Due to the fact that your humble blogger is not feeling so hot, forgive me for giving you a thin treatment of the wobbles and likely-looking collapse of a key crypto concern, Genesis. However, two excellent tweetstorms cover most of the key ground, and I will direct you to them shortly.
The unwind of FTX is certain to dominate business press, pundit, and politician attention due to how its uber connected and very recently idolized top brass have been revealed as drug-addled business incompetents who neverless seem to have done a very good job at disappearing a lot of the moolah, presumable for their personal use. The level of media noise and coming prosecutions (both the Southern District of New York and Bahama are reportedly ginning up filing) and the failure of supposedly sophisticated player to find anything amiss will presumably chill interest in crypto, particularly if other firms fall over due to FTX contagion.
If Genesis is one of them, it has the potential to be particularly damaging to the ambitions of crypto promoters for these speculative coins to become a serious alternative to fiat. Genesis provided a traditional suite of investment services together called prime brokerage to institutional investors, as in big money players. Importantly, as I understand it, Genesis was the only real contender in that space. That might sound really attractive (who doesn’t want to be a de facto near monopoly provider?) but it’s dangerous when you are the big market-maker trading (and more important, therefore holding large positions in) highly volatile assets.
So major institutions may have direct exposure if Genesis fails. And even if they don’t, the prospect that they could have will dampen institutional investor enthusiasm, particularly if unflattering facts come out during a bankruptcy.
Genesis took a body blow when hedge fund Three Arrows Capital failed. Genesis has lent to the tune of $2.4 billion. Genesis’ parent Digital Currency Group, filed a claim in bankruptcy court in July or $1.2 billion.
An update from the Financial Times in August:
Crypto broker Genesis will cut a fifth of its staff and replace its chief executive as it counts the cost of lending $2.4bn to hedge fund Three Arrows Capital…
Many of the industry’s best-known names, including Voyager Digital, BlockFi and Deribit, were also forced to liquidate some of Three Arrows’s positions when the investment shop failed to meet margin calls. Court documents showed that Genesis had lent Three Arrows $2.4bn in undercollateralised loans.
Genesis’s parent company Digital Currency Group, founded by investor Barry Silbert, has taken over the trading firm’s liabilities related to Three Arrows and lodged a $1.2bn claim in the US bankruptcy case.
You can see how the story changes as FTX unravels:
Furthermore, our operating capital and net positions in FTX are not material to our business. Circumstances surrounding FTX have not impeded the full functioning of our trading franchise.
— Genesis (@GenesisTrading) November 10, 2022
Our #1 priority is to serve our clients and preserve their assets. Therefore, in consultation with our professional financial advisors and counsel, we have taken the difficult decision to temporarily suspend redemptions and new loan originations in the lending business.
— Genesis (@GenesisTrading) November 16, 2022
Bloomberg reported on November 21 that Genesis was trying to raise money and might have to file for bankruptcy.
To spare you further suspense:
1/n – Why DCG and Genesis will go bankrupt – All information from public sources.
— degentrading (@hodlKRYPTONITE) November 23, 2022
Some of the highlights:
3/n – You can read the long form here. https://t.co/WikkyXHATd
— degentrading (@hodlKRYPTONITE) November 23, 2022
5/n – This is way worse than i thought. I thought the hole was just 1bn. Guess i was wrong by a factor of 2.
— degentrading (@hodlKRYPTONITE) November 23, 2022
And here is why Genesis is particularly important to the crypto ecosystem. Again the entire tweetstorm is very much worth your attention, but some highlights:
1/ Genesis is the only full-service prime broker in crypto. Genesis was a gem in the DCG portfolio.
It plays an critical role in enabling large institutions to access & mange risk.
The $1 Bn question – where does Genesis go from here? A thread on Prime brokers & Genesis
— Ram Ahluwalia (@ramahluwalia) November 20, 2022
5/n – This is way worse than i thought. I thought the hole was just 1bn. Guess i was wrong by a factor of 2.
— degentrading (@hodlKRYPTONITE) November 23, 2022
11/n – But as anyone with enough sense can tell you, this is just sheer financial trickery. Unless DCG pays back the money, Genesis’s balance sheet looks like this pic.twitter.com/lA2hpzfYq3
— degentrading (@hodlKRYPTONITE) November 23, 2022
14/n – DCG’s main assets at this point is (1) Their GBTC stake of 67M~ in shares (2) Value of Grayscale Biz (3) Genesis (probably worth zero)
— degentrading (@hodlKRYPTONITE) November 23, 2022
19/n – In a market now damaged with a crisis of confidence post FTX, Barry can probably only find buyers at 2x PE or less. Given that the earnings have crypto delta. and crypto is a dirty word now.
— degentrading (@hodlKRYPTONITE) November 23, 2022
25/n – The only way for sufficient dollars in the system to bid such a pile is for prices to go low enough. The last BTC will probably clear at 8k (GBTC disc applied to spot) with an avg selling price of 12k. Optimistically.
— degentrading (@hodlKRYPTONITE) November 23, 2022
So you heard about a probable big Bitcoin leg down here early.
And for those interested in the prospects for the crypto field regrouping, this tweetstorm explains how Genesis is a particularly important infrastructure provider.
1/ Genesis is the only full-service prime broker in crypto. Genesis was a gem in the DCG portfolio.
It plays an critical role in enabling large institutions to access & mange risk.
The $1 Bn question – where does Genesis go from here? A thread on Prime brokers & Genesis
— Ram Ahluwalia (@ramahluwalia) November 20, 2022
Again, the entire tweetstorm makes for important reading. To whet your appetite:
3/ A prime broker is not dissimilar from your own brokerage firm. You can buy/sell, borrow, go short, hedge, enter a derivative position. The broker charges a transaction fee and is regulated as a broker/dealer.
— Ram Ahluwalia (@ramahluwalia) November 20, 2022
8/ In practice, a matched book in OTC products never truly exists.
There is always an ‘Odd Lot’ (like the podcast 🙂
Clients expect a dealer to make a market. The dealer is temporarily taking a side of the trade until they can hopefully find another party to take the other leg
— Ram Ahluwalia (@ramahluwalia) November 20, 2022
10/There is an deep ecosystem of CeFi infrastructure that enables these prime brokers and clearinghouses to access and manage risk: FIX protocol (trading API), the DTCC, ISDA frameworks, dealer desks, the Options Clearing Corp, Bloomberg terminals, etc.
— Ram Ahluwalia (@ramahluwalia) November 20, 2022
13/ A bank-backed PB can tolerate a mismatch in the duration of its assets and liabilities. It has FDIC insurance, a lender of last resort, and a liquid market with standardized contracts.
A non-bank prime broker must seek to ‘duration match’ both sides of this. Not easy.
— Ram Ahluwalia (@ramahluwalia) November 20, 2022
21/ There are two moves. Raise equity at the DCG HoldCo level. Then inject capital into the subsidiary to restore confidence.
But, Genesis is capital intensive. It relies on capital and borrowings to make loans. The ROE has dropped since funding sources have dried. Negative NPV
— Ram Ahluwalia (@ramahluwalia) November 20, 2022
As we’ve repeatedly pointed out, the supposedly anti-institutional crypto entrepreneurs have over time wound up replicating the key component of the modern finance system. Genesis provided some essential plumbing. Even if it manages to fail gracefully, current customers will have positions frozen and eventually paid out at a loss. And in the catastrophic scenario of a big bitcoin dump, who knows what the knock-on effects will be.
