How GBTC premium trading ruined Barry Silbert, his DCG empire, and took the crypto lending platforms with them

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Introduction to the digital currency group

Digital Currency Group was founded by Barry Silbert in 2015, who went on to create the DCG empire by investing in hundreds of projects and businesses.

Digital Currency Wallet: (Source: DCG)

However, the largest company in DCG’s portfolio is Grayscale Investments, the largest Bitcoin holder in the world, other than Satoshi Nakomoto.

Major Bitcoin Holders: (Source: River Financial)

GBTC holds the equivalent of 633K BTC, or just over 3% of Bitcoin’s circulating supply. The net asset value (NAV) of the trust is approximately $10.5 billion at the time of writing.

Custody of BTC is held by Coinbase Custody. However, Coinbase has not yet verified whether it controls BTC. Yet, since Coinbase is publicly traded in the United States and therefore subject to audits, it is likely that BTC is stored under standard practices.

How does DCG make money?

DCG charges a 2% management fee for the underlying Bitcoin held in the trust.

According to SEC filings in Q3 2022, DCG earned $68 million from these fees while generating about $230 million in revenue per year. Revenue represents a significant percentage of the $800 million it generates annually. Barry Silbert corroborated these figures in a November 22 letter to shareholders.

GBTC, for a time, was the only way for US investors to get exposure to their IRA or 401k accounts, which is one of the reasons it traded at a premium for so many years. , up to 40%.

Even if GBTC were considered a security, it does not have the self-custody risks attributed to holding your keys for BTC. As demand grew, so did assets under management, which reached over $40 billion in the 2021 bull run.

Total assets under management: (Source: YCharts) Premium and discount

GBTC trades at a premium when shares change hands at a higher price than the underlying BTC. Conversely, if GBTC shares are trading below net asset value, GBTC is considered to be at a discount.

On February 24, 2021, GBTC went from a premium to a discount to its Net Asset Value (NAV). Unfortunately, it never returned to a premium, and the discount only deepened.

One reason for the discount can be seen in the increased competition from Bitcoin futures ETFs. Future ETF Valkyrie Bitcoin Strategy (BTF) launched in the November 2021 bull run, and holdings of the Purpose Bitcoin ETF in Canada are two of the main contenders. The Purpose Bitcoin ETF held 50,000 BTC in June 2022, but now only has around 24,000 BTC. Additionally, these and other funds tend to offer lower management fees, which suppresses the demand for GBTC.

Bitcoin ETF Holdings objective: (Source: Glassnode)

The discount for GBTC is currently at 48%, after a drop as low as 50%, which was the largest discount ever. The problem with holding GBTC is the mandatory 6-month lock-up of GBTC shares, which makes it highly illiquid. Also, when the discount increases, investors cannot redeem the shares. Additionally, holders do not own the actual BTC as it is a paper derivative of BTC.

GBTC Premium/Discount: (Source: TradingView)

From March 2021 to June 2022, Digital Currency Group purchased nearly $800 million worth of GBTC shares after it began trading at a discount to NAV. As a result, the company owned approximately 10% of the outstanding shares of the trust.

Buying GBTC eased institutional selling pressure and artificially supported the fund’s net asset value. DCG issued GBTC and attempted to defend GBTC’s price by acquiring GBTC using leverage.

One wonders if this differs from FTX issuing FTT tokens and attempting to defend the token using leverage. FTT and GBTC accounted for a large portion of FTX’s and DCG’s balance sheets, respectively.

Grayscale offers other similar trusts for alternative crypto assets. For example, the Grayscale Ethereum Trust (ETHE) is currently trading at a steep discount, and as of January 3, the fund’s discount to NAV has dropped to an all-time high of 60%.

Grayscale investment products: (Source: DCG)Genesis and lending platforms

Several bankrupt crypto companies, like 3AC and BlockFi, had heavy exposure to GBTC shares.

In 2021, 3AC held the largest position of GBTC shares with nearly 40 million, or a value of $1.3 billion. To put things into perspective, Ark Invest is now the largest shareholder outside of DCG, with just under 1% of the offering, or the equivalent of 6.5 million shares.

GBTC Holdings: (Source: Terminal Bloomberg)

As the GBTC premium rose by 40%, companies like 3AC and BlockFi took advantage of the returns to speculate in the market. This is how BlockFi was allowed to offer such high returns to customers. As the lockdown expired every six months, it allowed these companies to continue to generate profits, while Genesis was happy to continue lending money to companies like 3AC.

