Genesis may become the first thunderbolt in the cryptocurrency industry in 2023, as its parent company DCG is deeply mired in a debt crisis

Author: Daniel Li, CoinVoice

History often repeats itself in astonishing ways. The chain reaction of the FTX fraud has just come to a close, and now the American cryptocurrency exchange Gemini is embroiled in a new round of turmoil with Digital Currency Group (DCG), the parent company of Grayscale. DCG's subsidiary Genesis may become the first major casualty in the cryptocurrency industry in 2023.

Just as the FTX incident began with a Twitter feud between CZ and SBF, the DCG incident also started with a confrontation on Twitter between Gemini co-founder Cameron Winklevoss and DCG CEO Barry Silbert. On January 2, Winklevoss sent an open letter to Silbert, accusing DCG and its subsidiary Genesis of maliciously defaulting on $900 million owed to Gemini customers, casting a shadow over the cryptocurrency market once again. In the face of Gemini's relentless pressure, will DCG repeat the mistakes of FTX? If DCG collapses, what impact will it have on the cryptocurrency industry?

Genesis Deep in Debt Crisis, DCG Cannot Escape Responsibility

DCG is currently the largest venture capital firm globally, primarily investing in blockchain-related startups, with notable investments including BitPay, Ripple, and Coinbase. Its subsidiaries include investment firm Grayscale, blockchain media Coindesk, and the crypto lending giant Genesis, which is at the center of the current DCG crisis.

Genesis is one of the largest crypto lending institutions in the world, primarily engaged in market making and lending. During the FTX collapse, Genesis incurred a $175 million hole, which directly led to its lending department suspending redemptions and new loans. According to reports from Coindesk, in addition to the $900 million owed to Gemini, which caused the exchange to suspend user withdrawals from Gemini Earn in mid-November without specifying when it would resume, there is another group of creditors with debts totaling $900 million. Therefore, as of now, Genesis's total debt has approached $2 billion.

The $2 billion debt is estimated based on the information Genesis has publicly disclosed, but what is Genesis's actual liability? No one seems to know for sure. Due to the lack of regulation in the crypto industry, financial issues have long been questioned. For instance, when Genesis announced a $175 million loss during the FTX collapse, this figure raised significant doubts. Given Genesis's scale and the impact of the FTX collapse, the losses Genesis suffered are likely at least in the billions. Faced with such a massive hole, no platform has the capacity to fill it. Thus, when rumors surfaced that Genesis was seeking a buyout from Binance, Binance immediately denied it, stating that part of Genesis's business would conflict with future earnings. Notably, when the crypto exchange FTX sought a buyout from Binance, Binance provided the same reasoning as it did for Genesis, and shortly after, FTX declared bankruptcy.

As the largest victim in this incident, Gemini has clearly been pushed to a dead end; otherwise, it would not have resorted to publicly confronting DCG in such a confrontational manner. Gemini is a crypto exchange and custodian that allows users to buy, sell, and store digital assets, while Gemini Earn is a high-yield savings product designed for users, offering annual returns of up to 8% on crypto deposits, depending on the tokens held. After attracting user funds, Gemini would provide these to its partner Genesis for operation to achieve high annual interest returns.

After receiving funds from Gemini, Genesis would invest some of the money into projects within its parent company DCG to earn higher yields. Reports indicate that as of now, Genesis still has $2.8 billion in outstanding loans, and its debtors include its parent company DCG. Therefore, Genesis's debt crisis also implicates its parent company DCG.

Prior to the FTX collapse, the cooperation between Genesis and Gemini was relatively smooth until the liquidity crisis hit Genesis, making it unable to process withdrawals. Since most of the funds lent to Genesis by Gemini came from user funds in Gemini Earn, after the FTX incident and Genesis's suspension of withdrawals, a large number of users rushed to withdraw from Gemini Earn, which directly led to a liquidity crunch for Gemini, ultimately forcing it to announce a suspension of withdrawals. As of now, there are still 340,000 users' funds in Gemini Earn that cannot be withdrawn.

Faced with angry customers unable to withdraw their funds and impending lawsuits, Gemini is under immense pressure. After six weeks of fruitless attempts to recover funds, Gemini had no choice but to issue a final ultimatum to DCG, leading to the news of "Full Text of the Open Letter from Gemini Co-Founder to DCG: Demanding Repayment of $900 Million Debt." In the open letter, Winklevoss stated that DCG's internal fund management was chaotic, borrowing approximately $1.675 billion from its subsidiary Genesis for other group businesses, while this money was originally owed to Gemini Earn users and other creditors. Winklevoss demanded that Silbert publicly commit to working together to resolve the issue by January 8, 2023.

The industry generally believes that if DCG cannot provide a satisfactory solution by January 8, Gemini may force Genesis into bankruptcy liquidation, which would be a heavy blow to DCG. Once Genesis enters bankruptcy proceedings, it will trigger the liquidation of DCG's assets (based on redeemable loans), putting DCG at risk of bankruptcy, and its subsidiary Grayscale will also face significant risks.

To Save or Not to Save: DCG Faces a Dilemma

Last year, FTX was forced to file for bankruptcy protection due to its inability to repay debts, and founder SBF was arrested by the police. In light of this cautionary tale, can DCG avoid repeating the same mistakes? Most in the crypto community are not optimistic, as DCG faces two equally challenging choices. The first choice is to help Genesis repay the $900 million debt owed to Gemini; the second choice is to distance itself from its subsidiary Genesis, allowing Genesis to bear this debt on its own. Regardless of which option is chosen, the consequences for DCG are likely to be unbearable.

