Crypto’s Start to 2023
A Review of 2022 and a Deeper Dive into Gemini & Genesis
Last year markets re-priced every asset class as inflation spiked pushing central banks to hike rates and remove liquidity. The US saw 7 rate hikes, moving rates from close to zero to 4.5%, which led to significant sell-offs in both equities and fixed income. Crypto was no exception with Bitcoin falling from $65,000 in Nov of 2021 down to around $15,000 in November of 2022. A number of funds experienced major withdrawals and most of the larger crypto companies announced layoffs to allow for repositioning as the market dynamics changed. Perhaps what exaggerated this sell-off in major asset classes was the rapid rise in rates which caught much of the market off guard.
Fast forward to 2023 and we have seen the major crypto coins rally by 25%. So, what has changed in 2023 to bring on this rally? We are not convinced that the market is not more optimistic than it should be, but much of what has changed are inflation expectations. As shown in the chart below, markets have been pricing in a rather significant decrease in the expected inflation.
Source: FRED
As the market has begun pricing for inflation to fall in 2023 (and possibly a recession), the possibility of an end to the hiking cycle is bringing optimism to a market that is desperately in need of some good news.
Many hoped that the FTX collapse would be the last shoe to drop for crypto, but sadly this is not the case. In the last few months, we have seen two more crypto companies come under fire for a very public argument between an exchange called Gemini Trust Company LLC., owned by Tyler and Cameron Winklevoss, and Genesis Capital, a subsidiary of the Digital Currency Group, who specialize in crypto lending.
To preface the latest crypto developments, one thing has to be explained if it isn’t already understood. Many of the centralized crypto firms created partnerships and deal opportunities between them as the rise of crypto began. The idea was that by working together and cohesively, they can bring mass adoption and partake in shared mass growth. A nice idea and in times of prosperity, everyone wins. One bad apple, however, or in the case of crypto, a few bad apples with limited risk management experience can create a domino effect of mass failures. With this in mind, strap on your seatbelts.
Gemini launched a program called EARN in February of 2021 where crypto holders could lend out their holdings through Gemini’s partner, Genesis Capital, one of the many partnerships each company has in the space. Genesis first encountered trouble with the downfall of the now insolvent Three Arrows Capital (3AC). Genesis has filed a $1.2 billion claim against 3AC off of breached loans totaling more than $2.3 billion. Since then, Genesis’ troubles worsened after the massive collapse of FTX. Genesis has made claims that they have ‘no material exposure’ to FTX or it’s token FTT. They did admit, however, that they have $175M of funds locked on FTX’s platform.
While their total exposure in FTX may be considered ‘not material,’ the damage the collapse of FTX has caused across centralized exchanges was done. Spooked investors began pulling funds out of many centralized firms, one of them being Genesis. As their available liquidity began to drain, the already cash poor Genesis was forced to make a foreboding announcement known all too well in the crypto world.
In November, Genesis announced they would be halting customer withdrawals to the program as well as halting the dispersion of new loans. This led to the roughly 340,000 customers of Gemini EARN unable to remove their crypto assets. We have since seen both companies make multiple statements around the dispute.
Currently, there is roughly $900 million of client assets which have not been returned and multiple lawsuits have been filed. To make matters worse, the SEC has sued both Gemini and Genesis for violating investor protection laws. In a rather colorful response to the SEC, Tyler Winklevoss tweeted, “We look forward to defending ourselves against this manufactured parking ticket. And we will make sure this doesn’t distract us from the important recovery work we are doing.”
Don’t forget, another complexity in this debacle is that Genesis is a subsidiary of DCG, a crypto behemoth with over 200 crypto companies in its portfolio. After the FTX collapse, DCG had to issue Genesis a $140 million cash infusion. Furthermore, DCG owns the famous Grayscale Bitcoin Trust which is currently trading at a discount of 36%. When the trust was first released in 2013, it was one of the few ways for investors to get access to bitcoin in an institutional way, resulting in the trust trading at a premium for a number of years and peaking at a NAV premium of 89% in 2018. In 2021, we saw the premium move to a discount hitting a low in Dec 2022 of -48%. The discount has recovered slightly as bitcoin has rallied, but talk of a potential bankruptcy filing at the parent company DCG is not helping. Lastly, Genesis Capital was a liquidity provider for Grayscale.
If you want to really get into the weeds and have some fun connecting the dots, DCG owns one of the largest crypto media companies called CoinDesk. CoinDesk is the company that broke the news about insolvency issues with Alameda and FTX, leading to its eventual downfall and now DCG’s current liquidity issues. Talk about shooting yourself in the foot. Rumors of DCG selling CoinDesk have also started to circulate to help DCG raise funds.
So where does this leave the industry? Assuming that the end of the rate hiking environment is near, we could see major asset classes start to recover, including crypto. We think the more important question will be what have we learned from the past year. To us, the overarching theme of 2022 was that the core concept of crypto is decentralization. Unregulated centralized firms offering high rates of return was never what this was about. We have seen that time and time again, these firms did not have the risk management, the oversight, or perhaps most importantly, the motivation to protect client assets and it has been a painful lesson for many of those who invested.
What did work? Again, we will continue to beat this drum, decentralized lending, decentralized liquidity pools, and decentralized applications – the key offerings of crypto – continue to work in the way they should. As we look to the next two years, it is clear to us there are real benefits of the transparency, the automation, and the efficiency that decentralization offers. Conversations with key partners and investors lead us to believe that we are not alone in seeing this value and we expect to see more focus on the on-chain applications that are being developed to better serve clients and users.
And going one step further, there is a phrase around not seeing the forest from the trees. Blockchain technology will have large implications for many industries as there is much more to this technology than cryptocurrencies. As the price of bitcoin rises, it tends to spur more interest and investor faith in this space. On the other side, as major sell-offs happen, many people hear about money being removed from the space and the loss of confidence in the technology. But what we don’t often see, is that even in times of sell-offs, new investments continue to funnel into new ideas and new decentralized projects. The building has never stopped and it is important to recognize that over time, this technology will have great impact. We will see more ideas and more use cases for blockchain technology in the coming years and we are excited to be building in this space.
