Crypto collapse: Tornado Cash arrests, Federal Reserve shuts down Farmington Bank, Prime Trust played Terra-Luna

By Amy Castor and David Gerard

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“At this point, I think it’s near inevitable Sam’s going to try and copy Ross and hire a hitman to off his former girlfriend using 75pt Comic sans font on a non internet connected computer in the prison library in full view of the guards.”

— Rycochet

 

 

An ill wind

The US has charged Ethereum mixer Tornado Cash co-founders Roman Storm and Roman Semenov with laundering over $1 billion in criminal proceeds by operating Tornado Cash between 2019 and August 2022, when the US shut it down. [press release; indictment, PDF]

Storm has been arrested and Semenov has been added to the US sanctions list. Semenov was last heard of in Dubai, that jurisdiction of flawless international repute and tremendous civil liberties for your crypto. [OFAC; AP]

Tornado Cash was a stand-alone smart contract beyond any human control. But Storm and Semenov are being charged not with writing the code itself, nor even over the existence of the smart contract itself, but with “conspiracy to commit money laundering, conspiracy to operate an unlicensed money transmitting business, and conspiracy to commit sanctions violations” — by running a money transmission business that knowingly laundered criminal proceeds and funds for sanctioned entities.

Storm and Semenov made money from the Tornado Cash relays, which were the best way to use the smart contract. Their company, PepperSec, even got $950,000 in venture capital from an unnamed angel investor.

Merely operating the service was a long-standing violation of anti-money-laundering law — FinCEN expressly advised in 2019 that mixers are money transmitters. If you run a mixer in the US without registering, that’s a crime.

That’s bad enough — but actual crooks and sanctioned entities ran their dirty money through Tornado Cash. Storm and Semenov got messages from the victims of many crypto hacks — and even just those hacks added up to hundreds of millions of dollars in ETH.

The Feds got access to some of Storm and Semenov’s Signal chats — presumably via “CC-1” (or “Co-Conspirator-1”) from the indictment. We suspect that “CC-1” is Dutch Tornado Cash developer Alexey Pertsev, the third guy in PepperSec, who was arrested in August 2022, shortly after Tornado Cash was sanctioned, and was held in jail until April 2023. [CoinDesk]

The Axie Infinity hack of March 2022 appears to be what got the Office of Foreign Asset Control interested. North Korea stole $620 million in ETH and laundered $455 million of it through Tornado Cash.

Semenov and Storm blocked the North Korean hackers from the bit of the system that they ran — so North Korea started just accessing the smart contract directly. So Semenov and Storm could argue they aren’t responsible for this particular direct use of the standalone smart contract.

Storm’s lawyer, the highly competent Brian Klein at Waymaker Law, said: “We are incredibly disappointed that the prosecutors chose to charge Mr. Storm because he helped develop software, and they did so based on a novel legal theory with dangerous implications for all software developers,” because he has to, really. [Reuters]

Coinbase backed a suit against the Treasury to remove the OFAC sanctions on Tornado Cash. This suit has been thrown out. Judge Robert Pitman ruled that “Tornado Cash is an association” consisting of “its founders, its developers, and its DAO.” As such, Tornado Cash is “an entity that may be designated per OFAC regulations.” A similar suit filed by Coin Center is still in progress. [Doc 94; Doc 95; Coinbase-backed case docket; Coin Center case docket]

Sometimes you need to get their full attention

FTX-affiliated Farmington State Bank pivoted to digital assets in 2022 — in an attempt to create a stablecoin — without getting prior approval from its supervisors. So state and federal regulators have issued a cease and desist and the bank is being shut down. [Federal Reserve press release; Cease and desist order, PDF]

The joint enforcement action, from the Federal Reserve Board and the Washington State Department of Financial Institutions, bars Farmington from “making dividends or capital distributions, dissipating cash assets and engaging in certain activities” without permission. The bank has also been ordered to preserve all records.

This wasn’t a bank failure like the others this year — this was a bank getting shut down for bad behavior. The Fed didn’t take Farmington out back and shoot it — they made a point of taking it out front and shooting it.

Farmington was a tiny 135-year-old bank serving small rural towns in Eastern Washington. It’s operated out of the same one-story historic building since 1911 when it moved out of an office above a saloon.

