Will the crypto empire DCG be a scam worse than the FTX fraud?

Original Author: Vijay Boyapati (@real_vijay)

Compiled by: czgsws, 0x711, BlockBeats

As early as June 2022, after the collapse of Three Arrows Capital, there were rumors that DCG was also "unable to hold on." In January of this year, Genesis, unable to withstand the aftermath of the FTX collapse, officially filed for Chapter 11 bankruptcy. Zhu Su, the founder of Three Arrows Capital, had previously posted to expose DCG's fraudulent activities, defending his role as the "scapegoat."

In August of this year, Bloomberg reported that the New York Attorney General's office, SEC, and other regulatory agencies were investigating Genesis and its parent company DCG. In September, news broke again that "federal agents are conducting an in-depth investigation into DCG and its subsidiary Genesis" news. However, to this day, there is still no conclusion on what exactly DCG and its CEO Barry Silbert have done, and whether they should face legal judgment.

On November 6, crypto KOL Vijay Boyapati (@real_vijay) posted on social media accusing DCG and its CEO Barry Silbert of fraudulent behavior, claiming this was "a more significant fraud case than the SBF embezzlement case in 2022." So, is the Bitcoin trust created by DCG a Noah's Ark or a fraudulent scheme? Vijay analyzes the company layer by layer from his perspective.

BlockBeats has organized and compiled the original text as follows:

To fully understand DCG's fraudulent behavior and its impact, we must go back to 2013, when Barry Silbert founded Grayscale, which provided the first trust that allowed investors to purchase Bitcoin through their brokerage accounts. For many years, GBTC was the only way for stock market capital to gain exposure to Bitcoin, and due to its trust structure (without a redemption mechanism like an ETF), GBTC consistently traded at a premium to its NAV (Net Asset Value) in its early trading history. This meant that the market value of the fund was greater than its actual underlying asset (Bitcoin). Stock investors had limited choices and were willing to pay a premium for GBTC just to gain Bitcoin exposure.

GBTC shares are created by paying Grayscale with Bitcoin, and users can receive equivalent GBTC shares after six months. The existence of the GBTC premium (which once exceeded 40%) made arbitrage trading possible and increasingly profitable. Investors could engage in arbitrage by shorting a certain amount of Bitcoin (let's say x) while providing an equivalent amount of Bitcoin to Grayscale. Six months later, arbitrageurs could close their positions by selling GBTC (which traded above x Bitcoin) and profit from the premium. This is the common GBTC premium arbitrage trade.

Some market participants realized that this trade was "very promising" and seemingly risk-free (because the GBTC premium always existed), and began to flood in. Among them were two participants: the hedge fund Three Arrows Capital and the lending platform BlockFi (both of which are now in bankruptcy). Three Arrows Capital not only profited from the GBTC premium but also used leverage for arbitrage trading. They borrowed a large amount of Bitcoin to increase returns. But who did they borrow from? Genesis.

Like Grayscale, Genesis is also one of the subsidiaries of DCG. This corporate structure was intentionally modeled by Barry Silbert after Berkshire Hathaway's corporate structure and applied to the crypto market. Genesis is the largest, most important, and essentially primary brokerage service provider in the cryptocurrency market. It has both a trading/derivatives department (GGT) and a lending department (GGC), but to outsiders, it appears as a single entity since both departments share office space and even employees.

Genesis acquires Bitcoin by offering Bitcoin deposit rates to holders (regardless of size), then lends out those Bitcoins at higher rates and profits from the interest spread. Who does Genesis lend to? Three Arrows, BlockFi, Alameda, and others.

At this point, it should be noted that DCG directly controls GGT (Silbert served as its board chairman from 2013 to July 2022) and controls GGC through GGT. GGC did not establish a board until June 2022, at which time it appointed a board with two-thirds of its members coming from DCG.

