5MF (WEEK 1): GEMINI-DCG, SILVERGATE’S WOES, FED’S PLAN FOR 2023, MORE
Sign up for The Tokenist’s free daily newsletter and never miss a breaking development in macro finance.
The 5-minute newsletter on the important stuff in finance — explaining what’s going on, and why.
Let’s see what’s going on this week:
- Gemini Calls Out DCG: Cause of Concern?
- Judge Rules Celsius Owns $4.2B in User Funds
- FTX Ripples Reach Silvergate: What Happened
- Where Real-world Asset Tokenization is Now
- Fed Minutes Meeting: The Plan for 2023
Leveraged Leftover: Digital Currency Group
- Gemini Accuses Barry Silbert of Foul Play, Calls on DCG to Repay $900M (link)
Is DCG in Serious Trouble?
The process of crypto deleveraging continues on in 2023.
Fresh out of the potential bankruptcy oven, the lingering contagion from last year is hitting Digital Currency Group hard this week.
Here’s what you should know about DCG, headed by Barry Silbert:
- Prolific venture capital (VC) company in the digital asset space: acquired news outlet CoinDesk; established Genesis Global Trading for crypto lending; launched Grayscale Investments, the world’s largest asset manager for digital currency with a reported $50 billion in assets (as of December 2021).
- Due to FTX exposure ($175M locked funds), DCG’s Genesis halted user withdrawals soon after.
- Genesis, with DCG assuming its liabilities, had previously filed a $1.2B claim against the bankrupt Three Arrows Capital (3AC) in July. That Genesis loan to 3AC was partially collateralized by 17.4 million Grayscale Bitcoin Trust (GBTC) shares.
- Gemini, a well-audited crypto exchange run by the Winklevoss twins, used Genesis to supply liquidity for its Gemini Earn program — an interest yielding program similar to Celsius.
- Up until November, Larry Summers, former US Treasury Secretary and Obama advisor, served as a DCG advisor for 6.5 years. On Wednesday, Summers deleted all mentions of DCG on his personal website.
On Monday, Cameron Winklevoss published an open letter to Barry Silbert, DCG CEO. Cameron emphasized that 340,000 Gemini Earn users need their money back — $900 million in total. He also noted that “this mess” is entirely DCG’s fault because the umbrella company owes Genesis (DCG’s wholly owned subsidiary) ~$1.675 billion.
“You took this money — the money of schoolteachers — to fuel greedy share buybacks, illiquid venture investments, and kamikaze Grayscale NAV trades.”
By “Grayscale NAV”, Cameron referenced net asset value for Grayscale Bitcoin Trust (GBTC), which holds $10.65B worth of Bitcoin. The fund trades those BTC holdings as shares, but they have been trading at a -45% discount. This financial stress already manifested yesterday, as DCG shut down its $3.5 billion wealth management division, HQ Digital.
In short, a potentially colossal deleveraging domino is in the works, but heavily foreshadowed. Remember when Sam Bankman-Fried said this at a Congressional hearing in December 2021, referencing the 2008 financial crisis?
“You saw a number of high-collateral, bespoke, non-reported transactions happening between financial counterparties, which got re-packaged and re-leveraged again and again and again. So that no one knew how much risk was in that system.”
It’s as if SBF was describing what his top lieutenants, Gary Wang and Carline Ellison, pleaded guilty to. The same foreshadowing energy is emanating from Barry Silbert’s tweet as well.
Image credit: Twitter
By the end of January we will likely see how well this tweet aged.
How Celsius Just Unbanked its Earn Customers
- Celsius Wins Ownership of $4.2B Worth of Customers’ Funds (link)
- Celsius ‘Earn’ Assets Belong to Bankrupt Crypto Lender, Judge Rules (link)
Earn Money By Losing All Money
Continuing with the Earn fiasco theme, bad news has arrived for Celsius customers hoping to recover their funds.
Like Terra’s Anchor protocol, Celsius’ lending platform dipped into double-digit yield returns on users’ deposits. And, just like with Anchor, the yield-chasing caused Celsius to explode in popularity, gaining over 1.7 million customers last year.
Of that number, 600,000 users took advantage of the Celsius Earn program, which at one point held about $4.2 billion in deposits. Unfortunately, these customers didn’t ask themselves how it could sustainably offer up to an 18.63% APY.
Could it be by counting on more user deposit inflows, forming a pyramidal business model? Or could it be with CEO Mashinsky’s reckless trading with users’ funds?
