GBTC was the Genesis of the Crypto Credit Contagion (2024)

Analysis

Learn how GBTC works, how it’s associated with the recent crypto contagion, and why buying spot Bitcoin and taking self-custody helps you avoid all ofthese risks today.

This year has been abloodbath inthe broader cryptocurrencyspace. Leverage has carted off players from the field one after theother. One byone, we’ve seen crypto lenders and hedge funds, bodied and bloodied bythe high-interest rate environment after taking onleverage like drunkensailors.

Wehave seen multiple lenders, hedge funds, and exchanges like Voyager, Celsius, BlockFi, Three Arrows Capital, and FTX all implode asitwas discovered that many were woefully mismanaged ornothing more than Ponzischemes. You can read more about the recent collapse inThe FTX Fiasco and the Fallout toCome.

There were industry insiders out there who were publicly warning about the risks inthesystem…

1.) CEO ofDigital Currency Group (DCG) Barry Silbert

2.) Former CEO ofFTX and Alameda Research Sam Bankman-Fried

Inhindsight, itappears these men were working with some inside information because both oftheir companies have proven tobedeeply ingrained inthis daisy chain ofrisk. Genesis, with its poor risk management, and FTX, with its shady shell ofabusiness.

Itiswell-known bynow how Sam Bankman-Fried istangled upinthis creditcontagion. His Ponzi scheme, FTX, and Alameda Research isjust the latest and largest victim yet ofthis overleveraged catastrophe.

But now, this contagion has spread toone ofthe largest crypto prime brokers, Genesis Global Trading, which recently halted customer withdrawals and has hired advisors and lawyers topursue all options toavoidbankruptcy. There are plenty ofrumors about what the consequences ofGenesis bankruptcy would bewhen itcomes toDCG, which has its tentacles all over the broader cryptocurrencysystem.

Inaway, this contagion iscoming fullcircle. Here, Iwill highlight apaper trail that, inmyopinion, shows how this entire crypto credit contagion began with Silbert’s DCG conglomerate and theSEC. Itappears tobenearing its crescendo right where itstarted. Tobegin with, wemust goback and look atDCG. These companies comprise it, the investment products itoffers, and its contentious relationship with theSEC.

The GBTC Cash Cow

Genesis falls under the umbrella ofBarry Silbert’s crypto conglomerate DCG, which has invested inaround 200 cryptocurrency companies and projects since its founding in2015.

Here isasnapshot ofonly aportion ofDCG’s portfolio togive you some scale ofthe empire Silbert hasbuilt.

However, the most important parts ofDCG’s business come down toonly ahandful ofits subsidiaries, Grayscale Securities and Genesis GlobalTrading. Below isagraphic that shows the corporate structure ofDCG.

The most important company that DCG owns, byfar, isGrayscale Investments, which isanasset manager and the sponsor ofthe largest Bitcoin trust inthe world, GBTC.

Atthe current price, GBTC holds around $11.4 billion worth ofBitcoin. This equates to635,235 Bitcoin, oraround 3.3% ofBitcoin’s circulatingsupply.

GBTC isanabsolute cash cow for Grayscale and, consequently, DCG. Itcharges a2% management fee onthe underlying Bitcoin held inthe trust.* According toits SEC filings, Grayscale earned $68 million from this fee inQ3 2022, and atit* peak, itwas bringing in~$144 million aquarter from this feealone. AtBitcoin’s current price, Grayscale brings in~$230 million inrevenue annually from thefee. This equates toasubstantial portion ofthe $800 million inrevenue Barry Silbert said DCG earns annually inaletter toshareholders onNovember 22nd.

GBTC isaclosed-end trust that allows investors togain exposure toBitcoin without buying the underlying Bitcoinitself. Itisasecurity and has become extremely popular over the last several years because, for along time, itwas the only way for investors toget exposure toBitcoin intax-advantaged accounts like IRAs and 401(k)s.

Understanding how GBTC functions isimportant tocomprehend how this led toall the crypto lender explosions wehave witnessed thisyear. Accredited investors can create shares ofGBTC atNet Asset Value (NAV) bygiving USD orBTC toGrayscale. After a6-month lock-up period, the investors can convert the trust shares into GBTC shares, which are then freely tradeable onthe openmarket. Investors can never take the original BTC out ofthetrust. There isnoredemptionclause. They can only sell their GBTC shares atthe going marketprice. There isnomechanism bywhich investors can redeem theirBitcoin.

This isimportant because itcreates adynamic where the share price ofGBTC can trade onthe open market above orbelow the Net Asset Value (NAV) ofthe Bitcoin that underlies thetrust. When GBTC istrading atapremium, that means GBTC shares are trading atahigher price than the value ofthe underlyingBitcoin. When itistrading atadiscount, itmeans GBTC shares are trading atalower price than the value ofthe underlyingBitcoin.

