Forbes: The Predicament and Redemption of the Crypto Empire DCG

Original Author: Nina Bambysheva, Forbes

Original Compilation: Luffy, Foresight News

Barry Silbert, Founder of Digital Currency Group

In May 2022, the domino effect following the collapse of Terra quickly devastated the entire crypto industry. In the year that followed, Celsius Network, BlockFi, Voyager Digital, and FTX all filed for bankruptcy, and once-prominent cryptocurrency CEOs were either taken to court or imprisoned. Now, with Bitcoin surpassing $40,000, the crypto industry seems to have finally emerged from its winter.

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

Silbert's crypto winter continues, and this former billionaire faces a series of serious issues:

• New York Attorney General Letitia James seeks to prohibit DCG and Genesis from operating in New York as punishment for allegedly deceiving investors by attempting to cover up over $1.1 billion in losses related to the collapse of Singapore's Three Arrows Capital, one of Genesis's largest borrowers.

• Gemini President Cameron Winklevoss has also accused Silbert and DCG of defrauding Gemini depositors. Bloomberg cited sources saying 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 controls. It demands that DCG repay over $320 million in loans due in May 2023 by April 2024. According to a proposed bankruptcy plan submitted on November 28, DCG has agreed to new terms.

• Many Genesis creditors rejected DCG's latest recovery proposal made in August. The new plan allows Genesis to sue DCG for various reasons. DCG claims such allegations are unfounded, while Genesis prefers to settle rather than pursue accountability from its former parent company in court.

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

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

DCG denies the fraud allegations. "The note represents DCG stepping in to help Genesis after Three Arrows Capital defaulted in June 2022," a company spokesperson, who wished to remain anonymous, told Forbes via email. "DCG agreed to take on the $1.1 billion unsecured loan that Genesis lent to Three Arrows Capital, the recovery of which has been highly uncertain both in the past and present. DCG has not received any cash, cryptocurrency, or other forms of payment on the note and has assumed the risk of Genesis's losses on Three Arrows Capital without any obligation."

The spokesperson added that the note mechanism used to assist Genesis was based on the advice of DCG's "financial and legal advisors and our accountants."

Silbert and DCG also insist that they have cooperated with the New York Attorney General's investigation, claiming to be "caught off guard" by these allegations, which they describe as "baseless," and characterize Genesis's claims as "misleading." Nevertheless, a multitude of lawsuits and claims remain unresolved, and time is on Silbert's side.

Regarding Gemini's claim that DCG defrauded the exchange's depositors, DCG stated in a January statement, "This is Cameron Winklevoss's way of deflecting responsibility, as he is the one fully responsible for the operation of Gemini Earn, which he marketed to customers."

Bitcoin rose 157% last year, and the value of many digital assets behind Silbert's vast empire may have increased by billions of dollars. For example, Bitcoin miners have seen their stock prices soar in recent weeks, with Marathon Digital up 356% year-to-date. DCG's mining company Foundry now has a market value of $3 billion. Given its rich assets, DCG has performed much better than other victims of the Terra collapse.

Ram Ahluwalia, CEO of investment consulting firm Lumida Wealth Management, who has been closely following the case, stated that the biggest threat facing DCG currently seems to be the lawsuits in New York, which could force Silbert to divest Grayscale. "The New York Attorney General is trying to prohibit DCG from operating securities and commodities businesses in the state," Ahluwalia said, "legally, they will be required to cease various operations."

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

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

Worse still, a spot Bitcoin ETF may be approved, which could diminish Grayscale's appeal to future buyers. Ironically, Grayscale has been working to convert GBTC into a more investor-friendly ETF and recently won an important court ruling that further advanced the case, but the outcome could lead to a flood of new competitors, including giants like BlackRock and Fidelity, whose management fees for similar funds are only a fraction of the current levels.

Ahluwalia stated that losing Grayscale would plunge the scaled-down DCG "into endless settlements and litigation." He added that the remnants of Silbert's empire would effectively become "a bankrupt zombie company." However, the rebound in cryptocurrency could be its savior. In November 2021, at the peak of the cryptocurrency boom, DCG raised $700 million in a private placement led by SoftBank, achieving a valuation of $10 billion.

"If DCG ultimately cannot extricate itself from its predicament and reach a settlement with Genesis's creditors, they may be forced into bankruptcy," advisor Campbell stated.

DCG's recovery plan was initially supported by Genesis and the committee of unsecured creditors but lacked support from the special committee of Gemini and Genesis lenders, which proposed "the best feasible recovery plan."

