Notes 2/7: DCG Finds A Way Out, MakerDAO Earnings

After the spate of recent bankruptcies and scandals, crypto observers are waiting for the fall of a massive domino, one that would crash its ecosystem and prices. The crypto conglomerate Digital Currency Group (DCG) had become a strong contender for that title due to various problems at its subsidiaries. But it might not be the player to tip over the crypto house of cards.

DCG subsidiary Genesis’s trading arm was hit by the decline in market capitalization while its lending unit froze withdrawals because it did not have sufficient funds. In news today, DCG seems to have reached an agreement with its creditors to sell its trading outfit and convert debt to equity for its lending arm. The dilution in DCG equity was an expected development, given its mounting problems and the fall in prices for cryptocurrencies.

Separately, DCG has sold a quarter of its stock in Grayscale’s Ethereum Trust to raise as much as $22 million in multiple trades since January 24, the Financial Times reports. The shares are being sold at a 50% discount, according to securities filings seen by the publication. Incidentally, the ethereum held in the Trust are commingled and its shareholders have no specific rights to it, if the Trust goes under.

The Trust has sold “smaller blocks” of shares from its other portfolio of trusts including the Litecoin Trust, Bitcoin Cash Trust, Ethereum Classic Trust, and Digital Large Cap Fund.

Who Is Interested in Crypto?

Possible interested parties in DCG’s entities or in its Trust’s shares are not known.

But Genesis may not be short of suitors. The subsidiary’s trading and lending arms were, at one point of time, leading providers of liquidity and capital in crypto markets and could provide value to financial firms interested in dipping their toes into crypto as an asset class after regulatory authorities bring it under their jurisdiction.

The same, however, cannot be said of Grayscale’s Trusts. Prices for all cryptocurrencies have collapsed in the last year and the total market capitalization of its markets has fallen by more than half.

Declining market capitalizations for cryptocurrencies have had a corrosive effect on the share prices and discounts at Grayscale’s Trust portfolio. All its Trusts listed in OTC markets are trading at steep discounts to their net asset value (NAV).     

The identity of entities that purchased shares of the Ethereum Trust from Grayscale are not known. But it is safe to say that it was not a good trade. Ethereum’s move to a Proof of Stake (PoS) has made it a regulatory tinderbox, in danger of being classified as a security by the SEC.

That might result in “materially adverse” consequences for investors in the Trust and could even end in the Trust’s dissolution by Grayscale. The regulatory footing of Trusts for other coins like Litecoin stands on even slippery ground since they have no proven use case or future, as of this writing.  

MakerDAO Releases Earnings Statement

Ever wonder what a fantasy earnings statement looks like?

Decentralized Finance (DeFi) protocol MakerDAO’s 2022 earnings, released on Friday, might be a strong candidate. MakerDAO is a quasi-algorithmic stablecoin. it started off as an experiment in stablecoin backed entirely by Ethereum.

But reality intervened. There were hacks and pegs gone awry.

Since then, the stablecoin has pivoted from its original grand cryptocurrency-centric vision to a more prosaic dependence on real world assets (RWAs) like US Treasuries.

Self-Deception 101

MakerDAOs earnings are fantasy because they are denoted in DAI – a stablecoin mostly backed by cryptocurrencies. While the figures in its earnings report are in millions, very little of it seems to be real money.  

Most of DAI’s collateral constitutes of a mix of coins like Ethereum, staked Ether (stEth) and wrapped Bitcoin (wBTC). Ethereum is still under development and its price itself is a fantasy concocted at corrupt crypto exchanges.

Meanwhile, stETH and wBTC are wrapped or derivative versions of their more well-known crypto counterparts and generate revenue only when they are lent out. Even in this form, they are susceptible to runs and hacks. MakerDAO has recently begun moving away from its crypto-collateral towards Treasuries and USDC – a stablecoin that seems to be backed by US dollars.

Losses And More Losses

Even if one levitates to cryptosphere and considers DAI to be a valid currency, the downturn in crypto markets seems to have capsized MakerDAO’s finances.

Its revenues fell from 112 million in 2021 to 65 million in 2022. But that didn’t stop the protocol from more than doubling its operating expenses to 46 million from 21 million the previous year. No wonder then, the protocol’s operating profit crashed from 90 million in 2021 to 19 million in 2022.

If you can make it past the figures and weird terms, such as Surplus Buffer, you will find more surprises. One of them is a relatively healthy price-to-earnings ratio of 24.4 for the token or its protocol, I don’t know which. Or a Price to Book ratio of 6.1 for assets that probably have no value outside of the crypto ecosystem.

In 2022, we saw that the overall exposure to stablecoins isn’t risk-free, the earnings report authors write. No kidding.

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