This hurts investors holding GBTC because there can bewild fluctuations between the price ofGBTC compared tothe underlyingasset. This isalso why Grayscale has publicly stated that ithas structured GBTC legally since its inception toconvert into anETF oneday. With anETF, anauthorized participant can create orredeem shares tobring the ETF back toNAV. This would beanoptimal investment product for investors because there would benodiscounts orpremiums, the value ofthe ETF shares would always track the underlying Bitcoin, and the management fees would bemuch lower, too.

But, alas, the SEC did not approve Grayscale’s application toconvert GBTC into aspot Bitcoin ETF, and this market inefficiency with GBTC persisted, offering anarbitrage opportunity for investors.

This iswhere things started toget out ofcontrol.

Paper Bitcoin… ataPremium

For along time, GBTC was the only game intown for individuals and institutions togain exposure toBitcoin intax-advantaged accounts like IRAs and 401(k)s. Institutions were legally only allowed tobuysecurities. Atthe same time, demand for GBTC grew because people could gain exposure topaper Bitcoin conveniently without the challenges and security risks associated with taking self-custody. Asthe price ofBitcoin increased, investors flooded into the only Bitcoin investment product available tothem intheir brokerageaccounts.

This led toanexplosion inassets under management (AUM) for Grayscale, and the fees rolledin. Atit* peak during the bull market, over $40 billion dollars worth ofBitcoin was held inGBTC.

Due tothe lag between shares ofGBTC being created inthe trust and these shares hitting the open market after the 6-month lockup period, the increased demand created ashortage ofGBTC shares available onthe open market, driving the price ofthe shares uptoasignificant premium toNAV asdemand for Bitcoin soared inthe bullmarket.

One can observe below how GBTC traded atapremium for most ofits history before 2021.

One ofthe largest drivers ofthis GBTC premium was institutional investors, who began putting onanarbitrage trade totake advantage ofthe market inefficiency between the price ofGBTC and the underlying Bitcoin inthetrust.

This became known incrypto circles as“The Grayscale Trade.”

Step 2: Give Bitcoin toGrayscale, either with their own BTC orborrow itfrom alender like Genesis

Step 3: Hold GBTC shares for the 6-month lock-up period

Step 4: Sell the GBTC shares atapremium when the lock-up ends

Step 5: Close the short position

Step 6: Rinse and Repeat

With the GBTC premium breaching 20% atthe end of2020, this trade was basically free money for accredited investors who could doit. Itwas especially popular among crypto hedge funds and lending institutions, like Three Arrows Capital andBlockFi.

Inmany ways, much ofBlockFi’s business model revolved around this one unsustainable GrayscaleTrade. This was how BlockFi offered such high yields inits interest-bearingaccounts. They would rehypothecate user funds into this GBTC premium trade and roll itover every 6months. Since the premium was greater than the yield onits interest-bearing accounts, they could keep using this trade tofund theirbusiness.

After consistently putting onthis Grayscale Trade, Three Arrows Capital and BlockFi eventually became the two largest holders ofGBTC shares, collectively owning 58,741,046 shares ofGBTC asofQ4 2021.

Tobeclear, many other institutional investors were putting onthe same trade, but BlockFi and Three Arrows Capital were the most well-known, and they were putting itonwithsize. Asthis trade became more popular, the price ofGBTC and Bitcoin increased totheright.

This can beobserved inthe tripling ofBTC holdings inGBTC from 2020 to2021.

Things were going great for BlockFi and Three Arrows Capital asthey rolled over this Grayscale Trade every 6months. Itwas also going well for Genesis andDCG. Genesis was making akilling loaning out tothese firms toput onthe trade, and DCG was making more money than ever before from fees asGBTC’s AUM ballooned.

​​But the arbitrage trade wasn’t risk-free. Itonly worked ifthe GBTC premium was still there when your individual lock-up periodended. Without the premium, the whole money-making machine falls apart foreveryone. Afirm will actually lose money putting the trade onifthere isnopremium, especially ifthey borrowed toput onthe trade inthe first place, which alot ofthese firmsdid. And that’s precisely whathappened.

APremium Flips toaDiscount

February 24th, 2021— adate that will live ininfamy.

This was the day the GBTC premium vanished, never tobeseenagain. Since that day inFebruary, GBTC has been trading atamassive discount toNAV.

Suddenly, the darling trade ofthese hedge funds and lending firms wasgone. What made matters worse isthat these firms had tohold these illiquid GBTC positions due tothe 6-month lockupperiod. All they could dowas sit there and watch the GBTC discountwiden.

