Unpacking the Markets, Bitcoin Miami and DCG's Future

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1:30Ram Alawalia, co-founder and CEO of Lumina. Welcome back to Crypto Daily Briefing. Thanks for having me, Ash. Ram, it's always a pleasure to have you on the show. A lot to talk about today, especially from the macro to the micro. Talking of which, let's do a temperature should check on what's happening right now in price action. Bitcoin trading on my screen, 26 ,310. There's a lot of red. It's down on a trailing 24-hour basis, 3.7%. On a trailing seven-day basis, off 1.8%. Ethereum trading below the 1 ,800 handle at 1 ,792. Trailing 24-hour basis, off about 3.5%. Trailing seven-day basis, more or less flat, about minus 2.3, or minus, excuse me, 0.3%.

2:16Ram, there's the background. There's the context. A lot happening right now. We've got a lot of news flow on DCG and Gemini. We've got a lot of macro context to provide. Big picture, where are we right now in these markets? A lot to cover. So overall, market liquidity is receding. That's true in the crypto markets. It's also true in the capital markets. We're also seeing that inflation is remaining stubbornly high. There was a quote in the PayPal earnings transcript that says, quote, across the world, inflation is stubbornly high. And so it looks like the easy winds of inflation around goods and services are behind us.

2:58And now we're heading into a tougher road. And markets are trying to make sense of what lies ahead. The market still expects a Fed pivot. On the other hand, the most bid-up sectors in the market include defensives like healthcare and utilities from a PE ratio basis. We've also got a bid on the AI narrative theme. And meanwhile, the VIX is at 17. Yeah, there is that mismatch there. Ram, let me ask you this, this idea of receding liquidity for folks who may not know the financial markets jargon. What does it mean? Why is it important in crypto markets? Sure. So there are different kinds of liquidity.

3:42So one form of liquidity is ability to buy or sell a quantity of a digital currency or stock or bond. And what is the price impact from that? a highly liquid market, you can buy a large volume or quantity of a commodity or security or digital currency and not impact the price. And in the crypto market, one of the learnings from the Bitcoin Miami conference is that, and of course, in general, you're seeing this on Twitter as well, is that market liquidity has dropped dramatically. On that measure, you're getting the price impact of$50 million buy-sell that you would have seen a year, year and a half ago on a$2 million market order today.

4:27So markets are much more sensitive to market buy-sell orders. That's one measure of liquidity and other measures of liquidity. I mean, that's 25 to 1. That's a big shift. That's right. And a big driver of that, I contend, is the consequence of seeing Silvergate and Signature Send Network exit the market. We're now seeing the consequences of that. Market makers, like Jump, it's been reported, is also withdrawing their footprint from the market. And these are related, of course, because market makers, although they're not directly regulated by the SEC, they do have an obligation to adhere to OFAC, meaning anti-money laundering and sanctions control regime.

5:15And banks played a role for them in achieving that obligation. Yeah, I don't want to sort of so FUD here, but I want people to understand this concept of liquidity and the potential risk. And I think one of the sort of philosophical challenges to thinking about this is you can have this sort of creation of a fragility in a market without seeing a massive downturn in price. But it makes it a sets up a context or an environment or a market setup where the risk of that happening increases. that's right that's right and there's other factors at play here too we have a handful of market makers that are remaining and their business is growing i think that's one of the headline coming from these recent conferences the folks that are left standing are taking share and they're doing well uh you know galaxies market making businesses is growing cumberland is taking share and players are trying to fill the gap from the demise of FTX.

6:20Another interesting takeaway is FTX did play an important role in creating market liquidity, notwithstanding the issues around fraud and governance and other matters. And this is why you're seeing Coinbase look to develop an offshore herps market. And as you and your audience may know, herps are the primary trading instrument in crypto, it's a key source of market liquidity. There's a major gap in the market. Someone needs to go fill that. So it's another prong of the liquidity stool that's been missing. Yeah, we just had this conversation with Paul Graywall, the chief legal officer at Coinbase, I believe Coinbase International, headquartered down in Barbados.

7:03Right. Now, from a market's perspective, if you zoom out from crypto, and I always think about crypto as the marginal liquidity market, meaning when there's new liquidity entering markets, crypto is a disproportionate beneficiary of that. And then when liquidity leaves markets more generally, crypto is disproportionately hurt from that. You're seeing, of course, this debt ceiling issue. One of the consequences of the debt ceiling is that the treasuries had a drawdown on their TGA, essentially the checking account at the Fed. And once we inevitably get past this debt ceiling, I don't have a view on what happens or doesn't happen, but at some point we're going to get past this, you're going to have to see the Treasury issue a substantial amount of debt to the market to replenish the coffers.

