Concerns about Barry Silbert, DCG, Genesis, Grayscale and possible contagion risks

Is Barry Silbert’s DCG still in hot water? Apparently so. And if it falls, the contagion that has been plaguing the crypto world for the last year could expand even further. Prior to Terra’s collapse, its creator Do Kwon said that if his algorithmic stablecoin failed, the whole crypto world was going to implode. 

He was right. And the collapse of Terra brought the revelation that some of the most respected crypto firms were involved in risky, questionable and incestuous deals. Everyone was in bed with each other, hence the contagion.

We can still feel the ripple effects. It was bad enough when 3AC, BlockFi, Celsius, and Voyager fell one after the other, but the posterior FTX collapse was the one that really shook the ground crypto was built on. Apparently, everybody and their mothers had money in Sam Bankman-Fried’s derivative-focused exchange. By their own admission, DCG-owned Genesis has $175M worth of unidentified coins locked on the FTX platform. That doesn’t seem to be that much for a company that big, but the contagion doesn’t stop there. It spreads.

For example, cryptocurrency prime broker Genesis was the counterpart for the Gemini Earn program. Clients of the Winklevoss twins’ Gemini exchange lent their crypto assets to Genesis in exchange for yield, and apparently, none of the organizations disclosed the risks to their clients. But that’s not the worst part. Since they didn’t register the Gemini Earn product with the SEC, the commission initiated a probe into the two companies. If they end up paying a multi-million dollar settlement, thousands of Gemini Earn clients will have an even tougher time recouping their money.

‍

Is a DCG Chapter 11 filing in the cards?

So, DCG is still in hot water, and authorities on the matter still think that the company could end up filing for bankruptcy as its subsidiary Genesis already did. And before that happens, Grayscale, another DCG subsidiary, might have to dissolve the infamous GBTC trust. All the BTC that the trust holds might hit the market in one way or another, further expanding the contagion and sparking volatility across the whole crypto space.

Make no mistake, that hasn’t happened and it’s not a foregone conclusion. Barry Silbert sounds extremely optimistic in his latest DCG update: “To my peers in the trenches, now is a time to collaborate, cheer each other’s successes, and collectively take our industry to the next level.  Let’s all grow together, treat others with respect, and get back to having fun and making a dent in the universe,” he wrote. Is Silbert just stalling as Cameron Winklevoss has repeatedly said? Let’s examine the case before arriving at any conclusions.

‍

About DCG and its subsidiaries

Let’s start with the basics and get to know the main players.

• The Digital Currency Group or DCG is a crypto-focused venture capital company led by Barry Silbert. They are also a prime broker, and before the collapse, in 2021, they had $50 billion in AUM.
• Besides Genesis and Grayscale, the DCG owns CoinDesk, Foundry, and Luno.
• DCG also operated a wealth management firm under the name HQ. They closed it down in the first days of January. In a statement, the company claimed, "due to the state of the broader economic environment and prolonged crypto winter presenting significant headwinds to the industry, we made the decision to wind down HQ."
• Genesis was a prime broker and lending cryptocurrencies was its business. The division filed for Chapter 11 bankruptcy in the middle of January. Much more on Genesis later.
• Grayscale’s business is asset management, and their main product is the aforementioned Grayscale Bitcoin Trust or GBTC, which currently has about $10 billion in AUM.

‍

More about the Grayscale Bitcoin Trust or GBTC

Since the SEC refuses to approve a spot bitcoin ETF, GBTC shares were the only option for institutional investors that wanted exposure to BTC for years. For that reason, the GBTC traded at a premium over the underlying asset. In recent times, however, the SEC approved a series of bitcoin futures ETFs that cut into the Grayscale Bitcoin Trust’s market share. Those ETFs charge a cheaper management fee than GBTC’s controversial 2%, and money talks. The increased competition mixed with the bear market hit GBTC hard, and the fund now trades at a significant discount of almost 50%.

Besides Satoshi Nakamoto, nobody owns more bitcoin than the Grayscale Bitcoin Trust. As per their numbers, they hold approximately 635K BTC. However, during their parent company’s troubled times, Grayscale refused to perform a proof of reserves for unspecified security reasons. Coinbase, who’s supposedly the BTC’s custodian, vouched for them but showed no proof. However, it’s suspicious that in a post-FTX world Grayscale chose not to instill customer confidence by opening their wallets. 