Sowhy did the premiumdisappear?

The GBTC premium disappeared for avariety ofreasons. Here are two potential factors:

1. Increased competition inthe market with the arrival ofthe ProShares Bitcoin Strategy ETF onthe Toronto Stock Exchange and the Valkyrie Bitcoin Strategy future ETF onthe Nasdaq inOctober 2021. Also, other smaller competing products with smaller management fees were launched, like the Osprey Bitcoin Trust and the Bitwise Crypto IndexFund. These new products attracted capital and investors away from GBTC, reducing the premium intheprocess.

2. Asdemand for GBTC fell and the premium was arbitraged away, the trade became less enticing from arisk standpoint, and the premium becamenegligible. Itwas not worth the risk ofholding illiquid GBTC during the 6-month lockup period, especially ifthe premium was only afew percentagepoints. The marginal demand from the largest GBTC buyers (institutional investors) was nolonger there, and the premiumfell.

When the Grayscale Trade disappeared, these firms started toscramble toraise funds and search for yield inriskierendeavors. This was when things all started tofall apart behind thescenes.

BlockFi

InFebruary 2021, right before the GBTC premium disappeared, CoinDesk reported:

This boosted their GBTC shares to36.1 millionshares. Around this time, BlockFi was also planning tolaunch acompeting BlockFi Bitcoin Trust sothat they would not have torely onGBTC toput onthetrade.

This news started tocause anuproar across the cryptocurrencyindustry. People were not happy tofind out that BlockFi was performing this GBTC arbitrage trade inthe background, which led former CEO Zac Prince torespond with,

When asked about the GBTC arbitrage trade, BlockFi’s Chief Risk Officer, Rene van Kesteren, replied, "Locking upBitcoin inGrayscale could theoretically pose aliquidityrisk. But BlockFi discloses the arrangement tousers and takes steps todefuse anydanger."— March 4th, 2021

Asthe premium trade vanished and interest rates increased, BlockFi started togradually reduce the interest rates offered onits interest-bearingproducts. BlockFi initially advertised 6.2% APY onits interest-bearing cryptocurrencyproducts. Byits last days inbusiness, the yield offered onits Bitcoin interest-bearing product was only 2% APY.

When GBTC’s premium disappeared, BlockFi also raised $350 million inaSeries Dround, giving the company avaluation of$3billion. One has towonder ifthe loss ofrevenue from the GBTC premium trade played arole inthe timing ofthisraise.

Itwas around this time that BlockFi made arather large loan toa$10 billion cryptocurrency hedge fund with asterling reputation, Three Arrows Capital (3AC). Inaleaked investor call inJune 2022, itwas reported that BlockFi had loaned 3AC $1 billiondollars.

During the investor call, itwas discovered that two-thirds ofthe billion-dollar loan to3AC was collateralized byBitcoin. The remaining third were inshares ofGBTC, worth atotal of~$430 million atthe time ofliquidation.

According tothe call, "BlockFi was able toeasily liquidate its position inBitcoin but ran into problems with the GBTC because the discount had reached lows last week ofnearly34%. AsBlockFi attempted toliquidate its GBTC position, Pompliano explained, the price wentdown."

BlockFi’s liquidity issues with GBTC foreshadowed what was tocome for lenders with large GBTC positions during aliquiditycrisis.

Three Arrows Capital

Asthe discount disappeared, Three Arrows Capital suddenly found itself inquite thepickle. Ithad put onasignificant GBTC position with leverage provided byGenesis. 3AC now had tosell these shares atadiscount topay its debt obligations. With the GBTC share price and the broader cryptocurrency markets crashing, 3AC was effectively insolvent without the Grayscale Trade available tothem.

From 3AC’s bankruptcy filings inJuly, wenow know that Genesis loaned 3AC $2.3 billiondollars. This represented nearly 50% ofGenesis’s entire loan book atthetime! Tomake matters worse, the loans were undercollateralized with GBTC and other illiquid cryptocurrencies. The loans were collateralized with aBitcoin IOU, anether IOU, and two high beta centralized tokens, down anaverage of-88% year-to-date.

Asthe premium switched toadiscount, 3AC could not afford topay back its USD loan toGenesis and incurred large losses asthe GBTC premium turned into adeeper and deeperdiscount.

Itwas around this time when 3AC began desperately searching for anything tofill the hole that was once filled bythe GBTC premium trade toavoid itsdownfall. They began taking out USD loans from any crypto lender that would lend tothem. BlockFi, Voyager, and Celsius all gave out loans, often collateralized by3AC’s crypto and GBTC holdings, just like its Genesisloan.

