Outrunning Even the Worst Parts of Finance

Outrunning Even the Worst Parts of Finance
8 June 2022

This column explores cryptocurrency markets from the perspective of a somewhat-grizzled trading veteran with a quantitative background and perhaps too much experience doing derivatives janitorial work. Finance is an old industry with a long history of everything from productive innovation to cartoonish fraud. Here we take a grand skeptical tour of a new corner of that world, with two tools that have consistently helped traders for millennia in our steamer trunk: math and knowledge of the past.


So the Commodity Futures Trading Commission (CFTC) filed some pretty strong looking charges against Gemini.

The long-running joke about crypto speed running financial history looks to be coming home to roost. Gemini is (was!), generally considered to be a top-tier exchange that does their best to follow the rules, even if it means giving up business.

Of course, there is nothing new here. In 1991 Salomon Brothers was caught doing some dodgy stuff in Treasury bond auctions. Someone went to jail. Roger Lowenstein summarizes the situation well in When Genius Failed as “Though now Salomon did report the matter, the Treasury and Fed were furious. The scandal set off an uproar seemingly out of proportion to the modest wrongdoing that had inspired it. No matter; one simply did not – could not – deceive the U.S. Treasury.”

Very roughly: there are limits on how much of a bond issue you were allowed to buy. Certain types of customer orders were exempted from that limit. And Salomon was pretending (lying) that some bids were of that customer type when they were really for the house. This is, pretty inarguably, unacceptable behavior.

Enter Gemini. Of course we as-of-now have no idea what defense Gemini might bring. But, say what you will about the CFTC and regulators, court papers filed in the Southern District of New York are taken seriously. This document is pretty wild. Let’s enjoy some of the comedy here. Maybe none of this is true. It is, however, worthy of consideration as these are serious accusations made in public by serious people.

First off: they identify two individuals as “Gemini Principal-1” and “Gemini Principal-2” by code names. This is not what Churchill was talking about when he described Russia as “a riddle, wrapped in a mystery, inside an enigma.” We all have a pretty good guess who they are talking about. This isn’t like when Trump was listed as “Individual-1” and we kind of had to guess. This is as if he was identified as Fervently Gesticulating President-1.

The most off-the-wall paragraph is 107:

During the Relevant Period, in addition to not informing Commission staff of the existence of the bespoke or custom fee arrangement, Gemini did not inform Commission staff that it had chosen to suspend an employee who had been speaking for Gemini at the meetings or that Gemini Principal-1 and Gemini Principal-2 had formed the belief that this employee was not trustworthy.

The accusation is not only that one of the members of the team negotiating with the CFTC was fired for dishonest behavior. But, after that person was fired, the CFTC asked why they weren’t at the meetings anymore and Gemini neglected to mention they’d been fired for dishonest behavior. Also, one imagines they never retracted all that person’s statements. It would be kind of weird to say, “Yeah, they are in a different department now. No biggie. Also can we retract everything that person told you and forget it ever happened? You’d really be doing me a solid.”

We also get a bit of a look into how Gemini management sees their role as exchange operators.

As Gemini Principal-1 then wrote in an internal message to several other Gemini personnel regarding self-crossing and the Gemini Bitcoin Auction: “it’s really up to the MMs . . . MM’s are grownups, they can figure it out.”

“Self-crossing” means people trading with themselves. It’s meaningless if I sell something to myself, on an exchange or otherwise. There is no good economic reason to allow that, certainly not a lot of it. If you run an exchange and find your customers are trading with themselves all the time what are you supposed to do? One intellectually honest answer is to say “my customers are grownups, they can figure it out.” That is, quite plainly, running a free market. But if those trades feed into your special Auction process and that thing says “Trust Is Our Product” at the top of the page that seems different. If it said “our clients are grownups and these numbers are our product” that would be fair.

It would also be fair to disclose that sometimes:

…shortly before the first Gemini Bitcoin Auction, a potential auction participant expressed concerns to Gemini personnel about having cash or bitcoins (btc) in their account in order to participate in the auction and asked for a line of credit. In response, a Gemini personnel indicated, among other things, “I can ask [Gemini Principal-1 and Gemini Principal-2] if they’d do a personal loan to you guys for btc.”

That last line is quoted in the original document so the CTFC clearly has an email or recording or something. Or maybe they hired the dishonest person from those earlier meetings and made it up. At this point who really knows.

Also it’s worth mentioning that, at the time, this Gemini Bitcoin Auction was the sole pricing source for settling Cboe Bitcoin futures. So not a random irrelevant number. Those futures are now gone so at least any problems stopped with them in 2019.

Back to the main story, where we sort of do know what was happening because:

As Gemini Principal-1 explained to another Gemini personnel in an internal Gemini communication in or around August 2017, regarding certain Gemini market maker customers, “a number of them are using my capital, which makes up a material amount of their balance sheet.”

So a material amount of the assets of some market making customers was in fact borrowed from the exchange’s management in a personal capacity?

It is of course possible the CFTC made this up too. But they are the CFTC. It is easier to believe Seth Rogen wrote this as part of some The Big Short spoof where Jonah Hill and James Franco play charmingly confused hedge fund managers than that it was dreamed up by lawyers at the CFTC. Truly anything is possible here.

Alas this is where we part ways with re-running financial history. Does management sometimes have to inject personal funds to keep a business afloat? Sure. Does management lend their personal assets to clients so they can do fee-free wash trading during a “Trust Is Our Product” auction? No. That is a new one. That does not happen.

We went through the looking glass in 2017 and just found out. WAGMI? Congratulations. We made it.

Jon Reiter
Jon Reiter

Jon is a long-time derivative trader and quant that’s done both modelling and market-making work in New York, London, Tokyo and Singapore. Lately he’s applying traditional finance techniques in the blockchain space.

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