Tracking hundreds of active blockchain projects is a full-time job. But finding out how they are funded is much easier thanks to a few prolific venture capital firms. One of the biggest ones is Digital Currency Digital (DCG), the parent company of several key ventures such as Genesis Trading and Grayscale Holdings. Recently, the company has come under pressure over its public spat with Gemini over its Earn product and other issues. Is it another crypto crisis in the making?

Digital Currency Group’s Brief Overview

As an early Bitcoin investor, Barry Silbert was among the first cryptocurrency investors, having founded Digital Currency Group (DCG) in 2015. The company’s mission statement is simple – strategically invest in blockchain projects to create a financial ecosystem that is better than the current one.

This includes talent networking, capital access, market-making, and even media engagement to popularize said digital infrastructure. Accordingly, to achieve its goal, DCG has seven divisions, of which two have the largest impact on the crypto space.

Genesis Trading is the Citadel Security of cryptocurrencies; this institutional market maker provides liquidity for counterparties, whether it is derivatives, trading, lending, or just custody. During 2021’s bull run, Genesis was responsible for $131 billion in loan originations.

Grayscale Holdings is the BlackRock of cryptocurrencies, this asset manager is responsible for crypto funds that give investors exposure to digital assets as over-the-counter (OTC) shares. As such, Grayscale bridges traditional finance with digital assets. Presently, Grayscale’s funds include 25 cryptocurrencies, of which Grayscale Bitcoin Trust (GBTC) is the largest, holding 631.84k BTC ($10.87B), followed by Grayscale Ethereum Trust (ETH) at 3.04M ETH ($3.97B).

CoinDesk is the media and research division of DCG, notable for hosting the largest blockchain conferences, such as Consensus. DCG’s venture in market intelligence, mining, and staking is represented by Foundry. For a crypto exchange/wallet, DCG founded Luno, alongside TradeBlock as an API for end-to-end institutional trading.

Lastly, DCG founded wealth management platform HQ Digital, which is shutting down its $3.5 billion operation on January 31, 2023, due to the “broader economic environment and prolonged crypto winter.”

Out of DCG’s seven subsidiaries, two are already defunct – Genesis and HQ Digital.  How did this happen, and what to expect next?

Digital Currency Group’s $10B Valuation

As a strategic investor, DCG had made 297 investments in crypto projects during its history, having exited only 35, according to Crunchbase. As a recipient of capital, DCG raised $1.3 billion in total, out of which  $600 million was from Eldridge for debt financing in November 2021.

The second significant funding, at $700 million, was from SoftBank. This was secondary market funding, which means DCG acquired liquidity by selling some of its stake in private funds. Together with Google’s parent company, Alphabet, SoftBank’s funding was finalized in November 2021, which brought DCG’s valuation to $10 billion.

However, following the deadly combination between the Federal Reserve’s interest rate hikes and FTX/Terra/3AC wipeouts, the crypto market melted away 57% of its market cap from the beginning of 2022.

In other words, many investors overplayed their hand by stretching themselves thin during the 2021 market bull run, expecting a “supercycle”, as a prolonged period of sustained growth. With a reversal of the cycle into a “prolonged crypto winter,” it is a matter of how much debt was incurred during the failed supercycle.

DCG’s Liabilities and Genesis Falling

A week after FTX crashed in November, by halting user withdrawals, DCG’s Genesis Trading did the same. The official reason was “abnormal withdrawal requests which have exceeded our current liquidity.” In other words, a classic bank run.

By the end of Q3 2022, Genesis Trading had $2.8 billion in active loans. Gemini crypto exchange has been using Genesis as an institutional market maker/brokerage to facilitate Gemini’s Earn program. Its recipe was simple and identical to Celsius Network – users stake their assets for others to borrow in exchange for an interest rate.

Genesis representatives admitted that $175 million in users’ funds was held in now-defunct FTX. The same week, DCG injected $140 million worth of liquidity into Genesis. However, Genesis suffered a much bigger blow before when Three Arrows Capital (3AC) collapsed following the May’s Terra (LUNA) crash. According to bankruptcy court filings, Genesis borrowed $2.4 billion from 3AC.

As Genesis’ umbrella company, DCG assumed $1.2 billion of that claim against 3AC. But the string of liabilities doesn’t end there. A Dutch crypto exchange Bitvavo had also issued a debt claim against Genesis at around $300 million. Together with Bitvavo, Gemini formed a creditors’ committee to retrieve the funds.

DCG Crossed Winklevoss’ “Deadline”

On January 2, Gemini co-founder Cameron Winklevoss published an open letter to DCG CEO, Barry Silbert. He emphasized several points to clear things up:

• Genesis Trading stranded 340,000 users who cannot withdraw $900 million worth of funds.
• Digital Currency Group (DCG) owes Genesis ~$1.675 billion as its subsidiary.
• Barry Silbert failed to respond to Cameron’s two financial proposals in December.
• For the last-ditch effort, Cameron proposed a January 8th deadline as the final public commitment from Silbert to resolve the outstanding liabilities.

In return, Barry Silbert claims that DCG did not borrow $1.675 billion from Genesis. Since then, Silbert has not delivered another proposal, having stated in response to Cameron that DCG already delivered a proposal on December 29th.

In his letter, Cameron noted that Silbert extracted liquidity from Genesis “to fuel greedy share buybacks, illiquid venture investments, and kamikaze Grayscale NAV trades.” In the meantime, social media has been abuzz with Silbert’s “prophetic” tweet regarding a “daisy chain” of liabilities.

Potential Fallout

If push comes to shove and DCG defaults by failing to find new investors, it seems that users will be in the back line, just like with Celsius Network. Financial Times reported that Eldridge, the aforementioned $600M loan issuer to DCG, is first in line. The financing company is set to receive $350 million, given that a secured term loan ranks higher than DCG’s liabilities to other creditors.

More importantly, if new sources of liquidity are not found for Genesis, Silbert may dip into Grayscale investment products. At 631.84k BTC, Grayscale Bitcoin Trust (GBTC) alone holds about 3% of the Bitcoin circulation supply. Further, as GBTC trades at a 44% discount, it is yet to be confirmed if BTC funds are there.

Grayscale refused to offer any proof-of-reserve audit. The company stated that due to “security concerns, we do not make such on-chain wallet information and confirmation data publicly available.” This means that DCG liabilities to 3AC and others could be effectively secured by 17 million GBTC shares.

A selloff of Bitcoin holdings would suppress the entire crypto market, making it even more challenging to refund Genesis users. By the latest account, both the United States Department of Justice’s Eastern District of New York and the Securities and Exchange Commission (SEC) are probing DCG’s internal transactions with Genesis.

This article originally appeared on The Tokenist

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