On January 18, when the U.S. Department of Justice announced a major law enforcement action against an international crypto company in conjunction with the Treasury Department and the Federal Bureau of Investigation (FBI), the crypto market was on high alert. Many people speculated that the company might be Digital Currency Group (DCG), a U.S. crypto group that is at the center of public opinion, in a liquidity crisis, and is frequently rumored to be on the verge of bankruptcy. Some crypto investors even liquidated their positions in advance to avoid risks.
Although it turned out to be a false alarm in the end - the target of sanctions was Bitzlato, a Russian "third-line" crypto trading platform, and the market rebounded quickly, there is no doubt that DCG has been tacitly regarded as a time bomb by the crypto market. The reason why many people waited and watched with empty positions and did not catch up with this round of market at the beginning of the year was probably because of concerns about the future of DCG.
From the suspension of withdrawals by DCG subsidiary and crypto lender Genesis in November last year, to the crypto exchange Gemini Lianchuang's complaint against DCG demanding repayment of $1.675 billion in loans at the beginning of this year, to the subsequent regulatory actions - the US SEC accused Genesis of issuing and selling unregistered securities, US prosecutors and the SEC investigated DCG's internal fund transfer issues, to Genesis's formal application for bankruptcy protection today. DCG now seems to have reached the end of the road.
Will DCG, which is in debt and under regulation, fall because of this? How will DCG save itself? Will DCG's Grayscale Trust be affected and sell off crypto assets such as BTC and ETH, causing the crypto market to fall again?
1. DCG-Genesis and Gemini are in constant dispute
After nearly three months of suspension, crypto lender Genesis today officially filed for Chapter 11 bankruptcy with the U.S. Bankruptcy Court for the Southern District of New York. According to Odaily Planet Daily, the total debt of the top 50 creditors currently registered is $3.8 billion. The most notable one is Gemini, which is Genesis' largest creditor with a total debt of $765 million, slightly lower than the $900 million debt stated in the previous open letter from Gemini co-founders.
In the past few months, there have been constant disputes between Genesis, DCG, and Gemini, with the founders of the several parties sending "short essays" to each other across the air, stirring up the entire crypto market.
The cause of the incident was that Gemini had launched a financial product called "Earn" with an annualized return of 8%, and the funds raised were managed by Genesis. In November last year, Genesis was affected by the bankruptcy of FTX, and some deposits were not redeemed, resulting in a liquidity crisis. As a result, Genesis suspended all lending services and prohibited withdrawals. Later, the media broke the news that the parent company DCG had a debt relationship with Genesis, with the amount exceeding US$1.5 billion, and DCG also confirmed the authenticity of the debt.
As the largest creditor of Genesis, Gemini began to form a creditor committee with other parties, trying to negotiate with DCG to resolve the issue, but with little success. At this time, due to the suspension of "Earn" redemption, Gemini and its two founders were also sued by users for fraud and violation of trading laws. The Winklevoss brothers (Gemini's two founders) decided to fight back.
At the beginning of the new year, Cameron Winklevoss sent an open letter (click to read) to DCG founder Barry Silbert on behalf of more than 340,000 users of his Earn product, asking him to repay the more than $900 million owed. In the open letter, Winklevoss stated that DCG owed Genesis about $1.675 billion and accused Barry Silbert of refusing to cooperate and maliciously adopting delaying tactics.
Barry Silbert responded later, saying: "DCG did not borrow $1.675 billion from Genesis. DCG has never defaulted on interest payments to Genesis and is currently repaying all outstanding loans; the next loan is due in May 2023." According to Barry Silbert, there is a short-term debt between DCG and Genesis (due in May 2023), which is only $575 million - $447.5 million in cash and 4,550 BTC; another $1.1 billion promissory note is due in 10 years, that is, in June 2032, which is a debt between Genesis and Three Arrows Capital that DCG took the initiative to assume. At that time, DCG believed that once the market stabilized, there would continue to be a large demand for institutional prime brokerage services, and Genesis's huge brand influence had a great competitive advantage and was worth protecting.
However, this statement failed to impress the Winklevoss brothers. A week later, Cameron Winklevoss published another long article (click to read). Cameron said that Barry Silbert and other key personnel misled everyone through false statements, making all parties believe that Genesis had recovered from the losses of Three Arrows bankruptcy, thereby inducing lenders to continue to provide loans. Cameron believes that the $1.1 billion promissory note provided by DCG has not been actually cashed, which is a financial fraud, and its actual value will be greatly discounted - a 70% discount, and the market price may only be sold for $300 million.
In addition, Cameron also revealed to the DCG board of directors that its executives, in conjunction with Genesis and Three Arrows Capital, illegally manipulated GBTC, but the plot ultimately failed, causing Genesis to pile up in debt and triggering the DCG Group to fall into a liquidity crisis. Cameron also suggested that the DCG board of directors remove DCG's current CEO Barry Silbert and appoint a new CEO.
