DECLARATION of Erik Kellogg by BAM MANAGEMENT US HOLDINGS INC., BAM TRADING SERVICES INC. re [40] Memorandum in Opposition filed by BAM TRADING SERVICES INC., BAM MANAGEMENT US HOLDINGS INC.. (Leblanc, Andrew)
Page 1 UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF COLUMBIA
SECURITIES AND EXCHANGE
COMMISSION,
)
)
)
)
)
)
)
Plaintiff,
v.
BINANCE HOLDINGS LIMITED,
Civil Action No. 1:23-cv-
)
BAM TRADING SERVICES, INC.,
)
BAM MANAGEMENT US HOLDINGS, INC., )
and CHANGPENG ZHAO,
)
)
Defendants.
)
DECLARATION OF ERIK KELLOGG
Pursuant to 28 U.S.C. § 1746, I hereby declare as follows:
1.
I am the Chief Information Security Officer (“CISO”) of BAM Trading Services,
Inc. (“BAM Trading”). I have held this role since March 2022. In that role, I am responsible for,
among other things, administering and managing the security of crypto assets held by BAM
Trading on behalf of its customers and for its own account.
2.
I have over 25 years of experience working in the technology and cybersecurity
field. Much of this experience has involved developing and maintaining technology for financial
services companies including trading platforms, clearing agencies, institutional investment
managers, and proprietary trading firms. Over the course of my career, I have had direct
engagement with regulators, including the Securities and Exchange Commission (“SEC”), the
Commodity Futures Trading Commission, and the Federal Financial Institutions Examination
Council (“FFIEC”), regarding cybersecurity standards, governance, frameworks, and related
requirements. Page 2 3.
As set forth below, the crypto assets that BAM Trading custodies on behalf of its
customers are safe, secure, and within the sole possession, custody, and control of BAM Trading.
4.
The following describes the state of BAM Trading’s custody arrangements as of
the date of this declaration. My understanding is that all of this information has already been
provided to the SEC Staff in connection with its investigation of BAM Trading.
I.
CRYPTO ASSETS
5.
Crypto assets (also known as “digital assets”) are a digital, encrypted, and
decentralized medium of exchange that is not reliant on a third party to verify transactions. Crypto
assets are also referred to as “tokens” or “coins.”
A.
Crypto Asset Networks
6.
Most crypto assets are built on distributed ledgers, generally known as
“blockchains.” Blockchains are shared and immutable ledgers that facilitate and record
transactions that occur for a respective crypto asset. The function of blockchain is analogous to
what we may traditionally think of as a database or accounting ledger. Most banks and other
financial institutions maintain records of customer holdings in an internal database, which they
updates to reflect new account activity. However, this ledger can be changed and its security
depends on the trustworthiness and capabilities of the chosen institution. In contrast, a blockchain
is an immutable record that relies on technological controls to securely verify transactions without
needing to know or trust the counterparty to a transaction or any other market participants. This
is, in part, due to the public nature of the blockchain, which reflects the current holdings and
historic transactions of every account (known as a “wallet”) that has been established on the
blockchain, which enables trustless verification mechanisms to determine if the parties to a
transaction actually hold the assets they are proposing to transfer. Page 3 7.
While the focus of my declaration will be on “public blockchains,” which as the
name indicates are accessible by anyone, it is important to note that there are certain permissioned
blockchains, that are only accessible by the persons that have been given specific access.
8.
The principal difference between traditional database or accounting ledgers
maintained by entities such as banks or financial institutions and the blockchain is that the
blockchain is decentralized and transactions are facilitated without a centralized third party. For a
crypto asset transaction to be added to the blockchain, it must be validated by a party referred to
as a “validator,” which runs open-source software that implements the rules of the underlying
crypto asset protocol (referred to as a “consensus mechanism”) for determining whether a proposed
transaction is valid.
9.
Once a crypto asset transaction is initiated, validators on the network verify the
transaction based on publicly available information. The verified transaction is then added to a
block—a collection of verified transactions—and the block is then added to the chain of verified
blocks. The recording of a transaction on the blockchain is sometimes referred to as occurring
“on-chain.” The blockchain is organized chronologically, with the most recent block at the
beginning, and the oldest block at the end. After the crypto asset transaction is approved, the
balances for the accounts (i.e., wallets) sending and receiving the crypto assets are increased or
decreased based on the transaction amount.
10.
The combination of one or more crypto assets, the associated blockchain, and the
protocol for validating transactions and adding new blocks to the blockchain is considered a
“crypto asset network.” Page 4 B.
Consensus Mechanisms
11.
As noted above, these transactions are validated using the consensus mechanism
that is embedded in the crypto asset network’s protocol. These consensus mechanisms require at
least two “validators” to review each proposed transaction to confirm that the transferring party
has the assets necessary to complete the transaction and to ensure that the assets have not already
been sent to another party (known as “double spending”). If the transaction is valid, it is included
in a new block recorded on the relevant blockchain.
12.
The two main consensus mechanisms for approving crypto asset transactions are
“proof of work” and “proof of stake.”
a.
Proof of work, most famously associated with Bitcoin, requires the network
participants to confirm transactions by competing against each other by solving a mathematical
equation in order to produce new blocks in the blockchain. The entity that solves the question first
is awarded a newly minted crypto asset on the blockchain.
b.
For a proof of stake consensus mechanism, networks require participants to
deposit (or “stake”) tokens to the network in order to obtain the right to validate transactions on
the network (or act as a “validator”), and earn fees for performing this service. The staked tokens
serve as collateral to incentivize accurate and efficient validation of transactions; networks
typically reward a validator for effective service with tokens as compensation (a “staking reward”)
and may punish a validator for ineffective service by seizing some of their staked tokens (referred
to as “slashing”). This process of depositing tokens to a network and acting as a validator is
commonly referred to as “staking.”
i.
Any network participant can generally download the required open-
source software to act as a validator on a network. Page 5 ii.
In addition, holders of crypto assets can “delegate” their tokens to a
validator in order to earn staking rewards. These validators may also be known as “node
operators.” The validator typically performs the technical transaction validation services on the
crypto asset network and earns staking rewards as compensation for performing this service. The
validator in turn provides the staking rewards to the holders of crypto assets whot “staked” their
tokens, minus a fee as compensation for its services.
iii.
In these arrangements, the holders of the staked assets retain title
and custody of their tokens. However, the delegation of their tokens to the validator is reflected
on the crypto asset network’s public blockchain. In addition, some crypto asset networks impose
“bonding” or “unbonding” periods on staked assets, which restrict the asset’s ability to be
transferred or sold for some period of time after being staked or being unstaked.
13.
For both proof of work and proof of stake consensus mechanisms, the protocol
typically compensates transaction validators by generating a new token (or part of a new token)
on that network, a process referred to as “minting.” The newly minted crypto asset rewards are
delivered “on-chain” and reported on the blockchain (i.e., publicly viewable).
C.
Crypto Asset Wallets
14.
