Contracting Grayscale

*CEO of DCG Barry Silbert

Seasons 5-8 of Game of Thrones, also known as garbage time, featured a knight, Jorah Mormont, contracting a horrific disease. Greyscale would spread across ones body, inevitably hardening before they go insane and begin infecting others. A septic cocktail of eczema, rabies, and syphilis. A similar situation can be seen happening this past month with the unraveling of Barry Silbert's empire held under the umbrella of Digital Currency Group (DCG). DCG is the parent company of hundreds of crypto businesses, most notably the digital asset investment group Grayscale. Other familiar names include the lending platform Genesis Trading and news outlet CoinDesk. The recent downturn in the crypto market has revealed the insolvency of DCG as well as the poorly structured debt financing across all their subsidiaries. It appears the incestuous mafia of crypto institutions sharing bank accounts, loaning each other capital, and operating without any transparency could only be propped up for so long.

The Exposure

The collapse of FTX alongside a sharp drop in the price of Bitcoin has frayed the finance-bro vest of poorly structured and interwoven entities. DCG's infection of malinvestment begins with Genesis. Genesis Trading in the fourth major crypto lending and borrowing platform to file for bankruptcy in 2022 alongside Celsius, Blockfi, and Voyager Trading. Failure to meet client requests for withdrawals has forced Genesis Trading to freeze all user accounts. The question on everyones mind is, how are the funds that users deposited no longer in the bank?

It would appear and cannot yet be confirmed, that through leverage, Genesis attempted to generate additional yield for depositors by acting as both a bank and a hedge fund. As a bank they lent out user deposits to margin traders on other platforms. As a hedge fund, they took user deposits and invested them in illiquid companies (miners, Grayscale, DCG). . . really themselves. Much like a ponzi scam, the operation functions as long as no one asks for their money back. As panic spread that no exchange or lending platform was safe following the events over the past several months, users started what is incorrectly being referred to as a bank run. Genesis advertised that funds could be withdrawn at any time. What has happened to change the story?

The Infection

One group Genesis allowed substantial borrowing to was 3 Arrows Capital (3AC). 3AC met its demise with the collapse of Terra Luna in July of this year. 3AC is short roughly $1.2 billion they owe Genesis. It is unlikely Genesis will be repaid after 3AC's creditors seized their remaining cash totaling $35.6 million from a Singaporean bank and impounded their $30 million "Much Wow" Superyacht. Heres where the story becomes fascinating. DCG's golden llama, Grayscale, accounts for 80% of its revenue. The ideal solution here is to abandon the crypto lending model that has failed half a dozen times already. Focus on the core business, earn hundreds of millions each quarter in fees.

*3AC Founder Kyle Davies patronizes others on risk management

But this is crypto. This is Bitcoin. Where stalwart libertarians meet greedy financiers and bankers who don't want to politic and wait for Jamie Dimon to pass. They want to be the king now. No losses, only wins. We do not sow, we only reap!

DCG selects the misery loves company option. They assume responsibility of the Genesis loss to themselves through a promissory note. Spread the disease out evenly. $1.2 billion is now on the parent company's books and owed to DCG. On top of this, DCG had previously borrowed $575 million from Genesis to buy back DCG stock from non-employees. Probably to remove influence from board members. Still DCG double-dipped with no intention of washing their hands into what was essentially user deposits. In order to keep the money flowing, DCG thought it better to use the infinite money glitch rather than let growth occur normally. Outside of Genesis, DCG owes $350 million to Eldrige Industries, LLC on a 10-year note.

Gemini too finds itself precariously hanging in the lists. The golden Winklevii and their Gemini exchange claim Genesis owes them $900 million as part of their Gemini "earn" program (up from $700 million last week). The earn program allowed Gemini users to receive a steady flow of their initial deposit by allowing Genesis to access the funds. This would have been much more difficult to maintain than directly using Genesis. Based on the dealings of Celsius, FTX, and Blockfi; Genesis probably never really deposited user interest and only moved funds when users wanted to withdraw. It is surprising the earn program with Gemini was not cut off sooner. Genesis's IOU's now sit at a public $1.8 billion dollars.

*Gemini underdogs Cameron and Tyler Winklevoss chronicled in The Social Network. #2 & #3 in your hearts, #6 at the Beijing Olympics

Darkside of the Rainbow

Grayscale is an investment group offering "trusts" which mostly hold a singular crypto asset. Unfamiliar investors may find Grayscale's investment vehicles attractive because they make exposure simple to longtime networks and fan favorites such as Bitcoin, Ethereum, and Litecoin. The Bitcoin trust called GBTC was popular for its limited custodial risk as well as the ability to provide exposure to retirement accounts. Lesser known trusts include the assets for Decentraland, Horizen, Filecoin, and Livepeer. All trusts are held by Coinbase Custody to avoid conflict of interest. Grayscale's total assets under management is currently $10.78 billion, down from $30.68 billion in April 2022. DCG earns 80% of its revenue with estimated $600 million in fees generated by these trusts.