In response to Cameron’s request, Barry Silbert and DCG officials said that this was another desperate and non-constructive publicity stunt by Cameron, aimed at transferring the dissatisfaction of Gemini platform Earn users to DCG. In addition, Barry Silbert also wrote a shareholder letter (click to read) to clarify that the loan with Genesis was conducted "in the normal course of business" and distanced himself from Three Arrows Capital, FTX, and Terra (Luna).
Thanks to the Winklevoss brothers’ efforts, U.S. authorities began investigating the internal financial transactions of Barry Silbert’s crypto company. Bloomberg reported that investigators are “examining transfers between DCG and Genesis.” In addition, the U.S. SEC has also intervened, accusing Genesis Global Capital and Gemini Trust Company of offering and selling unregistered securities to retail investors through crypto lending programs.
In the end, Genesis, which DCG tried to save, inevitably filed for bankruptcy protection. It is worth noting that the companies currently filing for bankruptcy are Genesis Global Holdco and its two loan business subsidiaries, Genesis Global Capital and Genesis Asia Pacific. Other subsidiaries involved in derivatives, spot trading and custody businesses, as well as Genesis Global Trading are not included in the application documents and continue to engage in customer trading business.
“Genesis’ bankruptcy filing is the first step for Gemini to recover Gemini Earn users’ assets. Although Gemini has been working hard to negotiate with Genesis, DCG and its CEO have refused to provide fair processing information. This situation will change after Genesis files for bankruptcy protection. Under judicial supervision, Genesis will have to disclose information and let everyone know how things have come to this point.” Cameron Winklevoss commented.
2. Bull market expands blindly, bear market suffers heavy losses
DCG is also facing a liquidity crisis and is in debt to many companies.
Dutch cryptocurrency exchange Bitvavo said it had deposited 280 million euros in assets with DCG, but has been unable to withdraw cash since December last year due to liquidity issues. In its latest statement, Bitvavo said DCG had previously proposed to the company to repay only 70% of its debt; Bitvavo believed that DCG had enough funds to repay all debts, so it rejected the proposal.
In addition, British investment group Eldridge provided DCG with a debt financing of $600 million in November 2021. According to Barry Silbert, it still owes $350 million.
In the past few months, the hard-hit DCG has begun to actively cut costs to cope with the current market conditions, including cutting operating expenses, layoffs, etc., and also closed HQ, a wealth management subsidiary incubated by DCG in 2020, at the beginning of this year. It is reported that the company previously managed more than $3.5 billion in assets. "While we still believe in the HQ concept and its outstanding leadership team, the current downturn is not conducive to the short-term sustainability of the business." Barry Silbert wrote.
In addition, DCG also stated in a shareholder letter that it would suspend dividends. "In response to the current market environment, DCG is focused on strengthening its balance sheet by reducing operating expenses and maintaining liquidity. Therefore, we have decided to suspend DCG's quarterly dividend distribution until further notice." Just a month ago, DCG had stated that it was expected to achieve annual revenue of $800 million.
As more problems emerge, more and more celebrities and politicians are starting to distance themselves from DCG. Larry Summers, a Harvard University professor and former chief financial adviser to the Obama administration, joined DCG as a macroeconomic affairs adviser in 2016. He recently announced that he had left DCG and deleted his DCG-related resume from his personal website profile.
Glenn Hutchins, one of three directors on DCG's board and co-founder of Silver Lake, also resigned from the DCG board in November. Hutchins also serves on the boards of AT&T, Nasdaq, the Federal Reserve Bank of New York, the Brookings Institution, the Economic Club of New York, and the Center for American Progress.
Founded in 2015, DCG, which has a portfolio of more than 200 companies in 35 countries, now seems to have entered a development dilemma due to blind expansion in the bull market.
Take the funds DCG borrowed from its subsidiary Genesis, for example - DCG borrowed $500 million at an annualized interest rate of 10%-12% between January and May 2022, which was initially kept in the vault for emergencies. But in the end DCG decided to use the funds to buy back DCG shares from one of its earliest venture investors and invest in liquid tokens and public stocks (note: DCG did not explain the specific content of this part).
In addition, DCG also used the funds obtained from the British investment group Eldridge for expansion, mainly investing in GBTC (Grayscale Bitcoin Trust). According to statistics from Odaily Planet Daily, since the first quarter of 2021, DCG has spent a total of US$1.305 billion to purchase 54,823,667 shares of GBTC, with an average price of US$23.8 per share. According to the latest market price ($11.46), DCG has lost US$677 million; if it can be repurchased at the true value ($19.24) in the future, DCG will still lose US$250 million. The loss is so huge, firstly, DCG misjudged the situation and continued to increase its positions in the bear market. In particular, in the second quarter of last year, DCG spent US$550 million to buy 36.74 million shares of GBTC, and its assets have been halved as the market fell; secondly, due to the continuous increase in the discount rate of GBTC, it is currently reported at 40.4%.
However, DCG explained that the GBTC investment did not lose money and had been hedged with Bitcoin borrowed from Genesis. "DCG's investment entity hedged its GBTC long position with BTC borrowed from Genesis Capital to maintain market neutrality on such positions. DCG purchased GBTC on the open market when GBTC was trading at a significant discount to NAV, and like all other investments, these decisions were based on an assessment of the possible return-weighted risk."