Following Celsius’ July bankruptcy, a court ruling this Wednesday dealt the final blow to customer recovery. In a 45-page ruling, Judge Martin Glenn said that all $4.2 billion in customer funds is the sole property of Celsius Network, to do with as they please.
As legal precedents go, this is pretty bad but not surprising. In no uncertain terms, the court decision reaffirmed the long-standing mantra — ‘not your keys, not your coins.’
Now that customers’ funds are legally designated as belonging to Celsius, the company has full leeway to create a restructuring plan. To demonstrate an extreme, this plan could then solely focus on repaying creditors and giving bonuses to Celsius leadership without worrying about customers, who are now classified as unsecured creditors.
To add salt to injury, Celsius heavily marketed itself with the slogan “unbank yourself.” It looks like their terms of service just allowed them to unbank their own customers.
SBF’s Chaos Spreads to Silvergate
- Judge Orders Seizure of FTX’s Silvergate Balance as DoJ Takes Alameda’s HOOD (link)
- Silvergate Shares Down 41% Premarket as $8.1B Bank Run Revealed (link)
How Will the Crypto Market Respond?
Silvergate (SI), THE crypto bank, entered the blockchain world early on in 2013.
Thanks to its 24/7 Silvergate Exchange Network (SEN), handling over 1,300 cryptocurrencies, Silvergate has been providing multiple roles:
- Traditional banking services to crypto exchanges and other crypto-related businesses
- Platforming crypto-based lending and borrowing
- Investing and partnering with crypto-based companies
Image courtesy of Silvergate Bank.
So what happened?
If you recall, among its many holdings, FTX also holds Robinhood shares. But those shares were pledged to Alameda Research as SBF’s infinity slush fund as loan collateral. On Wednesday, a federal judge ordered the seizure of $456 million worth of HOOD stock.
And, naturally, Silvergate was the key facilitator as the custodian bank, being FTX’s major client. Additionally, in a separate bankruptcy filing, Bahamian liquidators are seeking the custody of FTX’s other funds. Silvergate responded by saying that FTX accounts have already been seized.
Nonetheless, not verifiably knowing what is under the hood of these financial institutions is a reliable recipe for a bank run. Consequently, as the news hit the wire yesterday, Silvergate Capital reported a frenzy of withdrawals worth over $8.1 billion in Q4 2022. The SI stock suffered a 40% drop.
Year-over-year, Silvergate stock is down by -90%. Image credit: Trading View
Yet, the legal move by the Department of Justice was just a trigger. Following poor preliminary Q4 earnings, Silvergate laid off 40% of its workforce. Likewise, the bank canceled the launch of its own stablecoin and wrote off the $196 million spent on buying Facebook’s Diem payment system.
The Q4 2022 earnings report noted $4.6 billion in available cash, with $5.6 billion in debt securities, mainly in US Treasuries. Most notably, Silvergate suffered deposit withdrawals from $11.9 billion to just $3.8 billion in 3 months.
If the bank run follows through completely, it looks like Silvergate could need a liquidity boost to stay afloat.
Enjoy 5MF? Click to forward it to three friends.
Tokenized Real-World Assets: A Resurgence in 2023?
- Why 2023 Might Be a Big Year for Real-World Asset (RWA) Tokenization (link)
Blockchain Meets TradFi
It’s easily forgotten that cryptocurrency is just one application of blockchain technology.
Another is using such a distributed database to immutably record (tokenize) physical/paper assets. The crypto/blockchain space runs on narratives, and one narrative suggests real-world asset (RWA) protocols are heading for a resurgence in 2023.
RWA tokenization provide multiple benefits to ‘real-world’ assets and processes in traditional finance:
- Increased liquidity: tokenized assets are easier to trade, increasing investor entry/exit in the market at near-instant settlements.
- Fractional ownership: each tokenized asset can be divided into smaller units, making it more accessible and affordable.
- Increased security: by neutralizing multiple dependencies and relying on a single decentralized network (blockchain ledger), RWAs are more resistant to failure and fraud.
- Increased transparency: blockchain’s public proof of ownership can revolutionize audits, providing (much-needed) trust and peace of mind to users.
For these apparent advantages, institutions are ramping up their RWA tokenization.
Last November, three global banks, JP Morgan, DBS Bank, and SBI Digital Asset Holdings, tokenized Singapore Government Securities Bonds alongside Japanese Government Bonds on Ethereum’s Polygon network.