3AC then went searching for yield with the newly acquired funds, where they found itwas apromising protocol calledAnchor. The Anchor protocol was offering a20% yield onthe Terra stablecoin, which was being promoted bythe now-wanted fugitiveDoKwon.

Here isZhu Su, Co-Founder ofThree Arrows Capital, tweeting about Terra Luna and Anchor about amonth before itscollapse.

Ofcourse, wenow all know how this ended up.Terra Luna crashed— wiping out ~$50 billion invalue inamatter ofdays.

3AC had massive exposure tothe Terra Luna collapse, likely partly because they were searching for yield toavoid bankruptcy and make upfor the losses incurred bythe GBTC premium flipping toadiscount.

Terra Luna’s collapse led to3AC’s implosion inthe early summer of2022, and this, inturn, took down many ofthe crypto lenders, too. All the counterparties took massive losses ontheir loans to3AC, which ultimately contributed totheir respective downfalls.

Genesis incurred amassive $1.2 billion dollar loss in3AC, effectively making itinsolvent. Itturns out that the counterparty risk Barry Silbert had been warning about inhis tweet from June 2021 was actually right under his nose the wholetime.

Genesis

This now leads ustoGenesis, the largest crypto prime broker, which dished out awhopping $130.6 billion dollars worth ofloan originations in2021.

Genesis has been hit byaplethora oflosses related tobad loans, fraudulent counterparties, and ageneral decline inthe price ofGBTC and cryptocurrencies ingeneral.

First, Genesis presumably took asignificant loss when Terra Luna collapsed after they swapped $1 billion worth ofBTC for $1 billion worth ofUST, which will probably godown asone ofthe worst transactions inhistory. This position has presumably been marked tozero after UST crashed.

The second event was the $1.2 billion dollar exposure to3AC. This was the initial response after the 3AC collapse from now resigned CEO Michael Moro, with the “large counterparty” now known tobe3AC.

Lastly was the recent exposure tothe FTX and Alameda Research Ponzischeme. Here isGenesis' timeline regarding their exposure toFTX.

November 8th— Genesis deniesexposure.

November 9th - Genesis says they have $7 million worth oflosses.

November 10th— Genesis says they have $175 million trapped onFTX.

November 11th—Genesis received a$140 million equity infusion from their parent company, DCG, tohelp provide some breathingroom.

November 16th— Genesis halts customer withdrawals and new loan originations, citing 3AC and FTX exposure.

November 17th— Reports surface that they are attempting toraise anemergency $1billion.

November 21st— Genesis slashes its raise target inhalf and warns ofpotentialbankruptcy.

Since then, ithas been discovered that Genesis owes customers ofcrypto exchange Gemini $900 million dollars, aswell asasecond group ofassorted creditors another $900 million dollars,for atotal of$1.8 billion dollars, and that number isexpected togrow. Inaddition, ithas been reported that Genesis has hired restructuring lawyers tohelp find away topreventbankruptcy.

InaGenesis fundraising documentleaked tothe WSJ, welearned that Genesis attempted toraise emergency funds due toa“liquidity crunch due tocertain illiquid assets onits balance sheet“…and…

“There isanongoing run ondeposits driven mainly byretail programs and partners ofGenesis (i.e., Gemini Earn) and institutional clients testing liquidity”

Later, itwas revealed that the “certain illiquid assets” onGenesis’s balance sheet comprised ~39 million shares ofGBTC pledged ascollateral from the 3AC loans and multiple loans toits parent company, DCG.

This leads ustothe final boss ofthis whole labyrinth ofleverage… DCG.

Digital Currency Group

When 3AC blew a$1.2 billion dollar hole inGenesis’s books, Genesis was effectivelyinsolvent. Inthe wake ofthe 3AC collapse itled tothis tweet from former Genesis CEO Michael Moro:

Itwas later revealed that by“assuming certain liabilities, ” DCG took the bad 3AC loan onits books, took out a$1.1 billion dollar promissory note due June 2032 from Genesis, and proceeded togive the cash right back toGenesis for them tofill the hole initsbooks.

Ifthis makes you raise your eyebrows alittle bit, then you are notalone. This kind ofintercompany loaning tokeep the company afloat issuspect, tosay theleast.

Barry Silbert explained this loan inhis letter toshareholders onNovember 22nd:

Ontop ofthat questionable loan tobail out Genesis from the bad 3AC loan, DCG also took out another $575 million intercompany loan from Genesis due May 2023 to“fund investment opportunities and torepurchase DCG stock from non-employee shareholders.”