The first choice means that DCG would need to take on an additional $900 million in debt, which would undoubtedly exacerbate its existing liquidity crisis, given that DCG already has excessive debt. Back in August 2022, DCG had previously helped its subsidiary Genesis bear debts related to the 3AC default, amounting to approximately $1.1 billion, which has now become DCG's debt. Currently, DCG is actively participating in the liquidation process of 3AC, seeking all available remedies to recover assets, but this is not a solution to the immediate crisis. Faced with Genesis's pressure, DCG has little time left to raise funds. In addition to the loans and long-term promissory notes with Genesis, DCG's financial reports indicate that it also has a $350 million credit debt owed to a small group of creditors led by Eldridge.

The largest asset held by DCG is 630,000 bitcoins. If calculated at the current market price of $16,500 per bitcoin, DCG's total assets amount to approximately $10.4 billion. However, these 630,000 bitcoins are both an asset and a liability for DCG. Because these bitcoins are held through GBTC, which was worth over $20 billion at one time, but has now shrunk by nearly half, meaning that the loss on this single holding exceeds $10 billion. How can DCG use this to repay Genesis's debt to Gemini? In this regard, Gabor Gurbacs, Director of Digital Asset Strategy at New York investment management firm VanEck, offered his advice: "In my personal view, the solution is for DCG to raise funds by selling equity to compensate Genesis's creditors; this is an honest and wise approach." Compared to selling bitcoin assets, selling equity may be the most suitable choice for DCG at this time.

The second choice, distancing itself from Genesis, means that the $900 million debt owed to Gemini would need to be borne by Genesis itself, which would undoubtedly push Genesis toward bankruptcy liquidation, as Genesis clearly does not have the capacity to repay such a massive debt. Genesis's bankruptcy would also have a significant impact on DCG, as its debt relationship with Genesis would put DCG's assets at risk of liquidation. Moreover, as Genesis's sister company, Grayscale would also find it difficult to remain unaffected, which would directly impact the largest bitcoin investment product, GBTC. GBTC holds the world's largest bitcoin reserves, so the collapse of Genesis/DCG would have a major impact on crypto traders. If investors can redeem GBTC shares for bitcoins or dollars, this would undoubtedly lead to another round of sharp declines in bitcoin and other altcoins.

What Impact Would DCG's Collapse Have on the Crypto Industry?

If DCG collapses, the negative impact on the crypto industry would far exceed that of the FTX and LUNA incidents. It would not only severely undermine the confidence of industry practitioners, leading to increased selling pressure in the secondary market, but it would also further damage the reputation of the crypto industry, causing traditional financial institutions to shy away. Currently, Gemini has issued a final ultimatum for January 8, and as the deadline approaches, the final outcome will soon be revealed. Whether it is Genesis's bankruptcy or both Genesis and DCG's bankruptcy, it would be a heavy blow to the current crypto industry.

Bitcoin Prices Could Fall Back to $3,000

If DCG, which holds 630,000 shares of GBTC, truly goes bankrupt, the foundation of trust in the entire crypto market would be on the verge of collapse. These GBTC assets would be sold off in the market, which would undoubtedly be a fatal blow to the already bearish crypto industry, causing bitcoin prices to plummet. The last time the Terra Luna collapse occurred, it liquidated only 80,000 bitcoins, and the price of bitcoin fell from $40,000 to $20,000. Currently, GBTC holds 630,000 BTC, and if liquidation occurs, it is not impossible for the price to drop back to $3,000.

Mining Companies Will Face Greater Hardships

The price fluctuations of bitcoin directly affect miners' profits. If bitcoin prices drop significantly, miners, who are already struggling in this bear market, will be forced to sell bitcoins to survive, leading to a spiral decline in bitcoin prices. Currently, mining companies facing bankruptcy or plummeting stock prices include: Compute North (bankrupt), Argo (stock price down 50%), Bitfarms (Nasdaq issued delisting warning), Core Scientific (stock price nearly zero), etc. According to CoinDesk, mining companies still have at least $1-2 billion in undisclosed debt.

Triggering a Wave of Bankruptcies Across the Blockchain Industry

Mining companies in the crypto industry generally operate with high leverage. In common debt forms, mining companies often seek loans by pledging mining machines. Companies like NYDIG, BlockFi, Galaxy Digital, Silvergate, Trinity Capital, and WhiteHawk can provide such loans. Once the DCG collapse occurs, mining companies will inevitably face widespread shutdowns or bankruptcies, leading to a wave of defaults that further endangers lenders, creating a chain reaction of collapses, which would undoubtedly deepen the decline of crypto finance. The collapse of FTX was seen as the Lehman Brothers moment for the crypto market, causing the closure of dozens of well-known institutions in the crypto industry. Compared to FTX, which was involved in a narrower scope, the collapse of DCG, as the world's most renowned investment institution, would trigger a wave of bankruptcies not only in the crypto industry but across the entire blockchain sector, marking the darkest hour for the blockchain industry.

Conclusion

If DCG truly collapses, it may become the final thunderclap for the crypto industry, a view that has been recognized by most crypto enthusiasts. Coincidentally, this perspective can be interpreted in two directions. One view holds that DCG's collapse will lead to a collapse of trust in the entire crypto industry, potentially leading to its decline; the other view suggests that if DCG collapses, all crypto institutions currently at risk will also fall in this wave of bankruptcies, leaving only the most excellent and safest institutions, leading to a rebirth of the crypto industry, with no more incidents of collapse. These two viewpoints represent two directions and two outcomes. Currently, the market seems to be waiting for a directional choice, with bitcoin prices having consolidated around $16,500 for eight consecutive weeks, neither breaking upward nor falling downward. The future direction of this market may hinge on the outcome of the DCG incident.