Finally, what crushed DCG were the two "black swan" events last year. One was the bankruptcy of Three Arrows Capital, Genesis lost $1.1 billion and transferred the debt to DCG, and then DCG continued to invest $340 million in new equity for Genesis to provide it with additional funds; the second was that FTX and Alameda were insolvent, and Genesis' accounts receivable were difficult to recover. If this bad debt was really "small in amount" as Genesis said, it would not have reached the point of filing for bankruptcy today. According to Twitter user @AP_Abacus, Barry and DCG had pressured Alameda to repay the $2.5 billion loan owed to Genesis.
"You took the money and fueled greedy stock buybacks, illiquid venture capital, and kamikaze Grayscale NAV transactions, which rapidly expanded your fund's fee-generating assets under management (Fee-Generating AUM). All of this was at the expense of creditors and was only for your personal benefit. Now is the time for you to take responsibility and do the right thing." Cameron Winklevoss commented on DCG founder Barry Silbert, "The idea in your head is that you can hide quietly in your ivory tower and all this will magically disappear; or, it will be someone else's problem. This is pure fantasy! To put it bluntly, this mess is entirely your own fault."
3. Subsequent impact: Will DCG go bankrupt?
Genesis currently has just $150 million in existing cash on hand, according to today’s press release. “We look forward to advancing our conversations with DCG and our creditors’ advisors as we seek to implement a path that maximizes value and provides our business with the best opportunity to position it for the future,” said Paul Aronzon, an independent Genesis director.
With Genesis filing for bankruptcy, DCG is running out of time, and the next goal of creditors will be to recover the money owed by DCG. Haseeb Qureshi, partner of Dragonfly Capital, said that Genesis creditors may ask DCG to redeem Genesis's $1.1 billion 10-year notes, which will cause DCG's liquidity to dry up and lead to its bankruptcy.
However, this statement was refuted by DCG founder Barry Silbert. He said that this $1.1 billion promissory note is non-redeemable and does not contain any other similar features of redeemable bonds. In other words, this promissory note can only be redeemed after 10 years; for DCG, the current funding gap is only the aforementioned short-term debt due in May this year: $447.5 million in cash and 4,550 BTC (95.55 million US dollars), close to $550 million.
According to the Financial Times, people familiar with the matter revealed that DCG is considering selling some of its venture capital assets, including 200 cryptocurrency-related projects in at least 35 countries, such as exchanges, banks and custodians, worth about $500 million. In addition, DCG's crypto media CoinDesk has also expressed its intention to sell part or all of its business; Cardano co-founder Charles Hoskinson said he is considering acquiring CoinDesk and plans to bid $200 million (Note: CoinDesk was originally acquired by DCG in 2016 for about $500,000 to $600,000, and currently has an annual revenue of about $50 million).
Of course, in addition to selling subsidiaries, another option for DCG is to sell part of its equity. In November 2021, DCG completed $700 million in financing at a valuation of $10 billion. Although the valuation will shrink in the bear market, it is not a big problem to sell part of the shares to raise hundreds of millions of dollars. According to The Block, Genesis' creditors negotiated with DCG to develop a pre-packaged bankruptcy plan, agreeing to a one to two-year grace period for repayment; in exchange, creditors will receive cash payments and equity in Genesis' parent company DCG.
In addition, the market was generally worried that the bankruptcy of Genesis would lead to the bankruptcy of DCG, which would in turn trigger a huge liquidation of GBTC. It should be noted that Grayscale itself is not involved in any debt of DCG. It is a completely independent third-party entity and will not be closed suddenly. In addition, even if all subsidiaries are sold at a low price, DCG is unlikely to sell Grayscale Trust. As DCG's flagship business and its cash cow, Grayscale is the most stable part of all businesses, contributing about $300 million in fee income each year - Grayscale Fund has a total holding of $16.191 billion and charges a 2% management fee each year.
DCG itself holds GBTC, and it will not suddenly dump it into the market. According to Grayscale CEO Michael Sonnenshein, DCG, Genesis, Coindesk and a number of affiliated companies are only allowed to sell 1% of the total outstanding shares to the open market every three months due to Section 144 of the Securities Exchange Act of 1933. In other words, companies such as DCG need to wait more than two years to realize their GBTC through the secondary market. Moreover, GBTC is currently severely discounted, and DCG is even less likely to sell it in large quantities at this point. It only needs to wait for the Grayscale Bitcoin Trust (GBTC) to be converted into a Bitcoin ETF to recover the funds according to the net value (Note: All of Grayscale's digital assets are stored in Coinbase Custody, not in custody by DCG).
In summary, whether it is the sale of some subsidiaries or the parent company's equity, DCG's short-term debt does not have a big gap, so the market does not need to worry too much. As for the next ten years, can DCG repay the $1.1 billion promissory note? As long as DCG does not collapse and the crypto market is still there, I think the possibility of repayment is still very high.
