This article is a summary of OKX Space, with excerpts from the editor.

DCG has invested in the following major businesses:

1. Grayscale, the world’s largest bitcoin fund and the institution holding the most bitcoins.

2, Genesis, it is the world’s largest crypto lending service, its main business is also lending, but its lending is not our traditional sense of bank borrowing or credit card borrowing, its mainly through the complex collateral to provide users with token lending services.

3. Foundry, the world’s largest bitcoin mining pool.

4. CoinDesk, the world’s largest cryptocurrency media.

This shows that DCG is indeed one of the largest cryptocurrency groups in the world. Back to why Genesis is in such big trouble, the logic is also very simple, the root cause is because it lent too much money to Three Arrows Capital and it has been having some unclear connections with Three Arrows Capital. Genesis lent a whopping $2.36 billion to Three Arrows Capital, with losses reaching $1.2 billion.

On January 20, Genesis Global Holdco, LLC and its two lending business subsidiaries filed for Chapter 11 bankruptcy reorganization in the U.S. Bankruptcy Court for the Southern District of New York. Genesis has more than $150 million in cash on hand to support the reorganization efforts. The largest creditors are Gemini platform borrowers at $765 million, followed by Bybit’s Mirana at $151 million, PayPal Financial at $150 million, Coincident Capital at $110 million, and others.

Now that we have a brief background, let’s go back to the first question and ask the 4 panelists to share your views. What do you think caused the Genesis crash?

Ning, CEO of Bastion Trading:

There are several parties involved: Genesis, DCG, Grayscale. The main problem right now is Genesis. DCG is the controlling shareholder of Genesis, and Grayscale is a subsidiary of DCG. Genesis is a company that, as the boss of OKX mentioned earlier, is a big market maker and lending platform, It does not own any assets. Part of the money in the platform may also be seed funds given by DCG, and a large part should be saved and then lent to those institutions and investors. Of course Genesis would require collateral many times, but sometimes it would require no collateral or inadequate collateral. As we all know, the market was very hot in the past few years, and at the peak of the boom, everyone was crazy to seize market share, so we may not think much about the problem of risk control. That’s why there are so many loopholes right now. The big holes known so far in the Genesis are: hundreds of millions of dollars for paypal; Three Arrows capital more than $1 billion; They had about $175 million in assets in FTX, but that was only the money they were locked up in when FTX collapsed. In addition, some of the collateral that FTX borrowed from them and gave to Genesis was FTT, but the FTT went from 40 or 50 dollars at the time to just a few cents now, so the collateral was worthless, but the money was still there, So if you add up this bad debt to Genesis, all of these things add up to a deficit of about $2 billion.

Does it affect DCG? I think as DCG itself, it certainly does not want to be affected, because in the organizational structure, DCG is the parent company, the following subsidiary exploded, the parent company will do what the worst thing. But because of what happened with Three Arrows Capital and what they bought back earlier, if they had borrowed money from Genesis when Genesis had a big reserve, at the same time Genesis might have invested some of it in Three Arrows Capital, because it didn’t have any money, So the money it’s putting in could also be the money it’s borrowing, which is hand over hand. So I think what’s happening here is that DCG wants to cut, or it wants to wait, because the most valuable part right now is definitely the Grayscale. Because Grayscale generates revenue of about 200 million to 250 million a year, according to the current price of bitcoin, if it doubles tomorrow, it will become 500 million, which is a very significant number. In other words, Grayscale could have paid it back if it had waited a few more years, so for DCG, it definitely wanted to buy time. And the depositors of course don’t want to do anything about it, they want to withdraw now, so I think it’s a multi-party game. Now depositors are asking Genesis for money to force DCG to pay up. And DCG means it can drag it out as long as it takes, and then it’s up to the creditors to force the directors of Genesis and the DCG to come through and make them pay. Another reason why DCG wanted to cut it was that there was Gemini in the middle. Genesis was a big lender to Gemini, so Gemini itself might be partly responsible at this time. But now Gemini is acting aggressively, trying to solve this problem as soon as possible. They are ready to make a mess, not admitting that it is their problem, but that it is DCG’s problem. So in general, it’s going to be a matter of how they end up playing the game, and whether Genesis is going to cause a DCG explosion or something like that, and I don’t think anyone is going to want to tear this thing down and sell it, so I don’t think a wholesale liquidation is going to happen. That’s my point.

Dong Bing (Chief researcher of Bitdeer)

With regard to the above discussion, I would like to return to the question Mr. Wu raised at the beginning, why did Genesis crash?

