5MF (WEEK 49): SBF INVESTIGATED FOR LUNA CRASH, CRYPTO’S 2022 FUNDING RECORD

Five Minute Finance

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12 min readDec 9, 2022

The 5-minute newsletter on the important stuff in finance — explaining what’s going on, and why.

Let’s see what’s going on this week:

Mazars Report: Binance Reserves Fully Collateralized
Retail Says it Sees the Bottom Coming
SBF Facing ‘Inquiry’ Over Cause of LUNA/UST Crash
Warnings Over $80 Trillion FX Swap Debt from BIS
2022 Crypto Funding Likely to Outperform 2021

Binance Audit Looks Good, but was it Really More of an ‘Assessment’?

Binance’s Bitcoin Reserves Are Fully Collateralized according to Auditing Firm Mazars (link)

Binance Slightly Overcollateralized

As the smoke clears from the collapse of FTX, the total crypto market cap is reeling from a $177 billion value loss.

More importantly, customer exodus is underway as over 200,000 BTC has been pulled off exchanges during the last 30 days.

Simultaneously, the responsibility of Binance has only grown. It is now the super exchange that handles 75% of users’ global trading volume. It would then be quite important to vet Binance’s holdings, right?

This happened on Wednesday when Mazars issued its Binance report. Mazars is an international accounting and auditing firm spread over 90 countries and employing +44,000 experts. By demanding Binance to execute small transactions across its wallets, Mazars reached the conclusion that the exchange’s holdings are, in fact, overcollateralized.

“At the time of assessment, Mazars observed Binance controlled in-scope assets in excess of 100% of their total platform liabilities,”

This aligns with Binance’s own proof-of-reserve snapshot that showed 101%:

Although this is good news for the crypto industry’s stability moving forward, an important aspect should be noted.

Mazar conducted an auditing procedure (AUP) in a way that the client (Binance) provides a list of tests to conduct. Mazar, as the Certified Public Accountant (CPA), then executes those tests and reports the findings.

In this case, those findings are favorable for Binance. But, AUP should not be confused with a proper financial statement audit. In that case, Mazar would’ve planned out Binance’s risk areas, to then collect and analyze evidence in support of Binance’s financial statements.

Francine McKenna, an accounting lecturer at The Whorton School at the University of Pennsylvania, brought up such concerns:

“They did a comparison of balances per public key address from a list they got from management. They did not compare any balances in independent banks or custodians or depositories… This is more worthless than even the Tether or USDC report”.

So while the review by Mazars seems more like a general assessment than a bullet-proof audit, it seems as though there are no red flags for Binance at the moment. Considering the shaky footing that centralized exchanges are currently standing on, that’s still a pretty good sign for the crypto market.

Survey: How Retail is Prepping for the Bottom

VIX Up 2% as US Equities Tumble Amid Increased Volatility (link)

Economic Weather Heading Into Recession, Retail Investors Prepping

Economic indicators are aligning themselves in a recessionary direction.

Volatility index (VIX), measuring investor sentiment, went up +2% on Wednesday, to its highest point in over two weeks. A higher VIX percentage means more volatility — and investor uncertainty.

The relationship is pretty simple: When VIX goes up, markets tend to go down:

The relationship between VIX and SPX was close to perfectly inverse this year. When SPX performs poorly, VIX goes up and vice-versa. Image credit: Trading View (MFHoz)

Because VIX is calculated through option prices, a declining VIX typically indicates that investors are relatively confident about the future market direction. Like clockwork, the S&P 500 went down -1.87% this week, while VIX went up by +2%. Moreover, West Texas Intermediate (WTI) crude oil is down -4.86% year-to-date, the lowest this year at $72.14 per barrel.

Reduced oil demand is more often than not a sign of a slowing economy that is about to turn into a recession. Consumers and businesses alike reduce their consumption of goods and services that require oil.

To add to the noise, the world’s largest asset manager, BlackRock, warned to “prepare for a recession unlike any other”:

“The old playbook of simply ‘buying the dip’ doesn’t apply in this regime of sharper trade-offs and greater macro volatility. We don’t see a return to conditions that will sustain a joint bull market in stocks and bonds of the kind we experienced in the prior decade.”

That’s wise to keep in mind, considering the Federal Reserve itself hired BlackRock at the height of the market crash in March 2020.

This suggests that a recession is yet to be priced-in when it comes to stocks. And it also means that Fed’s actions will not have as much sway as they used to, even when it comes to positive actions such as reduced rate hikes.

