DCG Through the Eyes of a CRO
Written by Roy Tse, Chief Risk Officer
What it means to be the “adults in the room” through the eyes of a Chief Risk Officer.
In the wake of the lawsuit filed by the New York Attorney General against Gemini, Genesis, and its parent company, Digital Currency Group (DCG), for allegedly defrauding investors through the Gemini Earn investment program, the term “adults in the room” might take on a different meaning. The AG is charging the crypto giants with defrauding more than 230,000 investors of more than one billion dollars through misrepresenting with the program as being a “low-risk investment”, as well as by attempting to conceal more than 1.1 billion dollars in losses through some creative accounting.
It Could’ve Been Me!
Mid-2020, at the height of covid and as bitcoin began its surge, I was in the midst of a career transition from traditional finance to crypto and came across a job posting from DCG. My crypto knowledge was mostly retail at that point, having immersed myself in protocol whitepapers, the promise of Web3, and which Pudgy Penguin on the Ethereum blockchain I most identified with.
I was ignorant about the institutional players, politics, and bureaucratic landscape, not privy to the true inner workings of the large crypto players. (Now that I am a bit wiser, the crypto sphere looks just like the traditional finance fraternities of old, just wearing hoodies instead of suit jackets.)
I began the tedious application process for the position of Head of Operations, consisting of four open-ended questions that presumed a tremendous amount of knowledge across disciplines. Questions like “What strategy would you deploy given DCG’s portfolio of companies?” were similar to the process for a comparable position at a traditional finance firm. My responses earned me access to a series of interviews with a very impressive lineup of division heads and potential colleagues.
The “Adults in the Room”
In a recent article, The Wall Street Journal compared DCG at its peak to Standard Oil, and the comparison is spot-on.
At the time of my interviews, DCG consisted of:
Five main subsidiaries in key verticals (Mining; Capital Markets; Asset Management; Wallet; News and Media).
100+ portfolio companies across various industries and geographies, funneling intelligence and insight to DCG.
A small, remarkable group at DCG headquarters dedicated to staying closely attuned to their key subsidiaries and crafting high-impact, big-picture strategies aimed at maximizing DCG’s portfolio returns.
Members of the team I interviewed with were the best and brightest from their respective disciplines and included Ivy-league graduates, bankers from tier 1 investment banks, and efficiency experts. At the end of every interview, I was blown away by the thoughtfulness, humility, and passion of each DCG employee I spoke with, touting the team, its mission, and DCG’s contribution to the crypto-community and the world at large.
The collective praise for Barry Silbert, DCG’s now-beleaguered CEO, “Barry is a genius,” was wrapped in raves about his business acumen and ability to holistically see the big picture while also having a detail-oriented approach and mindset for himself and the team.
I was clearly among the “adults in the room”. For this team, through Barry, crypto was inevitable - the way forward - and they were the pioneers paving the way for the rest of society. Many of the people I interviewed with spoke about “education” as a main component of the value that DCG brings. The team exuded a sense of confidence, from Accounting to HR, with an unflinching belief that no matter what happened, they had the talent and resources to overcome any obstacle.
The Allegations: While Some are Pedantic, Many Are Serious and Legitimate Cause for Concern
Which brings us back to the New York Attorney General’s lawsuit. The 58-page suit includes a number of ominous-sounding charges and allegations of misconduct against DCG, Genesis, and Gemini, which, on the surface, look pretty bad.
As a traditional finance risk manager for most of my career, many of the allegations are typical pain points for our industry, and numerous companies have committed similar violations unintentionally due to human error, ignorance of the rules, or accidental negligence. Given some of the seemingly baseless cases brought forth by the SEC and New York AG against crypto companies, it’s important to consider the allegations made and form our own conclusions on their merits and potential political motivations.
While the suit alleges many bad corporate practices and pushing and bending of policies and procedures that are not acceptable, in the interest of time (and my sanity), I am going to highlight a few of what I deem to be the most serious allegations which indicate that the “adults in the room” were anything but:
(Over-) concentration in Alameda
Promissory note – Genesis to DCG
Gemini Earn’s targeted clientele
Risk Management 101: Concentration Risk
The lawsuit alleges that nearly 60% of non-affiliated loans on Genesis’s books were to and with Alameda, the under-investigation FTX sister company, and that the collateral pledged was mostly FTT tokens which we now know to be of questionable market value. DCG and Genesis can claim ignorance of FTT’s market value; that level of skepticism should be allowed given how many “experts” in both traditional finance and crypto trusted FTX and FTT. What is NOT allowable and begs disbelief is permitting 60% concentration with any one counterparty.
One of the first phrases I learned in English was “don’t put all your eggs in one basket.” This simple, fundamental tenet of human behavior did not seem to be in effect at Genesis in July/August 2022. Despite the Three Arrow Capital default and implosion in June 2022, Genesis continued to allow nearly 60% concentration in one counterparty. In my 25-year career, I have rarely, if ever, seen a concentration that high for any significant amount of capital.