In either case, each crypto asset network maintains its public blockchain that
reflects all the transactions ever conducted on the network, with each transaction attributable to
digital “wallets” that have unique, publicly identifiable blockchain “addresses.” A crypto wallet
is software or hardware that enables users to store and use crypto assets. It is similar to a typical
wallet where a user may hold cash and credit cards; however, instead of holding physical items a
crypto wallet stores private “keys” which allows for transaction verification. Each crypto wallet Page 6 address contains information related to the wallet’s current balance, as well as the wallet’s history
of transactions, and can be viewed on the relevant crypto asset network’s public blockchain.
15.
A crypto wallet has two main components: (i) the publicly identifiable blockchain
address, and (ii) a “private key,” which acts as a password to authorize transactions from the wallet.
a.
Assets cannot be transferred from a crypto wallet without the private key.
However, anyone with the private key can authorize a transfer from a crypto wallet, similar to how
anyone that has possession of a bearer bond can redeem it. As a result, it is critical for wallet
holders to securely maintain their private keys, both to ensure that they are not shared with third
parties and that they are not lost, permanently locking the contents of the wallet.
b.
Wallets can be configured to use a single private key that is independently
sufficient to authorize a transfer from the wallets (known as “single-signature wallets”). Wallets
can also be configured to require the approval from multiple private keys or multiple portions of a
larger private key (known as “multi-signature wallets”). Multi-signature wallets can provide
additional protections over single-signature wallets, such as requiring authorization from multiple
individuals to approve a transaction or providing ways to recover keys that are lost or destroyed.
16.
Individuals and entities can maintain their own crypto wallets and private keys.
This is known as “self-custody.”
17.
Alternatively, individuals and entities can rely on crypto asset trading platforms or
other third parties to custody crypto assets on their behalf.
a.
Typically, these third-party custodians maintain assets on behalf of multiple
customers in a single wallet “an omnibus wallet” and track the holdings of individuals via a private
ledger, which shows all transactions into and out of the wallet. Page 7 b.
Omnibus wallets are employed for security purposes. As explained, each
crypto wallet has a public identifiable address where anyone can view the transactions in which
that respective wallet engaged and how much of a respective crypto asset a wallet contains at any
point in time. By maintaining assets on behalf of multiple customers in an omnibus wallet, a thirdparty custodian can protect each customer by not making public their total balance of any
respective crypto asset. When someone views the omnibus wallet’s public blockchain address, all
they will see is the total number of crypto assets contained in the wallet and transactions associated
with the omnibus wallet address. In addition, as explained below, the use of an omnibus wallet
can reduce the number of on-chain transactions, thereby reducing transaction costs.
18.
Crypto asset wallets can also either be “hot” or “cold.”
a.
Hot wallets are connected to the internet and are able to immediately
conduct transactions.
b.
Cold wallets are not available to immediately conduct transactions either
because they are not connected to the internet or are otherwise subject to technical controls limiting
their ability to conduct on-chain transactions (i.e., transactions that would be publicly available on
the blockchain). These additional protections provide additional layers of security and make it
more difficult to compromise a cold wallet.
B.
19.
Off-Chain Transactions
In addition to on-chain transactions, many crypto asset trading platforms facilitate
“off-chain” transactions.
20.
As noted above in Paragraph 17, crypto asset trading platforms that hold crypto
assets on behalf of their customers typically rely on omnibus wallets to hold customer assets. Page 8 Individual customer holdings are recorded on a private ledger maintained by the platform (i.e., an
internal ledger).
21.
When customers transact on a crypto asset trading platform, the transaction is
typically recorded as a change in ownership on the crypto asset trading platform’s internal ledger.
However, because customer holdings are maintained on an omnibus basis, no on-chain transaction
is recorded on the relevant blockchain. This is possible because the trades are conducted between
customers whose assets are both held in omnibus wallets by the trading platform: when the trade
occurs, the trading platform updates its internal ledger to reflect the trade, but no assets enter or
leave the trading platform’s omnibus wallets.
II.
BAM TRADING
22.
BAM Trading operates a crypto asset trading platform in the United States.
23.
BAM Trading is registered as a money services business with the Financial Crimes
Enforcement Network (“FinCen”), a bureau of the United States Department of Treasury.
24.
BAM Trading is also licensed to conduct business as a money services business, or
otherwise permitted to operate, in 43 states and the District of Columbia. I have been involved in
responding to examinations by certain of these state regulators.
25.
As described below, BAM Trading provides customers a safe and secure wallet
custody solution if they choose to leave their crypto assets on the platform. These crypto assets
are generally held on an omnibus basis. If customers do not wish to keep their crypto assets on
the BAM Trading platform, they are free to withdraw their crypto assets to any alternative thirdparty custodian, or to self-custody their crypto assets (i.e., maintain their crypto assets in the
customer’s own wallet).
26.
BAM Trading offers customers the ability to buy and sell crypto assets through its
electronic trading facilities. Page 9 a.
BAM Trading currently lists approximately 150 crypto assets on its
b.
Because BAM Trading holds customer assets on an omnibus basis,
platform.
transactions on the platform are recorded on its internal ledger but do not generally result in an on
on-chain transaction.
27.
In addition, BAM Trading also provides customers the ability to participate in a
staking service for certain crypto assets that use proof of stake consensus mechanisms (the
“Staking Service”).
a.
Currently, BAM Trading’s Staking Service supports approximately
b.
As part of the Staking Service, BAM Trading contracts with third-party
assets.
node operators that act as validators for the relevant crypto asset networks. BAM Trading
delegates the tokens of customers wishing to participate in the Staking Service to the validators.
As explained earlier, the process of delegation does not require a customer to give up title to his
or her assets.
c.
The third-party node operator retains a portion of the rewards generated
from staking these customer assets. BAM Trading retains a portion of the remainder as its fee for
offering the service. Customers participating in the program receive the balance of the rewards
associated with staking their tokens.
III.
CUSTODY OF CUSTOMERS’ CRYPTO ASSETS
28.
I will now describe how BAM Trading maintains custody of its customers’ crypto
assets if they choose to keep their crypto asserts on the BAM Trading platform. As I will describe,
BAM Trading employs a number of security measures to ensure that it maintains ultimate control Page 10 over the crypto asset that it holds on behalf of its customers and for its own proprietary account
and that those crypto assets are safe from cyberattacks or other malfeasance.
29.
BAM Trading maintains custody of most customer assets using wallet custody
software developed by and licensed from Binance Holdings Limited (“BHL”), a distinct legal
entity, separate from BAM Trading that is also ultimately owned by Changpeng Zhao (“Zhao”).
Although BAM Trading and BHL share common majority ownership, they are not within the same
corporate structure. Although this software was developed by BHL, BAM Trading maintains
custody and control over the crypto assets held in these wallets which were created for BAM
customers through the use of BHL’s software. There are separate custody arrangements for certain
asset that are staked through BAM Trading’s Staking Program. I will describe each below.
A.
Wallet Custody Software
30.
The wallet custody software licensed to BAM Trading by BHL provides a multi-
tiered wallet structure that is designed to securely hold crypto assets while maintaining sufficient
liquidity to facilitate near-term customer demand. Specifically, the wallet custody software has
three types of wallets: (i) customer-specific deposit wallets; (ii) omnibus hot wallets; and (iii)
omnibus storage wallets. I describe each below.
a.
