• By Amy Castor and David Gerard
  
  
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The New York Attorney General is suing crypto investment fund Genesis, its parent company Digital Currency Group (DCG), and the Gemini crypto exchange for defrauding customers of Gemini’s Earn investment product. [Press release; complaint, PDF]

Earn put investors’ money into Genesis — where it evaporated.

The lawsuit also charges former Genesis CEO Soichiro (a.k.a. Michael) Moro and DCG founder and CEO Barry Silbert for trying to conceal $1.1 billion in crypto losses with an incredibly dubious promissory note.

New York is asking the court to stop all three companies’ business in “securities or commodities” in the state. That’s all but a death sentence — bitcoin is a commodity in the US.

The SEC was already suing both Gemini and Genesis over the Gemini Earn product because it looked an awful lot like a securities offering. Separately, Gemini sued DCG in July 2023 — and just last week, Gemini also sued Genesis to reclaim missing funds. [Adversary complaint, PDF]

What happened?

Three Arrows Capital (3AC) crashed on June 13, 2022, and blew a gaping hole in Genesis’ loan book. DCG scribbled an IOU to shuffle an imaginary $1.1 billion of value into Genesis reserves.

This financial styrofoam filler didn’t save Genesis, which ultimately halted all withdrawals on November 16, 2022, just days after FTX/Alameda declared bankruptcy. Genesis filed for chapter 11 bankruptcy on January 19, 2023.

The NYAG says that Genesis and Gemini defrauded more than 230,000 Earn investors of more than $1 billion total, including at least 29,000 New Yorkers. New York says that thousands more lost money because of DCG’s actions.

The NYAG claims that:

• Genesis and Gemini lied to investors about Earn and Genesis’ credit-worthiness;
• Genesis lied to Gemini that it was solvent;
• DCG and Gemini lied to the public, including investors, about the promissory note;
• Earn is an unregistered security under New York’s Martin Act.

This is a complaint we recommend you read. We all knew some of what went on between Genesis, DCG, and Gemini, but this suit goes into great detail about what happened behind the scenes.

This is a civil complaint, not a criminal indictment — but the NYAG describes several crimes being committed, particularly by DCG, Genesis, Moro, and Silbert.

How Earn worked

Gemini, owned by Tyler and Cameron Winklevoss, and Genesis Capital, a subsidiary of DCG, partnered to launch the Gemini Earn program in February 2021 — just as bitcoin’s number was going up really fast. Crypto was a hot product!

Gemini and Genesis marketed Earn to the public as a “high-yield investment program” — which is just coincidentally a common marketing term used by Ponzi schemes. 

Earn promised to pay up to 8% yield. Ordinary investors could deposit their crypto via the Gemini exchange. You could get your money back anytime!

Earn was a pass-through fund to Genesis. Retailers put their crypto in Earn. Gemini then handed the funds off to Genesis, who then lent the money to institutional investors, notably crypto hedge fund 3AC in Singapore. Genesis was substantially a 3AC feeder fund — of which there were many.

When Earn investors wanted to withdraw their funds, Genesis had five days to return the principal and the interest, minus Gemini’s agent fee.

Gemini earned more than $22 million in agent fees for running Earn, plus more than $10 million in commissions when investors bought crypto on Gemini to put into Earn.

Paper thin

3AC was Genesis’ second largest borrower. 3AC had borrowed $1 billion of crypto at 8% to 15% interest, secured by $500 million of illiquid crypto tokens.

Genesis hadn’t received audited financial statements from 3AC since July 2020. But with interest rates like that, why worry — it’ll be fine, right?

It wasn’t fine. 3AC fell over on June 13, 2022, losing Genesis $1 billion. Babel Finance, another Genesis borrower, fell over on June 17, losing Genesis another $100 million — because in June 2022, everyone was falling over.

Genesis was $1.1 billion in the red — it didn’t have the funds to pay back Earn investors. Between mid-June and July 2022, Silbert and other DCG officers met with Genesis management to work out how to fill the hole in Genesis’ balance sheets — and what to tell counterparties such as Gemini.

One problem was that some of the collateral for 3AC’s loan was GBTC shares, issued by another DCG subsidiary, Grayscale — which Genesis couldn’t sell, due to restrictions on sales of stock by “affiliates” of the issuing company.

