SPACES CHAT: Jane Street vs the crypto markets
Below is an AI-assisted summary of today's wide-ranging Spaces chat on the implications of the Terraform Labs lawsuit against Jane Street, and broader peg-based systems.
Both the crypto markets and the wider trading world have been jolted this week by an explosive lawsuitfiled by the administrators of Terraform Labs against Jane Street, one of the world’s largest and most influential proprietary liquidity providers.
The claims, still to be tested in court and heavily redacted, allege that insider trading by Jane Street played a decisive role in the collapse of the Terra Luna algorithmic stablecoin system in May 2022.
Specifically, they state that Jane Street exploited privileged information about Terraform’s liquidity pool movements, withdrawing funds within minutes of a key internal shift and accelerating the de-pegging of TerraUSD. They further claim that the firm may have acted in ways that influenced bitcoin markets at a critical juncture, including around Terraform’s bitcoin-denominated reserves.
Whether the claims hold up remains an open legal question. But the case has already unlocked something more powerful: a wave of speculation about the structural power of firms like Jane Street — and whether the underlying plumbing of ETFs and stablecoins grants them asymmetric advantages that retail investors neither see nor understand.
The significance of the Terra Luna collapse, however, extends well beyond crypto lore.
The episode has become a foundational case study for regulators and central banks worldwide, shaping inquiries into stablecoin design, liquidity risk and reserve transparency. It has influenced parliamentary hearings, central bank research papers and forthcoming legislation aimed at tightening oversight of dollar-pegged tokens. If it were ultimately shown that insider trading, liquidity-provider conflicts or ETF-style market structure dynamics played a more decisive role than previously understood, many of those regulatory conclusions — which largely frame Terra as a simple case of algorithmic design failure and liquidity mismatch — may need to be revisited.
Those structural factors formed the backdrop to a wide-ranging discussion on Thursday among market practitioners, academics, and crypto veterans. Click below to hear the original recording. Read on for our summary.
A currency board for the digital age
As someone who has covered both ETFs and crypto for nearly 20 years — first at the Financial Times and Politico and now via Blind Spot and The Peg — I have long argued that stablecoins and ETFs are structurally similar. Both function as privatised currency boards oriented around maintaining a peg.
An ETF tracks an index; a stablecoin tracks the dollar. In both cases, confidence rests on reserves, arbitrage, and orderly creation/redemption. In both cases, opacity around reserves and settlement has generated periodic panic.
The Terra story, in that sense, echoes the famous “breaking the peg” episode when George Soros attacked sterling in 1992. In that case, traders exploited macroeconomic weakness in the Bank of England’s currency board. Terra, critics argue, may represent the privatised version: a private currency board whose vulnerabilities were attacked by sophisticated liquidity providers.
During the discussion, independent financial plumbing expert Frances Coppola cautioned that exploiting a structural weakness does not automatically equal insider wrongdoing. Terra’s algorithmic fragility was widely known. If Jane Street identified an opportunity to break a weak peg, that could be closer to Soros than to fraud.
Indeed, Coppola went further, suggesting that speculative attacks sometimes perform a cleansing function. Terra was widely regarded as fragile, even Ponzi-like in its yield mechanics. If a trader’s actions exposed that fragility, the resulting purge of weak structures — which preceded collapses at firms such as FTX — may have done the ecosystem a harsh favour.
At the same time, Coppola expressed scepticism that Terraform founder Do Kwon would ever be treated leniently, given the political climate. I noted, however, that hysteria can distort justice. The LIBOR prosecutions — including the controversial conviction of Tom Hayes — demonstrated how complex market structure issues can be flattened into criminal narratives under public pressure.
From Volcker to Delta One
The ETF dimension of this story cannot be separated from post-2008 regulatory reform. After the Volcker Rule curtailed proprietary trading by banks, risk-taking migrated into broker-dealer arms and “delta one” desks — business units focused on derivatives and index replication that could generate profits while remaining nominally client-facing.
Delta one became a major profit centre. ETF market making expanded rapidly. The business model was elegant: authorised participants (APs) could create and redeem ETF shares directly with issuers, arbitraging price differences between ETF units and underlying baskets.
