Notes 1/10: More Winklevoss Drama: Will GBTC Become A Casualty?

Yesterday, I wrote about the open letter sent by Cameron Winklevoss to the Digital Currency Group (DCG). The letter accuses DCG of “beyond commingling” its assets with those of Genesis, the group’s lending arm responsible for yield in the Earn program.

DCG is reported to have made a loan, in the form of a ten-year promissory note, to Genesis to help the latter cover its losses due to exposure to defunct hedge fund Three Arrows Capital.  

An Escalation

The situation escalated today.

Gemini co-founder Cameron Winklevoss amped up the rhetoric in a second letter this morning and called for the resignation of DCG CEO Barry Silbert. This letter outlines the relationship between Genesis and defunct hedge fund Three Arrows Capital (3AC) and its connection to GBTC’s ballooning assets under management (AUM) over the years.

According to Winklevoss, Genesis made loans of more than a billion dollars to 3AC in exchange for a collateral of worthless tokens. The firm’s intention was to create liquidity and demand for Grayscale’s GBTC shares. 3AC executed a recursive trade using the loans, meaning it used GBTC shares as further collateral for more Genesis loans.

Then it turned around to purchase the trust’s shares again and pump up their price. Or, to put it in Winklevoss’s words: “Barry’s financial Hotel California thought that it would print money for the DCG universe in perpetuity.”

Premium Turns to Discount

The trade would have worked if GBTC shares had consistently traded at a premium to its net asset value. But they have traded at a discount since last January, even as bitcoin set two records in the same period.

Winklevoss charges Genesis with lying about the problems in its order book and perpetuating accounting fraud by creating false metrics to allay investor fears. The FTX crash, and its aftermath of collapsing entities, exposed DCG’s fraud, according to him.

Of course, Winklevoss does not mention the due diligence that Gemini is supposed to have conducted to vet partners and safeguard user funds. As many publications have already pointed out, the blame game is strong in crypto right now.  

To add to DCG’s problems, the Department of Justice (DoJ) and the Securities and Exchange Commission (SEC) are reported to have issued subpoenas to DCG.

It is not clear whether replacing Silbert will make investors whole anytime soon. Enforcement action, if it does occur, by regulators is probably months away. “We are still in the very early stages of investigation,” Gareth Rhodes, founder of research firm Pacific Street, told CoinDesk. “The timeline (for this case) might be longer.” He added that subpoenas are “very common practice” in the financial services industry.

The DCG Behemoth in Crypto  

Almost daily, crypto is rocked by scandals and hacks. The current standoff in crypto is unique because it involves DCG – a crypto behemoth that has bankrolled some of its biggest players, such as crypto exchange Coinbase, Silvergate Bank, media site CoinDesk, and mining giant Foundry.

The conglomerate’s financials are a black box. If there are losses on its books, it is not providing any clues through public actions: the company was investing in startups as recently as last month.

DCG’s portfolio companies seem to be doing well. Foundry has the largest hash rate – computing power devoted to mining bitcoin – among miners of the cryptocurrency. Genesis, for all its troubles, is also among the industry’s biggest lending firms and is supposed to have received a fresh infusion of capital last November from investors. Grayscale’s GBTC is also supposed to be the biggest holder of bitcoins amongst publicly traded companies.

The breadth of DCG’s presence in cryptocurrencies means that it is not impossible, even desirable, for businesses to collaborate with each other to grow a fledgling sector. But DCG CEO Silbert has denied any hint of meddling in Genesis’s business. In an update released this afternoon, he states that “DCG does not direct any trades, loans, or borrows for Genesis’ business.”

Four sentences later, he contradicts himself. “In this way [through interactions with companies in its portfolio], DCG has fostered one of the most collaborative and vibrant communities of businesses in the blockchain and crypto space,” he writes.

Perhaps, an example of this collaborative fostering might be the banking relationships that many companies funded by DCG, including Genesis, had with Silvergate – another DCG entity?

There is already speculation on Twitter that DCG might be the next shoe to drop in a crypto ecosystem beset by scandals. But it is not easy or quick to unravel an entity like DCG that has multiple interests across various companies in cryptocurrency. It is a sum of its numerous parts or investments. A dissembling in one of its parts is more likely than a full contagion that keels the conglomerate over.

GBTC: A Vulnerable Peg in The DCG Crypto Palace

The most likely and vulnerable peg in the DCG structure is Grayscale’s Bitcoin Trust (GBTC). The trust, which is the biggest publicly traded investment vehicle for Bitcoin in the world, seems to have run its course.

It serves no purpose to investors or bitcoin.

It was launched in 2013 to provide exposure to a volatile asset class. In its current discounted state, that exposure has turned negative. Other funds available in the market – with less discounts to NAV and fees – also do a better job of tracking the cryptocurrency’s price.

Investors are locked into GBTC’s “roach motel” design because they cannot redeem its shares unless they find someone willing to take a bet on the trust’s prospects. Note that this bet will not be a bet on bitcoin or its potential but on the possibility that the trust’s shares will begin trading at a significant premium, as they have done in the past, again.

The chances of that happening are slim in the current climate of distrust and fear in slumping crypto markets. Even if bitcoin price were to reverse course and begin rising, there is no guarantee that GBTC’s discount will turn into premium.

An Opaque Market

An alternate course of action would be for Grayscale to buy up GBTC shares and reduce their supply and, as a result, the price discount. But it might not be such a good strategy because they operate in an illiquid market.

GBTC also trades in opaque OTC markets, meaning information about its biggest shareholders is hard to come by. As of this writing, institutional firms hold slightly more than 1% of its shares. That’s bad news since institutional firms can provide liquidity in an illiquid market. The mysterious holdings for GBTC shares also it susceptible to extreme volatility.

GBTC’s Path Forward

All of this means that GBTC is beginning to resemble dead weight in crypto. Its only utility is to throw off profits for Grayscale as management fees. It could be valuable due to its bitcoin holdings, reported to be among the biggest, but they are useless unless they effect a premium in its share price.

Grayscale rival firm Valkyrie investments is making a bid to run the trust but this Blockworks article states that they may find it difficult to overcome “airtight” legal documents that govern who run the trust.

A group of GBTC shareholders have also banded together and are calling for redeeming GBTC shares. Grayscale CEO Michael Sonnenshein has already floated the idea of a tender offer for up to 20% of the trust’s share earlier. That idea will require approval from the SEC and Grayscale’s mysterious shareholders.  

If anything, the numerous threads to the GBTC’s story make it clear that its days are numbered in its current form.

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