3AC took out a $2.36 billion loan from Genesis, another DCG company, which made up nearly 50% of Genesis’s entire loan portfolio. The loan consisted of illiquid cryptocurrencies and paper derivatives of Bitcoin and Ether.

In total, Genesis’ loan to 3AC was backed by 17 million shares of GBTC. Grayscale is a subsidiary of DCG with 446,000 shares in the Grayscale Ethereum Trust, 2 million native Avalanche (AVAX) tokens and 13 million NEAR tokens.

Genesis loan to 3AC: (Source: Bitcoinist)ETF

Barry Silbert and DCG argued for many years with the SEC to convert GBTC to an ETF. An ETF would track the underlying product, and there would be no premiums or discounts as the shares would be redeemed at net asset value, and management fees would be significantly lower.

The SEC continued to decline a cash ETF, which would have protected investors. Converting to a cash ETF would allow any investor buying at a discount to make a profit because it was trading at NAV.

ETFs are safer than a closed-end fund and are more transparent, with no premiums or rebates and lower fees. However, the SEC has approved futures ETFs and a Bitcoin Short Strategy ETF (BITI).

Grayscale is now suing the SEC, but the SEC has dismissed Grayscale, NYDIG, Wisdom Tree and other institutions. As a result, many countries around the world have seen spot ETFs approved in Europe, Canada and Africa.

Grayscale’s ongoing lawsuit with the SEC over ETFs has a final short deadline of Feb. 3 before a ruling is issued.

The SEC did not help investors

As the bounty for GBTC ended, the crypto ecosystem saw crypto lending platforms explode after explosion as these funds and lenders had to move further up the risk curve to make profits and return their entire consumers.

The SEC repeatedly failed to approve a spot ETF for GBTC, which ultimately would have prevented this from day one and could have prevented this leverage from being wiped out. As a result, the GBTC bounty would not have existed, and these companies would not have grown in size and taken on as much leverage as they did.

Grayscale had done everything it could to get a cash ETF approved.

The SEC rejected the spot ETF due to the possibility of spot bitcoin manipulation. However, approval of a CME Bitcoin futures ETF that does not track the underlying spot price can arguably be subject to manipulation and fraud just as quickly.

As mentioned above, there are several spot ETFs around the world, in Europe and Africa, for example. This has undoubtedly seen the flow of capital out of America into these jurisdictions.

Where are we now, around 2023?

If DCG were to go bankrupt, the company could be forced to liquidate its assets and make significant sales in GBTC and ETHC. This would put considerable selling pressure on Bitcoin and Ethereum.

However, according to Ryan Selkis, CEO of blockchain research firm Messari, majority shareholders of Grayscale Bitcoin Trust (GBTC) Genesis Global and Digital Currency Group cannot simply “empty” their holdings to raise more capital.

“The restrictions are due to Rule 144A of the U.S. Securities Act of 1933, which requires issuers of over-the-counter, or OTC, entities to give notice of proposed sales, as well as a quarterly cap sale of 1% of shares outstanding or weekly volume traded”

One notable option DCG could take is to initiate a Reg M, which would allow investors to redeem shares at net asset value, thereby reducing the current rebate spread.

On January 2, Cameron Winklevoss released an open letter to DCG CEO Barry Silbert questioning Barry about his delaying tactics as Genesis owes Gemini Earn users $900 million. Additionally, Cameron accuses Barry of using NAV business tactics, from which Barry personally benefits. The letter ended with Cameron Winklevoss telling Barry Silbert to find a solution by January 8.

However, the letter did not reveal whether DCG and Barry responded; one scenario that could prevail would be for the DCG to file Chapter 11.

On December 28, investment adviser Valkyrie submitted a proposal to become the new sponsor and manager of GBTC while also launching a fund to profit from discounted crypto.

As rumors continue to circulate, DCG/Genesis is under active investigation by the SEC. Sources confirmed that multiple whistleblowers have come forward.

The current situation of the DCG

Genesis is currently considering bankruptcy. DCG closes its wealth management subsidiary.

Bitcoin is a non-carrier digital asset with no counterparty risk; if the self-guard is correct, no leverage or return occurs. However, investors have personal responsibility for managing their finances.

The number one problem of human beings is often greed, which, as history tells us, usually leads to fraud, manipulation and centralization. By properly storing your Bitcoin, you are holding Bitcoin, not an IOU or paper derivative.

As we have seen in 2022, with counterparty risk occurring due to funds chasing high returns and using Bitcoin to chase yield, these firms will take the “by all means” approach.

Lessons will be learned, but it’s crucial to always do your due diligence, which is why the phrase “Not your keys, not your coins” is paramount in the Bitcoin ecosystem.

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