there is a risk you will move your money elsewhere.

With crypto, actually, you don’t really need an investment adviser to make the tricky decisions about where in the world to invest your money and in what assets. You have already invested it in your chosen crypto coin. Of course, you could move it from one form of crypto to another — you might need advice on that — but the nature of the crypto market is much simpler than, say, making complicated investments in the gazillions of companies out there.

So for the crypto intermediaries, there has to be some kind of superstructure that uses the value of the crypto in the possession of crypto holders — that would be you — and tries to make a turn on that value. Enter, the technical financial stuff.

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What FTX did, if you believe the press reports, was outrageous. The company used the collateral offered by crypto investors to invest in a crypto coin of its own minting, which it then lent, for a fee, to itself. A-mazing-ing.

I can hear you asking, how is it humanly possible that anyone could get away with a scam so transparent? Well, like with so many scams out there, pretty easily, it turns out. The whole infrastructure rested on two things: first, when you talk about crypto, people’s eyes glaze over. It’s too complicated. And second — and this will really shock you — greed. When there is money to be made, people look the other way. Or pretend to understand. Or something.

Anyway, how is Genesis different from FTX? Is it different? How is it the same as FTX? The whole story is not out yet, so this could change, and change very fast. But, as far as I can see, the big difference is that Genesis’ problem relates to a question about whether the organisation was breaking securities rules. A related entity to Genesis, the Gemini Trust, offered customers the option of earning “interest” on their passively held crypto by “lending” crypto to Genesis, which then would go and invest.

The US Securities and Exchange Commission (SEC) claims this product, called the Gemini Earn programme, effectively amounted to the offering of unregistered securities, which is illegal. But it’s tricky because Genesis claims this is like a bank account, it’s not a “security” as legally defined. To which the SEC would, you might expect, reply: Okay, so you are a bank then? So you comply with all those hundreds of banking regulations, and have deposit insurance and all that stuff? To which Genesis presumably replies: Er… sorry, I just have to take this call. Anyway, Gemini Earn has now been closed down, but the court case continues.

Gemini has, or had, around $3-billion in assets. Or perhaps less. So, you ask, what did Gemini invest in? Surely it invested in “safe-as-houses” investments, right? It surely wouldn’t invest in more crypto, would it? That would be like increasing the risk, not decreasing it. They wouldn’t be that stupid, would they?

Oh dear, if you believe that, then you are a little unfamiliar with the mindset of the crypto set. Gemini did invest, hugely, in a crypto hedge fund called Three Arrows Capital. Well, it wasn’t an “investment” so much as a $1.1-billion “loan”. The question is, how will that be paid back? And the answer is: nobody knows. Anyway, Genesis and Gemini are now in bankruptcy protection, so, as far as I can see, Luno crypto holders are protected.

But the problem is that this is all still up in the air.  And in the larger scheme of things, it asks a tricky question not only about crypto itself, which is obvious, but also for the crypto intermediaries out there. And the question is existential: how exactly are they adding value? As of now, the answer is that in most cases they are not. DM/BM