This $575 million dollar loan ismost likely entirely deployed bynow, asDCG has been purchasing GBTC shares inanattempt tostop the GBTC discount from wideningmore. The GBTC shares bought with this loan are likely down ~70% today.

DCG aggressively purchased shares last year toreduce the discount toattract and raisecapital. DCG publicly announced apledge tobuy $1 billion worth ofGBTC shares inNovember 2021. 2 weeks later, DCGraised $700 million dollarsinanequity round ata$10 billion dollarvaluation. The round was led bySoftBank, CapitalG, and RibbitCapital.

Below isachart that shows the amount ofGBTC shares owned byDCG. Today, DCG owns about 10% ofthe total GBTC supply.

You can see below how BlockFi liquidated all ofits GBTC holdings byQ1 2022, right asDCG was accumulatingshares. DCG isnow the largest shareholder ofGBTC, with 66,972,899shares.

From March 2021 toJune 2022,DCG bought $772 million ofGBTC shares atanaverage price of$40 dollars per share. With the GBTC price currently sitting at$8.98 today, that means DCG isdown anaverage of-77.5% onthose GBTC purchases (ouch).

The real problem here isliquidity.

Genesis needs liquidity now tofund its withdrawals and pay itscreditors. Genesis has short-term obligations, and itappears alot ofits capital was deployed into illiquid long-term investments, likeGBTC. Itwill gobankrupt ifitdoes not get capitalsoon. It’s possible that Genesis has already begun selling GBTC shares toraise cash and make some depositorswhole. This could beone reason why wehave seen the GBTC discount has dropped toanall-time low of-50%.

DCG owes Genesis $1.7 billion and other creditors $350 million and has already exhausted its liquid capital bybuying back GBTC shares and bailing out Genesis when itblew upfrom 3AC. Now, DCG isdesperately trying toraise cash tocontrol the fallout fromthe FTX fiascoand help Genesis and itself avoidbankruptcy.

Asyou can see, this isatotalmess.

The questions are:

• What options does DCG have?

• What could this mean for GBTC holders?

• What could this mean for the price ofBitcoin?

DCG’s Options

Although DCG finds itself inatight spot, itdoes have several options available tothem toavoidbankruptcy. Keep inmind that weare operating without all the informationhere.

Here are six potential avenues DCG can take:

This could provide abuffer for cash-strapped Genesis, but itwould not beenough tofix theproblem. They also are not incentivized todothis because itwould widen the discount even more and likely cause their AUM todrop, reducing their fees, their primary source ofrevenue.

It’s likely wehave already seen some ofthis selling asthe GBTC discount has widened oflate; however, DCG and Genesis cannot just sell their entire GBTC positions. GBTC isilliquid because there are legal restrictions concerning issuers ofasecurity selling over-the-counter. This iscalledrule 144A. Itisexplained onthe SEC’s website below,

“The number ofequity securities you may sell during any three-month period cannot exceed the greater of1% ofthe outstanding shares ofthe same class being sold, orifthe class islisted onastock exchange, the greater of1% orthe average reported weekly trading volume during the four weeks preceding the filing ofanotice ofsale onForm 144.”

Due tothis rule, Genesis and DCG would belegally required toprovide notice ofthesale. They would only beable tosell ~7 million shares everyquarter. For this reason, itwould take time for these entities tounwind their GBTC positions.

All inall, selling its GBTC shares would only beabandaid for abulletwound. Itwould likely only widen the discount further and reduce DCG’s fee revenue, sothis isn’t anideal option for DCG totake.

2.) Raise equity tofill the hole

The last time DCG raised funds, itwas valued at$10billion. This was near the top ofthe bull market when Bitcoin’s price was around $60,000. Now, they will need totry toraise adown round inachallenging environment with annual revenues down >50%.

But there isstill value inDCG beyondGenesis. Asmentioned above, Grayscale isacash cow that brings inannual recurring revenue of~$300 million attoday’s Bitcoinprices. They can leverage those future cash flows totry toraisecapital. DCG also holds anextensive venture portfolio, including assets like CoinDesk andFoundry. DCG can even raise funds from the 10% ofthe outstanding GBTC shares they own instead ofsellingthem. Lastly, they have bankruptcy claims in3AC, FTX, and Alameda Research that could fetch somevalue. Still, the details around those claims remainunknown.

IfDCG can pull itoff, itcould raise funds totry topay back the $1.7 billion itowes Genesis creditors byleveraging theirassets. But even then, it’s hard tosee how that would fill thehole.

3.) Sell off assets toraise capital

DCG could also sell its assets, including its venture portfolio, toraisecapital. One ofthe most valuable assets that itowns isCoinDesk. Semafor reports that people familiar with the situation state that buyers approached DCGtopurchase CoinDesk ataprice of$300 million. Itisestimated that CoinDesk brings inabout $50 million inannual revenue, mostly from its ConsensusConference.

