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Gemini's Open Letter: DCG's $1.1 billion promissory Note Market Discounts Only $300 million (full text)

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"Expose how DCG manipulates GBTC."

Gemini Associates Cameron Winklevoss

Qin Xiaofeng, Odaily Planet

Early this morning Beijing time, Cameron Winklevoss, co-founder of Gemini, a crypto trading platform in the United States, sent a long post.

Cameron said DCG founder and CEO Barry Silbert and other key personnel misled everyone by making false statements that Genesis had recovered from the Three Arrows bankruptcy, inducing lenders to continue providing loans. Cameron argued that the $1.1 billion in promissory notes offered by DCG had not actually been redeemed, and that their actual value would be greatly discounted -- at a 70% discount, it could fetch as little as $300 million.

In addition, Cameron also revealed to DCG's board of directors how his senior executives had conspired with Genesis and Three Arrows Capital to illegally manipulate GBTC, but the final plan failed, resulting in high debts of Genesis and triggering a liquidity crisis of DCG Group. The article also recommended that the DCG board remove Barry Silbert, the current CEO of DCG, and appoint a new CEO.

In response to Cameron's demands, Barry Silbert and DCG officials said it was another desperate and unconstructive publicity stunt by Cameron to divert the discontent of Gemini's Earn users to DCG.

Back on Jan. 3, Cameron sent an open letter to Barry Silbert demanding that he pay back more than $900 million he owes. Cameron also accused Barry Silbert of maliciously delaying tactics by refusing to cooperate. Barry Silbert then responded: "DCG did not borrow $1.675 billion from Genesis. DCG has never missed interest payments on Genesis and is currently paying all outstanding loans; the next loan due is in May 2023."

The following is the long article.

An open letter to DCG's Board of Directors:

I'm writing this letter to let you know, Gemini and more than 340,000 Earn subscribers were acquired by Genesis Global Capital, LLC (Genesis), parent company Digital Currency Group, Inc. (DCG), DCG founder and CEO Barry Silbert, and other key personnel. These individuals conspired to make false statements and mislead Gemini, Earn users, other lenders and the public at large about Genesis' solvency and financial health. They did so in order to mislead the lender into believing that DCG had absorbed the massive losses that Genesis had incurred as a result of the collapse of Three Arrows Capital (3AC), and to induce the lender to continue lending to Genesis. By lying, they hope to buy time to get themselves out of the mire they have created.

We're learning more every day, but here are the basics: Genesis lent $2.36 billion in assets to Singapore-based hedge fund 3AC, which collapsed in June 2022; After the collateral was liquidated, Genesis said it lost at least $1.2 billion. At this point, Barry Silbert (DCG founder) had two reasonable options -- either restructure Genesis's loan structure (inside or outside the bankruptcy court), or simply close the $1.2 billion hole. Unfortunately, he didn't do either.

At the time, Genesis's loan book had a total of about $8 billion, meaning 3AC's $1.2 billion loss represented roughly 15% of its loan book assets. (Note: The latest DCG article says Genesis's loan book is currently about $12 billion to $15 billion). At the time, restructuring could have addressed this gap, achieving full asset recovery for all lenders (including Earn users) in a short period of time and giving them direct access to liquidity. But Barry Silbert didn't do that. Nor is he going to plug the $1.2 billion hole -- instead, he's pretending to have done it himself.

Beginning in early July 2022, Barry Silbert, DCG, and Genesis began an elaborate campaign of lies to convince Gemini, Earn users, and other lenders that DCG had injected $1.2 billion in actual support into Genesis.

One, lie big, cover up the problem

"Public lies."7 "DCG has assumed certain Genesis liabilities related to 3AC to ensure we have the capital to operate and scale our business for the long term," tweeted Michael Moro, Genesis' then-CEO, on June 6.

This statement is false and misleading. In fact, the DCG did not ensure that Genesis had enough money to operate, and the DCG did not give Genesis a single penny of actual money to cover the loss of the 3AC. Instead, DCG entered into a 10-year promissory note with Genesis that paid 1% interest and matured in 2032. The note was a complete gimmick that did nothing to improve Genesis' immediate liquidity position or make its balance sheet solvent (more on that later). Michael Moro also tweeted at DCG at the time, but no one at DCG (including Barry Silbert) corrected his misstatement.

Private lies.Behind the scenes, multiple Genesis and DGG staffers began to spin more lies. On the same day of Moro's tweet (July 6), for example, Genesis's then-head of trading and lending, Matthew Ballensweig, emailed a document titled "Three Arrows Post-mortem" to multiple Gemini employees who manage the Earn program. Mr. Ballensweig announced his departure last September to join Exodus, a crypto wallet company. The "Key Facts" section of the document states: "The losses were largely absorbed by the DCG balance sheet, thus allowing Genesis sufficient capital to continue as a going concern (business as usual)."

This statement is false and misleading. In fact, DCG did not "absorb" 3AC losses on its balance sheet. Doing so would require DCG to inject real-time support into the Genesis. As I will explain below, the DCG promissory note did not leave Genesis with enough capital on its balance sheet to continue its normal business.

Accounting fraud.Ballensweig perpetuated the lie by including a document called "Gemini Risk Measurement Requirements" in the same email to Gemini employees. We found that the "financial condition of each Asset" section of the document contained at least two serious misrepresentations: (1) characterizing the DCG promissory note as a "current asset" (in a subcategory called "Other Assets"); (2) Value it at $1.1 billion.