Silbert told the board of DCG that Genesis was anticipating a run on the bank if word got out. So DCG began casting about for financing. Silbert also suggested to the DCG board on June 14, 2022, that they “jettison” Genesis.

But DCG and Genesis decided instead to act like everything was fine. On June 15, Genesis told everyone its “business is operating normally.” Two days later, Genesis CEO Michael Moro posted in a tweet reviewed and edited by DCG: “We have shed the risk and moved on.” [Twitter, archive; Twitter, archive]

Everything was not fine. The 3AC hole meant that Genesis’ loss exceeded its total equity, and Genesis couldn’t pay out Earn investors. Genesis hadn’t “shed the risk and moved on” — it still had the gaping hole in its balance sheet. It was not “operating normally” — it was floundering in a panic.

Genesis was unable to find anyone to lend them the money they needed, so they had to find a way to paper the hole before the end of the quarter.

The solution: DCG would make a loan from its right pocket to its left pocket and count the loan as an asset.

(When Tether and Bitfinex tried to pull the exact same trick a few years earlier, the NYAG fined them $18.5 million and kicked them out of the state.)

So on June 30 — the last day of Q2 2022 — DCG gave its wholly-owned subsidiary Genesis a promissory note for $1.1 billion. DCG would pay it back in ten years at 1% interest.

Both Silbert and Moro signed off on the IOU. The note was, of course, not secured by anything.

DCG never sent Genesis a penny — the note was only ever meant to be a $1.1 billion accounting entry so that Genesis and DCG could tell the world that Genesis was “well-capitalized” and that DCG had “absorbed the losses” and “assumed certain liabilities of Genesis.”

None of this was true. DCG wasn’t obligated to pay anything on the note for 10 years. And Genesis was still out $1.1 billion of actual funds.

Michael Patchen, Genesis’ newly appointed chief risk officer, said in internal documents that the promissory note “wreaks havoc on our balance sheet impacting everything we do.” 

Genesis directed staff not to disclose the promissory note to Genesis’ creditors, such as Gemini. Many Genesis staff didn’t even know about the promissory note until months later.

DCG’s piggy bank

DCG made Genesis’ problems even worse by treating Genesis like its own personal piggy bank. 

In early 2022, DCG “borrowed” more than $800 million from Genesis in four separate loans. When $100 million of this came due in July, DCG forced Genesis to extend the maturity date — and DCG still hasn’t paid a penny of it to date.

A DCG executive told a Genesis managing director on July 25, 2022, that DCG “literally [did not] have the money right now” to repay the loan. Genesis had no choice — the managing director replied: “it sounds like we don’t have much room to push back, so we will do what DCG needs us to do.” DCG also dictated the interest rate for this loan.

Around June 18, 2022, DCG borrowed 18,697 BTC (worth $355 million at the time) from Genesis. It partially paid this back on November 10, 2022 — with $250 million worth of GBTC! — but this still left Genesis with no cash to pay back its own creditors. And it still couldn’t liquidate the GBTC. 

It’s hard to consider the deals between Genesis, DCG, and Grayscale as anything like arm’s length — it was a single conglomerate’s internal paper-shuffling.

On November 2, CoinDesk reported that FTX, one of the largest crypto exchanges, was inflating its balance sheet with worthless FTT tokens. The report brought FTX tumbling down, and FTX filed for bankruptcy on November 11, 2022.

Around November 12, 2022, Genesis sought an emergency loan of $750 million to $1 billion from a third party due to a “liquidity crunch.” Its efforts were unsuccessful. On November 16, Genesis halted redemptions.

If you owe Gemini a billion dollars, then Gemini has a problem

Gemini Earn investors were supposed to be able to get their funds back at any time. This meant that those funds had to be highly liquid. Gemini told investors it was monitoring the financial situation at Genesis. 

Gemini absolutely failed to do this. They lied to investors, and they hid material information. 

Gemini got regular financial reports from Genesis. Gemini’s internal risk analyses showed that Genesis’ loan book was undercollateralized for Earn’s entire operating existence. But Gemini told Earn customers that Genesis had more than enough money to cover their loans.

Starting in 2021, Genesis’ financial situation went from bad to worse. In February 2022, after analyzing Genesis’ Q3 2021 financials, Gemini internally rated Genesis capital as CCC-grade — speculative junk — with a high chance of default.

