[NEWS IN FOCUS] Do Kwon and the regulators: Catch me if you can

Finance

Published: 23 Jul. 2022, 12:38 Updated: 29 Jul. 2022, 14:10

[NEWS IN FOCUS] Do Kwon and the regulators: Catch me if you can

An electronic display shows the falling price of a cryptocurrency at an exchange in Seoul on July 19. [NEWS1]

Forty billion dollars of value vanished, and so did the creator of the crypto coins that shook the market and affected the lives of many people in Korea and elsewhere.

Do Kwon has gone to ground. Holders of Luna and USDTerra, in the hundreds of thousands in Korea alone, are so far out of luck.

Over the next few months, and possibly years, the world's ability to deal with cryptocurrency failures will be tested. It will be seen whether regulators and prosecutors are able to handle the case and work their way through possible crimes involving blockchain-based virtual assets, which have no real center and have victims globally.

They could end up uncovering the biggest Ponzi scheme ever and getting convictions to match.

"Kwon Do-hyeong's case could result in an outcome similar to that for Madoff's Ponzi scheme," Cho Jung-hee, a managing partner at D.Code Law Group, said using Kwon's full name.

It is also possible that they walk away with nothing. Kwon has suggested in the press that he did nothing wrong and that there is a difference between failure and fraud.

Even if there is wrongdoing to be found, the regulators and prosecutors may not be up to the job. So far, it seems that might be the case. Singapore has gone silent despite the company behind the coins, Terraform Labs, being incorporated there and Kwon apparently working from the country.

Korea has been mixed in its response, at first saying that little could be done and insisting that law and regulation are still insufficient to deal with crypto.

Getting to the bottom of the Terra-Luna fiasco may be a long game. The plot is already thickening around the globe, from Seoul and Manhattan, with a range of characters — U.S. bureaucrats, Korean prosecutors, class action attorneys and disgruntled retail investors — dealing with the issue to one degree or another. If a crime is to be found, evidence of it may emerge slowly from disparate efforts attacking the problem from different directions.

The case of the missing billions is setting to play out like a slow-burn procedural with a few twists and turns.

A livestreamer on Korea's AfreecaTV that goes by the name "Chansus" arrives at the Seoul Seongdong Police Station in eastern Seoul on May 16 to be investigated on charges of trespassing at Terraform Labs CEO Do Kwon's residence. [NEWS1]

Potential damages

Potential damages are clear and huge.

In Korea alone, more than 200,000 people are said by the government to have been investors in the coins at the time of the collapse, in which Luna and TerraUSD lost nearly all their value. Some were investors in the Anchor Protocol, where rates of up 19.5 percent were promised for crypto deposits.

Corporate Korea has also taken a hit. Uprise, a Seoul-based crypto startup running a robo-advisor algorithmic trading service, reportedly lost around $20 million in trading Terra.

Kakao-backed Uprise said on July 11 that it faced "big loss" due to the volatility of Terra coins in May. The company, established in 2018, refused to reveal the total loss, but local media reported it at around 26.7 billion won ($21 million), citing sources from investment banks.

The company received investment from Kakao Ventures, KB Investment and Shinhan Venture Investment.

Kakao Ventures invested in a special purpose company established by Terraform Labs in 2018. It has not disclosed the amount it invested.

"We retrieved some of the investment, but we still have some ownership left in the company," said Jeong Ji-young, a spokesperson for Kakao Ventures. "As it became difficult for the company's value to rise, the future of the invested funds has grown dark."

Outside of Korea, the losses are adding up. 3AC, a Singapore-based crypto hedge fund, filed for bankruptcy in July. The company, which was reported to have $10 billion in cryptocurrency earlier this year, held $3 billion in assets as of April, according to the court filings.

Crypto lender Celsius, headquartered in Florida, filed for bankruptcy protection on July 13. In October 2021, CEO Alex Mashinsky said the company had $25 billion in assets under management. Now, Celsius owes its users around $4.7 billion, according to its bankruptcy filing.

More broadly, the failure of the two coins, with Luna and TerraUSD operating together to maintain the TerraUSD peg to the dollar, has caused untold devastation. Unconfirmed reports of lives being destroyed clog the discussion boards, with some people claiming to be broke and desperate. The cracking of Terra-Luna had a profound and continuing effect on faith in crypto in general and shook other financial markets, with whispers about a contagion, a Lehman-moment and systemic risk.

The regulators have started in on the case.

Even before the collapse of the coins, some investigations were underway. The U.S. Securities and Exchange Commission has issued a subpoena to speak with Do Kwon and other Terraform Labs principals about the Mirror Protocol.

According to a Bloomberg report citing an unnamed source, the SEC is also looking into TerraUSD directly for potential violations of federal investor protection regulations in the marketing of its coins.

In Korea, the National Tax Service has been investigating Terraform Labs principals for tax evasion since 2021, while the domestic prosecution in Korea has started to investigate Terraform Labs and co-founders Kwon and Daniel Shin on charges of fraud and fundraising without approval.

In June, prosecutors raided the NTS to get more information for their case, and on Wednesday, the Seoul Southern District Prosecutors Office raided seven crypto exchanges seeking information related to TerraUSD and Luna. They also raided other locations in connection with the case, including Shin's residence in Seongdong District in eastern Seoul.

Some employees of Terraform Labs have been prohibited from leaving Korea.

Class action suits have been filed in Korea and in the state of California, while the head of the U.S. Commodities Futures Trading Commission, the U.S. Comptroller of the Currency and the U.S. Treasury Secretary have all commented on the crash.

Justice Minister Han Dong-hoon met with Andres Griswold, co-chief of the Securities and Commodities Task Force at the U.S. Attorney's Office for the Southern District of New York, and Scott Hartman, chief of the Securities and Commodities Fraud Task Force of the same office, on July 5, and they agreed to share information on crypto cases.

Lawmakers hold an emergency seminar at the National Assembly in western Seoul to discuss reasons for the Luna crash and possible countermeasures in May. [YONHAP]

Innocent until proven

Kwon is suggesting his innocence, while Shin is working to distance himself from Terra-Luna.

People knowledgeable of the situation argue that Kwon should have known that the structures he had created were unsustainable.

"When it was pointed out that a 20 percent interest rate is impossible, CEO Kwon put on earphones," Kang Hyung-suk, a former software engineer at Terraform Labs, told KBS in reference to the rates being paid out through the Anchor Protocol.

Another former employee, who claims to have played a key role in development of Anchor Protocol, told JTBC that 3.6 percent was the appropriate interest rate based on his calculation and that he was told the rate would be 20 percent just a week before the service was introduced.

"Kwon must have known about the vulnerability of the stablecoin, but that does not cause a legal problem because it is a technical issue," Cho, the attorney, said. "A serious issue is with the Anchor Protocol. If the former employees testify, the testimonies can become meaningful evidence that could prove Anchor Protocol was a Ponzi scheme, and thus, Kwon's fraud."

Even if evidence of a crime or a regulatory infraction are found, at least one attorney wonders whether that will result in a meaningful punishment.

"The collaboration won't be that helpful in investigating the Terra crash," said Park Po-jun, an attorney at the Kisung law firm. "Kwon vanished in July. Even Singaporean police can't find him. Unless he is found, only Terraform Labs former executives will be punished for embezzlement or negligence, charges that are far from the essence of this issue, a Ponzi scheme."

Bernie Madoff, who ran the biggest Ponzi scheme to date, was jailed for 150 years.

BY JIN MIN-JI [jin.minji@joongang.co.kr]