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Will the crypto empire DCG be a more serious scam than FTX?

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Did DCG's botched GBTC arbitrage trading cause the previous crypto crash?

Original author: Vijay Boyapati (@real_vijay)

Translated by: czgsws, 0x711, BlockBeats

As early as June 2022, there were rumors that DCG was also "unable to hold on" after the Three Arrows Capital explosion. In January of this year, Genesis could no longer hold on in the aftermath of the FTX explosion and officially submitted the Chapter 11 bankruptcy application. Zhu Su, the founder of Three Arrows Capital, had previously revealed DCG's fraudulent behavior in a post, defending his own "scapegoat" identity.

In August of this year, Bloombergreported that the New York Attorney General's Office, SEC and other regulatory agencies were investigating Genesis and its parent company DCG. In September, it was reported that "US federal investigators are conducting a deep investigation into DCG and its subsidiary Genesis"news. However, to this day, what DCG and its CEO Barry Silbert have done and whether they should be subject to legal trial is still inconclusive.

On November 6th, cryptocurrency KOL Vijay Boyapati (@real_vijay) accused DCG and its CEO Barry Silbert of fraud on social media, stating that this is a "more important fraud case than the SBF corruption case in 2022." So, is the Bitcoin Trust created by DCG an ark or a fraudulent scheme? Vijay analyzes the company layer by layer from his perspective.

BlockBeats has compiled and translated the original article as follows:

In order to fully understand DCG's fraudulent behavior and its impact, we must go back to 2013 when Barry Silbert founded Grayscale, which offered the first trust that allowed investors to purchase Bitcoin from their brokerage accounts. For years, GBTC has been the only way for stock market capital to gain exposure to Bitcoin, and due to its trust structure (lacking an ETF-like redemption mechanism), GBTC traded at a premium to its NAV (net asset value) in its early trading history. This means that the fund's value in the market was greater than its actual underlying assets (Bitcoin). Stock investors had little choice but to pay a premium for GBTC just to gain Bitcoin exposure.

GBTC shares are created by paying Bitcoin to Grayscale, and after 6 months, users can receive equivalent GBTC shares. The existence of GBTC premium (once exceeding 40%) makes arbitrage trading possible and increasingly profitable. Investors can engage in arbitrage trading by shorting a certain amount (assuming x) of Bitcoin while providing an equal amount of Bitcoin to Grayscale. After 6 months, arbitrageurs can close their positions by selling GBTC (whose trading price is higher than x Bitcoin) and earn the premium. This is a common GBTC premium arbitrage trading strategy.

Some market participants realized that this type of transaction was "promising" and appeared to be risk-free (because GBTC's premium always existed), so they began to flock in large numbers. Two of these participants were hedge fund Three Arrows Capital and lending platform BlockFi (both of which are now bankrupt). Three Arrows Capital not only earned GBTC premiums, but also used leverage for arbitrage trading. They borrowed a large amount of Bitcoin to increase their returns. But who did they borrow money from? Genesis.

Like Grayscale, Genesis is also one of the subsidiaries of DCG. This corporate structure was intentionally modeled after Berkshire Hathaway's structure and applied to the cryptocurrency market by Barry Silbert. Genesis is the largest, most important, and essentially the 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 is just one entity as both departments share office space and even employees.

Genesis offers Bitcoin deposit rates to Bitcoin holders of all sizes, and profits by lending out these Bitcoins at higher rates and earning the interest differential. Who does Genesis lend to? Companies such as Three Arrows, BlockFi, and Alameda.

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

DCG has a strong incentive to encourage Genesis to issue Bitcoin loans for GBTC arbitrage trading, as these Bitcoins will flow into Grayscale (another crown jewel of DCG), and then liquidity will be trapped in Grayscale (because there is no ETF redemption mechanism). Grayscale uses these "locked" Bitcoins to charge a high fee of 2% per year for "fund management" (which basically means doing nothing). Currently, GBTC holds over 620,000 Bitcoins, which means that Grayscale will collect over 12,000 Bitcoins per year as management fees.