The 1% / Mind the GAAP
According to the NY AG lawsuit, DCG and Genesis entered into a promissory note to be paid in 10 years at 1% per annum interest rate.
It is widely known within the industry that transactions across related parties are generally permissible provided that the existence of the transaction is transparent and properly disclosed and that the terms of the transaction are “market”, meaning an unrelated party would do business with you at similar terms and prices. In the many related-party transactions I have been involved, my team and I made absolutely sure to 1) request proposals from unrelated parties; 2) obtain bids in some form of writing at minimum; and 3) archive and store received bids as verifiable proof for our financial auditors.
The idea, of course, is that a company with related business should be able to provide referrals to one another, but not at “sweetheart” terms and pricing that would hurt either company’s investors or breach fiduciary responsibilities.
It is baffling that the “adults in the room” with whom I met and interviewed could make such an obvious mistake if they were truly trying to disguise the situation. If the allegations are true, then it points to either hubris or ignorance, neither of which is acceptable.
The 1% interest rate aside, the NY AG suit alleges that in reports provided by Genesis to Gemini from July 2022 to November 2022, the promissory note between DCG and Genesis were “fraudulently categorized… as a current asset.”
Anyone who has taken an Intro to Accounting class is familiar with Generally Accepted Accounting Principles (“GAAP”). Current Assets are, simply, assets that are “current” which can be converted into cash or cash equivalents. Current Ratio, a common measure of near-term financial solvency for a company’s health and ability to pay creditors, is a ratio between a company’s Current Assets and Current Liabilities. A mis-categorization of the promissory note would drastically change the picture of a company’s financial health, especially given a note of this size.
Whether the mis-categorization was intentional or not, an error of this size is gross negligence at best. As all financial contracts are subject and open to review by a firm’s auditors, no reputable auditor would place its stamp of approval on a company’s financials unless it was confident that every stone had been turned…twice. The “adults in the room” must ensure that the terms, price, history, and chain of communications prior to the transaction were all properly performed and documented for the very real likelihood that the transaction was audited.
The fact that this erroneous reporting persisted for months and was not caught, especially during a period of intense stress and scrutiny, is not forgivable.
Don’t Mess with Main Street
The Gemini Earn program, launched in partnership with Genesis, was portrayed as a trusted intermediary to co-manage funds in generating yield for Earn participants. Gemini publicly touted their Earn program and its virtues, claiming it to be a low-risk investment for retail investors.
Yet, in its statement, the NY AG’s office highlighted the losses suffered by these investors: “Hardworking New Yorkers and investors around the country lost more than a billion dollars because they were fed blatant lies that their money would be safe and grow if they invested it in Gemini Earn.”
I think if I have learned any lesson in my years in traditional finance, it’s that “it’s a dog-eat-dog world” as long as the bloodshed stays in Wall Street and off of Main Street.
When institutions conduct business with one another, there is an implicit and legal understanding that while honesty and transparency are expected, each party is responsible for performing their own due diligence and rely on their experience and findings rather than on blind faith in their decision making. In that vein, legal and agency (SEC) enforced definitions of Qualified Purchasers and Accredited Investors exist to differentiate between what is largely classified as “institutional” vs. “retail”, creating a distinction between “Wall Street” and “Main Street”.
In 2008, my grandmother called me from Hong Kong to ask, “Why is your company [Lehman] losing all of my friends’ life savings?” My response that I worked for a different division entirely independent of the products in which her friends invested, however logical, was completely irrelevant to her. Her friends were impacted.
I am obviously not my grandmother. I work in the industry and because of that, am considered an Accredited Investor by SEC’s standards; effectively someone who has enough knowledge to have the responsibility to make sound investment decisions for themselves. Like my grandmother and her friends during the GFC, however, most of Earn’s investors were not Accredited Investors nor had the knowledge to dissect how Earn generates their yield.
The distinction between institutional and retail is an important one. Companies that conduct business with “retail” customers are typically subject to much more stringent standards and rules (rightfully so) by their regulatory bodies than companies who solely interact with “institutional” customers. Institutions are expected to have the expertise and resources to perform all the necessary due diligence in their decision making. Buyer beware.
Thus, Gemini, as a representative of the Earn program which is aimed at retail investors, has both a fiduciary and moral responsibility to ensure that the program is conducted with the utmost transparency and honesty.
If the NY AG’s allegations are proven to be true, it’s disappointing.
The Real Adults in the Room
Through this and many other lessons I’ve learned, I think being the “adults in the room” may be summarized as follows:
To have the confidence and experience to overcome obstacles as you face them;
To have the wisdom to know that you can’t win them all; and
To have the humility to accept and admit defeat.
While the veracity of the NY AG allegations will reveal itself over time, based on the excerpts from the suit, there does seem to be the sense that as the situation deteriorated, DCG, Genesis, and Gemini were all hesitant to acknowledge or admit the size and magnitude of the problem at hand. It eerily harkens to the lessons of FTX, Long Term Capital Management, Lehman, Enron, Madoff… all the way back to Charles Ponzi. History has a way of repeating itself.
Maybe it's time to reconsider who the adults in the room really are.