If you ask retail investors, they think the stock market will bottom next year. Just 1% plan to sell off their investments in 2023, according to a recent survey.

The survey involved 2,300 retail investors across the globe. A third of survey participants plan to invest more in 2023 than this year, while individual stocks remain favorites.

72% of respondents plan to invest in Apple, Microsoft, Google, Facebook and Netflix.

The most likely investment category picks in 2023 per a recent retail investor survey. Image credit: Fortune

That’s a strong vote for bottom confidence, considering Big Tech stocks lost ~$400 billion this year, up until October.

Index funds follow individual stocks in popularity, at 60%, while crypto is still ahead of real estate, at 38.2% vs. 34.8%.

Predictably, cash is ahead of bonds, at 28.5% vs. 24.2% retail investor preference for 2023.

By the latest Reuters polling, 60% of economists believe a recession will hit two straight quarters in 2023. On the upside, 35 of 48 economists say that any recession would be short and shallow.

Only time will tell if BlackRock is overstating its recession outlook.

Is SBF to Blame for the Collapse of… Terra (LUNA)?

FTX Founder Sam Bankman-Fried Is Said to Face Market Manipulation Inquiry (link)

New Alameda Accusations Lead to Investigation

Three forces commingled to shrink the total crypto market cap by -60% in 2022, from $2.2 trillion to $0.8 trillion.

The Fed’s interest rate hike is the overarching force that triggered overall suppression of asset prices. In turn, this ended the supercycle rumors and crypto’s yield-bearing experimentation.

As investors fled Terra’s Anchor protocol (which offered an 18%+ APY), this brought down both Terra (LUNA) and its associated TerraUSD (UST) algorithmic stablecoin. The latter depended on LUNA’s price to remain pegged to the dollar. When LUNA dropped, this wiped out ~$18 billion across Terra’s blockchain ecosystem, with a further ~$40 billion in contagion damage.

Ouch.

This is where Sam Bankman-Fried became prominent, hailed by the mainstream media as the bailout king, or “JP Morgan of Crypto”.

While SBF’s FTX/Alameda fraud is still unraveling, it is now speculated that SBF and Terra are more of a single second negative force, rather than two separate forces as previously thought.

The New York Times broke the news on Wednesday that federal prosecutors are probing whether SBF manipulated UST and LUNA prices so much so that it created the domino effect leading to the fall of FTX itself last month. The investigation is still incipient, but it is based on several occurences:

A flood of sell orders for UST, placed rapidly, and in small denominations.
A subsequent difficulty to match sellers with buyers.
As sell orders lingered, the price of UST dropped, which then sunk the price of LUNA, which then further suppressed UST as part of a vicious cycle.

The NYT reports that some of these sell orders came from Alameda. Yet Alameda allegedly also placed a big bet on the price of LUNA falling.

It appears as though Alameda worked as something closer to a subdivision of FTX rather than a separate market-making entity.

For instance, FTX exempted Alameda from margin calls (auto-liquidation). This was in John Ray’s declaration as part of FTX’s bankruptcy:

John Ray’s shocking report on FTX’s bankruptcy.

But, there is a glaring hole in this storyline of Alameda trading having caused the UST depeg, and then placing a bet that LUNA price would fall too.

Blockchain data, collated by @Cycle_22 who had discovered Hodlnaut’s insolvency, shows that Terraform Labs (TFL) themselves rapidly sold $450 million worth of UST weeks before the depeg.

Dumping of UST on Curve decentralized exchange. Image credit: @Cycle_22

In other words, not only did Alameda lose money during the UST’s depeg, as shown by their negative USDC stablecoin flow, but Terraform Labs had apparently exerted the same kind of selloff pressure of UST into the Curve exchange.

Purportedly, Terraform Labs, alongside Luna Foundation Guard (LFG), did that to swap UST for $1.5 billion worth of BTC in an over-the-counter (OTC) swap with Genesis Trading and 3AC hedge fund (both of which are now defunct).

That was the bid to bolster the failing UST peg, while also depleting UST from Curve? So, was this just a case of wrong timing? Blockchain researcher @FatManTerra has suggested a different dynamic was afoot.

In response to the NYT article, Terra’s Do Kwon is now hinting at Genesis Trading having provided Alameda the loan to depeg UST.

The truth is, with so many shady characters involved, nobody really knows what transpired. From the outside, casual observers see it as an extensive maze filled with dark tunnels that even authorities struggle to unravel.