DCG had a huge incentive to encourage Genesis to issue Bitcoin loans for GBTC arbitrage trading, as these Bitcoins would flow into Grayscale (another crown jewel of DCG), and then liquidity would be trapped in Grayscale (because there is no ETF redemption mechanism). Grayscale charges a high fee of 2% annually for "managing the fund" (which essentially means doing nothing) using these "locked" Bitcoins. Currently, GBTC holds over 620,000 Bitcoins, meaning Grayscale will collect over 12,000 Bitcoins annually as management fees.

Grayscale's profits flow to its parent company, DCG. At this point, you will notice that there are some significant conflicts of interest between DCG, Grayscale, and Genesis. In fact, Grayscale even knew about the loans Genesis provided to drive funds into GBTC. Documents show that Grayscale's CEO signed off on the loans Genesis provided to Three Arrows Capital. This indicates that Barry Silbert's claim that these family businesses operate with "a certain distance" is clearly ridiculous.

Over time, new methods for gaining Bitcoin exposure emerged in the stock market (such as Microstrategy's stock, futures ETFs, and foreign spot ETFs). New competition, combined with the massive amount of GBTC shares generated by arbitrage trading, began to impact the GBTC premium.

On February 23, 2021, the GBTC premium turned negative for the first time (i.e., it became a discount). Since then, it has never returned to a positive premium, with discounts reaching as high as 49%—meaning the fund was worth only half of its underlying asset value. The arbitrage trading was over.

With the end of GBTC premium arbitrage trading, Three Arrows Capital lost its most reliable and profitable way to make money. It then turned to another highly risky trade: TerraUSD arbitrage. Meanwhile, Genesis continued to provide them with loans.

On May 7, 2022, the Terra Luna ecosystem began to collapse, with LUNA and UST tokens essentially going to zero within days. Given its leverage, the collapse of LUNA & UST became the last straw that broke Three Arrows Capital, rendering it severely insolvent.

The bankruptcy of Three Arrows created a massive hole for the companies that lent to it, the largest being Genesis, which had provided a $2.3 billion loan to Three Arrows. While such risks can be managed through proper risk management and collateral usage, Genesis's risk management was abysmal.

In mid-June 2022, Three Arrows defaulted on the Bitcoin loans Genesis had provided. After liquidating the very few collateral they had, Genesis was left with a $1.2 billion gap on its balance sheet, and now it was also insolvent.

At this point, if lenders providing Bitcoin to Genesis attempted to withdraw their Bitcoins, Genesis would be unable to fulfill its obligations. At this juncture, it would have been the right move for Genesis CEO Michael Moro to announce bankruptcy.

However, Michael Moro did not announce bankruptcy; instead, he and his parent company's CEO Barry Silbert devised a plan to cover up the losses on Genesis's balance sheet. By doing so, they were able to alleviate lenders' concerns, thereby minimizing withdrawal activity.

In exchange for Genesis's bankruptcy claim against Three Arrows (which was nearly worthless due to 3AC's complete collapse), DCG would provide Genesis with an $1.1 billion "promissory note." Michael Moro assured the market that they had "thoughtfully mitigated the losses."

In fact, this promissory note was entirely a scam. Barry Silbert did not inject actual capital to fill the gap on Genesis's balance sheet but instead provided a note with a below-market interest rate that could not be redeemed for ten years.

It was clear that Barry Silbert knew the note would not solve Genesis's bankruptcy issues, as in Genesis's later bankruptcy, he valued the same note at only a small fraction of the $1.1 billion Genesis claimed. The gap on the balance sheet remained. After implementing this financial deception, Genesis executives began to work hard to convince clients of their solvency, falsely claiming that the received note was a liquid asset (equivalent to cash).

This raises the question, "Why did DCG intervene?" Why take the risk of committing criminal fraud when they could have let Genesis go bankrupt? The answer is:

DCG was one of Genesis's largest borrowers, treating its portfolio company Genesis as its piggy bank.

In fact, just after the Three Arrows collapse caused a gap in Genesis's balance sheet, DCG borrowed a massive loan of 18,697 Bitcoins from the bankrupt Genesis on June 18. DCG was also running GBTC arbitrage trading but was now trapped by piles of underwater GBTC.