Likewise, the Fed-charted Huntingdon Valley Bank integrated its loan collateral with Ethereum’s MakerDAO, the cornerstone of decentralized finance, with its lending and DAI stablecoin.
MakerDAO community used their MKR tokens to vote for large financial inclusion beyond on-chain DeFi Image credit: MakerDAO
So far, Maker protocol has accumulated $600 million as RWA collateral. Ethereum’s top lending dApp Aave has a nearly $8 million RWA market size.
Typically, tokenized real-world assets involve loans. To illustrate how this can work, look at FinTech company Branch’s automated loan issuance with machine learning algorithms. They typically provide loans to developing countries worth over $500 million.
In turn, Tinlake dApp, accessible through a non-custodial wallet, lists Branch’s tokenized loans as secured non-convertible debenture (SNCD). This is a type of debt companies use to raise capital, backed by the company’s own assets. Listed as Branch Series 3 (1754 Factory), this RWA currently yields 11.22% APY at a 3-year maturity in the Tinlake token pool.
As an open-source dApp, Tinlake transforms business portfolios (Asset Originators) into tokenized RWAs. Image credit: Tinlake
Of course, anything involving finance can become tokenized RWA. Case in point, GIG Pool accumulates tokenized funds for advanced gig worker payments, currently holding $2M in DAI stablecoin, with a yield of 5.2%.
Combining real-world assets and blockchain decentralization, is already underway. The ‘real-world’ benefits that RWA protocols purport suggest it’s only a matter of time before they continue to see increased use.
Job Opportunities: Stubborn Inflation Source
- Fed Wants ‘Flexibility’ on Rates as Inflation Remains Key Focus, Minutes Show (link)
The Wedged Fed
On the monetary policy front, the Federal Reserve published its monthly “minutes” meeting on Wednesday. Consisting of 12 Governors, the Federal Open Market Committee (FOMC) strongly influences the economy as it has control over the flow of money.
During 2020–22, the Fed drastically ramped up the money supply under near-zero interest rates to the tune of ~$5 trillion. This effort aimed to stimulate the economy amid business shutdowns and supply chain constraints, as a way to supplant lost economic activity with excess liquidity.
Fed Chair Jerome Powell featured in Tim van Helsdingen’s YouTube spoof,
‘Money Printer Go Brrr’.
In turn, excess liquidity triggered a 40-year high for inflation. Accordingly, the Fed’s credibility is at stake here. After all, the central bank’s dual mandate is to facilitate price stability and low unemployment.
But what if the latter impedes the former?
When there is low employment, there is less pressure on consumer spending. If consumer spending is not dampened by lowered demand for goods and services, then the inflation rate too is not suppressed. This is why the labor market is such a critical metric for the Fed.
With an unchanged unemployment rate of 3.7% in December, alongside twice the job openings compared to available workers, the Fed considers this a tight labor market. Therefore, to bring the labor market into “balance” (lower employment), the Fed is not expecting to cut rates in 2023.
“Participants cited the possibility that price pressures could prove to be more persistent than anticipated, due to, for example, the labor market staying tight for longer than anticipated.”
December’s Core PCE inflation rate (less food/energy) is 4.7%, well above the 2% target. To cut the legs of inflation in 2023, Fed Governor Neel Kashkari sees the funds rate topping 5.4%, or even more. However, James Bullard, President of the Federal Reserve Bank of St.Louis, sees the restrictive rates coming to a halt sooner rather than later.
Image credit: The Prospects for Disinflation in 2023, by James Bullard.
According to Bullard, 2023 will be the year of disinflation as “the real economy normalizes.”
Trends are certainly moving in that direction. JPMorgan reported that retail stock traders accounted for $3.1 billion in net exits last week, the third worst week in the stock market’s history.
As they say, ‘the Fed giveth and the Fed taketh away.’
Tweets of the Week
This 4% YoY increase is now well below the 7.1% increase in the shelter component of CPI.
Why is Shelter CPI still moving higher while actual rents are moving lower?
Shelter CPI is a lagging indicator & has significantly understated actual housing inflation over the last 2 yrs.
Leading indicator US trade balance suggests US already in recession.
Lagging indicator employment suggests US economy is fine.
Fed says they’re focused on employment… Buckle up.
Why you shouldn’t try to time the market:
13 narratives you should watch in 2023 (and a few to avoid)
2022 was one of the worst years ever for the US stock market