Grayscale has long sought to have their "trust," GBTC, converted to a spot ETF. However, repeated rejection from the SEC has halted their ability to expand. The SEC cited concerns about overall market regulation as well as its own inability to intervene. They also say responsibility somewhat falls on the CFTC for handling futures around Bitcoin. Their real smoking gun revolves around GBTC shares owned by DCG & Genesis. Allegedley DCG and Genesis collectively purchased $778 million dollars worth of GBTC shares which have been collateralized in part with the initial loan to Genesis. If we understand this horrific cycle of lending correctly, DCG could be forced to sell their shares in GBTC in order to satisfy obligations. This would however cause GBTC to sell a lot of Bitcoin on the open market and create downward selling pressure. If this happens GBTC and DCG are done. DCG relies on the fees from GBTC as their main revenue stream; they will attempt to prop this up as best they can before being forced to sell.

A failure to create the spot ETF has also caused the famous "Grayscale Discount", resulting in a large imbalance between the pricing and NAV of GBTC to Bitcoin. GBTC traded at a premium until March 2022 where it now trades at a 43% discount from NAV. DCG made the majority of its investments in GBTC in Q2 2022. They held almost the exact same trade that 3AC did before they collapsed by anticipating NAV returning closer to NAV. Cathy Wood has recently purchased $4.3 million dollars of GBTC through two separate purchases believing Bitcoin has bottomed and emphasizing Grayscale as cheap. Hopefully she will not be the 3rd person roped into this fantasy.

*Credit to Ram Aluwalia

To save face in the current slaughter, crypto companies have been posturing Proof-of-Reserves. A demonstration that user deposits exist and are held where they are supposed to be. Originally started by Kraken by auditing reverse merkel trees, no other company has chosen a route that transparently proves the existence of funds. Multiple exchanges picked audit dates after "accidentally" sending each other $320 million of either. When investors and critics requested Grayscale or Coinbase reveal their Proof-of Treasuries, they replied with a text PDF attestation. Completely normal for two companies once valued over $10 billion. Coinbase says they cannot discuss their custody process, Grayscale feigns ignorance and directs all questions to Coinbase. Barrow Downs Digital realizes we are far more responsible than every single competitor.

*Barrow Downs Digital Nano wallet. There is no risk to sharing this information, why cant the exchanges do it?

We fondly remember an occasion where a former Grayscale accountant asked Barrow Downs Digital to build and manage a complex node on a certain decentralized exchange. We also had interest in acquiring one, however the up keep cost and restructuring of the payout system extended the time frame of a positive return. What amazed us was their understanding of coefficients. The DEX recommended 1 million of X coins in order to run the node. We thought it might take 600k - 800k. They thought it could work with 250k. When asked how they arrived at that number, they said it sounded like a good number and changed their mind when they listened to our analysis (basic data taken from the DEX's home website page). We think about this line of logic and decision making in review of how DCG is handling its own strategy.

*Barry before deleting all social media accounts. Some would call this projecting

The Cure

The options available to refinancing your poorly thought out conglomerate are severely limited. Never-mind the story changing so rapidly that nobody can truly follow it. The path forward is most likely to result in Grayscale being sold off or purchased and brought under new management. Unless you are savvy enough to out trade others around the premium or discount to NAV, you are better off investing in the underlying asset. Barry Silbert, CEO of DCG, has claimed separate fundraising goals in the same week that DCG needs $500 million and then $2 billion to achieve functional form. We are only seeing surface level information. This onion is rotten to the core. A cursory review will leave in our humble opinion, a small minority of solvent businesses where DCG is the majority owner.

*Always great not to describe ownership or exposure levels.

It would be quite unfortunate to witness the collapse of your crypto empire. It is incredibly unfortunate to have your own media company, CoinDesk, detailing its demise day by day. If you or someone you love has had business relationships or contracts with Grayscale in the past, please contact Barrow Downs Digital immediately.

Update on the Consensus

The blog for Barrow Downs Digital is back and better than ever. We will feature the ever bizarre happenings in crypto as they surface. Overall mainstream journalism has fallen so far in coverage of crypto that news is breaking on the block-chain and twitter with more detailed explanations than the three day late, inaccurate editorials from Bloomberg, Fortune, New York Time, and CNBC. FTX will be a better movie than an article. DCG will only make it to 60 minutes. Nonetheless, I am sure Sam Bankman-Fried's parents have mixed feelings on their son's $10 billion dollar fraud, given they were gifted a $16.4 million Bahamanian mansion in the end. Hasam Alaikum!