Facing The Wheel
Since my last newsletter, I’ve felt a strange sense that something is about to break.
Identical boat twins Cameron and Tyler Winklevoss continued to spar with Digital Currency Group’s Barry Silbert over the $900 million of customer funds they’d loaned to Genesis, DCG’s crypto lending unit, sending another excoriating letter accusing Silbert of numerous acts of fraud.
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Their specific accusations are extremely annoying and stupid.
When Three Arrows Capital went up in smoke, they left Genesis with a $1.2 billion hole in their books - roughly 15% of their $8bn in assets. Cameron Winklevoss alleges that they could have restructured “inside or outside bankruptcy court” or “fill the $1.2 billion hole,” of which Barry Silbert chose to do neither.
Genesis - a company owned by Barry Silbert’s Digital Currency Group - received a $1.1 billion promissory note, which Genesis then claimed was a “current asset” on their asset documents and then provided to Gemini. A “current asset” is one that can be liquidated within a year.
The problem is that the promissory note was due in 2032 - and frankly, will Genesis or Digital Currency Group still be around then? - and has an interest rate of 1%, which is a lot longer than a year. The other problem is that they attempted to plug a $1.2 billion hole with an IOU.
Warning: This Bit Is Really Stupid: Gemini has also accused Silbert and Genesis of working with Three Arrows Capital to pump the assets under the management of Grayscale Trust - another part of Digital Currency Group that sells stocks that give you exposure to crypto assets.
Its largest and most high-profile investment vehicle, the Grayscale Bitcoin Trust (GBTC) is a stock you buy that is meant to equal 0.001 BTC. As I write this, it’s currently trading at a 42,70% discount.
One crucial detail is that you cannot redeem this stock for an actual Bitcoin. The other crucial detail is that GBTC takes a fee of 2% of the total assets under the management of the trust, regardless of how many shares have been issued. The amount of BTC they hold is referred to as the Net Asset Value - or NAV.
Another important thing is that one can “create” GBTC shares by sending Bitcoin to Grayscale or buy into the trust with US Dollars. This process differs from buying GBTC on the secondary markets insofar as there is a six-month lockup before you can sell your shares.
The Winklevii allege that Genesis and Three Arrows Capital were entering into a “recursive trade” that worked by Three Arrows Capital sending Bitcoin to Grayscale, creating GBTC shares that, thanks to the premium on the share price (which was trading above the value of 0.001 BTC at the time), worth more than the money that the cost of the Bitcoin they issued.
3AC then took these shares to Genesis and used them as collateral to borrow more Bitcoin. The Winklevii also allege that 3AC was selling shares for a premium after the lockup expired.
This worked for a while, because these shares continued to trade at a higher price than the cost of the Bitcoin that 3AC provided. However, in early 2021, GBTC began to trade at a discount to Bitcoin. This meant that the stock held by 3AC - and the collateral posted for loans with Genesis - was no longer profitable. Yet Genesis kept accepting GBTC as collateral on loans.
There are a couple of reasons that they might have done this:
To hoard shares in GBTC as a means of stopping the share price from dropping further.
To pump the assets under Grayscale’s Bitcoin trust - increasing the amount of money they’d make on their 2% annual fee. To be clear, this money cannot leave the trust unless the trust says so.
Gemini alleges that these trades between Three Arrows Capital and Genesis were characterized as collateralized loans on their balance sheet rather than what appears to be a big scam to give Barry Silbert free money.
When Three Arrows Capital went belly-up, Genesis was left with collateral it absolutely did not want to sell that was worth considerably less than the assets they’d loaned out. It is also extremely peculiar for a financial institution to not liquidate assets to cover a loss.
To summarize, Gemini’s co-brothers are suggesting that Barry Silbert used his loan company to increase the amount of Bitcoin in Grayscale’s coffers to increase the amount of money it made. Said Bitcoin trust’s holdings can only be reduced if the trust decides it wants to, or is compelled to by a shareholder vote.
