The Breakdown - DCG Responds as Gemini Accuses Company of Fraud

Episode Date: January 12, 2023

Crypto 2023 – like Crypto 2022, but angrier. This week, Gemini co-CEO Cameron Winklevoss accused Genesis, DCG and DCG CEO Barry Silbert of fraud in a major escalation of their fight over frozen funds. Silbert and DCG, CoinDesk’s parent, responded with their own letter and Q&A arguing that Genesis and DCG are fundamentally different entities. NLW covers the war of words and the community’s response to it.  - Join the most important conversation in crypto and Web3 at Consensus 2023, happening April 26–28 in Austin, Texas. Come and immerse yourself in all that Web3, crypto, blockchain and the metaverse have to offer. Use code BREAKDOWN to get 15% off your pass. Visit consensus.coindesk.com. - “The Breakdown” is written, produced by and features Nathaniel Whittemore aka NLW, with editing by Rob Mitchell and research by Scott Hill. Jared Schwartz is our executive producer and our theme music is “Countdown” by Neon Beach. Music behind our sponsor today is “Swoon” by Falls. Image credit: rudall30/Getty Images, modified by CoinDesk. Join the discussion at discord.gg/VrKRrfKCz8.

Basically, Gemini is saying this $1.1 billion promissory note is fraud, and DCG is saying, no, it's not. People in the community seem split between, on the one hand, the idea that Gemini has hired very good lawyers, who wouldn't let them pursue a weird strategy for no gain, versus on the other side the idea that if they actually had a big legal standing to fight from, they might not be doing it so in public. Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is produced and distributed by CoinDesk. What's going on, guys? It is Wednesday, January 11th, and today is Gemini versus DCG Part 2, The sequel. Before we get into that one quick note, there are two ways to listen to the breakdown.

You can hear us on the CoinDesk podcast network feed, which comes out every afternoon and features other great CoinDesk shows. Or you can listen on the Breakdown-only feed, which comes out a couple hours later in the evening. Wherever you listen, if you are enjoying the show, I would so appreciate it if you would take the time to leave a reading or a review, it makes a huge difference. But let's get into the meat of today, and that is, of course, the DCG drama continuing.

I mentioned on yesterday's show as I was finishing up recording that Cameron Winklevoss had just dropped another open letter, his second in two weeks. That letter ended up eliciting the longest response we've seen for months from DCG and its CEO, Barry Silbert. At this point, I don't think many of you need too much background, but the ultra-TLDR of the situation is that Genesis is a subsidiary of the digital currency group, DCG, who also own CoinDisc, by the way, and Genesis has both a lending business and a trading business.

The lending business in particular had a rough 2022. They were the biggest creditor of Three Arrow's capital after it collapsed, which led to DCG taking over that claim and the Genesis CEO resigning. Genesis also had $175 million or so stuck on FTX, and in the wake of the FTX collapsed, Genesis lending halted withdrawals. Among other things, that has trapped around $900 million that was part of Gemini's Earned program, which is their consumer yield program. As time has gone on, Gemini's customers have been getting angrier and angrier, and so too the public pressure from Gemini on Genesis and DCG has also ratcheted up. Last week, that took the form of an open letter asking for

Barry Silbert and DCG to come to the table by January 8th, which was Sunday. That's the letter in which Cameron Winklevoss accused Silbert of bad faith stall tactics, his words. In the wake of that, there was a bit of back and forth on Twitter, but nothing really more than that. Then of course, on Friday, Bloomberg reported that DCG and Genesis were being investigated by the Department of Justice, which took the situation up a couple more notches. Well, yesterday, on Tuesday, Cameron Winklevoss dropped a second open letter, and this one was even more accusatory than the first. This one was directed not to Barry Silbert, but to the entire digital currency group board. The big theme of that letter was that this was no longer just a public disagreement