But then in 2020, holding company FBH bought Farmington. FBH was controlled by Jean Chalopin, who is also the chairman of Deltec Bank — one of the main banks for FTX subsidiary Alameda Research and stablecoin issuer Tether.

Chalopin and Deltec are in the Bahamas — as were FTX and its founder Sam Bankman-Fried. FTX was one of Tether’s biggest customers.

Through Alameda Research, FTX acquired just under 10% of FBH on March 7, 2022, for $11.5 million. Ownership stakes below 10% don’t require regulatory approval. Just six days before, FBH had trademarked the name Moonstone Bank. Soon after, Farmington began doing business as Moonstone. [Press release, 2022; Justia]

When FBH took over Farmington, it agreed to maintain Farmington’s existing business model offering savings and loan services to farmers and ranchers in eastern Washington. Any change to this would require prior approval from the Federal Reserve Board of Governors, the Federal Reserve Bank of San Francisco, or the Washington DFI.

But in January 2023, Farmington did alter its business plan, quite radically. According to the Fed, Farmington made a deal with a “third party” to design IT infrastructure to “facilitate the third party’s issuance of stablecoins to the public.” In exchange, Farmington would get 50% of mint and burn fees.

We don’t know who the “third party” was or what stablecoin it was, existing or new, that Farmington planned to facilitate. Update: Looks like it was a new planned coin, US+ from Fluent Finance. [press release, 2022]

Soon after it went hard into the stablecoin business, Farmington/Moonstone announced it would be stepping away from crypto and returning to its roots as a community bank. We suspect the regulators had had a little word. [Business Wire]

Farmington, a state-chartered bank, did not have a Federal Reserve master account when FBH bought it, but it applied for one and was approved by the Federal Reserve Bank of San Francisco in June 2021. What a clever way to give a stablecoin access to central bank money. [San Francisco Fed, 2021]

We wrote before how Custodia in Wyoming tried to set up a stablecoin with access to central bank money, why this is bad, and why the Federal Reserve absolutely would not allow this.

The Fed says that “the Board’s action ensures the bank’s operations will wind down in a manner that protects the bank’s depositors and the Deposit Insurance Fund.” Farmington will wind down by August 31. The bank has sold all of its assets to the Bank of Eastern Oregon.

Farmington/Moonstone saw its overall deposits drop from $98.9 million in September 2022 to $16.3 million by the end of June 2023 after federal prosecutors seized $50 million from an FTX Digital Markets account at Moonstone.

Crypto custody is a steel when you’re playing Terra-Luna

Prime Trust has filed the first-day motion in its bankruptcy — and it’s a hoot. [Doc 14, PDF]

It turns out that Prime Trust had been gambling on Terra-Luna — and lost $6 million of customer money as well as $2 million of company money. This is despite previously claiming that “Prime Trust does not engage in any lending or borrowing services nor rehypothecation of customer assets.” [Prime Trust, 2022, archive]

But what killed Prime was the “Wallet Event.” Prime stored its ETH in a multi-signature address, the “98f Wallet.” The keys were kept in Trezor hardware wallets. The seed phrases were engraved on steel.

Prime migrated the stored assets to crypto custody firm Fireblocks between July 2019 and the first quarter of 2020. Believing all assets had been migrated, Prime disabled its own access to the 98f address. Unfortunately, customers were still sending crypto to the 98f address. This crypto is now unrecoverable — because Prime couldn’t find where they’d put the pieces of steel.

They tried to cover the hole by taking US dollars from “omnibus client accounts” to buy ETH to pay out the withdrawals — $76,367,247.90 in total.

Prime reported the Wallet Event to the Nevada Financial Institutions Division and other state regulators between September and November 2022.

The company says it worked with Nevada on the issues but suffered multiple “runs on the bank” — which it blames on “license revocations by certain state licensing agencies, negative press, incorrect reporting, and the demise of the BitGo transaction” — and so Nevada pulled the plug on Prime in June 2023.

Everyone in the C-suite who was involved in the “Wallet Event” was fired. But Prime has a wizard plan that will totally make customers whole by the fourth quarter of 2023! That’s a month and a bit away.

