Barry Silbert’s crypto winter rages on with a host of legal problems.
photo by Heidi Gutman/CNBC/NBCU Photo Bank/Getty Images
Digital Currency Group, which owns the sponsor of the Grayscale Bitcoin Trust, is mired in lawsuits and faces a potential ban in New York State. Rising crypto markets could be its salvation.
By Nina Bambysheva, Forbes Staff
The domino effect that followed the collapse of the terra cryptocurrency in May 2022 caused most of its casualties quickly. Within a year of the failure of the algorithmic stablecoin, bankruptcy petitions from Celsius Network, BlockFi, Voyager Digital and FTX had been filed and once-charismatic crypto CEOs were in court or in jail. Now, with bitcoin breaching $40,000 the crypto sector finally seems to be rising from its December 2022 nadir.
For Barry Silbert and his Stamford, Connecticut-based Digital Currency Group, however, the repercussions of Terra’s collapse have been like quicksand. His Genesis Global Capital lending unit filed for bankruptcy protection in January, but the conglomerate still has more than 200 companies in its vast investment portfolio, including crypto miner Foundry and digital-asset exchange Luno. Then there is the crown jewel, Grayscale Investments, which runs the world’s biggest bitcoin fund with a juicy 2% expense ratio on $27 billion of assets. Despite the rally in the price of bitcoin, shares of its flagship GBTC closed-end fund continue to trade at an 11% discount to its underlying bitcoin value. Last month, DCG sold its news website CoinDesk to Bullish, a crypto exchange led by Tom Farley, former president of the New York Stock Exchange, for an undisclosed sum.
As Silbert’s crypto winter continues the former billionaire faces a host of serious problems:
• New York Attorney General Letitia James seeks to ban DCG and Genesis from doing business in her state as a punishment for allegedly defrauding investors by trying to conceal more than $1.1 billion in losses linked to the collapse of Singapore-based Three Arrows Capital. The crypto hedge fund had been one of the largest Genesis borrowers.
• Cameron Winklevoss, president of the Gemini crypto exchange which was also named in James’ lawsuit, has also accused Silbert and DCG of fraud against Gemini depositors. The Federal Bureau of Investigation, the Securities and Exchange Commission, and state officials were looking into the allegations, Bloomberg reported, citing people familiar with the matter.
• Genesis accused its parent of treating it as a “de facto” treasury without appropriate corporate controls. It is asking DCG to repay more than $320 million of loans, initially due in May 2023, by April 2024. According to the proposed bankruptcy plan filed on November 28, DCG has agreed to the new terms.
• Many Genesis creditors refused DCG’s latest recovery proposal, which was offered in August. The new plan allows for the possibility that Genesis might sue DCG on several grounds. DCG says such claims are without merit, and Genesis says it would prefer to settle rather than pursue its former parent in court.
The fraud charges cited by New York in a civil suit include the allegation of stuffing the Genesis balance sheet with a questionable $1.1 billion 10-year promissory note, which came from DCG and that Genesis represented as a current asset.
“FTX was more like Bernie Madoff,” says Austin Campbell, an adjunct professor at Columbia Business School and managing partner of blockchain-focused Zero Knowledge Consulting, “but DCG is probably a little bit more like Enron if those accusations are true.”
Digital Currency Group denies the fraud allegation. “The promissory note represented DCG stepping in to help Genesis after the Three Arrows Capital default in June 2022,” a company spokesperson who asked not to be identified tells Forbes by email. “DCG agreed to assume Genesis’ $1.1B unsecured loan receivable from Three Arrows Capital, the recovery on which was and remains highly uncertain, with the promissory note from DCG. DCG did not receive any cash, cryptocurrency, or other form of payment for the promissory note and effectively assumed Genesis’ risk of loss on the Three Arrows Capital loan with no obligation to do so.”
The spokesperson adds that the promissory-note mechanism used to aid Genesis was suggested by DCG’s “financial and legal advisers, with inputs from our accountants.”
Silbert and DCG also insist that they had cooperated with the New York Attorney General’s investigation, were “blindsided” by the allegations, which they call “baseless,” and characterize Genesis’ accusations as “misleading.” Still, as the myriad of lawsuits and claims go on unresolved, time is on Silbert’s side.