One of the most complex factors in the Genesis bankruptcy resolution is the legal dispute between Genesis and Gemini. In 2021, Earn offered depositors willing to store cryptocurrency with Gemini an annual yield of up to 8%. Under this scheme, Genesis borrowed crypto assets from Gemini Earn customers to reinvest at higher rates, pocketing most of the spread after paying interest. Winklevoss's Gemini acted as an agent, handling deposits and withdrawals, and collecting a small commission from payments from Silbert's Genesis to Earn investors. Genesis suspended withdrawals on November 16, 2022, to protect assets.

Shortly before this, as the cryptocurrency market deteriorated due to a series of bankruptcies, Genesis agreed to provide collateral to ensure that Earn customers would not lose assets in the event of borrower default. The collateral used was shares of the Grayscale Bitcoin Trust, and it agreed to pay 30.9 million shares on August 15, 2022, and 31.2 million shares on November 10. When Genesis halted withdrawals six days later, Gemini canceled the redemption rights for the first batch of collateral, but the second batch had not yet been transferred. At the time of the cancellation, GBTC was trading at $9.20 per share.

Last month, Gemini sued Genesis for the remaining collateral. Allegedly, DCG had sent GBTC shares to Genesis, but the department refused to transfer them. The value of this collateral is now much higher, trading above $30. These shares are worth $1.6 billion, enough to cover the claims of Earn customers.

Genesis, however, has a different view. On November 21, it sued Gemini to recover $689.3 million withdrawn by Earn users within 90 days after Genesis filed for bankruptcy. Genesis also seeks to reallocate collateral to benefit all its creditors and contests Gemini's cancellation of the collateral redemption rights and additional GBTC shares. Gemini insists that due to the collateral transactions, Earn customers have priority claims.

There is another twist: when Gemini canceled the redemption rights, the value of the first batch of GBTC collateral was $284 million, and this figure has now risen to over $800 million. Gemini still controls these shares and states that 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's Gemini have acted maliciously. "I think creditors are feeling an incredible sense of frustration because this bankruptcy process has taken so long, and DCG is unwilling to propose a reasonable solution. They have repeatedly delayed and ultimately offered very unfavorable terms."

"I think the best outcome for creditors, DCG, and everyone at Genesis is to reach a fair settlement with DCG," said another Genesis creditor who identified himself as BJ on Telegram. "The lives of creditors have been severely disrupted by the bankruptcy process, while DCG has benefited from the delays in this case. I think finding a way to avoid protracted litigation involving fraud allegations against thousands of creditors is in DCG's best interest."

There is no doubt that the recovery of the cryptocurrency market is helping DCG. "DCG is either fighting for enough time to generate sufficient profits from Grayscale to help rebuild its balance sheet and eventually make payments to Genesis; or there is some other legal pressure forcing DCG to file for bankruptcy," said Jeff Dorman, Chief Investment Officer of crypto hedge fund Arca. "Right now, is there anyone with a big enough stick to force DCG to pay and push it into bankruptcy? So far, we haven't seen that."

Another anonymous creditor stated that Silbert and DCG may also benefit from the delays in Genesis's bankruptcy: "There are millions of dollars in loans (to Genesis) that were due in May, but he hasn't paid them back, and this is capital he can make money on. The current risk-free rate is 5%, so think about it, due to the delays, he can earn $30 million a year." According to documents submitted on November 27, DCG has reduced its subsidiary's debt from over $600 million to about $324.5 million.

"The deal that Genesis just reached with DCG regarding DCG's loans is absolutely ridiculous. These loans were due in May," creditor BJ scoffed. "They sued DCG for repayment, and they immediately gave them a break. That break period ended, and DCG hasn't paid them yet, 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 poised to receive SEC approval to launch a spot Bitcoin ETF. According to Bloomberg analysts, the timing of the approval is uncertain but could come before January 10.

If Grayscale successfully obtains SEC approval and converts GBTC into an ETF, the discount on the fund's holdings will narrow or be eliminated, thereby increasing its value to shareholders (one of the largest shareholders is Genesis). DCG's cash flow may be impacted by pressure to align management fees with ETF competitors. According to Morningstar, the average fee rate for ETF and mutual fund managers listed in the U.S. is below 0.4% of assets. However, given its $27 billion in assets as a closed-end fund, Grayscale would immediately become the largest ETF in the market. New funds flowing into the GBTC ETF could offset the reduction in its fee income.

Genesis creditor BJ explained, "If GBTC converts to an ETF and management fees are halved, this will affect the compensation we might receive." But he added that if the ETF is approved, it would be detrimental to DCG, and the actual situation would be very complex, "They are still the largest participant."

Regardless of what Grayscale does, Ahluwalia believes that DCG is facing "brand destruction," which could happen within two to three years.

"We repeatedly learn that this is detrimental to (the cryptocurrency market) sentiment," Arca's Dorman stated, "For a casual observer, this is bad because they only see negative headlines every day. These businesses will find a way to go elsewhere."