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TerraUSD Contagion: How Prime Trust failed after investment in Terra algorithmic stablecoin.

Edward Aziegbe

“However, not all stablecoins are created equal”, stated Prime Trust in one of its blogs. “Efficient and effective stablecoins need a reliable storage place for the underlying supporting assets, and seamless technology to manage the redemption/creation process without disrupting value stability”, Prime Trust pointed out, priming its platform as the custodian to trust. That was in January 2021.

In June 2022, Prime Trust raised over $100 million in a series B funding round. This is after previously raising $64 million five years earlier.

In August 2023, the parent company of Prime Trust, Prime Core Technologies, filed for bankruptcy; no thanks to its investment in a different kind of stablecoin—the algorithmic TerraUSD. 

Prime Trust, a digital asset custody service and fintech infrastructure provider, serves a range of clients, ranging from crypto exchanges and wallet apps to broker-dealers and banks.

The TerraUSD Contagion

Terra collapse in 2022 was a major contagion in the crypto industry. In the same year, FTX, BlockFi, Celsius Network, and Voyager Digital filed for bankruptcy in the United States. From Celsius to FTX, the plague of alleged financial mismanagement, poor corporate, and sometimes outright fraud against management, have raged the crypto industry. According to Jor Law who took over Prime Trust as CEO in November 2022 after serving on the board, Prime Trust spent $11.1 million while its revenues were $2.7 million only.

In a Coindesk report, Prime Trust lost $6 million and $2 million in user funds and treasury funds respectively after investing in TerraUSD. Consequently, Prime Trust filed for a Chapter 11 bankruptcy at the United States Bankruptcy Court for the District of Delaware on 24 August 2023. At the time of filing, Prime Trust had liabilities amounting to about $100 million to $500 million and between 25,000 to 50,000 creditors. According to its June filing, Prime Trust owed its clients over $85 million (in fiat) and $69.5 million (in crypto). Reportedly, it held only about $2.9 million and $68.6 million in fiat and crypto respectively. 

According to Prime Core Technologies’ report, its investment in the algorithmic stablecoin that eventually collapsed in May 2022 and increased spending in October and November 2022 contributed to its state of bankruptcy. No doubt, the crypto winter must have also hurt Prime Trust’s revenue.

After discovering a “substantial deficit between its assets and liabilities”, Nevada regulators petitioned the court.

Nevada Financial Institutions Division (NFID), a regulator that has been actively monitoring Prime Trust’s solvency, discovered that Prime Trust had improperly utilized customers’ funds to cover withdrawals since December 2021. The Nevada regulator.petitioned the court in June 2023 to place the company and its parent, Prime Core Technologies, into receivership. According to the Nevada regulators, this is partly due to a “substantial deficit between its assets and liabilities.” 

Things were particularly difficult for Prime Trust as most of the digital assets under its custody were held in illiquid assets. (Digital asset platforms particularly should always ensure it has liquid assets.)

Of course, in a state of panic, many cryptocurrency companies have withdrawn their assets from Prime Trust.

Citing the risk of “irreparable harm” to users, the public and “confidence in the emerging market of cryptocurrency”, the Nevada court agreed. It ordered the appointment of a receiver for Prime Trust. 

Earlier, Rival crypto custodian service Bitgo called off its planned acquisition of Prime Trust. Obviously, Bitgo must have discovered reasons the acquisition could no longer go on.

Also in June 2023, Banq, a subsidiary of Prime Trust, filed for bankruptcy. This is due to alleged mismanagement under the former CEO, Scott Purcell. Besides, Abra, partner company to Prime Trust, received a cease-and-desist order in Texas for alleged securities fraud. It is definitely not prime time for Prime Trust.

Read also: Proof of Reserves 

Investing clients’ funds in TerraUSD is a breach of trust.

Prime Trust has failed to safeguard client’s assets under its custody. It is also unable to fulfill withdrawals. This raises trust issues, violating Nevada trust laws.

Interestingly, at the height of FTX collapse, Prime Trust had issued a statement on 15 November 2022 where Prime Trust acknowledged that “[w]e are experiencing a seachange in the digital asset industry following the fallout from FTX, Celsius, and Terra”. Continuing, Prime Trust stated that “[w]ith billions of dollars vaporized overnight, it is understandable that consumers and our customers are asking fundamental questions concerning the stability and credibility of all market participants.”

Reassuring its customers, Prime Trust stated that it “has no counterparty exposure to the FTX ecosystem” and it has the financial strength to execute fully on its customer commitments. “Despite extreme market volatility”, Prime Trust said, “our platform stayed available, secure, and stable.” But that was FTX, not Terra.

Though Prime Trust does not rehypothecate assets nor lend or borrow against customer funds (as stated here), the $6 million and $2 million in user funds and treasury funds respectively that Prime Trust lost is due to its investment in TerraUSD.

If after separating client funds from corporate funds a custodian still ends up investing such customer funds without the consent of its customers, it really does defeat the essence of not commingling funds.

Presently, Prime Trust operates under the bankruptcy court’s jurisdiction. Restructuring efforts will be led by the former President of the Bank of Nevada, John Guedry, while the bankruptcy process will be led by Judge Susan.

Read also: FTX Collapse: Does FTX Token (FTT) have a future?

Custody of digital assets is serious business; needs all the regulation it can get.

If crypto exchanges are the window to the world of digital assets, custodians are the vault.

Digital asset custodians ensure the safekeeping, storing, holding, or maintaining of digital assets for institutions and individuals. Digital asset custodians, amongst other obligations, are obliged to act in the best interest of their clients. They must avoid situations that are likely to involve conflict of interest with the clients. Commingling, investing, or rehypothecating clients’ digital assets does not safeguard the rights and interest of clients. Clients must have access to their digital assets at all times, subject to fraud or legal procedures such as bankruptcy proceedings.

To ensure the above, regulators should require digital asset custodians to establish adequate frameworks for conflict of interest management, cybersecurity management, fund management, internal audit management, and risk management.

This is why there should be a registration/licensing system for digital asset custodians wherever they operate. In the absence of such a registration/licensing system, self-regulation—not only individually but collectively under a digital asset industry body—becomes even more vital. Ensuring trust and confidence in the digital asset space is a collective responsibility and in the best interest of all responsible players in the industry.

Read also: Top 6 Hacks on How To Avoid Losses in Crypto Trading