Forbes Leave it to fate, the predicament and redemption of the crypto empire DCG

Forbes Destiny, Dilemma, and Redemption of Crypto Empire DCG

Written by: Nina Bambysheva, Forbes

Translated by: Luffy, Foresight News

Barry Silbert, Founder of Digital Currency Group

In May 2022, the domino effect after Terra’s collapse quickly devastated the entire cryptocurrency industry. Within the following year, Celsius Network, BlockFi, Voyager Digital, and FTX all filed for bankruptcy, and once-prominent cryptocurrency CEOs either found themselves in court or behind bars. Now, with Bitcoin surpassing $40,000, the crypto industry seems to have finally emerged from the winter.

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For Barry Silbert and his Digital Currency Group (DCG) based in Stanford, Connecticut, the ripple effect of Terra’s collapse felt like quicksand. His lending division, Genesis Global Capital, filed for bankruptcy protection in January this year, but the group still owns over 200 companies in its vast investment portfolio, including cryptocurrency miner Foundry, digital asset exchange Luno, and the crown jewel Grayscale Investments (the world’s largest Bitcoin fund with $27 billion in assets and a 2% expense ratio). Despite the rise in Bitcoin prices, Grayscale’s flagship product, GBTC, still trades at an 11% discount compared to Bitcoin spot. Last month, DCG sold its news website CoinDesk to Bullish, a cryptocurrency exchange led by former NYSE President Tom Farley, for an undisclosed amount.

Silbert’s crypto winter continues, as the former billionaire faces a series of serious issues:

• New York State Attorney General Letitia James seeks to ban DCG and Genesis from conducting business in New York as punishment for allegedly hiding over $1.1 billion in losses related to the collapse of Singapore’s Three Arrows Capital, one of Genesis’ largest borrowers.
• Gemini cryptocurrency exchange President Cameron Winklevoss also accuses Silbert and DCG of defrauding Gemini depositors. Bloomberg, citing sources, reported that the FBI, SEC, and state officials are investigating these allegations.
• Genesis accuses its parent company of treating it as a “de facto” treasury without proper corporate governance. It demands DCG to repay over $320 million in loans due in May 2023 by April 2024. According to the proposed bankruptcy plan submitted on November 28th, DCG has agreed to new terms.
• Many Genesis creditors rejected DCG’s latest recovery proposal presented in August. The new plan allows Genesis to sue DCG for various reasons. DCG claims these allegations are baseless, while Genesis prefers a settlement rather than pursuing legal action against its former parent company.

The fraud charges mentioned in the New York civil lawsuit include the suspicious $1.1 billion 10-year note on Genesis’ balance sheet, which came from DCG and was marked as a current asset.

Austin Campbell, a part-time professor at Columbia Business School and managing partner at Zero Knowledge Consulting, a blockchain-focused firm, said, “FTX is more like Bernie Madoff, but if these allegations are true, DCG may be more like Enron.”

DCG denies the fraud allegations. “The note represents DCG’s effort to assist Genesis after Three Arrows Capital defaulted in June 2022,” an unnamed company spokesperson told Forbes via email. “DCG agreed to take over the $1.1 billion unsecured loan that Genesis had lent to Three Arrows Capital, the repayment of which remains highly uncertain both in the past and now. DCG has not received any cash, cryptocurrency, or other form of payment on the note and assumed the risk of Genesis’ loss on Three Arrows Capital without any obligation.”

The spokesperson added that the note mechanism used to aid Genesis was approved by DCG’s “financial and legal advisors, as well as our accountants.”

Silbert and DCG also insist that they have cooperated with the investigation by the New York Attorney General and were caught off guard by these allegations, which they describe as “baseless” and misleading.” However, numerous lawsuits and claims are still unresolved, and time seems to be on Silbert’s side.

As for Gemini’s claim that DCG defrauded exchange depositors, DCG stated in a January statement, “This is Cameron Winklevoss trying to dodge responsibility, as he is the sole operator of Gemini Earn and was responsible for marketing the product to customers.”