The profits of Grayscale flow to its parent company DCG. At this point, you will find that there are some important conflicts of interest between DCG, Grayscale, and Genesis. In fact, Grayscale even knows that Genesis provided loans to promote funds flowing into GBTC. Documents show that the CEO of Grayscale signed a loan provided by Genesis to Three Arrows Capital. Therefore, Barry Silbert has stated that the idea that these family businesses operate by "keeping a certain distance" is clearly ridiculous.

With the passage of time, new methods have emerged in the stock market to gain exposure to Bitcoin (such as Microstrategy's stock, futures ETFs, and foreign spot ETFs). The new competition, coupled with the large amount of GBTC shares generated by arbitrage trading, has begun to impact the premium of GBTC.

On February 23, 2021, the premium of GBTC turned negative for the first time, meaning it became discounted. Since then, it has never returned to a positive premium and the discount has reached as high as 49%, which means the fund is only worth half of its underlying asset value. Arbitrage trading is no longer viable.

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

On May 7th, 2022, the Terra Luna ecosystem began to collapse, causing the LUNA and UST tokens to essentially drop to zero within a few days. Due to their leverage, the collapse of LUNA & UST became the final straw that broke Three Arrows Capital and left them severely in debt.

The bankruptcy of Sanjian has caused huge loopholes for companies that provide loans to it, the largest of which is Genesis, which provided Sanjian with a loan of $2.3 billion. Although such risks can be managed through proper risk management and the use of collateral, Genesis' risk management is very poor.

In mid-June 2022, Three Arrows defaulted on a Bitcoin loan provided by Genesis. After liquidating its meager collateral, Genesis was left with a $1.2 billion shortfall on its balance sheet and is now insolvent.

At this point, if the lender of Bitcoin to Genesis attempts to withdraw the Bitcoin, Genesis will be unable to fulfill its obligations. In this case, it would be appropriate for Genesis CEO Michael Moro to declare bankruptcy.

However, Michael Moro did not declare bankruptcy. Instead, he and his mother company's CEO Barry Silbert devised a plan to cover the losses on Genesis' balance sheet. By doing so, they were able to alleviate concerns from Genesis' creditors and minimize withdrawal actions.

As part of the bankruptcy claim by Genesis against Three Arrows Capital (due to 3AC's complete collapse and being almost worthless), DCG will provide Genesis with $1.1 billion in "promissory notes". Michael Moro assures the market that they have "thoughtfully mitigated the losses".

In fact, this futures contract is a complete scam. Barry Silbert did not inject actual capital to fill the gaps in Genesis' balance sheet, but instead provided a note with a below-market interest rate that cannot be redeemed within ten years.

Obviously, Barry Silbert knows that the promissory note cannot solve the bankruptcy problem of Genesis, because in the later bankruptcy of Genesis, his valuation of the same note was only a small part of the 1.1 billion US dollars claimed by Genesis. The loophole in the balance sheet still exists. After implementing this financial fraud, Genesis executives began to work hard to convince customers of their solvency, falsely claiming that the promissory note received was a liquid asset (equivalent to cash).

When DCG said "there is no basis for this case", it strongly leans towards the double discourse of the enterprise. The case is detailed and comprehensive, and is supported by an experienced and knowledgeable witness. DCG has not made any meaningful rebuttal to any of the charges brought 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 still sits on his throne. Here, I will quote the words of the US prosecutor who sued SBF:

"When I became a prosecutor in the United States, I promised that we would spare no effort to eradicate corruption in the financial markets. This is what is meant by 'spare no effort.' This case has progressed at lightning speed - this is not a coincidence, it is a choice. This case is also a warning to every fraudster who thinks they are untouchable, who thinks their crimes are too complex for us to catch, who thinks their power is too great to prosecute, or who thinks they can talk their way out of being arrested. Those people should rethink their actions and stop. If they do not, I guarantee that our handcuffs are sufficient to arrest them all."