between business partners, but an accusation of fraud. The letter kicks off, I am writing to let you know that Gemini and more than 340,000 earn users have been defrauded by Genesis Global Capital, together with its parent company Digital Currency Group, its founder and CEO, Barry Silbert, and other key personnel. These parties conspired to make false statements and misrepresentations to Gemini, earn users, other lenders, and the public at large about the solvency and financial health of Genesis. They did so in an effort to mislead lenders into believing that DCG had absorbed massive losses that Genesis occurred from the Three Arrow's capital collapse and induce lenders to continue making loans to Genesis. By lying, they hope to buy time to dig themselves

out of the hole they created. Hell of a start. So fraud by way of lying about the financial health of Genesis. That's the key idea here. So what then are Cameron's argument? First, he said Genesis lented about $2.36 billion to $3.3 capital. Second, after the collateral was liquidated that led to a loss of about $1.2 billion. Third, Winklevoss claims that at that point, DCG could have restructured the Genesis loan book or patched the hole, but that it didn't do either. Quote, beginning in early July 2022, Barry, DCG, and Genesis embarked on a carefully crafted campaign of lies to make Gemini, earn users, and other lenders believe that DCG had injected $1.2 billion dollars of actual support into Genesis.

Now, this campaign of lies is what the accusation of fraud rests upon, so what are their arguments here? Winklevoss writes on July 6, Michael Morrow, then CEO of Genesis, tweeted, DCG has assumed certain liabilities of Genesis, related to 3AC, to ensure that we have the capital to operate and scale our business for the long term. This statement was false and misleading. In reality, DCG had not ensured that Genesis had capital to operate. In fact, DCG hadn't given Genesis so much as a penny of actual funding, to make up for the 3 AC losses. Instead, DCG entered into a 10-year promissory note with Genesis at an interest rate of 1% due in 2032.

This note was a complete gimmick that did nothing to improve Genesis's immediate liquidity position or make its balance sheet solvent. And even though DCG was tagged in Morrow's tweet, no one from DCG, including Barry, bothered to correct his misstatement. Now, holding aside the PR-ness of this whole fight here, this question of the 10-year promissory node in terms of how legitimate it is, and whether it represents Genesis and DCG businesses operating at arm's length is one of the key questions in this whole affair. Now Winklevoss's letter goes on to argue that there were more

lies in private communications, and that DCG had not in fact absorbed the 3AC loss as claimed. Instead, the letter argues DCG and Genesis were engaging in to use Winklevoss's words accounting fraud. There was a document shared at that time, Gemini says, called Gemini Risk Metric Request. Winglevoss writes, quote, The financial position per asset section of this document contained what we have since discovered to be at least two critical misrepresentations. One, it characterized the DCG promissory note as a current asset within a subcategory labeled other assets, and two, it valued it at $1.1 billion. First, as a matter of generally accepted accounting principles and common

understanding, a quote current asset refers to cash, cash equivalence, and other assets that can be exchanged into cash within one year. A promissory note with a principal repayment due in 10 years falls outside of the definition of a current asset by a country mile. Second, there is no market on earth that would value an unsecured long-dated promissory note at face value. The net present value of this note would be heavily discounted, approximately 70%, to reflect its value as of today, perhaps 300 million. So as you can see here, it is this promissory note, this 10-year promissory note that is really at the guts of this thing. Now, the last section of Winklevoss's letter, which accounts for almost two pages,

effectively amounts to an accusation that the only way in which Gemini would have gotten itself into this situation was if it wasn't serving its own interest as an independent company, but instead serving larger DCG goals. This is an argument which, if accepted to be true, would obviously undermine the narrative of independence between DCG and its subsidiary. This undermining of the distance between DCG and Genesis is clearly Gemini's goal with this letter. Now, to get specific, the letter argues that Genesis's goal was never to make as much money and manage risk as it might have been if it was independent. Instead, they argue it was to prop up the grayscale Bitcoin trust nav trade. Remember, for much of the run-up in 2020 and 2021, GPDC traded at a premium to the

underlying Bitcoin it represented. In 21, however, that's switched. Here's the way Winklevoss characterizes what happened then. Disturbingly, not only did Genesis not close out 3AC's position when the nav trade inverted, something any rational independently operated business would have done, it continued to lend to 3AC on attractive terms and accept GBT as collateral. For gray scale this had the desired effect of keeping GBT shares from being sold into the market, which would have depressed the share price and further widened the discount to net asset value. But for Genesis, this had the undesired effect of keeping its risk position open and allowing it to grow. Why would Genesis enter into a toxic risk position where the best it could do was