The wallet custody software runs on servers in an Amazon Web Services
(“AWS”) datacenter in northern Virginia. The AWS account was established by BHL on behalf
of BAM Trading.
i.
Currently this AWS environment is used exclusively to host
the wallets used to maintain BAM Trading’s crypto assets. Page 11 ii.
As described below, while BHL established the AWS
account that hosts BAM Trading’s wallet custody software, BHL does not have access to, or
control over, the assets BAM Trading maintains on behalf of its customer or for its own account.
iii.
Thus, this arrangement provides BAM Trading control over
a licensed copy of the wallet custody software while protecting BHL’s interest in the intellectual
property embedded in the wallet custody software and its source code.
b.
Transfers between wallets maintained by means of the wallet custody
software are directed from BAM Trading’s internal ledger management system, known as PNK.
In addition to facilitating transfers, PNK maintains the official ledger that reflects each customer’s
crypto asset holdings on the BAM Trading platform.
i.
The software underlying PNK was also originally developed
by BHL. However, BAM Trading received a copy of the PNK source code, and BAM Trading
personnel are now solely responsible for managing BAM Trading’s use of PNK, without the
involvement of BHL.
ii.
Certain transfers are conducted automatically by PNK,
subject to dollar thresholds managed by BAM Trading personnel.
iii.
Other transfers must be manually initiated and approved.
iv.
BAM Trading requires multiple levels of approval for
manually initiated and approved transfers to ensure that a single person does not have authority to
transfer assets off of the platform.
31.
Deposit Wallets. If a BAM Trading customer seeks to transfer existing crypto
assets from a wallet outside the BAM platform (i.e., an external wallet) to their BAM Trading
account, the wallet custody software automatically assigns the customer a deposit wallet to receive Page 12 those funds. These wallets are customer-specific and only hold assets on behalf of the assigned
customer.
a.
For such customers, the PNK system is configured to assign a unique,
customer specific, deposit wallet for each respective crypto asset network currently supported by
BAM Trading even if the customer is only depositing one such crypto asset.
b.
PNK is configured to automatically transfer the contents of customer-
specific deposit wallets to BAM Trading’s omnibus hot wallets, described in Paragraph 32 below,
if their balance exceeds predefined thresholds.
32.
Omnibus Hot Wallets. BAM Trading maintains omnibus hot wallets to conduct
on-chain transactions, such as facilitating customer withdrawals. There is at least one hot wallet
for each crypto asset network supported by the BAM Trading platform. These wallets are omnibus
wallets and hold assets on behalf of multiple customers, as well as proprietary assets owned by
BAM Trading.
a.
These wallets are configured to hold approximately five-times the volume
of daily withdrawals for each crypto asset. The withdrawal limit can vary based on prevailing
market conditions, but the design is intended to minimize the security risk of storing too many
crypto assets in the hot wallet yet still maintaining sufficient liquidity to support customer requests.
b.
PNK is configured to automatically transfer the contents of these omnibus
hot wallets to BAM Trading’s omnibus cold wallets, described in paragraphs 33 below, if their
balance exceeds predefined thresholds. These transfers are entirely automated and subject to
thresholds controlled by BAM Trading.
c.
BAM Trading’s omnibus hot wallets are configured to allow transfers to
external wallets. Page 13 i.
Customer initiated-transfers of less than $1 million (or other
applicable customer-specific limit) are automatically approved by PNK.
ii.
Liquidity management transfers initiated by BAM Trading
or a larger customer-initiated transfer must be approved by two different members of BAM
Trading’ clearing team.
iii.
No BHL personnel have access or authority to initiate or
approve transfers from BAM Trading’s hot wallets. Certain entities ultimately owned by Mr. Zhao
that are BAM Trading customers can, like any other customer, withdraw crypto assets from their
own BAM Trading accounts. However, these transfers are limited to those entities’ own crypto
assets.
33.
Omnibus Cold Wallets. BAM Trading maintains omnibus cold wallets to securely
custody customer and proprietary crypto assets that are not immediately needed to conduct onchain transactions. In other words, cold wallets are more secure than hot wallets but they have
additional security controls that make them more difficult to access than hot wallets. There is at
least one cold wallet for each crypto asset network supported by the BAM Trading platform. These
wallets are omnibus wallets and hold assets on behalf of multiple customers, as well as proprietary
assets owned by BAM Trading. These omnibus cold wallets have several important security
features.
a.
First, these wallets are controlled using the Threshold Signature Scheme
(“TSS”). Under TSS, the private key for a wallet is split multiple ways into “shards” and
distributed to multiple persons “shard holders.” Assets can only be moved if the transaction is
approved by a defined quorum of shard holders. Page 14 i.
BAM Trading’s omnibus cold wallets currently have seven
key shards. Votes by four shard holders approving the transaction are necessary for any crypto
asset movement.
1.
Senior BAM Trading personnel with experience in
crypto asset custody hold four key shards. Three of these individuals are located in Canada; one
is located in the United States. Two of these individuals were formerly employed by BHL but has
worked solely for BAM Trading since the summer of 2021. None of these individuals is currently
associated with BHL or has any relationship with Mr. Zhao.
2.
BHL personnel hold the remaining three key shards.
As described below, BHL holds these shards for disaster recovery purposes. In the unlikely event
that three of BAM Trading’s key shards are simultaneously impaired, BAM Trading can continue
to operate and move assets to and from its cold wallets by leveraging BHL’s key shards. However,
BHL’s shard holders may participate to approve transactions in the normal course for various
reasons, including when transactions are initiated after-hours in the United States, but during
working hours in the locations that the BHL shard holders reside.
3.
As a result of BHL only having three key shards, any
transfer from BAM Trading’s cold wallets requires the approval of at least one BAM Trading
personnel. As an added security measure, no single key shard holder knows the identities of the
other key shard holders. It is my understanding that pursuant to BAM Trading’s proposed
stipulation with the SEC, all seven key shards for BAM Trading omnibus cold wallets would be
held by BAM Trading personnel in the United States.
ii.
If a key shard is lost, destroyed, or compromised, a quorum
of the remaining key shards can vote to approve the creation of a replacement. This process Page 15 requires approval from four key shard holders. As a result, BHL cannot unilaterally create or
replace any of BAM Trading’s key shards.
b.
Second, assets from the omnibus cold wallets can only be transferred to a
list of pre-approved “whitelisted” wallets.
i.
The only whitelisted wallets for BAM Trading’s omnibus
cold wallets are BAM Trading’s omnibus hot wallets, and as described below, BAM Trading’s
staking wallets. I understand that BAM Trading previously produced a list of these whitelisted
wallet addresses to the SEC Staff.
ii.
Adding a new whitelisted wallet requires the unanimous
approval of all seven shard holders.
iii.
As a result, even if an unauthorized transfers from BAM
Trading’s cold wallets occurred, those crypto assets could only be moved to another wallet
controlled by BAM Trading personnel. Crypto assets could not be transferred to external wallets
controlled by third parties.
c.
Third, transfers of crypto assets from BAM Trading’s omnibus cold wallets
may only be initiated by designated members of BAM Trading’s clearing team. This team is
comprised of six well-qualified people. None of these individuals are currently associated with
BHL or has any relationship with Mr. Zhao.
i.