As to Gemini’s contention that Digital Currency Group had perpetrated a fraud on the exchange’s depositors, a DCG statement in January said “This is another desperate and unconstructive publicity stunt from Cameron Winklevoss to deflect blame from himself and Gemini, who are solely responsible for operating Gemini Earn and marketing the program to its customers.”
Bitcoin is up 157% in the last year, and many of the digital assets underlying Silbert’s vast empire could be worth billions more now. Bitcoin miners for example have soared in recent weeks: Marathon Digital is up 356% year-to-date. DCG’s miner Foundry could be worth as much as $3 billion today. Given its trove of assets, DCG is already faring far better than the other victims of Terra’s collapse.
For now, the largest threat for DCG seems to be the New York action, which could force Silbert to spin off Grayscale, says Ram Ahluwalia, CEO of investment advisory Lumida Wealth Management, who has been following the case. “New York Attorney General seeks to prohibit DCG from running a securities and commodities business within the state,” Ahluwalia says. “They would legally be required to cease performing all sorts of functions.”
If James prevails, DCG won’t be able to do business in New York, and it could soon become a wider problem: other states could also take similar actions, Ahluwalia adds.
Manager of more than a dozen crypto funds, including the massive Grayscale Bitcoin Trust (GBTC), Grayscale accounts for nearly two-thirds of DCG’s revenue, according to a recent investor letter seen by Forbes. Of the $188 million of revenue reported by DCG in the third quarter, Grayscale brought in 67% or $126 million—2.5 times more than the next-biggest subsidiary, Foundry.
Making matters worse, Grayscale’s value to a future buyer may be diminished by the likely approval of exchange-traded funds based on the bitcoin spot price. Ironically, Grayscale has fought to change GBTC to an investor-friendly ETF format, and it recently won an important court battle that furthers its case, but the result is likely to be a raft of new competitors, including giants like BlackRock and Fidelity, offering similar funds with management fees that are a fraction of the current level.
Losing Grayscale would leave a reduced DCG “mired in endless settlements and lawsuits,” Ahluwalia says. The remnants of Silbert’s empire would effectively become “an insolvent zombie company,” he adds. However, the crypto rally may be its savior. DCG was valued at $10 billion in November 2021, at the peak of the crypto frenzy, after it sold $700 million of stock in a private sale led by SoftBank.
“If DCG doesn’t eventually get off and settle with the creditors of Genesis, they could get forced into bankruptcy,” says consultant Campbell.
DCG maintains its recovery plan, initially supported by Genesis and the Committee of Unsecured Creditors but not Gemini and the Ad Hoc Group of Genesis lenders, provides “the best recovery available.”
One of the main complications to the resolution of the Genesis bankruptcy is the legal feud between Genesis and its Earn program partner Gemini. Earn offered savers willing to park their crypto with Gemini annual yields as high as 8% in 2021. Under the arrangement, Genesis borrowed crypto assets from Gemini Earn customers, reinvested them at higher rates and pocketed much of the difference when it passed interest back to the Earn users. The Winklevoss’s Gemini acted as the agent, processing deposits and withdrawals and taking a small cut from payments made by Silbert’s Genesis to Earn investors. Genesis suspended withdrawals on November 16, 2022 to preserve assets.
Shortly before that, as conditions in the crypto market deteriorated amid a cascade of bankruptcies, Genesis agreed to post collateral to ensure the Earn customers would not lose capital if borrowers defaulted. The collateral it used were shares in the Grayscale Bitcoin Trust, and it agreed to an installment of 30.9 million units on August 15, 2022 and 31.2 million more on November 10. When Genesis halted withdrawals six days later, Gemini foreclosed on the first batch, but the second had not been transferred. At the time of the foreclosure, the GBTC shares traded for $9.20 each.
Last month, Gemini sued Genesis for the remaining collateral. It said DCG had sent the shares to Genesis, but the unit refused to pass them on. The collateral is far more valuable now than when it was posted, trading above $30. Taken together, the shares are worth $1.6 billion—more than enough to cover the claims of the Earn customers.
Genesis sees it differently. It filed an action against Gemini on November 21 to recover $689.3 million withdrawn by Earn users within 90 days of Genesis’ bankruptcy filing. Genesis also wants to reapportion the collateral to benefit all of its creditors and disputes Gemini’s foreclosure and entitlement to the additional GBTC shares. Gemini insists that the Earn customers have priority because of the collateral deal.