not lose money? Things only begin to make sense when you realize that the Bitcoin this swap was stuffing into the Grayscale Trust like a Thanksgiving turkey is stuck there forever. It can never be redeemed, or at least until Grayscale and its sole discretion, decides to implement. a redemption program allowing GBTC shares to be converted back into Bitcoin. As a result, Barry was comfortable with Genesis loading up more and more on this toxic trade because it was a gambit to feed the Grayscale Trust. Barry's Financial Hotel California that would print money for the DCG universe in perpetuity. The end would justify the means. So here's the money shot of this Winklevoss open letter. Quote, instead of booking these swaps as the risky derivatives that they were,

Genesis hid them by mischaracterizing the first and last legs of these swap transactions as collateralized loans on its balance sheet. This made the Genesis balance sheet appear healthier than it originally was, fraudulently inducing lenders to continue making loans. In June 22, the music stopped. 3AC collapsed laying bare the poisonous fruits of this radioactive trade. Instead of stepping up to solve this self-created problem and despite having earned more than a billion dollars in fees, all of the expense of Genesis lenders, Barry refused to take responsibility. Instead, he resorted to committing fraud to protect his ill-gotten gains. At the end of the letter, Winklevoss demands that Barry be replaced as CEO of DCG.

Now, we'll get into the longer Barry and DCG response in just a moment, but quite soon after Winklevoss tweeted this letter, the DCG account responded. At DCG co says, this is another desperate and unconstructive publicity stunt from Cameron to deflect blame from himself and Gemini, who are solely responsible for operating Gemini Earn and marketing the program to its customers. We are preserving all legal remedies in response to these malicious, fake and defamatory attacks. DCG will continue to engage in productive dialogue with Genesis and its creditors with the goal of arriving at a solution that works for all parties. Now, whoever you think has the right or wrong of it in this situation,

it is certainly the case that one of the attempts of Winklevoss's letters is to make this seem entirely like a Genesis problem and not at all like a Gemini problem. In fact, based on the way this letter was written versus the first letter was written, it seems likely to me that they took to heart that they might have overplayed that hand when it came to the first letter. After all, the program was named a Gemini, or not Genesis. assert. Still, when it came to the DCG response, the community wasn't so sure about what they had to say. DC investor writes, I don't know, reading the letter as someone who has no dog in this fight,

I suspect you're soon going to have STNY resolve this for you. Collins Belton writes, ah, so your defense is that they were stupid enough to trust you as a counterparty, and now you won't release customer funds they are solely responsible for not predicting your malfeasance. However, while there was a lot of skepticism around DCG's initial response, there was also a broad sense that the open letters reek of, if not desperation, then clearly limited options. Pentoshi responded to the Cameron thread saying, Cameron, deadline January 8th. Reality, there is no deadline. We tipped our hand and don't have one. We will literally do nothing. Lee Drogan from Star Killer Capital says, JFC just sue him into bankruptcy already. That's where this is

going enough with trying to get him to play ball. Ram Aluwalia, who has been following the situation closely, writes, Cameron's letter does read like a formal complaint. It also opened. opens the door for Gemini-earned clients to sue now, and these loan terms will be aired in discovery. DCG now has another off-balance sheet liability in the form of lawsuits. Coin Bureau writes, one can imagine how bad it has to have become for Cameron to publicly accuse Barry of fraud on Twitter. He wouldn't have done so if his lawyers didn't think there was substantial evidence of it, and it's only Tuesday. Still, Scott Johnson, the general partner at G.B. Capital and finance lawyer, says if you actually have a claim that makes sense

to pursue, you don't need to issue public nastygrams. Seen so many out-of-court restructurings and it's painfully obvious by actions who has leverage. And here it's not Gemini. Just a flyer to hopefully build public pressure. But then again, the flip side from some folks like Bitcoin Jack is don't forget Winklevye hired Kirkland and Ellis. Anything they publicly say is carefully crafted, reviewed, researched, vetted, etc. by crem de la crem of lawyers. So I assume that means they think slash no, they have a strong case. Otherwise, this opens them up for serious countersuit. So anyway, all of this would obviously be some serious developments if nothing else had happened. but after months of near public silence, Barry Silbert and DCG decided to comment on this one.