Gemini also found out that Genesis had a massive loan to Alameda — secured by FTT tokens! The same illiquid FTX internal supermarket loyalty card points that were discovered by Ian Allison at CoinDesk to make up about one-third of Alameda’s alleged reserves.

Even after Genesis recalled $2 billion in loans from Alameda, the crypto lender was still full of loans to affiliates, including its own parent company DCG. 

In June 2022, the crypto markets crashed and burned. But Gemini continued to reassure investors that it was safe to feed money to Genesis via Earn.

This was apparently fine when it came to someone else’s money, but according to the complaint: 

During this same period, Gemini risk management personnel withdrew their own investments from Earn. A Gemini Senior Risk Associate working on Earn withdrew his entire remaining Earn investment — totaling over $4,000 — between June 26, 2022, and September 5, 2022.

Likewise, Gemini’s Chief Operations Officer [Noah Perlman], who also sat on Gemini’s Enterprise Risk Management Committee, withdrew his entire remaining Earn investment — totaling more than $100,000 — on June 16 and June 17, 2022.  

This was when DCG tried to paper over the hole in Genesis’ balance sheet with a $1.1 billion IOU.

Gemini realized things weren’t good at Genesis, but it’s not clear that they realized how bad they were — not helped by Genesis lying to Gemini about their true condition.

From June to November 2022, Genesis would send Gemini false statements on their financial condition — for instance, saying that the DCG promissory note could be converted to actual cash within a year, when in fact, it was a 10-year note. 

Gemini didn’t tell investors that Genesis was in trouble. Instead, they thought they’d “educate clients on the potential losses” and “properly set clients’ expectations.”

When the Gemini board was advised of Genesis’ financial state in July 2022, one board member compared Genesis debt-to-equity ratio to Lehman Brothers before it collapsed.

Gemini tried and failed to extricate itself from Genesis. They just could not get the funds back. But they knew that Genesis operated as a closely controlled sockpuppet of DCG, and they wanted Silbert to make good on Genesis’ debt. 

As things at Genesis got worse, Gemini worked out how to break the news to Earn creditors.

On September 2, 2022, Gemini finally decided to terminate Earn. On October 13, Genesis formally terminated the Earn agreements and demanded the return of all investor funds. 

On October 20, 2022, Silbert met with Cameron Winklevoss of Gemini. Silbert said that Gemini was Genesis’ largest and most important source of capital — meaning that Genesis could not redeem Earn investors’ funds without Genesis declaring bankruptcy.

Gemini quietly granted Genesis multiple extensions to return investor funds.

On October 28, 2022, Silbert finally let Genesis tell Gemini the true terms of the promissory note — just two weeks before Gemini cut off withdrawals.

For some reason neither we nor the NYAG can fathom, Gemini cointinued to take investors’ money and put it into Earn right up to the end!

Customer service

Gemini didn’t do anything so upsetting for Earn investors as to tell them about Genesis’ unfortunate condition — even as Gemini’s own staff closed out their positions in Earn.

One customer wrote to Gemini on June 16, 2022, three days after 3AC collapsed, asking if any of their funds were with 3AC. Gemini didn’t answer the question, but replied with vague reassurances about Genesis’ trustworthiness.

Another wrote on June 27, 2022: “with other exchanges like Celsius and Blockfi I am concerned about Gemini. Does Gemini have any similar vulnerabilities? … liquidity vulnerabilities? … risky investments/loans that would risk my assets or cause Gemini to halt withdrawals?”

Gemini responded: “Gemini is partnering with accredited third party borrowers including Genesis, who are vetted through a risk management framework which reviews our partners’ collateralization management process.”

This investor was sufficiently reassured to send in another $1,000.

A third customer wrote on July 24, 2022, asking specifically if Gemini was involved in any of the “drama” around 3AC and if it impacted Earn. Gemini said they weren’t involved in anything regarding 3AC — even as the 3AC crash had in fact blown out Earn.

The consequences

The NYAG is asking the court that all three companies be permanently banned from dealing in “securities or commodities” in New York — e.g., bitcoin.

Some of the press coverage noted this provision — but didn’t notice that it would be a near death sentence for a crypto business. DCG’s profitable Grayscale business would have to leave New York or be sold off. Gemini would be kicked out of the state.

New York is also seeking restitution for the victims and disgorgement of ill-gotten gains.

Also, they all get fined $2,000 each. It’s possible that bit of the General Business Law could do with an update.