They also could sell Grayscale toanother asset manager tomanage. Asset managers would need toseriously consider this offer, given the lucrative 2% managementfee. This would not impact GBTC shareholders much either, which isagood thing, but itwould certainly impactDCG. This would beselling their main revenuedriver. Itisestimated that DCG could sell Grayscale for ~$500 million tothe rightbuyer. Yet, ifDCG sold Grayscale, itwould basically bekissing its businessgoodbye.

And still, this would likely not beenough tofill DCG’shole.

4.) Restructure loans with Genesis creditors

Genesis could work with DCG torestructure its loans togive both parties morerunway.

Right now, DCG owes Genesis $1.7billion. It’s ineverybody’s best interest ifDCG can negotiate and strike adeal with Genesis creditors, allowing both parties toavoidbankruptcy.

IfDCG can work out aresolution with Genesis creditors, perhaps they can survive tolive anotherday. IfDCG can’t come toaresolution, then Genesis will likely gointo bankruptcy, and DCG will have toanswer toits creditors inthe bankruptcycourts.

DCG could raise money and inject capital into Genesis sothat they can fund some oftheir depositor’s withdrawals. Ormaybe DCG could negotiate with Genesis creditors toroll their debt into DCG warrants. This would give them asenior claim onthe cash flow fromGBTC. This could beenticing toGenesis creditors, given GBTC’s annual recurringrevenues.

There are many different ways they may come toadeal, and Ibelieve itisinthe best interest ofboth parties todoso. Ifadeal was worked out, perhaps both DCG and Genesis could avoidbankruptcy. However, it’s hard tosee how any investor could trust Genesis after all ofthis.

5.) Seek Reg MExemption

For GBTC shareholders— this would beaGoldilocksscenario.

Ifthe SEC approves this, Reg Mwill allow GBTC shareholders toredeem their shares for the underlying assets ata1:1ratio. So, ifReg Mrelief was approved bythe SEC, the GBTC discount would practically disappear overnight asitwould allow Grayscale tocreate and redeem shares simultaneously and return the fund back toNAV.

The SEC would need toapprove in-kind redemptions for shareholders totake custody ofthe underlyingBitcoin. This could pose challenges because alot ofGBTC shareholders hold the security inaccounts that aren’t legally allowed tohold spotBitcoin. However, shareholders could still redeem their shares for cash atNAV instead ofthe alternative ofselling the shares ata40% discount onthe openmarket.

This would beapositive outcome for GBTC investors, and the SEC would doright byshareholders toapprove this relief and allow in-kind redemptions toprotectinvestors. I’m skeptical about whether the SEC will approve this because they have already denied Grayscale’s application toconvert toanETF this year, which would have given Grayscale the Reg Mexemption.

Byapproving aReg Mexemption, the SEC would risk appearing supportive ofthe cryptocurrency industry inthe wake ofFTX’scollapse. Since they already rejected Grayscale’s application toconvert GBTC into anETF earlier this year, it’s hard tosee them approving Reg Mrelief. Atthis point, itbecomes agame ofpolitics instead ofamatter ofprotecting retail investors and GTC shareholders.

6.) Liquidate the Trust

This isthe nuclear option and appears highly unlikely, given that DCG would bekilling its cashcow. Byliquidating the trust, DCG would lose all that annual recurring revenue from the fee, essentially ending any hope for the business tocontinue.

Shareholders ofGBTC cannot vote toliquidate the trust after the 75% shareholder liquidation provision was amended inthe GBTC charter back in2018.

Today, the liquidation ofthe trust isatthe sole discretion ofthe sponsor, and the incentive for them tovoluntarily dothis just doesn’t addup.

The one way that aliquidation ofthe trust can occur isinthe event ofaDCG bankruptcy orinsolvency unless 50% ofthe shareholders vote tomove the trust toanew sponsorinstead.

Inthe event ofbankruptcy and subsequent liquidation ofthe trust, itremains unclear whether ornot shareholders would beable totake in-kind redemptions ofthe underlying Bitcoin orifitwould have tobedistributed indollars.

I’m not alawyer, but the language makes itsound like shareholders would beable toredeem the underlying Bitcoin atthe sponsor’s discretion, which isapotentially positiveoutcome.

Ifthat isnot the case, dollars would need tobedistributed toGBTC shareholders. This means that DCG would need tosell all 635,235 Bitcoin onthe openmarket. This would crash the price ofBitcoin, and there would likely bealot ofprice slippage asthe sponsor sold theBitcoin. This would result inless value being returned back toGBTC shareholders and would tank the price ofBitcoin intheprocess. This would not beideal.

