It’s fascinating how connected everything in Crypto is.

An event occurring almost 8 months ago has caused a chain of events that has just claimed another victim, Genesis trading.

Chances are you’re not familiar with the name, but we’re talking about a company that has been revealed to have $5 billion in liabilities.

That’s almost as much as FTX, and we all know how big that was.

An event occurring almost 8 months ago has caused a chain of events that has just claimed another victim, Genesis trading.

Chances are you’re not familiar with the name, but we’re talking about a company that has been revealed to have $5 billion in liabilities.

That’s almost as much as FTX, and we all know how big that was.

Bottom line, this is no ordinary victim, especially if you consider that this collapse has the potential to destroy one of the crown jewels of Crypto.

Therefore, this could just simply be the tip of an iceberg much, much scarier than we initially claimed it to be.

But that’s not all, as this demise is also extremely controversial, as it has caused an all-out war between Crypto tycoons that includes a multi-billion fraud accusation.

Is Crypto’s Titanic meeting its iceberg moment?

A sad story of potential fraud and poor risk management

Last week, Genesis trading filed for Chapter 11 bankruptcy, unable to withstand the huge hole in the balance sheet caused by a series of extremely clumsy investments and an unfiltered passion for gambling.

Naturally, the first question is, how did this happen?

Well, let’s put it this way, it was a poorly-executed masterclass of loan engineering.

Crypto is all about debt

Genesis Trading is — or was — one of the prominent Crypto lenders in the space.

That is companies that lend money to others in exchange for collateral and interest payments.

In other words, Crypto lenders let you borrow money and, to hedge themselves from the risk you might not return the money, they ask request a certain amount of an asset, known as collateral, that they will keep if you fail to pay back your loan.

As Crypto loans are very risky, they are normally overcollateralized, which means that in order to borrow a certain asset you need to deposit in the lender’s account another asset with a higher total value of the deposit than what you’re borrowing.

If that doesn’t make any sense, that’s because overcollateralized loans are almost nonexistent outside Crypto, but make total sense in this industry.

The reason is simple. For a lender, overcollateralization is a matter of survival.

As measuring creditworthiness is not an option in Crypto these days, lending is extremely risky, so it simply doesn’t make sense to offer anything other than overcollateralized loans.

If you’ve understood this then, well… you’re now more suited to lead Genesis’ risk department than the actual folks there, as they managed to completely mess up to unprecedented levels.

This is a tragic story in three parts.

Careful who you get into bed with

Genesis’ demise can be traced back to one cataclysmic event, the collapse of 3AC in June 2022.

Up until that moment, 3AC and Genesis’ relationship was perfect, almost the quintessential definition of what a financial relationship should be. As Genesis provided liquidity for 3AC’s investments and 3AC was “killing it”, everything was sunshine and smiles.

The relationship was so close, that Genesis started giving undercollateralized loans to 3AC, loans where the amount that the lender gets back is smaller than what it lent.

As mentioned, 3AC collapsed in June amid a, among other things, fatal investment in the previously demised Terra/Luna ecosystem. At the time 3AC went under, Genesis had $2.4 billion in outstanding loans to this fund.

As the loans were undercollateralized, Genesis only managed to recover half of it, so suddenly they had a $1.2 billion hole in their books.

Not great.

That hole needed to be closed. Real quick.

Daddy DCG to the “rescue”

To better understand how Genesis was saved we need to understand its context.

Genesis Trading was part of the Digital Currency Group, or DCG, a holding owned by Crypto-legend Barry Silbert. This holding also totally owns Grayscale, the biggest Crypto trust in the world, among others. Also, DCG holds numerous other partial investments as it also acts as a VC.

It’s safe to say they are quite a big deal.

Consequently, when Genesis found itself with a billion-dollar hole in its books, DCG “saved the day”.

And how did DCG pull that off?

DCG assumed that exposure by swapping those $1.2 billion in claims with a 10-year promissory note, a legal instrument in which DCG promises to pay the agreed amount sometime in the future.