The response took the form of a DCG shareholder letter. The first part of the letter was excerpted in a thread from Silbert himself. It was frankly a lot of background and context setting, with the first paragraph being a rehash of what DCG has done, the second paragraph being about the early days of the industry, the third paragraph being about how hard the last year has been, and then it just sort of ends. However, there is a whole separate section, and that's really where the meat of this was. The second section was organized as a Q&A, and the thrust of it was pretty clearly and transparently to reinforce the argument of distance between DCG as a holding company and its subsidiaries as independent concerns. Question two, how does DCG interact with its wholly own

subsidiaries? Quote, since DCG was founded or subsidiaries have launched and operated as independent companies with their own management teams, financial and risk management protocols, and legal and compliance oversight. Each subsidiary has its own culture, operational structure, and incentive mechanisms. Every aspect of each subsidiary's day-to-day business is directed by the respective subsidiaries' leadership team. DCG has a team of approximately 50 individuals that makes investments, supports our portfolio companies, and provides strategic guidance and general oversight to our subsidiaries. To be abundantly clear, DCG does not direct any trades, loans, or borrows from Genesis' business. Question three, do DCG and any of its wholly owned subsidiaries commingle cash? No, each of DCG's

wholly owned subsidiaries has its own bank accounts, securities accounts, and crypto accounts, and maintains separate books and records. Now we get to the meaty bits a few questions later. Question 7. How much does DCG owe Genesis Capital? DCG writes, like hundreds of other institutional investors, DCG borrowed capital from Genesis Capital, the lending arm of Genesis. These loans were always structured on an arm's length basis and were priced at prevailing market interest rates.

This answer then goes on to discuss the loan that matures in May of this year, plus some other smaller investments. Of course, that doesn't get to the thorny question of the Three Arrow's Capital promissory note, which comes later. Question 13. What was DCG's relationship with? with 3-R0's capital. DCG has never had a relationship with 3-R0's capital. Barry does not recall of her meeting, speaking with or otherwise privately communicating with the 3-0 capital

principles, aside from an introductory call with one of the co-founders in 2020. DCG has never coordinated purchases or sales of GPDC or any other investments with 3-R0 Capital. Genesis had a trading and lending relationship with 3-0 Capital, and 3-0 capital defaulted on its loans from Genesis. Separately, 3-Ros Capital was an investor in various gray-scale products. But then the bigger one, question 14. Why did DCG take over the bankruptcy claim against 3AC and what did DCG get in return from Genesis Capital for the $1.1 billion promissory note? Quote, until the summer of 22, Genesis Capital was the premier crypto lending firm in the

world. When 3AC defaulted on its loans from Genesis and numerous other lenders in June 22, there was palpable fear in the market of contagion spreading through and devastating the entire industry. That was one consideration in DCG moving to assist Genesis Capital. In addition, DCG firmly believed that substantial demand for institutionalized prime brokerage services would continue once the crypto market stabilized. Genesis had unrivaled expertise and the best institutional client base in the world, having built the first institutional

crypto trading desk in 2013 before eventually launching Genesis Capital in 2018. Thus, DCG believed that Genesis, both the trading division and the lending desk, were worth protecting. DCG and its board determined that it was in the best interest of Genesis, its lenders, and DCG to try and help support Genesis. The mechanism that was recommended by our financial and legal advisors, with input from our accountants, was for DCG to assume the 3ACC, claim and replace it with the promissory note due to Genesis. The $1.1 billion promissory note, which matures in 2032, represents DCG's assumption of liabilities owing to Genesis from 3AC in connection with their default in June 22. DCG agreed to assign and exchange Genesis's $1.1 billion unsecured loan

receivable from 3AC, the recovery of which was highly uncertain, with the promissory note from DCG. DCG did not receive any cash, cryptocurrency, or other form of payment for the promissory note. DCG effectively assumed Genesis's risk of loss on the 3AC loan with no obligation to do so. Importantly, the $1.1 billion promissory note is not callable and does not contain any other similar features of a callable bond. Additionally, Genesis assigned to DCG its claims against 3AC, and as part of the transaction agreed that any recovery received by DCG in respect to the 3AC liquidation will go directly to paying down the $1.1 billion promissory note. Now, the rest of the Q&A are largely used to disavow other bad actors in the ecosystem.