Bitcoin rose 157% last year, and the value of many of the digital assets behind Silbert’s massive empire may have increased by billions of dollars. For example, Bitcoin miners’ stock prices have skyrocketed in recent weeks, with Marathon Digital up 356% so far this year. DCG’s mining subsidiary, Foundry, now has a market value of $3 billion. Given its rich assets, DCG has fared much better than other victims of Terra’s collapse.

Ram Ahluwalia, CEO of investment consultancy Lumida Wealth Management, who has been following the case closely, said the biggest threat facing DCG seems to be the New York lawsuit, which could force Silbert to give up Grayscale. “The New York State Attorney General is attempting to ban DCG from operating securities and commodities businesses in the state,” Ahluwalia said. “Legally, they would be required to cease various operations.”

Ahluwalia added that if James wins, DCG would be unable to conduct business in New York, which could quickly become a broader issue: other states may take similar actions.

According to an investor letter recently seen by Forbes, Grayscale manages over ten cryptocurrency funds, including the large-scale Grayscale Bitcoin Trust (GBTC), which accounts for nearly two-thirds of DCG’s revenue. Grayscale’s revenue accounted for 67% of DCG’s $188 million in third-quarter revenue, or $126 million, which is 2.5 times that of the second-largest subsidiary, Foundry.

What’s even worse is that the approval of a Bitcoin spot ETF may weaken Grayscale’s appeal to future buyers. Ironically, Grayscale has been trying to turn GBTC into an investor-friendly ETF and recently won a significant court case, further advancing the proceedings. However, the outcome may be the emergence of numerous new competitors, including giants like BlackRock and Fidelity, with management fees for similar funds being only a fraction of the current level.

Ahluwalia suggests that losing Grayscale will leave DCG “embroiled in endless settlements and lawsuits.” He adds that the remaining power of the Silbert Empire will actually become a “debt-ridden zombie company.” However, the rebound of cryptocurrency may be its savior. In November 2021, at the peak of the cryptocurrency frenzy, DCG sold $700 million in a SoftBank-led private placement, valuing it at $10 billion.

<p"If DCG ultimately can't escape its predicament and reach a settlement with Genesis' creditors, they may be forced into bankruptcy," consultant Campbell states.

DCG’s recovery plan initially received support from Genesis and the Unsecured Creditors Committee but not from Gemini and the Genesis Lenders’ Special Committee, which offered a “viable best recovery plan.”

One of the most complex factors in the Genesis bankruptcy solution is the legal dispute between Genesis and Gemini. In 2021, Earn offered up to an 8% annual yield to depositors willing to store their cryptocurrency on Gemini. Under the scheme, Genesis borrowed cryptocurrency from Gemini Earn customers at a higher interest rate for reinvestment and pocketed most of the spread after paying interest. Winklevoss’ Gemini acted as an intermediary, handling deposits and withdrawals and taking a small commission from Silbert’s Genesis to Earn investors’ payments. Genesis suspended withdrawals on November 16, 2022, to protect its assets.

Prior to this, as the cryptocurrency market worsened due to a series of bankruptcies, Genesis agreed to provide collateral to ensure that Earn clients would not lose their assets in the event of borrower default. The collateral used was shares of the Grayscale Bitcoin Trust, and Genesis agreed to deliver 30.9 million shares on August 15, 2022, and 31.2 million shares on November 10, 2022. When Genesis suspended withdrawals six days later, Gemini rescinded the redemption rights for the first batch of collateral, but the second batch had not yet been transferred. At the time of rescission, the trading price of GBTC was $9.20 per share.

Last month, Gemini sued Genesis, demanding the remaining collateral. It is alleged that DCG had sent the GBTC shares to Genesis, but the department refused to transfer them. Now, the value of the collateral is much higher than initially, with a trading price exceeding $30. These stocks combined are worth $1.6 billion, enough to satisfy the claims of Earn clients.