Everybody still hates Binance

Binance has lost its UK payment processor Checkout.com as of August 17 over money laundering concerns. Before this, Binance was one of Checkout’s biggest customers. Checkout was processing up to $400 million a month for Binance in recent months. [Forbes]

You’d almost think sanctions-busting was part of Binance’s business model. This time it’s money from Russia and blacklisted Russian banks using Binance’s peer-to-peer service. [WSJ]

Binance lost its Visa-branded crypto credit cards in July and is losing its Mastercards as of September 22. [Bloomberg, archive]

It woz my lawyers wot done it

Sam Bankman-Fried wants to invoke an advice-of-counsel defense and blame FTX’s lawyers for his rational decision-making. Prosecutors told Judge Lewis Kaplan that if Sam was going to say his lawyers did it, he needed to say who the lawyers were, so they named the lawyers: [Doc 222, PDF]

… Fenwick lawyers as well as in-house counsel for FTX, including Dan Friedberg, Can Sun, Ryne Miller, and others, were involved in reviewing and approving decisions related to these matters and others, which gave him assurance that he was acting in good faith.

At Sam’s new home in MDC Brooklyn, his lawyers say he’s been subsisting on bread and water and sometimes peanut butter because the prison has been unable to accommodate his vegan diet. The jail has also failed to supply Sam’s court-ordered medication. [Twitter, archive]

Sam and his lawyers have been trying to work out laptop and internet access to review discovery in time for his trial in October. Sam’s lawyers argue the material can only be viewed online. Judge Kaplan says that for now, Sam can meet with his lawyers in the courthouse cell block, but he has to give prosecutors 48 hours’ notice so they’ll have time to prepare hard drives of evidence for him to review. [Doc 223, PDF]

Regulatory clarity

The SEC has sued New York crypto investment firm Titan for promising ridiculous annual returns of up to 2,700% — based on assuming 21% in the first three weeks, on a completely hypothetical account, and extrapolating that to the rest of the year. Titan is paying out $192,000 in disgorgement and an $850,000 civil penalty. [SEC press release; Complaint, PDF]

Three Arrows Capital principals Kyle Davies and Zhu Su founded a new exchange, OPNX, to trade the debts of bankrupt crypto companies such as Three Arrows Capital. Dubai’s Virtual Assets Regulatory Authority has just slapped a 1.2 million dinar (USD $2.7 million) fine on Davies and Zhu and Mark and Leslie Lamb of CoinFLEX for violating investment promotion laws. [VARA]

PayPal is “pausing” UK crypto purchases as of October 1, 2023. The FCA has new rules on crypto marketing which take effect starting October 8 — including a “cooling-off” period for first-time buyers. So PayPal needs to work out how to reverse the irreversible. [FCA]

Coinbase has suspended stablecoins USDT, DAI, and RAI for Canadian users. Canada restricted trading of algorithmic stablecoins earlier this year after the collapse of Terra-Luna last year. [CoinDesk]

Nate Chastain gets three months in prison and a $50,000 fine for insider trading at OpenSea. [DOJ, Twitter, archive]

The unceasing drone of good news for bitcoin

If you follow crypto bankruptcies, and especially if you’re a creditor in a crypto bankruptcy, you’ll know Kroll, which supplies services to bankrupt companies. Kroll got hacked and lists of FTX and BlockFi creditors were leaked — the information that FTX wanted to keep under seal, but which they’re now calling “non-sensitive.” No passwords were leaked, just names and contact details. But watch out for scammers. [CoinDesk; Twitter, archive; Twitter, archive]

The Centre consortium that issued the USDC stablecoin is being dissolved. USDC issuance will be managed entirely by Circle. Coinbase has bought a share in Circle. [Coinbase]

In case you actually believed NFT bros ever gave a hoot about artists, they’re abandoning the royalty fees excuse — that artists would get paid a bit for resales. OpenSea will stop collecting royalties as of March 2024. But you can still optionally tip the artist! [OpenSea; Verge]

Zeke Faux from Bloomberg has a book about crypto, Number Go Up, coming out in September — it seems to be the season. Bloomberg has excerpted his section on social media scammers who use tethers, and the awful industry behind them. [Bloomberg]

CoinDesk’s El Salvador correspondent Jonathan Martin keeps trying and failing to use bitcoin there, with no more success than in his first report. He can see Bukele’s vision! In the Lightning future! If not at all in the present. Nothing works, but that’s good news. [CoinDesk]

Media stardom

Forkast on the UK and crypto: “Could Rishi Sunak’s blockchain dream live on without him?” With quotes from David. [Forkast]