If DCG allowed Genesis to go bankrupt, it too would enter bankruptcy proceedings and be forced to repay the massive loan obtained from its subsidiary. Instead, Barry Silbert and DCG chose to "pretend to be unaware and prolong the inevitable."

The bankruptcy issues of Genesis ultimately came to light in November 2022, when FTX collapsed, and clients across the sector rushed to withdraw their Bitcoins. Genesis was unable to meet clients' withdrawal requests and froze withdrawals on November 16, 2022.

At that time, DCG/Genesis was still arguing that it was the collapse of FTX and the ensuing market turmoil that led to the "temporary" freezing of its clients' funds. In fact, Genesis had been insolvent since June of that year (when Three Arrows collapsed).

Even after freezing withdrawals, Genesis still claimed it was not insolvent, merely facing a "duration mismatch" issue. In other words, it had enough funds to meet withdrawal requests but not immediately available. This was deeply misleading.

On January 19, 2023, Genesis was forced to declare bankruptcy and slowly revealed the extent of its deceptive practices to creditors. Creditors painfully realized that DCG had never truly addressed Genesis's bankruptcy issues.

On October 19, 2023, the New York Attorney General filed a civil lawsuit against Genesis, DCG, and individuals Barry Silbert and Michael Moro. The complaint is detailed and substantive, accusing them of a large-scale conspiracy that defrauded hundreds of thousands of investors.

Although the NYAG's lawsuit against Silbert and others is civil in nature, it is likely that the Southern or Eastern District of New York will categorize this case as criminal. Many ordinary investors lost their life savings, and DCG/Genesis became the epicenter of the 2022 market collapse.

The collapse of Genesis shares many striking similarities with the FTX fraud:

• Deceptive balance sheets

• False public statements to placate investors

• A small group of insiders committing financial fraud

• Trusting that their financial media would not bother to ask sharp questions

This story is as significant and important as the FTX collapse but has received little public attention. The ending of the story could be equally dramatic—Barry Silbert and Michael Moro could become cellmates with SBF.

As U.S. attorneys pointed out during the trial of FTX, "Any false or fraudulent statements made to obtain or retain lawfully obtained assets are felonies."

For those closely following, warning signs were present. Michael Moro was forced to leave or jump ship shortly after implementing the promissory note fraud. Lawrence H. Summers also resigned from his advisory role at DCG, possibly sensing some very suspicious happenings internally.

When the fraud is exposed and prosecuted, the small core circle that understands what happened at DCG/Genesis will become cooperating witnesses, just like SBF's inner circle testified against him.

From the lawsuits filed, the New York Attorney General already has a cooperating witness who served on Genesis's board during the promissory note fraud.

Unfortunately, financial media (Bloomberg/Reuters/CNBC) has been extremely negligent in both the Genesis case and the previous FTX case. When faced with important questions, they provided template responses, showing an embarrassing gullibility (for example, SBF claimed there was no conflict of interest between FTX and Alameda).

Non-corporate journalists like @coffeebreak_YT and @laurashin have been raising tough questions and maintaining a rational skepticism when receiving meaningless or unsubstantiated answers.

When DCG claims "there is no basis for this case," it leans heavily towards corporate double talk. The case is detailed, thorough, and supported by an experienced and knowledgeable witness. DCG has yet to provide any meaningful rebuttal to any of the allegations made by the New York Attorney General.

So who will step up to break the deadlock? Hundreds of thousands of investors have suffered losses, many of whom have been severely impacted, yet Barry Silbert remains seated on his throne. Here, I will quote the words of the U.S. prosecutor who prosecuted SBF:

"When I became a U.S. prosecutor, I promised we would spare no effort to root out corruption in the financial markets. This is what is meant by sparing no effort. This case is moving at lightning speed—this is no coincidence; it is by design. This case is also a warning to anyone who thinks they are untouchable, who believes their crimes are too complicated for us to catch them, who think they are too powerful to be prosecuted, or who believe they can talk their way out of being arrested. Those people should rethink and stop their actions. If they do not, I guarantee our handcuffs are sufficient to arrest them all."