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Truth. Transparency. Fiduciary duty. These words do not appear to exist for key intermediaries in the crypto sphere, setting the stage for the mother of all contagions as the blowback from the FTX saga shows no sign of halting. Today, the venture capital company, Digital Currency Group (DCG), was forced to pen a letter to its shareholders to soothe the fraying nerves. Will this suffice? Let’s find out.
Digital Currency Group owns five major companies: CoinDesk, the crypto mining equipment retailer Foundry, the crypto brokerage firm Genesis, the digital assets exchange Luno, and Grayscale Investments, the company behind the Grayscale Bitcoin Trust (GBTC).
Digital Currency Group first featured on the crypto contagion radar last week when the lending arm of Genesis, formally known as Genesis Global Capital, revealed that around $175 million of its funds were trapped within the now-bankrupt FTX exchange. Concurrent with this disclosure, Genesis Global Capital halted all loan creations and redemptions. It also announced an equity infusion of $140 million from DCG. So far, so good. But then the New York Times revealed this week that Genesis was exploring the declaration of bankruptcy as a viable option and has hired Moelis investment bank to provide assistance.
This does not make any sense. Genesis Global Capital had $2.8 billion in total active loans as of the end of Q3 2022. Moreover, with the $140 million equity infusion from Digital Currency Group, the crypto lending firm’s effective balance sheet hole should have been reduced to just $35 million. So, are we to now believe that Genesis is potentially going under on account of a $35 million shortfall?
At the same time, the discount at which the units of Grayscale Bitcoin Trust (GBTC) trade relative to their theoretical Bitcoin-based price reached nearly 50 percent toward the end of last week, suggesting widespread skepticism among investors regarding GBTC’s financial wholesomeness.
I'm not deep in the weeds enough to understand the implications of what happens when multiple players in this loop get taken out, which appears to be happening. Thoughts, Twitterverse? pic.twitter.com/jRHboQCK16
— Michael Kao (@UrbanKaoboy) November 18, 2022
So, how is the contagion from FTX’s bankruptcy now spreading like poisoned ivy among key crypto nodes? Well, Michael Kao, a commodities trader at Goldman Sachs, illustrated some of the potential contagion vectors via a flow diagram. The probable use of GBTC units as collateral can explain the stress that Digital Currency Group and its subsidiaries are currently experiencing, especially if that collateral is now being dumped, thereby creating a negative feedback loop. This phenomenon can also account for the confoundingly high discount at which GBTC units continue to trade.
DCG/Barry letter to shareholders pic.twitter.com/lHLZDpFCUy
— minigrogu (@minigrogu) November 22, 2022
Nonetheless, Digital Currency Group founder and CEO, Barry Silbert, chose to take the initiative today by penning a letter to the shareholders, noting:
“In recent days, there has been chatter about intercompany loans between Genesis Global Capital and DCG. For those unaware, in the ordinary course of business, DCG has borrowed money from Genesis Global Capital in the same vein as hundreds of crypto investment firms. These loans were always structured on an arm’s length basis and priced at prevailing market interest rates. DCG currently has a liability to Genesis Global Capital of ~$575 million, which is due in May 2023.”
While Silbert stressed that “inter-company” loans were structured on an arm’s length basis, it is as yet unclear whether Genesis Global Capital can demand an earlier repayment of its $575 million loan to Digital Currency Group. After all, the crypto lending firm is currently experiencing a severe liquidity shortfall, judging by its willingness to explore the bankruptcy option. Silbert also revealed that DCG stands to earn around $800 million in revenue in 2022.
Apart from the loan from Genesis Global Capital, Digital Currency Group’s only other liabilities include a $1.1 billion promissory note that is due in 2032 and a $350 million credit facility from Eldridge. Of course, the question remains: how far will DCG go to rescue its flailing subsidiaries? Meanwhile, the contagion vectors keep spreading, and the probability of a systemic meltdown is growing by the hour.