Thus, crypto asset transfer requests require the involvement
of two separate groups of BAM Trading personnel: the clearing team that will initiate a transfer
request and the key shard holders who only to confirm, deny or take no action on a respective
transfer request. Requests must be sent to a dedicated member of BHL’s security operations team,
who then issues the TSS-approval request. Page 16 ii.
No BHL personnel, nor Mr. Zhao himself, have access or are
authorized to initiate transfers from BAM Trading’s cold wallets.
d.
As a result of these controls, which are specifically designed to ensure BHL
does not have the access or authority to unilaterally transfer crypto assets from BAM Trading’s
omnibus hot and cold wallets to external wallets, BAM Trading maintains exclusive control over
the crypto assets it maintains in the wallet custody software on behalf of its customers and its own
account.
e.
External transfers may only be conducted from BAM Trading’s omnibus
hot wallets. Transfers that exceed pre-set thresholds may only be approved by designated members
of BAM Trading’s Clearing team. Other customer-initiated transfers may be automatically
approved by PNK.
f.
Transfers from BAM Trading’s omnibus cold wallet require the approval of
four key shard holders, at least one of whom must be a BAM Trading employee. These wallets
are configured so that assets may only be transferred to predefined whitelisted wallets controlled
by BAM Trading. And again, the only whitelisted wallets are BAM Trading’s omnibus hot
wallets.
g.
Under these controls, there is no way for third parties, including BHL, to
transfer assets from the BAM Trading platform to external wallets.
B.
Custody of Staked Assets
34.
In addition to the default custody arrangement described above, BAM Trading also
offers its Staking Services, which are subject to different custody arrangements. Page 17 35.
Staked assets are currently maintained in three ways. The allocation of assets
depends across custody solutions depends on several factors, including when the asset became
compatible with the TSS encryption protocol described above.
36.
First, certain staked assets are custodied in TSS-enabled staking wallets within the
wallet custody software.
a.
These wallets are subject to the same TSS security as BAM Trading’s
omnibus cold wallets, except that they are configured to use four of the seven key shards. Two of
these key shards are held by BAM Trading personnel; the remaining two key shards are held by
BHL personnel. It is my understanding that pursuant to BAM Trading’s proposed stipulation with
the SEC, all four key shards for BAM Trading staking cold wallets would be held by BAM Trading
personnel in the United States.
b.
Two key shards are required to authorize a transfer or staking operation.
The only whitelisted wallets for BAM Trading’s staking cold wallets are BAM Trading’s omnibus
cold wallets. As all whitelisted wallets are BAM Trading omnibus cold wallets, BHL unilaterally
with its two key shards does not have the capability to transfer staked crypto assets off of the BAM
Trading platform. To whitelist additional addresses requires all four key shard holders (to
unanimously approve the wallet address. To reiterate, because of the security measure of only
permitting staked assets to be transferred to whitelisted wallet addresses, BHL could not transfer
staked assets to any external wallets.
i.
In terms of transfers, the only whitelisted wallets for the
TSS-enabled staking wallets are BAM Trading’s omnibus cold wallets and certain “fee” wallets
used to retain BAM Trading’s portion of the staking rewards earned from participating in the
Staking Service. As a result, crypto assets in these TSS-enabled staking wallets may only be Page 18 transferred to BAM Trading’s omnibus cold wallets or the fee wallets that are also under its
control.
ii.
In terms of staking operations, two shards are also needed to
stake or unstake assets. These operations do not result in a transfer of the assets from the TSSenabled staking wallets. Instead, they merely reflect that the relevant tokens have been delegated
to the third-party node operator for participating in a staking pool. At all times, staked assets
remain in the TSS-enabled staking wallet, subject to BAM Trading’s custody and control.
37.
Second, certain crypto assets offered through the Staking Service are held in wallets
maintained by BitGo and Aegis, two U.S.-based third-party custody providers.
a.
These assets are custodied by BitGo and Aegis through their commercial
custody services.
b.
I understand that, BitGo and Aegis both employ mutli-signature private
keys. As a result, transfers of crypto assets from BitGo and Aegis must be approved by both a
BAM Trading key holder, as well as, respectively, a keyholder from BitGo or Aegis.
c.
Assets staked through the BitGo and Aegis wallets remain in the BitGo and
Aegis wallets. As with the TSS-enabled staking wallets, the staking process results in the
delegation of governance rights, but does not result in a transfer of the crypto asset to another
party, or a change in custody or control of the crypto asset.
38.
Third, a small number of staked assets were previously held on a Ledger hardware
wallet (“Ledger Device”). The Ledger Device is a cold wallet custody product produced by an
unaffiliated third-party entity. Ledger devices are publicly available for purchase and are marketed
as a personal custody solution for individuals or entities. Page 19 a.
The Ledger Device is maintained in a safe deposit box in Singapore that is
exclusively under the control of BAM Trading personnel. The private key for this device is held
by a BHL employee.
b.
As of today, there are no customer assets held on the Ledger hardware
wallet.
IV.
ADDITIONAL CONTROLS
39.
In addition to the controls described above, BAM Trading has implemented
numerous surveillance mechanisms and alerts to ensure the safety and security of customer assets.
40.
For example, these controls automatically alert members of BAM Trading’s
clearing and security teams of any transfers of greater than $100,000. There are also alerts if
anyone requests access credentials to the PNK system.
V.
CONCLUSION
41.
Based on my experience and current knowledge, I understand that these practices
are consistent with industry best practices regarding the custody of crypto assets.
42.
No BHL employee or combination of employees have the ability or authority to
move assets within BAM Trading’s wallets (whether cold or hot) or to external wallets outside of
BAM Trading’ control.
43.
I am not aware of any instances in which BHL employees sought to move BAM
Trading’s crypto assets or otherwise attempted to interact with BAM Trading’s crypto assets
without authorization or instruction from BAM Trading personnel.
44.
I am not aware of any other facts that would affect my conclusion that BAM
Trading maintains custody and control over the crypto assets that it maintains on behalf of its
customers. Page 20 I declare under penalty of perjury under the laws of the United States of America that the foregoing
is true and correct.
Executed this 12th day of June, 2023, in Washington, DC.
Ffik Kellogg
PDF Page 1
PlainSite Cover Page
PDF Page 2
Case 1:23-cv-01599-ABJ Document 42 Filed 06/12/23 Page 1 of 20
UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF COLUMBIA
SECURITIES AND EXCHANGE
COMMISSION,
)
)
)
)
)
)
)
Plaintiff,
v.
BINANCE HOLDINGS LIMITED,
Civil Action No. 1:23-cv-01599
)
BAM TRADING SERVICES, INC.,
)
BAM MANAGEMENT US HOLDINGS, INC., )
and CHANGPENG ZHAO,
)
)
Defendants.
)
DECLARATION OF ERIK KELLOGG
Pursuant to 28 U.S.C. § 1746, I hereby declare as follows:
1.
I am the Chief Information Security Officer (“CISO”) of BAM Trading Services,
Inc. (“BAM Trading”). I have held this role since March 2022. In that role, I am responsible for,
among other things, administering and managing the security of crypto assets held by BAM
Trading on behalf of its customers and for its own account.
2.