In fact, I think this is also a common problem in the industry. Looking back over the last year, Genesis is not the first and probably won’t be the last institution to explode. There have been many crypto lenders doing similar business to Genesis before it exploded. By contrast, the DeFi platforms that lend to each other have so far kept their business afloat. The widespread explosion of centralized lending platforms points to some common problems in the industry. I think some people are saying that DeFi’s survival is no big deal, it’s just that it’s overmortgaged. However, I think this requirement of excess mortgage is in line with the basic logic of finance. I can only say that DeFi follows the basic logic and law of finance and is doing its business properly. If a person takes out a mortgage on his house, the market value of his house is 10 million yuan, he cannot lend 10 million yuan in full, he can only lend 7–8 million yuan, this is because the house is a relatively volatile, relatively stable and predictable asset. If you take cryptocurrency as collateral, it is known to all that the volatility of crypto assets is very large. For example, when the market value is at its highest in 2021, it is worth 1 million. Now it is good to be worth 200,000. But I think in reality how many centralized crypto lenders are this prudent? You can do that without the crash. This is an important reason why so many lending platforms have crashed in the face of market downturns over the past year. Genesis probably made the same mistake.

In addition, there may have been an element of bad luck in the Genesis storm, such as the fact that they did get some collateral, but failed to clear it enough to liquidate the position. In May and June last year, there was a huge amount of serial clearing in the market. Compared with the fully automated DeFi platform, the centralized lending institutions were in a inferior position in the clearing efficiency, which led to the liquidation of some loans in the process of price avalanche, resulting in huge losses.

Of course, the first aspect of the problem, namely the failure to fully adhere to financial prudence in lending, is Genesis’s most fatal problem, and is a common problem for Genesis and other centralized crypto lenders. They may have problems with their business processes, problems with their business logic, and these problems are triggered in a series of bear markets. Causing these institutions to fall like dominoes.

Next question, does the Genesis crisis implicate DCG? I think there’s a lot of uncertainty about this from a legal point of view, and it’s too early to draw conclusions. Much of the information floating around is based on rumor and speculation. More concrete evidence, such as the loan documents between DCG and Genesis, is needed to determine the actual loan relationship and mutual obligations between the two. So far, we’ve been able to confirm from public information that DCG did borrow about $1.65 billion from Genesis, but how did that loan come about? Is there a real lending relationship? Are there any provisos or preconditions for these loan contracts to come into effect? Or something like an automatic rollover so that DCG never defaults, the details of which we can only guess at now, will need to come out with more facts, perhaps in a lawsuit. I think if DCG does go bankrupt because of the demise of Genesis, it will most likely have to be determined through some sort of litigation process. But it is certain that if the two sides do choose to go to court to resolve the issue, it will not be resolved overnight, more likely to be a very long process.

The final question is that the market’s focus on the DCG crisis is largely due to concerns about another round of liquidation, particularly at Grayscale. Will Grayscale be liquidated? My understanding is basically the same as Ning. Grayscale operates a trust product. Under the Anglo-American law, the trust product is highly independent and isolated. It is created by the contract, and its termination or liquidation must follow the contract. I took a special look at the legal documents submitted by Grayscale to SEC, which set very clear conditions for the liquidation of Grayscale trust. In addition to some force majeure factors, such as the collapse of the Bitcoin network, the collapse of the bitcoin market to zero, or major lawsuits, The actual conditions for Grayscale to liquidate, in fact, is that Grayscale itself is canceled or bankrupt, and there is no administrator to take over its position, resulting in an unmanaged trust, and eventually liquidation.

But the problem is that Grayscale does not appear to be a party to the current debt relationship, and it does not owe money to anyone. In this case, there is no need or urgency to liquidate Grayscale. In other words, the current Genesis crisis is unlikely to lead to passive liquidation of Grayscale. That leaves only the possibility that Grayscale’s shareholders voluntarily cancel and liquidate Grayscale, which is clearly not in anyone’s interest at the moment. Because Grayscale is the biggest cash cow in the current debt standoff, any rational party to solve the current debt crisis should not force Grayscale to liquidate, but should strive to keep it, the only point that needs to be wrestled with is the ownership of Grayscale control. In fact, this has been a focal point of contention so far, and the ultimate goal of all these moves is probably to fight for ownership of DCG, ownership of Grayscale, and the right to distribute its revenue.

Zheng Di (Independent investor)

I think it’s inevitable that Genesis will go into liquidation, but I don’t think it will lead to a cascade of DCG failures. There are plenty of options for DCG, such as raising money from Grayscale or its own equity.

