Forbes: Resigned to fate, the dilemma and salvation of the crypto empire DCG

Written by: Nina Bambysheva, Forbes

Compiler: Luffy, Foresight News

Barry Silbert, Founder, Digital Currency Group

In May 2022, the domino effect following the collapse of Terra quickly wreaked havoc on the entire crypto industry. Within a year, Celsius Network, BlockFi, Voyager Digital, and FTX all filed for bankruptcy, and the once-glamorous crypto CEO was either sent to court or jailed. Now, with BTC topping $40,000, it seems that the crypto industry is finally coming out of the cold winter.

For Barry Silbert and his Stanford, Connecticut-based Digital Currency Group (DCG), the impact of the Terra collapse was like quicksand. **His Genesis Global Capital lending arm filed for bankruptcy protection in January, but the group’s sprawling portfolio still has more than 200 companies, including crypto miner Foundry and digital asset exchange Luno, as well as crown jewel Grayscale Investments, the world’s largest BTC fund with $27 billion in assets and a 2% expense ratio. Despite rising BTC prices, Grayscale’s flagship GBTC is still trading at an 11% discount to BTC spot. Last month, DCG sold its news site CoinDesk to Bullish, a cryptocurrency exchange led by former NYSE president Tom Farley, for an undisclosed amount.

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

• New York State Attorney General Letitia James sought to ban DCG and Genesis from doing business in New York as punishment for allegedly defrauding investors by trying to cover up more than $1.1 billion in losses related to the collapse of Singapore’s Three Arrows Capital, a crypto hedge fund that was one of the largest Genesis borrowers.
• Cameron Winklevoss, president of crypto exchange Gemini, has also accused Silbert and DCG of defrauding Gemini depositors. Bloomberg, citing sources familiar with the matter, said the FBI, the Securities and Exchange Commission and state officials are investigating the allegations.
• Genesis accused the parent company of treating it as a “de facto” treasury without proper corporate control. It requires DCG to repay more than $320 million of loans due in May 2023 by April 2024. Under the proposed bankruptcy plan filed on November 28, DCG has agreed to the new terms.
• Many Genesis creditors rejected DCG’s latest recovery proposal in August. The new program allows Genesis to sue DCG on a variety of grounds. DCG said such allegations were baseless, while Genesis said it would rather settle than hold its former parent company accountable in court.

Allegations of fraud cited in the New York civil lawsuit include a suspicious $1.1 billion 10-year promissory note on Genesis’ balance sheet, which came from DCG, which Genesis labeled as a liquid asset.

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

DCG has denied the fraud allegations. “This promissory note represents DCG’s help to Genesis after Three Arrows Capital defaulted in June 2022,” a company spokesperson told Forbes via email, speaking on condition of anonymity. "DCG has agreed to assume a $1.1 billion unsecured loan from Genesis to Three Arrows Capital, the recovery of which was, and remains, highly uncertain. DCG did not receive any cash, cryptocurrency, or other form of promissory note payment and, without obligation, assumed the risk of Genesis’ loss on Three Arrows Capital. 」

The spokesperson added that the promissory note mechanism used to assist Genesis was provided by DCG’s “financial and legal advisers and the opinion of our accountants.”

Silbert and DCG also insisted that they cooperated with the New York Attorney General’s investigation and were “caught off guard” by the allegations, which they called “baseless” and described Genesis’ allegations as “misleading.” Still, a plethora of lawsuits and claims remain unresolved, and time is on Silbert’s side.

As for Gemini’s claim that DCG is committing fraud against exchange depositors, DCG said in a statement in January that “this is an interface for Cameron Winklevoss, who is the sole authority of Gemini Earn’s operations and who promotes the product to customers.” 」

BTC is up 157% in the last year, and the value of many of the digital assets behind Silbert’s vast empire may have increased by billions of dollars. For example, BTC miners’ share prices have soared in recent weeks, with Marathon Digital up 356% year-to-date. DCG’s mining company, Foundry, is now worth $3 billion. Given its abundance of assets, DCG has already fared much better than the other victims of Terra’s collapse.

Ram Ahluwali, chief executive of Lumida Wealth Management, an investment advisory firm that has been following the case, said the biggest threat to DCG at the moment appears to be a lawsuit in New York, which could force Silbert to drop Grayscale. “The New York State Attorney General is trying to prohibit DCG from operating securities and commodities businesses in the state,” Ahluwalia said, “and legally, they will be required to cease all kinds of businesses.” 」

If James wins, DCG won’t be able to do business in New York, Ahluwalia added, which could soon become a broader issue: other states could take similar action.

According to an investor letter recently seen by Forbes, Grayscale manages more than a dozen crypto funds, including the massive Grayscale Bitcoin Trust (GBTC), which accounts for nearly two-thirds of DCG’s revenue. Of the $188 million in revenue reported by DCG in the third quarter, Grayscale accounted for 67%, or $126 million, 2.5 times that of its second-largest subsidiary, Foundry.

To make matters worse, a BTC spot ETF could be approved, which could diminish Grayscale’s appeal to future buyers. Ironically, Grayscale has been working hard to transform GBTC into an investor-friendly ETF and recently won a major court battle that further advanced the case, but the result could be the emergence of a slew of new competitors, including giants like BlackRock and Fidelity, with management fees for similar funds at a fraction of current levels.

Ahluwalia said the loss of Grayscale would plunge the downsized DCG “into endless settlements and lawsuits.” He added that the remnants of Silbert’s empire would effectively become “an insolvent zombie corporation”. However, the cryptocurrency’s rally could be its savior. In November 2021, at the height of the cryptocurrency boom, DCG sold $700 million in a private placement led by SoftBank, valuing it at $10 billion.