I have over 25 years of experience working in the technology and cybersecurity
field. Much of this experience has involved developing and maintaining technology for financial
services companies including trading platforms, clearing agencies, institutional investment
managers, and proprietary trading firms. Over the course of my career, I have had direct
engagement with regulators, including the Securities and Exchange Commission (“SEC”), the
Commodity Futures Trading Commission, and the Federal Financial Institutions Examination
Council (“FFIEC”), regarding cybersecurity standards, governance, frameworks, and related
requirements.
1
PDF Page 3
Case 1:23-cv-01599-ABJ Document 42 Filed 06/12/23 Page 2 of 20
3.
As set forth below, the crypto assets that BAM Trading custodies on behalf of its
customers are safe, secure, and within the sole possession, custody, and control of BAM Trading.
4.
The following describes the state of BAM Trading’s custody arrangements as of
the date of this declaration. My understanding is that all of this information has already been
provided to the SEC Staff in connection with its investigation of BAM Trading.
I.
CRYPTO ASSETS
5.
Crypto assets (also known as “digital assets”) are a digital, encrypted, and
decentralized medium of exchange that is not reliant on a third party to verify transactions. Crypto
assets are also referred to as “tokens” or “coins.”
A.
Crypto Asset Networks
6.
Most crypto assets are built on distributed ledgers, generally known as
“blockchains.” Blockchains are shared and immutable ledgers that facilitate and record
transactions that occur for a respective crypto asset. The function of blockchain is analogous to
what we may traditionally think of as a database or accounting ledger. Most banks and other
financial institutions maintain records of customer holdings in an internal database, which they
updates to reflect new account activity. However, this ledger can be changed and its security
depends on the trustworthiness and capabilities of the chosen institution. In contrast, a blockchain
is an immutable record that relies on technological controls to securely verify transactions without
needing to know or trust the counterparty to a transaction or any other market participants. This
is, in part, due to the public nature of the blockchain, which reflects the current holdings and
historic transactions of every account (known as a “wallet”) that has been established on the
blockchain, which enables trustless verification mechanisms to determine if the parties to a
transaction actually hold the assets they are proposing to transfer.
2
PDF Page 4
Case 1:23-cv-01599-ABJ Document 42 Filed 06/12/23 Page 3 of 20
7.
While the focus of my declaration will be on “public blockchains,” which as the
name indicates are accessible by anyone, it is important to note that there are certain permissioned
blockchains, that are only accessible by the persons that have been given specific access.
8.
The principal difference between traditional database or accounting ledgers
maintained by entities such as banks or financial institutions and the blockchain is that the
blockchain is decentralized and transactions are facilitated without a centralized third party. For a
crypto asset transaction to be added to the blockchain, it must be validated by a party referred to
as a “validator,” which runs open-source software that implements the rules of the underlying
crypto asset protocol (referred to as a “consensus mechanism”) for determining whether a proposed
transaction is valid.
9.
Once a crypto asset transaction is initiated, validators on the network verify the
transaction based on publicly available information. The verified transaction is then added to a
block—a collection of verified transactions—and the block is then added to the chain of verified
blocks. The recording of a transaction on the blockchain is sometimes referred to as occurring
“on-chain.” The blockchain is organized chronologically, with the most recent block at the
beginning, and the oldest block at the end. After the crypto asset transaction is approved, the
balances for the accounts (i.e., wallets) sending and receiving the crypto assets are increased or
decreased based on the transaction amount.
10.
The combination of one or more crypto assets, the associated blockchain, and the
protocol for validating transactions and adding new blocks to the blockchain is considered a
“crypto asset network.”
3
PDF Page 5
Case 1:23-cv-01599-ABJ Document 42 Filed 06/12/23 Page 4 of 20
B.
Consensus Mechanisms
11.
As noted above, these transactions are validated using the consensus mechanism
that is embedded in the crypto asset network’s protocol. These consensus mechanisms require at
least two “validators” to review each proposed transaction to confirm that the transferring party
has the assets necessary to complete the transaction and to ensure that the assets have not already
been sent to another party (known as “double spending”). If the transaction is valid, it is included
in a new block recorded on the relevant blockchain.
12.
The two main consensus mechanisms for approving crypto asset transactions are
“proof of work” and “proof of stake.”
a.
Proof of work, most famously associated with Bitcoin, requires the network
participants to confirm transactions by competing against each other by solving a mathematical
equation in order to produce new blocks in the blockchain. The entity that solves the question first
is awarded a newly minted crypto asset on the blockchain.
b.
For a proof of stake consensus mechanism, networks require participants to
deposit (or “stake”) tokens to the network in order to obtain the right to validate transactions on
the network (or act as a “validator”), and earn fees for performing this service. The staked tokens
serve as collateral to incentivize accurate and efficient validation of transactions; networks
typically reward a validator for effective service with tokens as compensation (a “staking reward”)
and may punish a validator for ineffective service by seizing some of their staked tokens (referred
to as “slashing”). This process of depositing tokens to a network and acting as a validator is
commonly referred to as “staking.”
i.
Any network participant can generally download the required open-
source software to act as a validator on a network.
4
PDF Page 6
Case 1:23-cv-01599-ABJ Document 42 Filed 06/12/23 Page 5 of 20
ii.
In addition, holders of crypto assets can “delegate” their tokens to a
validator in order to earn staking rewards. These validators may also be known as “node
operators.” The validator typically performs the technical transaction validation services on the
crypto asset network and earns staking rewards as compensation for performing this service. The
validator in turn provides the staking rewards to the holders of crypto assets whot “staked” their
tokens, minus a fee as compensation for its services.
iii.
In these arrangements, the holders of the staked assets retain title
and custody of their tokens. However, the delegation of their tokens to the validator is reflected
on the crypto asset network’s public blockchain. In addition, some crypto asset networks impose
“bonding” or “unbonding” periods on staked assets, which restrict the asset’s ability to be
transferred or sold for some period of time after being staked or being unstaked.
13.
For both proof of work and proof of stake consensus mechanisms, the protocol
typically compensates transaction validators by generating a new token (or part of a new token)
on that network, a process referred to as “minting.” The newly minted crypto asset rewards are
delivered “on-chain” and reported on the blockchain (i.e., publicly viewable).
C.
Crypto Asset Wallets
14.
In either case, each crypto asset network maintains its public blockchain that
reflects all the transactions ever conducted on the network, with each transaction attributable to
digital “wallets” that have unique, publicly identifiable blockchain “addresses.” A crypto wallet
is software or hardware that enables users to store and use crypto assets. It is similar to a typical
wallet where a user may hold cash and credit cards; however, instead of holding physical items a
crypto wallet stores private “keys” which allows for transaction verification. Each crypto wallet
5
PDF Page 7
Case 1:23-cv-01599-ABJ Document 42 Filed 06/12/23 Page 6 of 20
address contains information related to the wallet’s current balance, as well as the wallet’s history
of transactions, and can be viewed on the relevant crypto asset network’s public blockchain.
15.
A crypto wallet has two main components: (i) the publicly identifiable blockchain
address, and (ii) a “private key,” which acts as a password to authorize transactions from the wallet.
a.
Assets cannot be transferred from a crypto wallet without the private key.