Genesis has a different perspective. On November 21, it filed a lawsuit against Gemini, requesting the return of $689 million that Earn users withdrew from Genesis within 90 days of filing for bankruptcy. Genesis also hopes to redistribute collateral to benefit all its creditors and objects to Gemini’s right to redeem collateral and additional GBTC shares. Gemini insists that Earn customers have priority in receiving compensation due to the collateral transactions.

There is another twist: when Gemini canceled the redemption right, the initial batch of GBTC collateral was valued at $284 million, which has now increased to over $800 million. Gemini still controls these stocks and claims to hold them for the benefit of Earn depositors.

An anonymous Genesis lender told Forbes that many creditors believe that Silbert’s DCG and Winklevoss’ Gemini have acted maliciously. “I think the creditors are feeling incredibly frustrated because this bankruptcy process has taken so long, and DCG is unwilling to propose reasonable solutions. They have repeatedly delayed and ultimately proposed very unfavorable conditions.”

“I think the best outcome for creditors, DCG, and Genesis as a whole is to reach a fair settlement with DCG,” said another Genesis creditor who goes by the name BJ on Telegram. “Creditors’ lives have been severely disrupted by the bankruptcy process, while DCG has benefited from the delays in this case. I believe finding a way to avoid prolonged litigation involving thousands of creditors with fraud allegations is in DCG’s best interest.”

Undoubtedly, the recovery of the cryptocurrency market is helping DCG. “DCG either seeks enough time to rebuild its balance sheet with the profits it made from Grayscale, eventually enabling it to pay Genesis, or there are other legal pressures that force DCG to file for bankruptcy,” said Jeff Dorman, Chief Investment Officer of cryptocurrency hedge fund Arca. “So far, we haven’t seen anyone wielding a big enough stick to compel DCG to pay up and force its bankruptcy.”

Another anonymous creditor suggests that Silbert and DCG may also benefit from the delay in Genesis’ bankruptcy: “There was a multi-million dollar loan (to Genesis) due in May, but he hasn’t paid it back yet, and that’s his capital to make money. The current risk-free interest rate is 5%, so you can imagine he is making $30 million a year due to the delay.” According to documents filed on November 27, DCG has reduced its subsidiary’s debt from over $600 million to about $324.5 million.

“The deal Genesis just made with DCG regarding the DCG loan is absolutely ridiculous. These loans were supposed to be due in May,” scoffed creditor BJ. “They sued DCG to repay the loan, and they immediately gave them a break. That break period ended, DCG still hasn’t paid them, and now they are ready to give them another break. This is unfair to the creditors.”

Meanwhile, the clock is ticking. Grayscale and other asset management companies, including BlackRock, Ark, WisdomTree, VanEck, Invesco, and Fidelity, seem to be on the verge of receiving SEC approval to launch a Bitcoin spot ETF. According to Bloomberg analysts, the approval timing is still uncertain, but it could happen before January 10th.

If Grayscale successfully obtains SEC approval and converts GBTC into an ETF, the discount on the fund’s holdings value will narrow or disappear, thereby increasing its value to shareholders (one of the largest shareholders being Genesis). DCG’s cash flow could be affected by the pressure to match the expense ratio of ETF competitors. According to Morningstar, the average expense ratio for US-listed ETFs and mutual fund managers is less than 0.4% of assets. However, given that Grayscale has $27 billion in assets as a closed-end fund, it would immediately become the largest ETF in the market. The new funds flowing into the GBTC ETF could offset the decrease in expense income.

Genesis bondholders, BJ, explained, “If GBTC converts to an ETF with halved management fees, it would affect the compensation we could receive.” But he added that if the ETF gets approval, it would be unfavorable for DCG, and the actual situation would be complex, “they would still be the largest participants.”

Regardless of the action taken by Grayscale, Ahluwalia believes that DCG is facing potential “destruction” of its brand, a situation that could occur within two to three years.

“We repeatedly understand that this is detrimental to the sentiment of the cryptocurrency market,” said Arca’s Dorman, “for a casual observer, this is bad because they only see negative headlines every day. These companies will find a way to pivot.”

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