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New Old $80 Trillion Vulnerability Uncovered

BIS Concerned as FX Swap Debt Swells Up to $80T (link)

BIS Waves Red Warning Flag

In its recent quarterly review, BIS revealed a ginormous $80 trillion debt liability in the foreign exchange (FX) markets.

The FX market is the world’s largest liquid market, accounting for $6.6 trillion in daily average volume. The reason for this is simple. Whenever a company needs to tap into foreign markets, they go to FX to swap domestic currency for foreign currencies. However, BIS revealed $80 trillion in FX obligations as swaps and currency derivatives:

$26 trillion among non-banks, such as pension funds, outside the US.
$39 trillion among non-US banks that have limited access to credit from the Federal Reserve.
$15 trillion as on-balance sheet dollar debt.

Meaning, non-US financial institutions owe $65 trillion in dollar-denominated debt in FX swaps/currency swaps and forwards. This rolling debt is the motherload of debts, larger than the combined sum of dollar Treasury bills (short-term government debt), repo (repurchase agreement borrowing for short-term liquidity), and commercial paper (short-term corporate debt).

But why would financial institutions, like pension funds, go into FX debt?

Let’s take the forward derivative as an example. If a trader believes that the value of the US dollar will increase relative to the euro in the coming months, they can enter into a forward contract to sell euros and buy dollars at a predetermined exchange rate on a specified date in the future.

This allows the trader to lock in a favorable exchange rate and protect themselves from potential losses if the market moves against them. Such bets make up trillions of dollars, with ~80% having a maturity under one year.

Enormous liabilities have to be rolled over in just under one year. Image credit: BIS

The implosion of this massive rollover debt would then depend on a multitude of factors, with currency fluctuations and counterparty businesses still being in the game as the biggest ones.

Moreover, given that the dollar makes up ~87% in FX trades, other central banks would have to print their domestic currencies to feed the debt, which would only exacerbate global inflation levels.

At the same time, many key cogs could wind up broken as central banks raise interest rates to combat inflation. Suffice to say, this is a very dangerous and fragile combo as the underpinning of the global financial system.

With the right (or wrong) stressful market event, BIS warns that the situation could send serious shockwaves across all markets.

Amid Crypto Winter, VC Funds Continued to Pour In

Despite FTX Blowout, Crypto Funding Set to Surpass 2021 Record (link)

Crypto Saw Plenty of Funding in 2022

A recent survey ranked crypto investments at third place for retail investors in terms of overall preference for 2023’s outlook, sandwiched between index funds and real estate, at a 38.2%.

Another report from PitchBook ads to the big crypto investment picture. As dire as the FTX and Terra (LUNA) fallouts may seem, venture capital (VC) funding of crypto projects in 2022 is heading to exceed 2021.

In the first 9 months of 2022, VC firms poured $19.9 billion into the crypto space, which is +44% higher than the same period for 2021.

However, there is a considerable slowdown in Q3 2022, as VC funding dropped by -38.3% compared to Q2 2022. Q3’s total figure is around $4 billion.

But the sign of the times is definitely here. Web3, with its hype as the next iteration of the internet based on blockchain and AI, saw a surge in VC funding in Q3, at $1.5 billion. This surge in Web3 startups is +44.5% higher than in Q2.

NFT sales also dropped by -68.2% in Q3 2022, as NFT trading activity continues to decline as well.

Naturally, things slowed down a bit as 2022 went on. And, it’s likely that they’ll only get worse post-FTX.

Yet if the crypto space can successfully overcome the rough year of 2022 and rebound with more transparency and security, then the industry could eventually continue down this same path of seeing plenty of investor activity — from both retail and large VC firms alike.

Tweets of the Week

Over the last 30 years, in an average recession the Fed ends up cutting rates by almost 400 bps.
And 300 bps of cuts happen in the first 12 months.
The bond market is pricing at best a 40% chance of a proper recession.

@MacroAlf

Ethereum developers determined on Thursday that the next hard fork, called “Shanghai,” will have a target release time frame of March 2023. This upgrade will include EIP 4895 that will allow Beacon Chain staked ETH withdrawals.

@WuBlockchain

It’s been an interesting year

@WClementeIII

US **total** crude oil inventories (both commercial and the Strategic Petroleum Reserve) have fallen to a 36-year low, dropping below the previous bottom set in 2001 | #OOTT

@JavierBlas