However, anyone with the private key can authorize a transfer from a crypto wallet, similar to how
anyone that has possession of a bearer bond can redeem it. As a result, it is critical for wallet
holders to securely maintain their private keys, both to ensure that they are not shared with third
parties and that they are not lost, permanently locking the contents of the wallet.
b.
Wallets can be configured to use a single private key that is independently
sufficient to authorize a transfer from the wallets (known as “single-signature wallets”). Wallets
can also be configured to require the approval from multiple private keys or multiple portions of a
larger private key (known as “multi-signature wallets”). Multi-signature wallets can provide
additional protections over single-signature wallets, such as requiring authorization from multiple
individuals to approve a transaction or providing ways to recover keys that are lost or destroyed.
16.
Individuals and entities can maintain their own crypto wallets and private keys.
This is known as “self-custody.”
17.
Alternatively, individuals and entities can rely on crypto asset trading platforms or
other third parties to custody crypto assets on their behalf.
a.
Typically, these third-party custodians maintain assets on behalf of multiple
customers in a single wallet “an omnibus wallet” and track the holdings of individuals via a private
ledger, which shows all transactions into and out of the wallet.
6
PDF Page 8
Case 1:23-cv-01599-ABJ Document 42 Filed 06/12/23 Page 7 of 20
b.
Omnibus wallets are employed for security purposes. As explained, each
crypto wallet has a public identifiable address where anyone can view the transactions in which
that respective wallet engaged and how much of a respective crypto asset a wallet contains at any
point in time. By maintaining assets on behalf of multiple customers in an omnibus wallet, a thirdparty custodian can protect each customer by not making public their total balance of any
respective crypto asset. When someone views the omnibus wallet’s public blockchain address, all
they will see is the total number of crypto assets contained in the wallet and transactions associated
with the omnibus wallet address. In addition, as explained below, the use of an omnibus wallet
can reduce the number of on-chain transactions, thereby reducing transaction costs.
18.
Crypto asset wallets can also either be “hot” or “cold.”
a.
Hot wallets are connected to the internet and are able to immediately
conduct transactions.
b.
Cold wallets are not available to immediately conduct transactions either
because they are not connected to the internet or are otherwise subject to technical controls limiting
their ability to conduct on-chain transactions (i.e., transactions that would be publicly available on
the blockchain). These additional protections provide additional layers of security and make it
more difficult to compromise a cold wallet.
B.
19.
Off-Chain Transactions
In addition to on-chain transactions, many crypto asset trading platforms facilitate
“off-chain” transactions.
20.
As noted above in Paragraph 17, crypto asset trading platforms that hold crypto
assets on behalf of their customers typically rely on omnibus wallets to hold customer assets.
7
PDF Page 9
Case 1:23-cv-01599-ABJ Document 42 Filed 06/12/23 Page 8 of 20
Individual customer holdings are recorded on a private ledger maintained by the platform (i.e., an
internal ledger).
21.
When customers transact on a crypto asset trading platform, the transaction is
typically recorded as a change in ownership on the crypto asset trading platform’s internal ledger.
However, because customer holdings are maintained on an omnibus basis, no on-chain transaction
is recorded on the relevant blockchain. This is possible because the trades are conducted between
customers whose assets are both held in omnibus wallets by the trading platform: when the trade
occurs, the trading platform updates its internal ledger to reflect the trade, but no assets enter or
leave the trading platform’s omnibus wallets.
II.
BAM TRADING
22.
BAM Trading operates a crypto asset trading platform in the United States.
23.
BAM Trading is registered as a money services business with the Financial Crimes
Enforcement Network (“FinCen”), a bureau of the United States Department of Treasury.
24.
BAM Trading is also licensed to conduct business as a money services business, or
otherwise permitted to operate, in 43 states and the District of Columbia. I have been involved in
responding to examinations by certain of these state regulators.
25.
As described below, BAM Trading provides customers a safe and secure wallet
custody solution if they choose to leave their crypto assets on the platform. These crypto assets
are generally held on an omnibus basis. If customers do not wish to keep their crypto assets on
the BAM Trading platform, they are free to withdraw their crypto assets to any alternative thirdparty custodian, or to self-custody their crypto assets (i.e., maintain their crypto assets in the
customer’s own wallet).
26.
BAM Trading offers customers the ability to buy and sell crypto assets through its
electronic trading facilities.
8
PDF Page 10
Case 1:23-cv-01599-ABJ Document 42 Filed 06/12/23 Page 9 of 20
a.
BAM Trading currently lists approximately 150 crypto assets on its
b.
Because BAM Trading holds customer assets on an omnibus basis,
platform.
transactions on the platform are recorded on its internal ledger but do not generally result in an on
on-chain transaction.
27.
In addition, BAM Trading also provides customers the ability to participate in a
staking service for certain crypto assets that use proof of stake consensus mechanisms (the
“Staking Service”).
a.
Currently, BAM Trading’s Staking Service supports approximately 17
b.
As part of the Staking Service, BAM Trading contracts with third-party
assets.
node operators that act as validators for the relevant crypto asset networks. BAM Trading
delegates the tokens of customers wishing to participate in the Staking Service to the validators.
As explained earlier, the process of delegation does not require a customer to give up title to his
or her assets.
c.
The third-party node operator retains a portion of the rewards generated
from staking these customer assets. BAM Trading retains a portion of the remainder as its fee for
offering the service. Customers participating in the program receive the balance of the rewards
associated with staking their tokens.
III.
CUSTODY OF CUSTOMERS’ CRYPTO ASSETS
28.
I will now describe how BAM Trading maintains custody of its customers’ crypto
assets if they choose to keep their crypto asserts on the BAM Trading platform. As I will describe,
BAM Trading employs a number of security measures to ensure that it maintains ultimate control
9
PDF Page 11
Case 1:23-cv-01599-ABJ Document 42 Filed 06/12/23 Page 10 of 20
over the crypto asset that it holds on behalf of its customers and for its own proprietary account
and that those crypto assets are safe from cyberattacks or other malfeasance.
29.
BAM Trading maintains custody of most customer assets using wallet custody
software developed by and licensed from Binance Holdings Limited (“BHL”), a distinct legal
entity, separate from BAM Trading that is also ultimately owned by Changpeng Zhao (“Zhao”).
Although BAM Trading and BHL share common majority ownership, they are not within the same
corporate structure. Although this software was developed by BHL, BAM Trading maintains
custody and control over the crypto assets held in these wallets which were created for BAM
customers through the use of BHL’s software. There are separate custody arrangements for certain
asset that are staked through BAM Trading’s Staking Program. I will describe each below.
A.
Wallet Custody Software
30.
The wallet custody software licensed to BAM Trading by BHL provides a multi-
tiered wallet structure that is designed to securely hold crypto assets while maintaining sufficient
liquidity to facilitate near-term customer demand. Specifically, the wallet custody software has
three types of wallets: (i) customer-specific deposit wallets; (ii) omnibus hot wallets; and (iii)
omnibus storage wallets. I describe each below.
a.
The wallet custody software runs on servers in an Amazon Web Services
(“AWS”) datacenter in northern Virginia. The AWS account was established by BHL on behalf
of BAM Trading.
i.