This plumbing was largely invisible to retail investors. But it was here that privileges emerged, establishing the norms that allowed the close-knit relationship between former Terraform employee, Bryce Pratt, to continue on with his former employer once he joined Jane Street.
Authorised participants and regulatory exemptions
APs operate under regulatory exemptions not available to ordinary investors.
Because ETF shares can only be created or redeemed during defined daily windows, a market maker who sells shares after the cut-off time may not be able to complete the corresponding creation until the following cycle, generating temporary fails that are permitted under market-making exemptions.
In international ETFs, mismatched settlement cycles and market holidays can compound the lag. Supporters argue these flexibilities are operational necessities that keep liquidity flowing; critics counter that they create space for extended settlement chains that look, from the outside, like synthetic supply.
According to veteran market maker “Trading Dutchman,” these fails are not evidence of phantom shares circulating in the market, as some academics worry, but of mechanical timing differences between ETF creation windows and underlying market settlement cycles. International ETFs can further complicate settlement due to holidays and differing T+ cycles.
In Europe, he noted, settlement discipline is stricter, with escalating fines for fails. In the US, exemptions have historically been more permissive, though oversight has increased since episodes like the 2010 flash crash.
Nonetheless, critics still argue that these exemptions allow shadow supply to be created at will and to circulate freely. Practitioners insist they are bookkeeping artefacts in a fully collateralised system.
Kathleen Tyson, a veteran “liquidity plumber” with experience spanning triparty repo, FX and central banking, widened the lens further.
She argued that authorised participants in ETFs function much like interdealer brokers in wholesale markets — privileged liquidity providers operating with lower transparency requirements because of their systemic role.
In her view, the exemptions granted to APs — including latitude around settlement, the ability to transact internally or through affiliates, and the capacity to create shares to facilitate shorting — create structural space for self-dealing if incentives misalign.
She also stressed that scrutiny of high-frequency firms is no longer confined to the U.S, noting that regulators in jurisdictions such as India have already taken action against major trading firms over market conduct concerns. For Tyson, the Terra lawsuit is less an isolated crypto scandal than a trigger for overdue examination of how deeply embedded liquidity providers are in ETF, crypto and even precious metals markets — and whether existing oversight is sufficient.
The tension between those interpretations was central to the debate.
“Create to lend” explained
Much of the controversy highlighted in the chat revolves around a mechanism known as “create to lend” which critics contend equates to naked shorting in the market. Trading Dutchman helped to break down how that process works in practice, and why it doesn’t constitute a naked short:
A hedge fund — say, Millennium — wants to short $500 million of a semiconductor ETF tracking the SOX index.
The hedge fund approaches its prime broker, such as JPMorgan.
JPMorgan, as an authorised participant, creates $500 million worth of new ETF shares directly with the issuer.
Simultaneously, JPMorgan shorts the exact underlying basket of semiconductor stocks in proportionate weights, remaining fully hedged.
JPMorgan lends the newly created ETF shares to the hedge fund.
The hedge fund sells those ETF shares into the market and deploys capital elsewhere.
At every stage, according to practitioners, positions are collateralised and hedged. If the hedge fund closes its short, it buys back the ETF shares, returns them to the prime broker, which redeems them with the issuer, closing the hedge.
From this perspective, there is no “naked” shorting: no unbacked sale of non-existent shares. Every ETF unit created corresponds to an offsetting position in the underlying basket.
Critics counter that the aggregate effect resembles fractional reserving: more economic claims circulate than original issued shares. In stressed scenarios — sudden recalls, liquidity shocks, or dislocations — the system depends on arbitrage functioning flawlessly.
The disagreement is less about arithmetic than about systemic fragility.
Reg SHO, Strategy and borrow costs
Senior finance lecturer at Dartmouth, John Welborn, introduced empirical data that sharpened the discussion.
First, he noted that approximately 90 percent of securities appearing on the Reg SHO threshold list — meaning they have persistent settlement fails — are ETFs.
Second, leveraged single-stock ETFs, particularly those referencing MicroStrategy (now rebranded as Strategy), frequently appear on that list. MicroStrategy itself, heavily leveraged to bitcoin, shows unusual features in securities lending markets.