First, according to generally accepted accounting principles and consensus, "current assets" means cash, cash equivalents, or other assets that can be converted into cash within one year. A promissory note, whose principal is to be repaid within 10 years, does not fall under the definition of "current assets" at all.

Second, there is no market in the world that values unsecured long-term notes at face value. The net present value (NPV) of the note would be heavily discounted (about 70 per cent) to reflect its current value (probably $300m). (Note: Gemini is saying that DCG's $1.1 billion promissory note would need to be sold at a discount and could fetch as little as $300 million.)

The accounting misconduct also appears in the balance sheet Ballensweig sent to Genesis as of June 30, 2022. The misrepresentations (repeated in numerous documents sent to Gemini and other lenders in the months that followed) turned out to be a ruse designed to make Genesis appear solvent and able to meet its obligations to lenders, without DCG actually committing to provide the financial support necessary to make that happen. DCG wants to have its cake too. Barry Silbert and DCG would have gotten away with it had it not been for the collapse of FTX. (Note: DCG's latest response says that in the period since Three Arrows' default, DCG has invested about $340 million in new equity in the Genesis entity to provide it with additional capital.)

Ii. 3AC, Genesis and gray relational transactions

How did it come to this? Greed. As an independent business, it was hard to imagine Genesis lending 3AC so much money, given the poor quality of the collateral it had put up.

Genesis made the loans because they were part of a larger plan to make DCG businesses richer. More specifically, Genesis was willing to lend to 3AC at all cost because 3AC was using the money to make "suicidal" Grayscale NAV trades -- a recursive trade, The assets under management of the Grayscale Bitcoin Trust (ticker: GBTC) have ballooned, as have the fees earned by its issuer, Grayscale Investments, LLC (Grayscale), a wholly owned subsidiary of DCG.

Note: The transaction logic is that 3AC borrows from Genesis to create shares of Grayscale Bitcoin Trust, then 3AC pledges these GBTC shares in Genesis, borrows more Bitcoin and repeats the above step (repeat pledge). When the 12-month (and later 6-month) lock-up of a specific portion of GBTC shares expires and GBTC is at a premium (trading at a premium to net asset value), 3AC can sell GBTC shares and charge a premium. That worked, but in early 2021, GBTC shares began trading at a discount to NAV - and the discount has persisted and widened ever since. Not only did this kill the NAV trade, it also meant that the GBTC collateral 3AC issued in Genesis was losing value, further exacerbating the liquidation of 3AC's loans.

Genesis records these interactions with 3AC as real mortgages. However, this is not the case at all. In effect, 3AC was merely a conduit (bridge) for Genesis, allowing Genesis to trade efficient swaps between BTC and GBTC stock with the Grayscale Trust. 3AC is a mule that carries assets between two parties, one connected to BTC and the other to GBTC. In the deal, Genesis is betting that GBTC shares will be worth more than BTC's in the future. Eventually, the Genesis risk factor spiked.

In effect, Genesis has been the winner of this zero-sum trade until 2021, as GBTC has been trading at a positive premium. Starting in March 2021, GBTC contango disappeared and began to discount, and Genesis was no longer a viable business. Normally, all things being equal, gains and losses would cancel each other out; in other words, Genesis would be both a loser and a winner. Surprisingly, though, Genesis never seemed to win, as it apparently always ceded them - the GBTC share premium - to 3AC. This means that Genesis only participates in the loss, turning what was originally a zero-sum trade into a negative-sum trade.

Disturbingly, when the NAV trade reversed, as any rational, independently run business would have done, Genesis not only failed to unwind the 3AC collateral, but continued to lend to 3AC on attractive terms and accept GBTC as collateral. For Grayscale, the effect would be to keep GBTC's shares from being sold into the market, which would depress the share price and widen the discount even further. But for Genesis, this had the perverse effect of keeping its risk position open and continuing to grow.

Why did Genesis get into a toxic risky position when the best it could do was not lose money? The truth comes when you actually realize that the Bitcoins in the grayscale Trust are stuck there like a Thanksgiving Turkey forever. GBTC can never be redeemed, or at least until Grayscale, at its sole discretion, implements a redemption program that allows GBTC shares to be converted back into bitcoin.

The end result is that Barry is comfortable with Genesis pouring more and more money into this toxic trade because it's a strategy to fund the Grayscale Trust - Genesis is like a money-printing machine that works forever for the DCG universe. The end justifies the means.

Original accounting fraud.Rather than register the swaps as risky derivatives, Genesis lumped them together on its balance sheet, misrepresenting them as mortgages. This made Genesis's balance sheet look healthier than it really was, fraudulently inducing lenders to keep making loans.

In June 2022, the song is over. The 3AC crashes, exposing the radioactive fruit. Barry took no action to fix the problems he had created, and despite earning more than $1 billion in fees by this time - all of which were borne by Genesis creditors - he refused to accept responsibility. Instead, he resorted to fraud to protect his ill-gotten gains.

3. Fire the CEO and move on

All that said, we don't see a bright future as long as Barry Silbert is CEO of DCG. He has proved himself unfit to run DCG, unwilling and unable to reach a fair and reasonable settlement with creditors.

As a result, Gemini, on behalf of 340,000 Earn users, is asking the Board of Directors to immediately remove Barry Silbert as CEO and appoint a new CEO to right the wrongs that occurred during Barry's tenure. Genesis borrowers, including Earn's subscribers, have been badly hurt, and they deserve a resolution to restore their assets.

I am confident that under DCG's new management, we can work together to reach a positive out-of-court settlement that provides a win-win outcome for everyone, including DCG's shareholders.