Currently this AWS environment is used exclusively to host
the wallets used to maintain BAM Trading’s crypto assets.
10
PDF Page 12
Case 1:23-cv-01599-ABJ Document 42 Filed 06/12/23 Page 11 of 20
ii.
As described below, while BHL established the AWS
account that hosts BAM Trading’s wallet custody software, BHL does not have access to, or
control over, the assets BAM Trading maintains on behalf of its customer or for its own account.
iii.
Thus, this arrangement provides BAM Trading control over
a licensed copy of the wallet custody software while protecting BHL’s interest in the intellectual
property embedded in the wallet custody software and its source code.
b.
Transfers between wallets maintained by means of the wallet custody
software are directed from BAM Trading’s internal ledger management system, known as PNK.
In addition to facilitating transfers, PNK maintains the official ledger that reflects each customer’s
crypto asset holdings on the BAM Trading platform.
i.
The software underlying PNK was also originally developed
by BHL. However, BAM Trading received a copy of the PNK source code, and BAM Trading
personnel are now solely responsible for managing BAM Trading’s use of PNK, without the
involvement of BHL.
ii.
Certain transfers are conducted automatically by PNK,
subject to dollar thresholds managed by BAM Trading personnel.
iii.
Other transfers must be manually initiated and approved.
iv.
BAM Trading requires multiple levels of approval for
manually initiated and approved transfers to ensure that a single person does not have authority to
transfer assets off of the platform.
31.
Deposit Wallets. If a BAM Trading customer seeks to transfer existing crypto
assets from a wallet outside the BAM platform (i.e., an external wallet) to their BAM Trading
account, the wallet custody software automatically assigns the customer a deposit wallet to receive
11
PDF Page 13
Case 1:23-cv-01599-ABJ Document 42 Filed 06/12/23 Page 12 of 20
those funds. These wallets are customer-specific and only hold assets on behalf of the assigned
customer.
a.
For such customers, the PNK system is configured to assign a unique,
customer specific, deposit wallet for each respective crypto asset network currently supported by
BAM Trading even if the customer is only depositing one such crypto asset.
b.
PNK is configured to automatically transfer the contents of customer-
specific deposit wallets to BAM Trading’s omnibus hot wallets, described in Paragraph 32 below,
if their balance exceeds predefined thresholds.
32.
Omnibus Hot Wallets. BAM Trading maintains omnibus hot wallets to conduct
on-chain transactions, such as facilitating customer withdrawals. There is at least one hot wallet
for each crypto asset network supported by the BAM Trading platform. These wallets are omnibus
wallets and hold assets on behalf of multiple customers, as well as proprietary assets owned by
BAM Trading.
a.
These wallets are configured to hold approximately five-times the volume
of daily withdrawals for each crypto asset. The withdrawal limit can vary based on prevailing
market conditions, but the design is intended to minimize the security risk of storing too many
crypto assets in the hot wallet yet still maintaining sufficient liquidity to support customer requests.
b.
PNK is configured to automatically transfer the contents of these omnibus
hot wallets to BAM Trading’s omnibus cold wallets, described in paragraphs 33 below, if their
balance exceeds predefined thresholds. These transfers are entirely automated and subject to
thresholds controlled by BAM Trading.
c.
BAM Trading’s omnibus hot wallets are configured to allow transfers to
external wallets.
12
PDF Page 14
Case 1:23-cv-01599-ABJ Document 42 Filed 06/12/23 Page 13 of 20
i.
Customer initiated-transfers of less than $1 million (or other
applicable customer-specific limit) are automatically approved by PNK.
ii.
Liquidity management transfers initiated by BAM Trading
or a larger customer-initiated transfer must be approved by two different members of BAM
Trading’ clearing team.
iii.
No BHL personnel have access or authority to initiate or
approve transfers from BAM Trading’s hot wallets. Certain entities ultimately owned by Mr. Zhao
that are BAM Trading customers can, like any other customer, withdraw crypto assets from their
own BAM Trading accounts. However, these transfers are limited to those entities’ own crypto
assets.
33.
Omnibus Cold Wallets. BAM Trading maintains omnibus cold wallets to securely
custody customer and proprietary crypto assets that are not immediately needed to conduct onchain transactions. In other words, cold wallets are more secure than hot wallets but they have
additional security controls that make them more difficult to access than hot wallets. There is at
least one cold wallet for each crypto asset network supported by the BAM Trading platform. These
wallets are omnibus wallets and hold assets on behalf of multiple customers, as well as proprietary
assets owned by BAM Trading. These omnibus cold wallets have several important security
features.
a.
First, these wallets are controlled using the Threshold Signature Scheme
(“TSS”). Under TSS, the private key for a wallet is split multiple ways into “shards” and
distributed to multiple persons “shard holders.” Assets can only be moved if the transaction is
approved by a defined quorum of shard holders.
13
PDF Page 15
Case 1:23-cv-01599-ABJ Document 42 Filed 06/12/23 Page 14 of 20
i.
BAM Trading’s omnibus cold wallets currently have seven
key shards. Votes by four shard holders approving the transaction are necessary for any crypto
asset movement.
1.
Senior BAM Trading personnel with experience in
crypto asset custody hold four key shards. Three of these individuals are located in Canada; one
is located in the United States. Two of these individuals were formerly employed by BHL but has
worked solely for BAM Trading since the summer of 2021. None of these individuals is currently
associated with BHL or has any relationship with Mr. Zhao.
2.
BHL personnel hold the remaining three key shards.
As described below, BHL holds these shards for disaster recovery purposes. In the unlikely event
that three of BAM Trading’s key shards are simultaneously impaired, BAM Trading can continue
to operate and move assets to and from its cold wallets by leveraging BHL’s key shards. However,
BHL’s shard holders may participate to approve transactions in the normal course for various
reasons, including when transactions are initiated after-hours in the United States, but during
working hours in the locations that the BHL shard holders reside.
3.
As a result of BHL only having three key shards, any
transfer from BAM Trading’s cold wallets requires the approval of at least one BAM Trading
personnel. As an added security measure, no single key shard holder knows the identities of the
other key shard holders. It is my understanding that pursuant to BAM Trading’s proposed
stipulation with the SEC, all seven key shards for BAM Trading omnibus cold wallets would be
held by BAM Trading personnel in the United States.
ii.
If a key shard is lost, destroyed, or compromised, a quorum
of the remaining key shards can vote to approve the creation of a replacement. This process
14
PDF Page 16
Case 1:23-cv-01599-ABJ Document 42 Filed 06/12/23 Page 15 of 20
requires approval from four key shard holders. As a result, BHL cannot unilaterally create or
replace any of BAM Trading’s key shards.
b.
Second, assets from the omnibus cold wallets can only be transferred to a
list of pre-approved “whitelisted” wallets.
i.
The only whitelisted wallets for BAM Trading’s omnibus
cold wallets are BAM Trading’s omnibus hot wallets, and as described below, BAM Trading’s
staking wallets. I understand that BAM Trading previously produced a list of these whitelisted
wallet addresses to the SEC Staff.
ii.
Adding a new whitelisted wallet requires the unanimous
approval of all seven shard holders.
iii.