All inall, aliquidation ofthe trust isalast-ditch option that DCG isunlikely totake voluntarily. Inthe event ofDCG’s bankruptcy, there islanguage inthe charter that makes itappear like in-kind bitcoin redemptions would bepossible ifthe trust wasliquidated.

The real risk that GBTC shareholders need toconsider iswhether the Bitcoin underlying the trust issecure and accountedfor.

Coinbase isthe qualified custodian forGBTC. They legally cannot rehypothecate orlend out the Bitcoin and have tokeep the account segregated from otherfunds. Coinbase recentlyannounced inapublic statementthat all ofthe Bitcoin underlying GBTC was accountedfor.

Investors were unsatisfied that Coinbase didn’t show proof ofthis cryptographically, and Iunderstand thatconcern. But, excluding the non-zero possibility that DCG, Grayscale, and Coinbase are running afraudulent operation, Ihave noreason tobelieve that the Bitcoin isnotthere.

Coinbase isaregularly audited publiccompany. GBTC islikely one ofits largest clients for its Coinbase Custodyproduct. IfCoinbase somehow mismanaged the Bitcoin that underlies the largest Bitcoin fund inthe world, noother entity would trust their custody solution ever again, especially now that other institutional-grade custody solutions like Fidelity and BNY Melonexist. ItisinCoinbase’s best interest that the Bitcoin isthere, and ifthey say itis, then Ibelieve there isa99.9% chance itis.

Incase you are someone who understandably isn’t satisfied without on-chain confirmation, then here isErgo’s findings, arespected on-chain analyst from OXT Research.

Ergo and his team tracked down all the Bitcoin on-chain that underlie the GBTC trust held atCoinbase, and all the Bitcoin werethere.

Ergo’s findings should provide asense ofrelief for GBTC holders. The Bitcoin underlying GBTC has been independently verified on-chain and isaccounted for inCoinbaseCustody.

The Blame Game

Inthis piece, Iattempted tolay out evidence that alot ofthis crypto contagion began and isnow culminating withDCG. Itall revolved around the Grayscale Trade that was present due toGBTC’s structure asaclosed-endtrust. Once the GBTC premium trade disappeared, hedge funds and crypto lenders went further out onthe risk curve inpursuit ofyield rights asthe Federal Reserve started increasing interestrates. Itwas arecipe fordisaster. Risk happens fast, and sobegan awave ofbankruptcies that spread like wildfire throughout the entire broader cryptoindustry.

So, who istoblame for this complex web ofleverage and speculation?

Sure, you can blame the crypto lenders for their shockingly poor riskmanagement. You can blame the hedge funds and institutional investors for putting onrisky trades with obscene amounts ofleverage, too. You can also blame scammers and criminals like DoKwon and Sam Bankman-Fried for running Ponzi schemes andfrauds. You can blame DCG for providing the leverage for investors toput onthis Grayscale Trade and letting them roll itover every 6 months, ripping off retail investors intheprocess. You can even blame the Federal Reserve for creating this easy money, yield-chasing environment that encouraged and allowed speculation torunrampant.

But tome… Ithink the one institution that could have actually prevented this from getting soout ofhand, just bydoing its job, istheSEC.

According tothe SEC’s website, its mission isto“protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.”

Iwould say the SEC has failed its mission inits refusal toapprove the conversion ofGBTC into aspot BitcoinETF. Ithink the damage speaks foritself.

Ifthe ETF conversion had been approved, then the premium trade would not haveexisted. Ifthe premium trade would not have existed, these firms would not have grown tothe size they had and taken onasmuch leverage astheydid. Alot ofthis mess could have beenavoided.

Inmyopinion, the SEC failed inits mission bynot approving aspot inBitcoin ETF, resulting incountless retail investors needlessly being harmed and losing their life savings inthis crypto creditcontagion.

ETFs are asafer, better investment structure for investors than aclosed-end fund like GBTC because ETFs have nolockups, nopremiums/discounts, lower fees, more transparency, and better taxtreatment.

Although Grayscale had selfish motives for wanting anETF (togain market share and attract capital toits product), you have togive them somecredit. Grayscale has been doing everything itcan toconvert GBTC into anETF. They became the first SEC reporting company in2020 and thus have toadhere toahigher level ofdisclosure and financial reporting than other companies inthespace.

Despite this, theSEC rejected their ETF application this yearand insteadapproved aCME Bitcoin Futures ETF. Grayscale isnowsuing the SECfor approving afutures ETF and not approving its spot ETF conversion.