To answer Mr. Wu’s question, why did Genesis have these problems? In fact, I think Genesis, being a very important sister company to Grayscale, played a very important role in Grayscale’s growth. And in a sense, Grayscale’s premium arbitrage strategy has been very popular since 2020, when the GBTC premium peaked at 40% and has been around 20% for years, Since it’s tied to the tax-free benefits of IRAs, a 15% to 20% premium is very reasonable. Then in such a process, it is certainly impossible for DCG to say that it is left-handed, still less to admit that it subscribed and then pockmarked the premium profits. It must rely on some third parties in the market. If there are such third-party institutions, such as Three Arrows or some other well-known institutions in the market, Presumably all traded in Grayscale’s premium arbitrage strategy at some point, essentially helping DCG make Grayscale bigger. We know that Grayscale was actually $475 million when it first launched, but now GBTC still has $10.5 billion, and ETH Fund has more than $3 billion left, even with the price of the currency falling so much. As a result, DCG can get an annual management fee of 300 million dollars in current price from GBTC and ETHE trust products. Therefore, it is true that Grayscale is a cash cow as mentioned by the previous two guests. It is a non-redeemable semi-closed trust. We can think of it as a closed-end fund, and the fact that it can’t be redeemed in this situation means that as long as it’s not dissolved, it’s going to be able to charge 2% or 2.5% a year, so nobody wants it to be dissolved. From another point of view, as long as someone takes money to do the subscription in kind, then its scale is bound to grow continuously. As for selling its shares, it has nothing to do with its management scale and management fee income, so it is just like the existence of “eat but not throw up”.

In this sense, Grayscale, DCG, Genesis, and Three Arrows are all communities of interest. There may not have been a deliberate collusion, but in fact, there has been a collusion to make Grayscale as big as it is today and make it a cash cow. It is inevitable that organizations like Three Arrows will help, of course, three Arrows objectively also want to make money. Therefore, when Three Arrows or other institutions were dealing with Genesis, were there any loan conditions that could be negotiated? For example, it was said that the shares of GBTC or ETH were pledged to Genesis to borrow tokens, and then the interest rate was very low, maybe only 1%~2%. And then the margin requirement may not be that high. You can imagine, as a partner of “collusion”, put forward some relatively lax loan conditions, I think it is a natural thing, otherwise who will help you to expand the management scale? So the decline in risk control is an inevitable result. In addition, as the guests said before, it was true that the market was too hot before, if the loan principle was not relaxed, it would not be able to do business. But finance is a yield-front risk-back existence, and it may take two to four years to see when the money will be paid out.

As for why did Genesis fail? In fact, Mr. Wu has already said the exact amount, Genesis’ exposure to Three Arrows is about 2.3 billion dollars, and then left a hole of 1.175 billion dollars. At that time, DCG said to inject 1.175 billion dollars into Genesis to fill the hole, but DCG had no money. So they put money in Genesis on paper, they wrote a promissory note to Genesis, and they agreed to pay it back in 10 years, in 2032, which is the same amount that DCG didn’t have to pay, but they did lend it $1.175 billion, which theoretically means that it wasn’t an existing immediate liability. But these days it seems to be believed that the promissory note has a call clause, which means that if Genesis goes bankrupt, the $1.175 billion will be called immediately. So every analyst that we’re seeing in the market now is putting this $1.175 billion into the equation, as a liability, as a real liability, not as a contingent liability. So at the heart of this is the question of whether or not the $1.175 billion promissory note has a clause that Genesis has to pay back if it fails, which the market has tacitly accepted. (After AMA, DCG released a detailed explanation of the problem. First, the $1.175 billion promissory note is not a callable bond, nor does it contain any callable clause, which emphasizes that the Genesis bankruptcy reorganization is not related to DCG; Second, it emphasizes that these two loans from DCG to Genesis are Arm’s length, that is, the parties to the transaction are independent and equal, in an attempt to emphasize that DCG group will not be affected in Genesis’s problems)

The second is another $500m of debt due in May, so DCG has to pay a total of $1.675 billion. According to the common calculation method in the market, it is generally believed that DCG owes 2 billion dollars, but I think it is unlikely to infect DCG, because the GBTC on hand of DCG still has about 1 billion dollars, which is about 10% of GBTC. GBTC is now worth 10.5 billion dollars, and of course it’s not going to sell this thing, it’s going to sell it at a bigger discount, it’s going to take collateral. DCG still has some ETHE, I’m not sure how much, but if you add all that up, plus Grayscale’s $300 million in overhead revenue, minus some expenses, plus maybe $225 million in other DCG subsidiaries, Or Grayscale alone should be able to raise a few hundred million dollars, plus other GBTC shares, and some invested assets, etc., DCG’s enterprise value is about 3.2 billion dollars, minus 2 billion dollars of debt is about 1.2 billion dollars, That means it could use a $1.2 billion equity valuation to raise a few hundred million dollars, roll over existing debt, and still pay for it.

The previous guests are also right that DCG is trying to buy as much time as possible. If it doesn’t work out, it will have to shut Genesis down with all its might, depending on whether the $1.175 billion will be paid back immediately. Now everyone is staring at the Grayscale piece of fat meat, some time ago in the market also said that they do not want to vote DCG, just want to vote Grayscale, it is estimated that they are still in the process of bargaining. CZ said it was interested in Genesis a while ago, but it turned out that it was actually interested in some collateral that Genesis had, probably a lot of which was GBTC, probably hoping to get some of GBTC’s shares at a discount.

