February 2, 2023

Analysis | Crypto’s Hotel California Traps the Winklevoss Twins

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You can get into crypto any time you like, but can you ever leave? A fierce $900 million Bitcoin feud between the billionaire Winklevoss twins and Barry Silbert suggests the virtual currency bubble’s main legacy is a version of Hotel California, with clients desperately hoping for fresh money to pick up the tab — or a change in management that will let them check out.At the heart of the dispute is a crypto lending business that blew up in spectacular fashion last year after bringing Cameron and Tyler Winklevoss and Silbert together. As relatively early Bitcoin adopters, the moguls no doubt recognized one big challenge in crypto: How to earn money from a pile of virtual tokens with no intrinsic value.

The result was a cottage industry of platforms, including the Winklevii’s Gemini Earn. Gemini took crypto from depositors and lent it to Silbert’s crypto brokerage Genesis, which in turn entrusted it to investors including Three Arrows Capital (3AC) looking to juice returns. In the frothy times of everything going up, everyone checked in: Eye-popping interest rates of 7%, the promise of instant withdrawals and the names involved meant few really read the fine print.But when markets went south, the new structure became yet another gilded cage: Everyone wanted to leave but nobody could settle the bill. When 3AC went bankrupt in July, Silbert’s Digital Currency Group had to cover some of Genesis’ debts with a $1.1 billion promissory note, while FTX’s downfall in November meant platforms everywhere froze withdrawals — including Gemini and Genesis. More than 340,000 Gemini Earn customers are trapped in limbo, owed $900 million by Genesis.

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Ordinarily, absent a white knight or magic bundle of outside cash, one might reasonably expect the cascade of defaults to trigger a bankruptcy procedure or meeting to hash out a settlement, which is what the Winklevoss twins had hoped to do with Silbert by Jan. 8. But, this being crypto, one annex of the hotel always seems to lead to another rather than an exit. Silbert may be biding his time or reshuffling his assets because there is a golden egg-laying goose in his empire: Grayscale Bitcoin Trust, the biggest digital currency fund in the world. And this fund has a California-like layout of its own: It charges 2% annual management fees based on the net asset value of its holdings, bringing in $615.4 million in 2021 alone.

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Holders have little choice beyond selling their shares on the open market in the crypto winter — there’s no redemption mechanism to get at the fund’s underlying Bitcoin holdings. And this may be why the Winklevoss twins are resorting to public accusations of self-dealing and accounting fraud against Silbert and asking for him to step down. Besides painting Gemini as a victim of Genesis rather than an enabler, Cameron’s Winklevoss’s latest letter pressures Silbert to shed more light on his opaque empire with regulators circling and hedge funds agitating. The $1.1 billion promissory note in particular is described as a “gimmick” and inadequate funding.  The result is that DCG may reluctantly find itself forced to give up control of its most precious entity — Grayscale — or trigger a bankruptcy of Genesis, which for Gemini might unlock funds to repay customers. (DCG on Tuesday called Winklevoss’s letter “malicious, false and defamatory” and said it would engage in “productive dialogue with Genesis.”)

This mess has plenty of possible outcomes, none of them objectively great for the retail customers taken on the crypto joyride. Even if somehow a direct connection is forged between Grayscale’s cash flow and the claims of Gemini’s disgruntled depositors, it will be the hedge funds looking for an angle on Silbert’s trust or the legal advisors handling claims that will probably come out best.In the meantime, the twins do have a point in trying to shine a light on DCG, where US authorities are already scrutinizing internal transfers. We’ve seen from FTX the dangers of opaque, sprawling entities that aren’t held to a high standard by counterparties or regulators. DCG has a portfolio of over 200 companies and funds, and more transparency is needed — not least where Grayscale Bitcoin Trust is concerned, given how costly and poor a trade it has been. The trust’s price fell 76% last year, and trades at a 39% discount to its net asset value.Yet there’s also plenty of blame to go around in the broader picture of how we got here. Jonathan Bier’s book on crypto lending, Reckless, makes clear that the latest bursting of this bubble has all the hallmarks of a generalized financial crisis; greed, bad risk management, conflicts of interest, insufficient regulation and unsustainable trading strategies. Genesis’s balance sheet expanded too fast, while the Winklevoss twins’s search for new revenues saw them adopt laser-eyed hype all the way. “The individual feels like doge is money? Then it is,” Gemini COO Noah Perlman said in 2021, referring to the dog-linked cryptocurrency that its founders established as a joke.

Whatever happens, crypto’s Hotel California problem is likely to stay. You can’t use Bitcoin to pay your bills or live off the income without cashing out. The lending business will likely survive, but in much smaller size, while crypto fans try to bring more buyers in to prop up the price. Which means regulators need to be vigilant. Nobody’s out yet.

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More From Bloomberg Opinion:

• Beware the Dangers of Too Much Crypto Regulation: Tyler Cowen

• Navigating 2023 With Seven Charts and a Cat: Ashworth & Gilbert

• Beware Crypto Billionaires Boasting of Audits: Lionel Laurent

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Lionel Laurent is a Bloomberg Opinion columnist covering digital currencies, the European Union and France. Previously, he was a reporter for Reuters and Forbes.

More stories like this are available on bloomberg.com/opinion

©2023 Bloomberg L.P.

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