As a result, even if an unauthorized transfers from BAM
Trading’s cold wallets occurred, those crypto assets could only be moved to another wallet
controlled by BAM Trading personnel. Crypto assets could not be transferred to external wallets
controlled by third parties.
c.
Third, transfers of crypto assets from BAM Trading’s omnibus cold wallets
may only be initiated by designated members of BAM Trading’s clearing team. This team is
comprised of six well-qualified people. None of these individuals are currently associated with
BHL or has any relationship with Mr. Zhao.
i.
Thus, crypto asset transfer requests require the involvement
of two separate groups of BAM Trading personnel: the clearing team that will initiate a transfer
request and the key shard holders who only to confirm, deny or take no action on a respective
transfer request. Requests must be sent to a dedicated member of BHL’s security operations team,
who then issues the TSS-approval request.
15
PDF Page 17
Case 1:23-cv-01599-ABJ Document 42 Filed 06/12/23 Page 16 of 20
ii.
No BHL personnel, nor Mr. Zhao himself, have access or are
authorized to initiate transfers from BAM Trading’s cold wallets.
d.
As a result of these controls, which are specifically designed to ensure BHL
does not have the access or authority to unilaterally transfer crypto assets from BAM Trading’s
omnibus hot and cold wallets to external wallets, BAM Trading maintains exclusive control over
the crypto assets it maintains in the wallet custody software on behalf of its customers and its own
account.
e.
External transfers may only be conducted from BAM Trading’s omnibus
hot wallets. Transfers that exceed pre-set thresholds may only be approved by designated members
of BAM Trading’s Clearing team. Other customer-initiated transfers may be automatically
approved by PNK.
f.
Transfers from BAM Trading’s omnibus cold wallet require the approval of
four key shard holders, at least one of whom must be a BAM Trading employee. These wallets
are configured so that assets may only be transferred to predefined whitelisted wallets controlled
by BAM Trading. And again, the only whitelisted wallets are BAM Trading’s omnibus hot
wallets.
g.
Under these controls, there is no way for third parties, including BHL, to
transfer assets from the BAM Trading platform to external wallets.
B.
Custody of Staked Assets
34.
In addition to the default custody arrangement described above, BAM Trading also
offers its Staking Services, which are subject to different custody arrangements.
16
PDF Page 18
Case 1:23-cv-01599-ABJ Document 42 Filed 06/12/23 Page 17 of 20
35.
Staked assets are currently maintained in three ways. The allocation of assets
depends across custody solutions depends on several factors, including when the asset became
compatible with the TSS encryption protocol described above.
36.
First, certain staked assets are custodied in TSS-enabled staking wallets within the
wallet custody software.
a.
These wallets are subject to the same TSS security as BAM Trading’s
omnibus cold wallets, except that they are configured to use four of the seven key shards. Two of
these key shards are held by BAM Trading personnel; the remaining two key shards are held by
BHL personnel. It is my understanding that pursuant to BAM Trading’s proposed stipulation with
the SEC, all four key shards for BAM Trading staking cold wallets would be held by BAM Trading
personnel in the United States.
b.
Two key shards are required to authorize a transfer or staking operation.
The only whitelisted wallets for BAM Trading’s staking cold wallets are BAM Trading’s omnibus
cold wallets. As all whitelisted wallets are BAM Trading omnibus cold wallets, BHL unilaterally
with its two key shards does not have the capability to transfer staked crypto assets off of the BAM
Trading platform. To whitelist additional addresses requires all four key shard holders (to
unanimously approve the wallet address. To reiterate, because of the security measure of only
permitting staked assets to be transferred to whitelisted wallet addresses, BHL could not transfer
staked assets to any external wallets.
i.
In terms of transfers, the only whitelisted wallets for the
TSS-enabled staking wallets are BAM Trading’s omnibus cold wallets and certain “fee” wallets
used to retain BAM Trading’s portion of the staking rewards earned from participating in the
Staking Service. As a result, crypto assets in these TSS-enabled staking wallets may only be
17
PDF Page 19
Case 1:23-cv-01599-ABJ Document 42 Filed 06/12/23 Page 18 of 20
transferred to BAM Trading’s omnibus cold wallets or the fee wallets that are also under its
control.
ii.
In terms of staking operations, two shards are also needed to
stake or unstake assets. These operations do not result in a transfer of the assets from the TSSenabled staking wallets. Instead, they merely reflect that the relevant tokens have been delegated
to the third-party node operator for participating in a staking pool. At all times, staked assets
remain in the TSS-enabled staking wallet, subject to BAM Trading’s custody and control.
37.
Second, certain crypto assets offered through the Staking Service are held in wallets
maintained by BitGo and Aegis, two U.S.-based third-party custody providers.
a.
These assets are custodied by BitGo and Aegis through their commercial
custody services.
b.
I understand that, BitGo and Aegis both employ mutli-signature private
keys. As a result, transfers of crypto assets from BitGo and Aegis must be approved by both a
BAM Trading key holder, as well as, respectively, a keyholder from BitGo or Aegis.
c.
Assets staked through the BitGo and Aegis wallets remain in the BitGo and
Aegis wallets. As with the TSS-enabled staking wallets, the staking process results in the
delegation of governance rights, but does not result in a transfer of the crypto asset to another
party, or a change in custody or control of the crypto asset.
38.
Third, a small number of staked assets were previously held on a Ledger hardware
wallet (“Ledger Device”). The Ledger Device is a cold wallet custody product produced by an
unaffiliated third-party entity. Ledger devices are publicly available for purchase and are marketed
as a personal custody solution for individuals or entities.
18
PDF Page 20
Case 1:23-cv-01599-ABJ Document 42 Filed 06/12/23 Page 19 of 20
a.
The Ledger Device is maintained in a safe deposit box in Singapore that is
exclusively under the control of BAM Trading personnel. The private key for this device is held
by a BHL employee.
b.
As of today, there are no customer assets held on the Ledger hardware
wallet.
IV.
ADDITIONAL CONTROLS
39.
In addition to the controls described above, BAM Trading has implemented
numerous surveillance mechanisms and alerts to ensure the safety and security of customer assets.
40.
For example, these controls automatically alert members of BAM Trading’s
clearing and security teams of any transfers of greater than $100,000. There are also alerts if
anyone requests access credentials to the PNK system.
V.
CONCLUSION
41.
Based on my experience and current knowledge, I understand that these practices
are consistent with industry best practices regarding the custody of crypto assets.
42.
No BHL employee or combination of employees have the ability or authority to
move assets within BAM Trading’s wallets (whether cold or hot) or to external wallets outside of
BAM Trading’ control.
43.
I am not aware of any instances in which BHL employees sought to move BAM
Trading’s crypto assets or otherwise attempted to interact with BAM Trading’s crypto assets
without authorization or instruction from BAM Trading personnel.
44.
I am not aware of any other facts that would affect my conclusion that BAM
Trading maintains custody and control over the crypto assets that it maintains on behalf of its
customers.
19
PDF Page 21
Case 1:23-cv-01599-ABJ Document 42 Filed 06/12/23 Page 20 of 20
I declare under penalty of perjury under the laws of the United States of America that the foregoing
is true and correct.
Executed this 12th day of June, 2023, in Washington, DC.
Ffik Kellogg
20
Back to 