Now, if you read that carefully, you will have noticed something’s off.

If Genesis needed urgent liquidity to cover up the losses, how does a piece of paper saying “I will pay you the money in a few years' time” cover that liquidity need?

In accounting terms, the hole is no more, but the liquidity issue remains. In other words, Genesis was still in need of urgent money. Money that DCG, by handing in that promissory note, proved it didn’t have.

But this isn’t, by far, the end of the story for this promissory note.

You wish.

Two other things are setting the alarms throughout the Crypto space, a situation that leads us to the third actor in this play, Gemini.

The billionaire twins are in trouble

In February 2021 Gemini, a very relevant centralized Crypto exchange owned by the billionaire Winklevoss twins launched a new product, Gemini Earn.

This product, launched in partnership with Genesis — oh god, here we go — allowed Gemini users to deposit money in the Earn product so that Genesis could lend it. Genesis would take a cut, Gemini also as it was acting as a mule of sorts and Gemini Earn users earned interest payments from the lending.

Everything went fine until last November when FTX collapsed.

Although Genesis wasn’t massively exposed to it, the overall bank run that this collapse caused impacted them, as fear spread through the industry.

Suddenly, Genesis customers were demanding Genesis repay $875 million, which obviously Genesis didn’t have.

The solution?

Genesis froze withdrawals.

When this happened, Gemini Earn users, all of a sudden, found themselves incapable of withdrawing their money, an issue they are still facing today, the total amount stuck being around $700 million.

The twins respond with open fire

This situation has prolonged to the point that the Winklevoss twins have formally accused DCG of fraud, arguing that the promissory note was used as an accounting trick to lure Genesis creditors into believing that Genesis was now liquid and safe, when the truth was that the $1.2 billion hole remained.

And all of this is without even considering the dubious terms of the promissory note, a bona fide unsecured loan (no collateral given), that was issued at a 1% interest.

This is incomprehensible when, at the time, the most secure loans in the open market were being issued at 3–4% minimum, due to the increasingly hawkish policies of the Federal Reserve.

Very, very sketchy.

Naturally, as Genesis was so intertwined with DCG and Grayscale, one has to ask… who’s next?

Is Mr. Grayscale next?

Unsurprisingly, all eyes have turned to Grayscale and the rest of DCG’s belongings.

Fear has widely spread, as many look in terror as to what might happen to Grayscale if DCG is unable to raise liquidity to pay creditors.

Truth be told, Grayscale is without a doubt DCG's cash cow, so they will surely get rid of anything else before even thinking about touching it.

However, a hard-selling scenario is almost guaranteed as DCG needs to raise, literally, billions to pay creditors, so chances are that various cryptocurrencies in DCG’s portfolio will suffer great sell-offs in the near future.

This is bad, of course, but it’s nowhere near as close to the potential damage that a Grayscale collapse would cause.

The best solution for Grayscale investors but a drama for the rest

That is, DCG could be forced to undergo a Reg M procedure with its Grayscale trusts.

This essentially means that the Bitcoin and Ethereum locked in the trusts would be unwinded, and investors would be able to redeem $1 of BTC for 60 cents of GBTC and 40 cents of ETHE shares (trading at 41% and 60% discounts respectively).

This protects investors, that receive an amount equal to the total value of the underlying asset. However, the terms of how that would go down are not clear.

Luckily, a full sellout is very improbable, as the SEC will probably be open to allowing in-kind redemptions.

That is, instead of having investors get paid in cash, which would mean that billions of dollars in Bitcoin and Ethereum would be dumped into markets first, crushing prices, investors could be paid with other assets, like stocks, for example.

However, this is all conjecture, so full cash-in-hand scenario is also a possibility.

I wonder what a $10 billion Bitcoin sellout would cause… yeah, not great.

Let’s hope for the best

In the meantime, all we can do is watch and wait.

But stop thinking about what price your Crypto will be tomorrow, and start thinking about what Crypto is really solving. Once you’ve figured that out, you’ll be fine.