Sep 1, 2023

What Are The Implications of the DCG Deal and the Grayscale Case?

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There's a bit more nuance to Grayscale's legal victory than meets the eye–let's take a look.

Digital Currency Group (DCG), the parent company of cryptocurrency lender Genesis Global Capital, has reached an "in-principle" deal with #Genesis creditors to resolve claims brought up in Genesis' bankruptcy filing. However, a group of creditors holding $2.4 billion in claims is opposing the deal, calling #DCG's contribution "wholly insufficient." Under the proposed deal, DCG would make partial repayments on outstanding loans totaling $1.73 billion through new debt facilities and installment payments. DCG claims this could result in 70-90% recovery for unsecured creditors, but the opposing creditor group disagrees. The opposing creditors argue that DCG and Genesis agreed to the deal without properly considering potential legal claims against DCG and its executives, including CEO #Barry #Silbert. They say the deal inappropriately releases DCG and Silbert from future liability. This group threatens to block approval of any bankruptcy plan that includes the current DCG agreement. The conflict over the DCG deal has stalled Genesis' bankruptcy proceedings, which were filed in January. The opposition from creditors holding a majority of claims against Genesis makes it unlikely the current deal will be approved.

Further negotiations or litigation may be needed to resolve the standoff before the wind-up of Genesis can be completed. #Grayscale scored a major legal victory this week in its ongoing battle with the Securities and Exchange Commission (SEC) to convert the Grayscale Bitcoin Trust (GBTC) into a spot bitcoin exchange-traded fund (ETF). The ruling by the U.S. Court of Appeals criticized the #SEC's inconsistent treatment of spot bitcoin #ETFs compared to already approved bitcoin futures ETFs. Grayscale persuasively argued that its proposed spot bitcoin ETF is fundamentally similar to the futures-based products in both its composition and its robust surveillance-sharing agreements. This decisive legal win has forced the SEC into a difficult position and increased the likelihood of a spot bitcoin ETF finally gaining regulatory approval this year. Bloomberg ETF analysts estimate the probability has risen to 75% for 2023, up from 65% previously. They believe the SEC's legal and public relations setbacks will make further denials of spot bitcoin ETFs "politically untenable." However, the same analysts expect the SEC to delay pending decisions on spot bitcoin ETF proposals from asset managers like VanEck, Valkyrie, and Fidelity originally due in early September. Nonetheless, in the wake of the Court of Appeals judgment, the path forward for a spot bitcoin ETF now appears far clearer. The SEC must either reverse course and approve the conversion of the Grayscale Bitcoin Trust, deny it on different and more robust legal grounds, or take the dramatic step of forcing existing bitcoin futures ETFs to close. Neither of the latter options seem likely given the reputational harm the SEC would suffer. In the short-term, the court ruling provided an immediate boost to Grayscale and the bitcoin market. The GBTC discount versus its underlying bitcoin assets shrank from -25% to -17% following the news. The shrinking GBTC discount in recent months has been a positive sign for the chances of regulatory approval. The Court of Appeals gave the SEC 45 days to request a rehearing before the full circuit court. Once that window closes, the court will issue its final order with directives for how the case will proceed. But after this latest defeat, the SEC may decide to give up its opposition rather than risk another loss. While uncertainties remain around the precise timing, it now seems almost inevitable that 2023 will see the launch of the first U.S. spot bitcoin ETF. Such a move would open the bitcoin market to trillions in investment capital and be a validating moment for the cryptocurrency industry. For Grayscale and bitcoin investors, this week's legal victory represents a major step toward that milestone.

However, although it may seem like Grayscale has scored a big win for DCG, that doesn’t appear to be the case. Grayscale and DCG have essentially kept GBTC shareholders captive and have been profiting from them through fees, which they will lose once GBTC converts to an ETF. Currently, Grayscale generates 2% annually from approximately 630k BTC, much of which they could lose to rival ETFs like BlackRock or VanEck once their ETFs are also approved. While Grayscale might see its own ETF approved first, it’s likely to experience heavy outflows despite potentially lower fees of 0.5%. What DCG stands to gain at this point is restored credibility, more interest and trading volume for ETHE with hopes it too will convert to an ETF, narrowing of the heavy discounts on its other crypto-related trusts, and therefore strengthening of DCG’s balance sheet. This could put DCG in a better position to repay Genesis creditors.

Gemini has joined two other creditor groups in objecting to Genesis' proposed bankruptcy resolution plan, arguing it lacks detail and does not provide assurances for repaying some of Genesis' largest debts. Attorneys for Gemini said the plan revealed on August 29 is "woefully light on specifics" and economic consideration. The objections follow similar filings from two other creditor groups, with all three calling for an end to the exclusivity period that has allowed Genesis to negotiate bankruptcy terms through mediations. Gemini claims the proposed deal does not resolve claims against Digital Currency Group, Genesis' parent company which Gemini says has not paid approximately $630 million in loans owed to Genesis.

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