Yes, DCG invested $250,000 in FTX's Series B and had a small trading account with them, representing less than 1% of their transactions, but Barry had no relationship with Sam other than an email conversation in the middle of 22, and of course, Sam was never on the DCG board. What's more, no, DCG didn't have any relationship with Celsius, and no DCG wasn't involved with Terra Luna, aside from purchasing 60,000 Luna tokens in late 21 and early 22, to help foundry set up a staking node. And finally, no, of course, DCG doesn't have any knowledge or reason to believe there is an Eastern District of New York investigation regarding intercompany loans.

So that's what DCG had to say about itself. Join CoinDesk's Consensus 20203, the most important conversation in crypto and Web3, happening April 26 through 28th in Austin, Texas. Consensus is the industry's only event bringing together all sides of crypto, Web3, and the Metaverse. Immerse yourself in all that blockchain technology has to offer creators, builders, founders, brand leaders, entrepreneurs, and more. Use code breakdown to get 15% off your paths.

Visit consensus.com, or check the link in the show notes. Now, when it comes to community reactions, first of all, people were not impressed with the threat itself, which, as I mentioned, was just the starting letter cut up into Twitter form. Hall Press, North Rock Digital, writes, this letter really answers zero and does zero to move the needle.

Just more nothingness for months likely. My base case is that both Genesis and DC end up in bankruptcy, but don't think this leads to any material selling and think the market has already digested it. Autism Capital writes, what kind of statement is this? Ten tweets with nothing said. In the Q&A posted on the website, Barry makes huge effort to separate DCG in Genesis, claiming DCG had no commingling of funds and DCG had no relationship with Alameda, Sam,

FtX, 3AC, a lot of, quote, Barry does not recall. Gaborga Bocks simply quoted an Italian proverb, saying 100 wagon loads of thoughts will not pay a single ounce of debt. And when it comes to the substance of that effort to separate, DCG and Genesis, people are sort of seeming to assume that it will be figured out in the long run. Lee Drogan again from Star Killer Capital writes, does Barry really not think everyone has the receipts and that when the DOJ knocks on everyone's door, they're going to hand him over? So that is more or less where things stand right now. Basically, Gemini is saying this $1.1 billion

promissory note is fraud, and DCG is saying, no, it's not. People in the community seem split between, on the one hand, the idea that Gemini has hired very good lawyers, who wouldn't let them pursue a weird strategy for no gain, versus on the other side the idea that if they actually had a big legal standing to fight from, they might not be doing it so in public. Meanwhile, while all of this is going on on the public stage, it seems that there are moves behind the scenes as well. Bitvavo is a Dutch crypto exchange that has $297 million locked up on Genesis, and on Wednesday they released a statement about a proposal from Genesis and DCG to repay them at a 70% level. Effectively, they say that the solution is unacceptable, and they repeat many of the

arguments made by Gemini. So we're already going long, we'll wrap it there, but that is the story from where I'm sitting. At the risk of covering the play-by-play, like the psychodrama that it is, the DCG and Gemini situation continue to strike me as the most important or significant potential contagion left in this ecosystem, or at least one of the two or three biggest sources of potential contagion. It's certainly the one that's farthest along in the development of the story, and one that will, somewhere or another, have some resolution. What's more the principles involved, keep ratcheting up the stakes with their public statements. And so like it or not, this is a story that we have to keep our eyes on. Hopefully you're working on much more interesting things.

And whether you are or not, I appreciate you hanging out here and listening. Until tomorrow, be safe and take care of each other. Peace.