Wormhole rescue shows crypto world can move fast and fix things, but winter is coming

IF there's one thing more shocking than the fact that a hacker was able to exploit a software bug and drain some US$320 million worth of cryptocurrency from something called Wormhole, it's this: Backers of the project were able to replace the pilfered tokens in a matter of hours.

In another, not-so-distant era, this was the type of coding bug that could have threatened to put a traditional financial firm out of business. In fact, that almost happened to Knight Capital Group a decade ago.

The electronic market maker was driven to the brink of bankruptcy by some bad code, before a dramatic bailout among many of Wall Street's best-known shops allowed it to avoid Chapter 11. The firm was later taken over by a rival.

Wormhole

In the case of Wormhole, the problem with the code turned out to be almost as disastrous as the one that forced Knight to seek a US$400 million cash infusion to survive. Yet the move-fast-and-break things ethos of the crypto world was met with a startling move-fast-and-fix- things response this time.

Jump Trading Group, which helped develop Wormhole, put up the money to replace the 120,000 wETH, or "wrapped Ether", that the hacker was able to create and then abscond with.

And it's not the only example. Last month, hackers fleeced the exchange BitMart to the tune of US$150 million in cryptocurrencies. BitMart, which had just closed a venture-capital funding round, used its own capital to cover the incident.

The incidents highlight just how much cash - both traditional and digital - is sloshing around the crypto world, and how quickly it can be put to work with seemingly little time spent put into thinking about the risks of throwing good money after bad.

Wormhole's saviour, Jump Trading Group, has roots that lie in the same high-frequency trading and electronic market making industry where Knight operated. Its quick and expensive response suggests that it sees enormous potential profits in crypto despite a 9-figure setback.

Development of Wormhole was originally started by a company called Certus One. Jump acquired Certus One last year and took over development of the Wormhole protocol, which is what's known as a "bridge" that connects different blockchains, such as Ethereum and Solana, to allow tokens to trade on blockchains other than their home turf.

Such a bridge helps traders avoid the famously slow and expensive transactions on the Ethereum network, which underpins many crypto projects.

In this episode, faulty code allowed a hacker to create, or "mint", a token tracking the cryptocurrency Ether on the Solana blockchain, and then move it back over to the Ethereum network.

Profiting from Wormhole

"Given the size of investment they have and continue to make, and the willingness to cover 100 per cent of this loss, I assume they intend to profit from Wormhole somehow in the long run," said Kyle Samani, co-founder of Multicoin Capital, which manages a hedge fund and venture fund in the crypto space.

Chicago-based Jump's efforts in crypto partly trace their origins to a group of interns at the University of Illinois, including Kanav Kariya, the head of the company's crypto division. In an interview last year, Kariya said Wormhole has enormous promise. "I don't think you can think big enough," he said.

Dave Olsen, the president of parent company Jump Trading Group, has compared the effort to the earliest American traders who met under a buttonwood tree on Wall Street in the late 1700s to hash out the structure and rules that would govern the New York Stock Exchange.

"In a lot of ways, we're getting back to first principles of trading," he told Bloomberg Businessweek in an interview last month.

As its crypto project was taking shape, Jump was, to put it generously, effusive in its enthusiasm. In an essay unveiling its approach to the space, the trading firm said it was always asking how it could do more.

"The resounding answer has become a battle cry for our team: to build," the firm wrote. "To build the plumbing and the railroads, and to build communities. The rhythm of that chant has driven us deeper into the ecosystems we're involved in and unearth the trove of system design and engineering problems that lie between us and the promised land."

In this case, a hacker helped them do exactly that. Yet it was a very expensive pit stop on the road to the promised land.

During the brutal cryptocurrency sell-off last month, volumes also tumbled - a development that doesn't bode well for exchanges that trade the digital tokens.

Total spot volume slumped to US$1.8 trillion in January, a decline of more than 30 per cent from the previous month, according to a report from CryptoCompare. That was the lowest turnover since the end of 2020. Even at its intra-month peak of US$91 billion on Jan 24, trading was down nearly 50 per cent from December.

"It's just an exceptionally quiet, fearsome and uncertain time in crypto," said Ed Hindi, chief investment officer and co-founder of Tyr Capital. "Smart money, as they say, doesn't sleep, it doesn't take holidays. But 3-day traders in crypto, they do take a break, especially when they get hurt," he said, referring to an industry term for institutional and other bigger players.

The decline in trading volume will have a direct impact on revenues for Coinbase Global and Robinhood Markets, according to Julie Chariell, a Bloomberg Intelligence analyst. Roughly 90 per cent of Coinbase's revenue and about 40 per cent of Robinhood's are driven by crypto trading.

Investors in digital currencies and other riskier assets have been shaken so far in 2022, rattled by a newly hawkish Federal Reserve that's getting set to withdraw stimulus from the system.

Bitcoin, the largest cryptocurrency, has lost a fifth of its value this year, while some smaller coins, as well as tokens influenced by social-media sentiment, have posted even larger drops.

An index tracking the largest 100 cryptocurrencies is down 26 per cent year to date, while the Bloomberg Galaxy DeFi Index, which bundles some of the largest decentralised finance protocols and apps, has tumbled 31 per cent in the same stretch.

Demand for all things crypto had skyrocketed in 2021, with crypto-asset manager Grayscale Investments finding that a majority of investors had gotten involved with the asset class during the year. That means the recent slump could be painful for anyone who got in relatively recently.

Underwater

In fact, a recent Glassnode analysis found that almost all of the supply held by short-term investors is underwater.

"Ordinary mortals' interest may take more time to heal," James Malcolm, head of foreign exchange and crypto research at UBS, wrote in a note, noting, however, that that's not necessarily the case in the venture-capital space.

It doesn't help that memories of the last "crypto winter" - a phrase endemic to the digital-asset space that refers to a sharp slump followed by months of doldrums - are renewing fears that a repeat could be playing out currently.

The last such decline happened in 2018, when Bitcoin fell roughly 80 per cent and subsequently took more than a year to reach another high. BLOOMBERG