Third, Welborn highlighted that borrow costs for bitcoin ETF shares such as IBIT are extraordinarily low — at times effectively zero or even negative in real terms. That means short sellers may effectively be paid to borrow the shares once cash collateral rebates are accounted for.
Additionally, he observed that in MicroStrategy, a significant share of short interest appears collateralised by non-cash instruments, possibly swaps — introducing further opacity.
To practitioners, low borrow costs reflect supply-demand dynamics and capital charges on holding bitcoin-related exposures. To academics, they raise questions about structural distortions and incentives.
The 10am “slam”
Political strategist Ron Steslow asked whether authorised participants’ privileged position could suppress price discovery. If they disclose long ETF holdings but hedge those exposures with derivatives, does that asymmetry distort public perception?
The answer from practitioners was clear: market makers are delta-neutral. SEC filings showing large ETF positions do not reveal offsetting hedges, but those hedges exist. The purpose is liquidity provision, not directional betting.
As for the so-called 10 a.m. “slam” — the online theory that Jane Street systematically dumps bitcoin ETF-related positions each morning — the consensus among market professionals was sceptical. Cash-creation ETFs operate under strict compliance monitoring. Attempting to manipulate fix prices would be, in their words, “tremendously stupid,” given surveillance and enforcement risk.
In other words, repeated time-stamped volatility is more plausibly explained by thin liquidity windows than by coordinated suppression.
Transparency: illusion or evolution?
A significant thread also concerned transparency itself.
I argued that, historically, ETF plumbing was deeply opaque. In the early 2010s, authorised participants and delta one desks were reluctant to discuss mechanics publicly. Synthetic ETFs used swaps and collateral substitutions that few retail investors understood.
Trading Dutchman pushed back, insisting that ETF conferences, prospectuses and industry documentation provide ample detail today. From his perspective, accusations of secrecy often stem from misunderstanding of operational mechanics rather than concealment.
The deeper issue, however, may be epistemic rather than intentional. Even if documentation exists, the complexity of exemptions, settlement windows, securities lending and derivative hedging creates informational asymmetry between professionals and retail participants.
Vinay Gupta framed the entire debate as a symptom of balance-sheet opacity. In theory, blockchain technology allows simultaneous settlement and visible one-to-one mapping between tokens and underlying assets. In practice, crypto markets increasingly replicate traditional finance’s off-chain opacity.
The ideal of a shared ledger with T+0 settlement could eliminate many of these timing and collateral complexities. But regulation may eventually pull crypto into the same framework of exemptions and hidden hedges.
Cleansing or conspiracy?
Bitcoin advocate Joe Nakamoto warned against collapsing the entire 2022 crypto winter into a single villain narrative. Terra’s collapse triggered cascading failures across the ecosystem, but structural fragility was already embedded.
Coppola’s provocative view — that breaking a weak peg may serve a market-cleansing function — stood in tension with online claims that liquidity providers are suppressing bitcoin’s rightful price.
Between conspiracy and catharsis lies a harder truth: both ETFs and stablecoins depend on confidence in arbitrage mechanisms operated by privileged intermediaries.
The discussion ended on a more sobering note: in today’s climate, what is technically correct can quickly become secondary to what is politically useful. With Donald Trump’s Trump Media & Technology Group publicly alleging that firms such as Jane Street are engaged in naked shorting via ETF mechanics and purposeful settlement fails, market structure debates risk being pulled into a broader political struggle.
Once questions about settlement timing, borrow costs or authorised participant exemptions are framed as evidence of systemic sabotage, the conversation shifts from plumbing to populism. Discussants noted that in that environment, nuance tends to evaporate — and regulatory responses can be shaped as much by narrative momentum as by technical fact.
The Jane Street lawsuit may ultimately hinge on evidence of insider information. But the debate it has unleashed reaches far beyond one firm.
It forces uncomfortable questions about the power of delta one desks born of the Volcker era, about authorised participant exemptions, about settlement timing, about borrow cost anomalies, and about whether market plumbing that works smoothly in calm weather can withstand systemic stress.
In both crypto and traditional finance, the peg holds — until it doesn’t.