Inresponse, Grayscale started acomment submission portal onits website where investors can submit comments about the SEC’s rejection during the SEC’s 240-day reviewperiod.

Since June 19th,11,609 comment lettershave been submitted, many from GBTC shareholders. Grayscale writes, “99.96% ofcomment letters were submitted insupport ofthe conversion.”

Inthe past, the SEC has denied dozens ofsimilar spot ETF applications from other major players inthe space, including Fidelity’s WisdomTree Bitcoin ETF and NYDIG’s Bitcoin ETF, mainly citing alack of:

1. qualified custodian solutions

2. investor protections and market manipulation and fraud

The qualified custodian concern isunfounded in2022. Several qualified custodians operate today, including Fidelity, BNY Melon, State Street, andCoinbase. This problem has been solved foryears.

Asfor the spot Bitcoin market manipulation and fraud, how bad could itbeifthe SEC found itsuitable enough toapprove aCME Bitcoin futures ETF that’s supposed totrack the underlying spotmarket?

Futures contracts are inherently more expensive tomanage, don’t track the underlying spot price aswell, and are more subject toprice manipulation.

Fidelity performed alead-lag analysisand submitted their findings tothe SEC that empirically showed how the CME Bitcoin futures market leads price discovery inBitcoin futures and spotmarkets.

Fidelity’s main takeaway from the analysis was,

“Our study’s finding that the CME Bitcoin futures market leads Bitcoin price discovery across Bitcoin futures and spot markets means that anactor trying tomanipulate the ETPwould bereasonablylikely tohave totrade inthe CME Bitcoin futures market.”

Fidelity’s analysis shows that ifabad actor wanted tomanipulate the price ofBitcoin, they would have better success ifthey used the futures market rather than the spot market, but yet, still nospot Bitcoin ETF approval from theSEC.

Even SEC Commissioner HesterM. Peirce isdumbfounded bythe SEC’s continued rejection ofaBitcoin spot product,

"The Commission’s resistance toaspot Bitcoin ETP isbecoming almost legendary.”

Byrejecting spot Bitcoin ETF applications, approving Bitcoin futures ETFs, and allowing GBTC topersist asit’s currently structured, the SEC has failed toprotectinvestors.

Lastly, regulators inmany other countries, such asCanada, Australia, South Africa, and Europe, have all approved spot BitcoinETFs. These products have resulted incapital flight abroad asinvestors seek abetter investmentvehicle. The SEC’s failure toapprove the conversion ofGBTC into anETF not only hurt investors but has also negatively impacted American competitiveness.

Ultimately, some ofthe blame for the wealth destruction we’ve seen across the broader cryptocurrency industry falls atthe feet ofthe SEC for not allowing GBTC tobeconverted into aspot BitcoinETF. These regulators are incharge ofprotecting investors and creating fair and efficient markets; it’s about time itgot back onits statedmission. For all ofthese reasons, it’s long past due for the SEC toapprove aspot BitcoinETF.

Conclusion

Ifthere are any lessons tobelearned from this web ofleverage and fraud, they are this: leverage and counterparty riskkill.

AsCustodia’s CEO Caitlin Long famously said onapanel with Sam Bankman-Fried atthe Bitcoin 2021 conference,“Afool and his leveraged Bitcoin are soon parted.”

All ofthese institutions tried toplay fiat games ontop ofBitcoin. Lenders tried tooffer yield onadisinflationary asset and got REKT doingit. Investors tried tochase yield byleveraging uptotheir teeth, making riskier and riskier bets, and getting REKT doing it.

Swan’s Andy Edstrom said itbest back inMay,

Another big takeaway from this daisy chain ofcounterparty risk is“Not your keys, not your coins.”

What Celsius, Voyager, Genesis, FTX, and BlockFi should teach every investor isthat there isnosubstitute for holding spotBitcoin. When you hold GBTC, orBitcoin, onanexchange orlending platform, you donot ownBitcoin. You own paperBitcoin. You own aBitcoinIOU. You are putting your trust inacounterparty, not animmutableledger.

The beauty ofBitcoin isthat ifyou take self-custody, you never have totrust another exchange, lender, custodian, orBitcoin trust everagain. Ifyou never want tobecaught upinbankruptcy proceedings, become avictim ofafraudster, orhave toread the fine print ofatrust charter, then take ownership ofyourBitcoin. You can avoid all ofthese counterparty risks forever bywithdrawing your Bitcoin into your ownpossession. That iswhy werecommend buying spot Bitcoin and taking self-custody toall our Swanclients. Ifyou want toavoid all ofthis nonsense, then that’s all you have todo.

It’s thatsimple.

Don’t trust, verify.