“If DCG can’t finally get out of trouble and settle with Genesis’ creditors, they could be forced into bankruptcy,” advisor Campbell said.

DCG’s recovery plan, which was initially supported by Genesis and the Unsecured Creditors Committee, but not by Gemini and the Genesis Lenders Ad Hoc Panel, provides the “best possible recovery scenario”.

**One of the most complex factors in Genesis’ bankruptcy resolution is the legal dispute between Genesis and Gemini. **In 2021, Earn offers up to 8% APY to depositors who are willing to keep their crypto at Gemini. Under the scheme, Genesis borrows crypto assets from Gemini Earn customers, reinvests them at a higher interest rate, and pockets most of the difference after paying interest. Winklevoss’ Gemini acts as an agent, processing deposits and withdrawals, and collecting small commissions on payments from Silbert’s Genesis to Earn investors. Genesis suspended withdrawals on November 16, 2022 to protect assets.

Shortly before that, as cryptocurrency market conditions worsened due to a series of bankruptcy events, Genesis agreed to provide collateral to ensure that Earn customers would not lose assets in the event of a borrower default. The collateral it used was shares in the Grayscale BTC Trust and agreed to pay 30.9 million shares on August 15 and 31.2 million shares on November 10, 2022. Gemini foreclosed on the first tranche of collateral when Genesis halted withdrawals six days later, but the second tranche has not yet been transferred. At the time of foreclosure, GBTC was trading at $9.20 per share.

Last month, Gemini sued Genesis for the remaining collateral. DCG allegedly sent GBTC shares to Genesis, but the department refused to transfer them. The value of the collateral is now much higher than it was then, trading at over $30. Combined, the shares are worth $1.6 billion, which is enough to satisfy Earn customers’ claims.

Genesis has a different view. It filed a lawsuit against Gemini on Nov. 21 to recover $689.3 million that Earn users withdrew within 90 days of Genesis filing for bankruptcy. Genesis also wants to redistribute the collateral to benefit all of its creditors and disputes Gemini’s right to foreclose on and additional GBTC shares. Gemini insists that Earn customers have the right of first refusal as a result of the mortgage transaction.

There was another turning point: when Gemini foreclosed, the first GBTC collateral was worth $284 million at the time, a figure that has now grown to over $800 million. Gemini still controls the shares and says it holds them for the benefit of Earn depositors.

A Genesis lender who requested anonymity told Forbes that many creditors believe both Silbert’s DCG and Winklevoss’ Gemini are acting in bad faith. "I think creditors are already feeling an incredible sense of frustration because this bankruptcy process has taken so long and DCG is unwilling to come up with a reasonable solution. They procrastinated again and again, and in the end they put forward very unfavorable conditions. 」

“I think the best outcome for creditors, DCG and Genesis owners is a fair settlement with DCG,” said another Genesis creditor who calls himself BJ on Telegram. "The lives of creditors have been severely disrupted by the bankruptcy proceedings, and DCG has benefited from the delay in this case. In my opinion, it is in DCG’s best interest to find a way to avoid protracted litigation of fraud allegations involving thousands of creditors. 」

There is no doubt that the recovery of the cryptocurrency market is helping DCG. ** “DCG will either have enough time to make enough profit from Grayscale to help rebuild its balance sheet and eventually pay Genesis, or there will be some other legal pressure to force DCG to file for bankruptcy.” Jeff Dorman, chief investment officer at crypto hedge fund Arca, said, "Now, is there anyone with a big enough stick to force DCG to pay and force it out of business? 」

Another anonymous creditor said Silbert and DCG could also benefit from the delay in Genesis’ bankruptcy: "There are millions of dollars in loans [to Genesis] that are due in May, but he hasn’t paid them off yet, and that’s the capital he can make money on. The current risk-free rate is 5%, so you think about it, he could get $30 million a year because of the delay. DCG has reduced more than $600 million of its subsidiary’s debt to about $324.5 million, according to a Nov. 27 filing.

"The deal that Genesis has just struck with DCG regarding DCG loans is absolutely ridiculous. The loans were due in May. Creditor BJ scoffed. "They sued DCG for repayment of the loan, and they immediately put them to rest. That break is over, DCG hasn’t paid them yet, and now they’re ready to give them another break. This is unfair to creditors. 」

At the same time, the clock was ticking. Grayscale and other asset managers, including BlackRock, Ark, WisdomTree, VanEck, Invesco and Fidelity, appear to be on the verge of receiving SEC approval to launch spot BTC ETFs. According to Bloomberg analysts, the timing of approval is uncertain, but it could be before January 10.

If Grayscale succeeds in obtaining SEC approval and converting GBTC into an ETF, then the discount to the value of the fund’s holdings will shrink or wipe out, increasing its value to shareholders (one of the largest shareholders is Genesis). DCG’s cash flow could be hit by pressure on management fees to align with ETF rivals. According to Morningstar, the average expense ratio of U.S.-listed ETFs and mutual fund managers is less than 0.4% of assets. However, given that it has $27 billion in assets as a closed-end fund, Grayscale will immediately become the largest ETF on the market. The reduction in fee income can be compensated for by the new money flowing into the GBTC ETF.

Genesis creditor BJ explained: "If GBTC is converted to an ETF, the management fee is halved, which will affect the compensation we may receive. But he added that if the ETF were approved, it would be bad for DCG, and the reality would be complicated, “They are still the biggest players.” 」

Regardless of Grayscale’s actions, Ahluwalia believes DCG is facing brand “destruction,” which could happen in two to three years.

"We’ve learned over and over again that this is bad for [crypto market] sentiment. Arca’s Dorman said, "It’s terrible for a casual observer because they only see negative headlines every day. These businesses will find a way to other places. 」