It’s also important to consider that the Winklevosses have a vested interest in framing themselves as victims that acted in good faith, and specifically not responsible for the $900 million of funds tied up (read: lost) in Genesis. Except there was an obvious time for them to act - when it was revealed that Genesis loaned $2.4 billion to Three Arrows Capital in July of 2022. They are attempting to craft a narrative that suggests that everything seemed fine at the time. Except it wasn’t - It obviously wasn’t, because the questions to ask would have been “can we see what that $1.1 billion current asset is?” and if the answer was “no,” then it was time to pull every penny from Gemini Earn.
It has now come out that Genesis owes more than $3 billion to creditors, and the SEC has charged both Gemini and Genesis with offering unregistered securities through Gemini Earn. I am not a lawyer, but it seems this is a fairly straightforward case. Investors had a reasonable expectation of return (a yield on their crypto) in a common enterprise (Gemini) with an expectation of profit (the percentage yield return) to be derived by the efforts of others (Gemini lending the assets to Genesis). One very specific element of the suit that likely terrifies the Winklevii is that it will, if successful, require them to pay back the $900 million from Gemini’s coffers - something that they can both afford to and absolutely do not want to do. And a case like this will almost certainly lead to discovery that would reveal exactly how much Gemini knew and when they knew it.
As I have previously said, these are “allegations.” Your sources are “twin brothers that are called Tyler and Cameron” and noted criminal founder of Three Arrows Capital, Zhu Su. However, Gemini’s letter was clearly edited by several lawyers, and it would be incredibly shocking if they made these allegations without significant evidence. If what they’re saying is true, Silbert may have run a sophisticated yet utterly ridiculous fraud operation that was, like every single other stupid thing that’s happened in the last year, entirely predicated on nothing bad happening.
What happens now? Well, Genesis is likely preparing to file for bankruptcy this week, which will wrap their remaining assets up in a lengthy legal process that will in all likelihood delay any kind of restitution to the tune of years. Digital Currency Group is halting quarterly dividends to its shareholders citing “the current market environment” and a need to “strengthen its balance sheet.”
As I have repeatedly said, all of this is code for “we do not have enough money,” and “the current market environment” refers to the fact that nobody in the world would lend money to a company (or conglomerate) that specifically doesn’t have enough money because they lost it making stupid loans. It’s not entirely dissimilar to Sam Bankman-Fried begging for $8bn of “emergency funding” to plug the holes he’d punched in FTX.
Digital Currency Group is treading water. Genesis has tried to make deals with their creditors, who are refusing for reasons such as “we want all of the money back, not some of it.” As Daniel Kuhn of Coindesk wrote, the worst-case scenarios involve DCG selling its “sizable positions in GBTC,” which would effectively destroy the value of the trust, or worse still file for bankruptcy protection itself. If that happens, there will be 635,000 BTC (and many other cryptocurrencies) sitting in bankruptcy that could reasonably be used to cover debts that Digital Currency Group has. DCG is facing probes from the SEC and Department of Justice going back to before FTX’s collapse, and Silbert can only spend so much time jingling his keys before everything comes crashing down.
I have tried to consider whether there’s a good ending to this story. Genesis has billions of dollars of debt, and the cryptocurrency industry no longer prints money (and perhaps never will again). Lenders tend to lend money to companies based on their ability to repay them, and that is something that Genesis (and Digital Currency Group) have proven repeatedly and publicly they are unable to do. Silbert himself got rich making bets on distressed assets, but I severely doubt any were as distressed as these.
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Komm Susser Turd
Meanwhile, Twitter CEO and ultra-divorcé Elon Musk has found himself sitting between two options - making good on a deal or facing the wheel.
Musk’s painful $44 billion Twitter acquisition (a leveraged buyout) came with $13 billion of debt, which includes yearly interest payments of around $1.5 billion. Problematically, Musk’s acerbic and boneheaded management style has led to a 40% drop in daily revenue (their Q4 2022 revenue also decreased 35% year-over-year), in part thanks to 500 large advertisers dropping the platform.