Another important part of the story is that DCG has been trying to transform the Grayscale Bitcoin Trust into an ETF for years. Since an ETF value would theoretically track the underlying asset, the transformation would get rid of premiums and discounts. The SEC has refused their requests every time, breaking all of the GBTC holders’ hearts. And currently, Grayscale is suing the SEC for this exact reason. 

‍

The Three Arrows Capital/ DCG story

Three Arrows Capital or 3AC was a cryptocurrency-focused hedge fund. The Terra collapse hit them the hardest, and it came to light that they had borrowed billions of dollars from Genesis and Voyager, among others. At some point, they held almost 40 million GBTC shares. Apparently, they used those shares and other assets as collateral to borrow $2.3 billion from Genesis.

To cover for that loss, DCG signed a $1.1 billion promissory note to Genesis. This is widely known at the moment, but at first Barry Silbert and company didn’t disclose this to investors. Not only that, but DGC already owed $575 million to Genesis. In the recent DCG update, the company shared the whole story, “DCG’s investment entity borrowed BTC during 2021 and 2022 at a weighted average interest rate of 3.85%, which include amounts previously borrowed that have since been repaid to Genesis Capital, leaving the current 4,550 BTC loan balance.”

‍

The Gemini Earn story

The battle between the Winklevoss twins’ Gemini and Barry Silbert’s DCG is one for the ages. After the FTX collapse, everyone tried to collect the loans they had made. And, as we already explained, the Gemini Earn program consisted of loans to Genesis that generated yield. According to Cameron Winklevoss’ first open letter to Silbert, Genesis owed $900 million to Gemini. The twin also claimed that Silbert has “been engaging in bad faith stall tactics.”

In the previously quoted DCG update, Silbert addressed the issue, claiming “this is another publicity stunt from Cameron Winklevoss to deflect blame from himself and Gemini. Any suggestion of wrongdoing by DCG or any of its employees is baseless and completely false.” After that letter, Gemini officially closed down the program with an e-mail to their clients. “This officially terminates the Earn Program and requires Genesis to return all assets outstanding in the program,” Gemini wrote.

This is where things get interesting. The same day that Genesis froze withdrawals on the Gemini Earn program, the Winklevoss twins’ exchange announced that they’d sold more than 30 million GBTC shares in a private sale. Since those shares were part of the collateral, they applied the $284.3 million they earned to the aforementioned debt. Since that was part of the overall deal, Genesis lawyers have apparently been working overtime to invalidate the contract. 

Plus, reportedly Genesis is trying to classify Gemini Earn clients as unsecured creditors. In case of a distribution of goods, this classification would give priority to institutional investors and secured creditors over them.

‍

About Genesis’ Chapter 11 filing

In the DCG letter to shareholders, the company explained, “Genesis has its own independent management team, legal counsel, and financial advisors, and appointed a special committee of independent directors, who are in charge of the Genesis Capital restructuring, and who recommended and decided that Genesis Capital file chapter 11.” In the massive filing, Genesis listed over 100K creditors and over $11 billion in liabilities.

Following that, some of those creditors who lent their cryptocurrency to Genesis filed a securities class action lawsuit against DCG and Barry Silbert.

‍

The initiative to redeem GBTC

When it rains, it pours. Since DCG and Silbert are in hot water, people don’t trust the Grayscale Bitcoin Trust anymore. The redeemGBTC campaign is trying to change the Trust management and reduce the fees, but their main objective is to find a way for shareholders to redeem their shares. If successful, the GBTC clients might even receive real bitcoin for their troubles.

The campaign’s creator is Bitcoin Magazine’s David Bailey, who has been pretty vocal about the situation on Twitter. Among other things, Bailey denounced the back door deal that gave Gemini all of the GBTC shares they sold. “The revelations from the Genesis bankruptcy filings are stunning and there are many threads deserving of deep investigation... but DCG pledging 10% of GBTC's float to Gemini is immoral and illegal. The SEC must move swiftly to force redemptions and protect the public.”

The question here is, does Grayscale really have all the bitcoin they claim to have? They probably do, but why did they refuse a proof of reserves procedure? That would have surely calmed some of the agitated GBTC clients.

There’s another burning question, as well.  Is a DCG Chapter 11 filing in the cards? Let’s hope it isn’t, because if an institution of this magnitude falls, the crypto world could take years to recover.