There’s another twist: when Gemini foreclosed it bought the first tranche for its own account at the prevailing market value of $284 million. That has increased to more than $800 million, and Gemini still controls those shares, which it says it is holding for the benefit of Earn savers.
Many creditors believe both Silbert’s DCG and the Winklevoss’s Gemini are acting in bad faith, a Genesis lender who requested anonymity told Forbes. “I think creditors have just felt an incredible sense of frustration that this bankruptcy process has taken as long as it has, that DCG was unwilling to come up with a reasonable settlement. They’ve delayed and delayed and come back with very unfavorable terms.”
“I think the best outcome for everyone—creditors, DCG, and Genesis—would be reaching a fair settlement with DCG,” says another Genesis creditor who identifies as BJ on Telegram. “Creditors’ lives have been dramatically disrupted by this bankruptcy process, while DCG has only benefited from the significant delays in this case. I would think it’s in the best interest of DCG to find a way to avoid protracted litigation that will involve charges of fraud from thousands of creditors.”
There is no question that recovering crypto markets are helping DCG. “There’s no natural conclusion here other than DCG either just buying enough time so that the profits they’re making from Grayscale help them build back their balance sheet enough that they can ultimately make a payment to Genesis and get them to go away or there’s some other legal pressure that forces DCG to file” for bankruptcy, says Jeff Dorman, chief investment officer at crypto hedge fund Arca. Now, “is there anybody with a forceful enough stick that can actually demand payment from DCG itself and force a bankruptcy? Thus far we haven’t seen it,” Dorman says.
Silbert and DCG could also be benefiting from the delays in the Genesis bankruptcy, says another anonymous creditor: there are “millions in loans [from Genesis] that were due in May that he hasn’t paid back, and that’s capital that he can earn money on. The current risk-free interest rate is 5% right now, so if you think about it, that’s $30 million worth of value per year he can accrue because of the delays.” According to a November 27th filing, DCG has winnowed down more than $600 million in debt to its subsidiary to about $324.5 million.
“The deal that Genesis just made with DCG related to DCG’s loans is absolutely ridiculous. Those loans were due in May,” snorts creditor BJ. “They sued DCG to get them to pay the loans, and they immediately gave them a break. That break expired, DCG hadn’t paid them and now they’re ready to give them another break. It’s not fair to the creditors.”
Meanwhile, the clock keeps ticking. Grayscale and other asset managers, including BlackRock, Ark, WisdomTree, VanEck, Invesco and Fidelity, seem to be getting close to finally receiving SEC approval for a spot bitcoin exchange-traded fund. The timing of the approval is uncertain but could come before January 10, according to Bloomberg analysts.
If Grayscale succeeds in getting the SEC’s approval and converts GBTC into an ETF, the discount on the value of the fund’s holdings will narrow or close, increasing its value to shareholders—one of the largest of whom is Genesis. DCG’s cash flow could take a hit under pressure to bring management fees in line with ETF competitors. Managers of U.S.-listed ETFs and mutual funds have expense ratios averaging less than 0.4% of assets, according to Morningstar. However, Grayscale would immediately launch as the largest ETF in the market, given the $27 billion in assets it has as a closed-end fund. New money flowing into the ETF version of GBTC could make up for any reduction in its fee income.
“If the fees get cut in half with GBTC’s conversion into an ETF, it will impact the payments that we might be able to get,” explains Genesis lender BJ. But it’s not so simple to say that if an ETF gets approved, it will be bad for DCG—maybe initially, but not necessarily, he adds. “They are still the biggest player out there.”
Regardless of Grayscale’s course of action, Ahluwalia believes that DCG is facing brand “destruction,” which could play out over the course of two to three years.
“What we’re learning over and over again is that it’s bad for [crypto market] sentiment,” says Arca’s Dorman. “It’s bad for a casual observer who just sees nothing but negative headlines every day. The businesses will just find a way to go elsewhere.”
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This article was updated on December 11, 2023, to
• Clarify the relationship between Digital Currency Group and the Grayscale Bitcoin Trust
• Correct the month which the latest DCG recovery plan was offered
• Correct the characterization of loans made to DCG by Genesis
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