Struggling Digital Currency Group closing out 2022 with a whimper

Digital Currency Group (DCG) is racing down the road to ruin as its Genesis and Grayscale subsidiaries struggle to stay afloat.

Last Friday night saw a precipitous drop in the value of multiple alt-coins, including many associated with companies in which DCG had invested. DCG traditionally receives vast quantities of tokens issued by these companies in exchange for its investment and many of these tokens suddenly went into freefall.

To be sure, acquiring, pumping and dumping is DCG’s standard operating procedure, it’s just that they’re usually a little more subtle about the process. This helter-skelter dash for the exits understandably fueled speculation that DCG’s need to plug the holes on its balance sheet was even greater than it’s letting on.

The current ‘crypto winter’ hasn’t been kind to DCG, whose founder Barry Silbert issued a note to shareholders last month that tried to downplay the severity of the crisis facing DCG. But Genesis is struggling to find the billions it needs to meet its obligations and the Grayscale Bitcoin Trust (GBTC) is trading near its record low share price (closing Tuesday just above $8, down from $39 at this point last year) and at a record discount to its assets under management.

Last Saturday, the Netherlands-based Bitvavo Group, which operates an digital asset exchange and staking service, warned its customers that DCG was “currently experiencing liquidity problems due to the current turbulence in the cryptomarket.” Bitvavo said DCG had “suspended repayments until this liquidity issue has been resolved” but has promised to “present a plan in the coming weeks” to dig itself out of its hole.

Bitvavo has around €280 million “allocated to DCG” but insists that Bitvavo is “able to prefund any locked assets at DCG” and thus “Bitvavo customers are not exposed to DCG liquidity issues.” Bitvavo says it’s in active correspondence with DCG and “the expectation is that the outstanding deposits will be reimbursed by DCG over time.” Should DCG fail to meet its obligations, “Bitvavo will step in to protect its customers.”

However, a DCG spokesperson told Reuters that Bitvavo’s €280 million was held by Genesis, not DCG, because Genesis was an “independent subsidiary.” A Bitvavo spokesperson retorted that “given the mingling within the group, we hold DCG responsible for the outstanding amount.”

Genesis creditors get in line

Genesis was recently added to the creditors’ committee overseeing the bankruptcy of the FTX exchange and its affiliated companies. Last month, Genesis revealed—after initially denying it had any significant exposure to FTX—that it had $175 million tied up on the defunct exchange. GCC International, the Bermuda affiliate of Genesis, will now enter the creditor Thunderdome to squabble over the thin strips of flesh left on FTX’s bones.

That frozen $175 million forced DCG to provide Genesis with an emergency $140 million infusion last month. DCG has loaned Genesis a total of $575 million due in May 2023, with an additional $1.1 billion promissory note due in 2032.

Even with those emergency backstops, Genesis had been trying to raise $1 billion in additional capital. This was later reduced to $500 million after investors treated the pitch like Joe Biden showing up at Mar-a-Lago wearing an “I’m president, bitch!” t-shirt.

Gemini Earn, the lending arm of the Gemini digital asset exchange, is believed to have as much as $900 million of its customers’ funds locked up on Genesis when the latter firm suspended withdrawals on November 16. Gemini, along with Bitvavo and other Genesis victims, have formed their own creditors’ committee in the hopes of holding DCG’s feet to the fire.

Earlier this month, this Genesis creditors’ committee tapped Kirkland & Ellis as its legal counsel and Houlihan Lokey as its financial advisor. Last Saturday, Gemini announced that Houlihan Lokey “has begun advocating for a plan to resolve the liquidity issues at Genesis and DCG and provide a plan for the recovery of funds.” Gemini cautioned that it was early days and it would update users as new info became available.

Gemini users will have to get in line behind Todd Boehly, the head of the Eldridge investment group, which was cited in Silbert’s November letter to investors as having provided DCG with a sizable loan the previous November. Around $350 million of this loan remains outstanding and the Financial Times reported that, if Genesis goes under, the full sum becomes immediately repayable due to the preferential terms of Eldridge’s senior secured loan.

It’s seems almost certain that there won’t be enough room in the lifeboats when the S.S. Genesis finally rolls over and slips beneath the waves. Which could explain why some creditors appear willing to sell their stakes on a ‘dark market’ for pennies on the dollar.

Grayscale (not the fatal skin disease on Game of Thrones, but close)

For years now, Grayscale has failed to convince the U.S. Securities and Exchange Commission (SEC) to let it convert GBTC to a spot-based exchange traded fund (ETF). Grayscale has filed legal appeals in the hope of overturning the SEC’s rejections, but this has only served to further irk GBTC shareholders, who must pay Grayscale an annual 2% fee on its total BTC holdings. These fees amount to hundreds of millions of dollars per year and reportedly account for around 2/3 of DCG’s total revenue.

In an ‘end of year’ letter to investors this week, Grayscale Investments CEO Michael Sonnenshein acknowledged the prevailing “macro-level distrust of crypto and crypto intermediaries.” Sonnenshein said he “welcome[s] the skepticism from investors, regulators and legislators” while declaring that crypto downturns have historically been used to “strengthen core capabilities and solidify foundations for long-term growth and stability.” Or, you know, go extinct, but tomato, tomahto.

Sonnenshein expressed confidence that Grayscale would ultimately prevail in its SEC appeal—although the SEC’s latest legal filing insists that the risk of fraud is still too great to approve a spot BTC ETF—but in the event that the courts side with the SEC, “we would explore other options to return a portion of GBTC’s capital to shareholders.”

These options could include a tender offer for “no more than 20% of the outstanding shares of GBTC,” but this would require the SEC’s approval, which Sonnenshein admits isn’t a given. A tender offer would also require shareholders to approve amending GBTC’s trust agreement, which doesn’t currently permit redemptions or repurchases of shares by GBTC.

Should the tender offer be approved, additional offers may follow. In the meantime, GBTC would continue to operate “without an ongoing redemption program until we are successful in converting it to a spot [BTC] ETF.”

Limited options

Earlier this month, Bernstein analysts offered a sobering palette of options for DCG, highlighted by the ‘nuclear option’ of dissolving GBTC and allowing shareholders to exchange their shares for the BTC held (allegedly) by the Trust.

Raising additional capital may be a less radioactive option but, as Genesis has found, investors aren’t in the mood to plow into anything ‘crypto’ just now. And with billions owed to outside parties, DCG looks like a very bad bet. However, Berntstein suggested a more ‘strategic’ arrangement, say, some institution joining DCG in a partnership, although that would require Silbert to surrender “a large part of the pie.”

The final option Bernstein suggested was for DCG to purge all non-core assets which, if DCG’s ‘everything must go’ token dump is any indication, appears to already be underway. But there are larger assets that could be flogged, such as the CoinDesk crypto news site, South Africa’s Luno investment app or Foundry.

On Monday, Silbert responded to a Twitter user asking how he was with the curt reply: “looking forward to getting this year behind us.” Seems Barry thinks flipping the calendar will help flip DCG’s fortunes. If the angry replies to his tweet are any indication, 2023 may prove an even tougher pill for DCG to swallow.

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