This particular issue of “not having enough money” and “having a lot of debt” is coming to a head, as Musk’s first interest payment is due toward the end of this month, according to the Financial Times. While it seems unlikely that Twitter would default on its debt, with Musk likely working out some kind of delay in payments as he works out options, the prospect of bankruptcy isn’t off the table. Musk’s other options include bankers replacing $3 billion of the unsecured debt with margin loans backed by Musk’s stake in Tesla, with his holdings dropping from $170 billion in April 2022 (when he started the process to buy Twitter) to around $50 billion today.
The Financial Times reports that Musk has already pledged around 63% of his existing Tesla shares - excluding options, his stock accounts for about a third of his net worth - as collateral for loans. On top of that, Tesla has a rule that executives can only borrow up to 25% of the value of their stock - meaning that as Tesla’s value continues to tumble, so does the amount that Elon can use as collateral, taking away his ability to raise large amounts of money using his most liquid and valuable asset.
This makes the possibility of trading debt for margin loans - effectively replacing Twitter’s debt with Tesla stock - even more painful, because it will inevitably lead to Musk having to break his promise not to sell more Tesla stock for the next 18-24 months.
As I wrote at the end of last year, Musk is facing a reckoning both fiscally and reputationally, and one might argue that the two are inseparable. There is no scenario I can think of where Twitter becomes a profitable enterprise under Musk (who has said he expects it to spend $6 billion without further cost-cutting measures, and that’s before you consider the yearly interest payments). Even if he restructures the debt to include his Tesla stock, Musk is betting, thematically, that nothing bad will ever happen to him or Tesla - who will report their earnings next week.
Musk needs Tesla to succeed at a time when his focus is diverted toward the world’s largest argument generator. Tesla has begun delivering their Semi Truck, but PepsiCo’s Vice President Mike O’Connell made a strange comment about its range, claiming that “for heavier loads of sodas, the trucks will do shorter trips of around 100 miles,” suggesting that heavier loads might stymie the range of a truck that is being sold to companies for the specific task of moving heavy things a long way.
While the Cybertruck is meant to come out this year, it appears that Tesla has only just started building the part of the factory to build the cybertruck. When (if!) the Cybertruck arrives, it will face competition from deep-pocketed rivals like Ford and GM, which have already brought their battery-powered trucks to market, as well as from newer EV firms, like Rivian. Even Lordstown Motors, a startup carmaker that spent much of 2022 teetering on the edge of oblivion, has started deliveries of its Endurance pick-up.
Finally, Musk has reduced the prices of Teslas across the board, which will increase sales, depress margins, and still doesn’t fix the overall problem that Teslas have mostly looked the same (if not marginally worse) for anywhere from 6 (Model 3) to 10 (Model S) years. At a time when Tesla desperately needs to be fresh and innovative, their product suite has stagnated into a mishmash of “sort of but not quite premium.”
In a vacuum, Tesla’s situation is surmountable, but in the shadow of Twitter and a distracted Chief Executive, it’s hard to imagine Musk can save both companies. Twitter is both a financial and psychological burden, a continual gravitational pull on his ego that demands he must constantly post to prove to everyone that this wasn’t a disastrous deal. His obsessive cost-cutting and push for a ‘hardcore’ culture have done little to make the company profitable, and his arbitrary ban of certain third-party clients based on rules that he will not name have only served to upset and annoy the few power users the site has.
Whatever happens, Musk has spent a great deal of money - $26 billion in cash, and however much Tesla stock he’s had to sell - to graphically humiliate himself, all while tanking his net worth and assuring he’ll never be the richest man in the world again. Now he stands trial in a class action suit around his ill-fated “funding secured” tweet, which promised to take Tesla private at $420 a share. A case that will, if the plaintiff prevails, cost Musk billions.
This will be the year that truly defines Musk’s legacy. Will he be seen as a firebrand making daring deals that eventually pay off?
Or will he be seen as a childish, oafish ghoul, incapable of accepting criticism or responsibility?
I don’t know, but I’m looking into it.
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