Finally, some FUDs in the market now say that the GBTC discount of DCG is very deep, about 40 to 50 percent, saying that the money is not enough, so they want to dissolve the trust, so as to recover the discount and get more money. This is actually a very outrageous statement. Because if someone really has this subjective desire, once it shows, there will be hedge funds to go long GBTC and short BTC at the same time, including ETH. The final result is likely to be that the discount does disappear or greatly narrow, but in fact GBTC may not rise too much, but ETH will fall. And if someone does that, they’re killing their own golden eggs, which is not in their interest at all, so there’s no reason to believe that anyone would have the incentive to do that. Of course, one would ask whether some shark-level hedge fund player would want to actively liquidate the trust and make a profit at a 40 percent discount, which is not very realistic. Just like what the guest said before, there are many restrictions on liquidating the trust. In addition to those mentioned just now, there is another one that at least someone should collect more than 75% of GBTC share before voting to dissolve the trust. But only DCG has 10%, that is to say, only 15% of the goods outside are left. As long as a little opposition will not collect all, this is basically impossible to do. And if there really is a big crocodile to do this thing, in the market to collect a little, as soon as there is a wind, this discount may be filled up immediately, so this is not very realistic assumption. It is because of so many difficulties that GBTC has such a large discount, the market is still very smart, it will not maintain such a large discount.

I would also like to add to the conclusion that we have been analyzing what DCG has done without any legal problems. In fact, it is clear that the regulators have begun to take notice of DCG recently, and there are rumors that they have begun an investigation, so it remains to be seen. Of course, I think without these things, we just look at the current information and commercial terms, I think DCG should not be a problem. I have seen what Su Zhu said, that is to say, Genesis had poor risk control and accepted FTT as collateral, and they knew by themselves that it was impossible for them to get back the loan. Su Zhu also said that some of them took money and bribes, which depends on whether there is evidence. That would be a boon for regulators, depending on how it turns out.

Ning:

Su Zhu should now be a person of interest, perhaps even wanted. So what Su Zhu is doing now is actually causing trouble in the east. “It’s not my fault, it’s others’ fault”. Genesis’s ass is not clean either, which makes everyone overlook the fact that the achievement of Three Arrows is totally supported by Genesis. In fact, Three Arrows has been engaged in traditional finance since 2013. It was a very small company, and it grew into a giant directly from a small organization in nineteen or twenty years with a wave of extremely large unsecured loans from Genesis. At that time, the premium of BTC was about 20% to 40%, and the highest premium of ETH was 800%. Indeed, the Three Arrows experienced a premium at that time, and suddenly grew from a relatively small asset scale to over billion. After the billion, Three Arrows believed that there was no risk control, so they acted more boldly, which resulted in the current result. At present, Su Zhu is being sued. Of course, he hopes to make more room for compromise in the lawsuit between them by saying that Genesis’s ass is not clean.

I just want to add that there are two possibilities for Grayscale’s liquidation. One is that Grayscale’s filing with the New York regulator says that it can be dissolved if it exceeds 75%. Another is that according to its treaty, more than 50% of its terms can be changed, that is, more than 50% can be claimed. Everybody’s interests are aligned, everybody wants to run Grayscale, everybody doesn’t want to dismantle Grayscale, everybody wants to go after Grayscale, and even Gemini, for example, is the focus of their discussion right now, Must be talking to Gemini about selling Grayscale to them. Another is to use the method of procrastination to make yourself wait a few years.

The other consequence was that if Genesis went out of business it would go into the proceedings of chapter11, both good and bad. The good thing was that if Genesis went into chapter11, there would be a liquidator, and the liquidator would have the right under the law to go back even if the loan was not due, because its duty was to collect all the debts. If Genesis goes into liquidation, its $1.1 billion in promissory notes, $500 million in loans, can be traced directly back to DCG, which could result in DCG being unable to pay up and going into liquidation. The downside is that if it goes into liquidation, it’s the business of the liquidator, and the liquidator is usually one of the larger liquidators, and they don’t sort it out very quickly, because the liquidator is billed by the hour, so they keep dragging it out. If Genesis goes bankrupt, its liquidators come in and drag it out for 10 years, and DCG goes out of business, and they drag it out for another 10, 20 years, and the claimants don’t always get paid, and Grayscale’s money goes to the lawyers. In this case, it’s a bit like in a movie where two people point guns at each other to see who goes down first. In fact, right now, people are talking about Grayscale’s management rights and how to discount the financing, how much money to plug the hole, and everyone is very confident that they can plug it, it’s just a matter of who will win.

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