7:52The deficit right now is about$2 trillion per year. So within the next couple of months, certainly inside of six months, you should see a trillion dollars in debt issue. Why does that matter? Well, it matters because this is the opposite of quantitative easing, right? So when the Federal Reserve purchases bonds from the open market, they're adding liquidity, they're adding to bank reserves. When you have the issuance of bonds, you're selling bonds to the market, you're withdrawing liquidity from the market. And a trillion dollars in six months is a significant number. Consider that the entire size of quantitative easing was$9 trillion.

8:30So the fact that the Treasury does have to issue this, it creates an accelerant of what we might experience around the eventual introduction of quantitative tightening or the acceleration of quantitative tightening more generally. So let's explain for folks who may not know the importance and the impact of financial conditions, liquidity in the banking system that traders have access to. Sure. So banks intermediate credit. And when the money supply is going negative, then banks have less ability to generate new loans. And we're seeing that in the hard data today. If you look at the most recent reporting, month-over-month loan growth across banks, more general credit growth as well as CRE credit growth has come to us still.

9:20Some of that likely is the consequence of the March banking issues. We have to see whether that's permanent or temporary. But liquidity finances assets. If you have access to liquidity, then you can purchase assets. So it's an important form of financing. So when liquidity is withdrawn from the system, then it's harder to execute or finance transactions. All things being equal, liquidity supports asset prices. All things being equal, liquidity supports asset prices. Rom, I know you've just gotten back, I believe, from Austin, Texas, and Miami, that being shorthand for CoinDesk Consensus and Bitcoin 2023.

10:00What's the scuttlebutt? What's the feeling on the ground? What are folks talking about when you go out to have a cocktail, not necessarily from the podium? So there are a few themes here. One is around the venture market. Two is innovation. Third is around Bitcoin ordinals and the rise of Asia, the resurgence of Asia. Let me cycle through those briefly. So in the venture market, the theme is that there's still a lot of venture capital chasing a finite set of opportunities. And valuations remain high. They are coming in. Certain rounds, particularly later rounds, are experiencing locked markets, for example, like a Series C de minimis transaction activity because founders don't want to get markdowns, and perhaps the venture funds are trying to avoid that too.

10:48It is flowing back to earlier rounds like seed, but even so, the valuations are still elevated to where you were post-financial crisis. Consider that Uber and Robinhood were valued in their seed round at$4 million,$8 million, respectively. And now you're still seeing seed rounds at$20 to$30 million, not always with traction. So that's one. More pain to come in venture. The second theme within venture is this bet on the rise of Asia. And this is in part driven by regulatory and also the roots of crypto. So, of course, Singapore and Japan and Hong Kong are relaxing and creating frameworks for crypto.

11:30CZ reported on Twitter today that China, state-run media, had some discussion of crypto. I haven't looked into that closely myself, but that's quite interesting. And so a number of the top venture funds we've talked to are making a bet on the rise of that or resurgence of that customer segment. We are also hearing of entrepreneurs relocating or establishing their domicile in friendly regulatory jurisdictions, which is incredibly unfortunate. So that's on the venture side. Now, the product innovation, a few things, tokenization, restaking is all the raging out, eigenlayer, and of course, ZK rollups I'm also excited about.

12:14Hey, everyone, we're going to take a quick pause and hear a word from our partners. We'll be right back.

12:23why don't you break that down and explain it for folks who don't have engineering backgrounds sure i'll walk through that so tokenization is listing an asset on chain so unlike securitization which is opaque uh can lead to illiquid markets it almost ended the banks and or unaligned the banks in 2008 blockchain gives us tokenization which allows us to list assets on chain with transparency with standardization, and together that creates liquidity. So if you remember the scene from the big short where Michael Burry is crawling on the floor trying to figure out the FICO score on a loan, looking at a dot matrix printer output.

13:01The blockchain puts all that to bed. The blockchain creates real-world transparency. And it's a surprising fact that in today's securitization markets or private securitizations, which are a substantial portion of securitizations. You still do not have low-level data. My prior company, I started PureIQ. We fixed that by providing data to different hedge funds, but it's not a public requirement. So that's one, that's tokenization. You're seeing institutions like Wellington. Wellington is one of the largest global asset managers. Wellington's a big deal. Wellington is testing tokenization on AVAX subnets as well as on other L2s, including MATIC.

13:44It's very interesting because the current approach on tokenization is this middle ground. It initially started as fully permissionless, and that didn't work for regulatory reasons. And there was also an approach on fully private permission networks, for example, like the R3 blockchain, which is created by a consortium of investment banks. Well, that didn't go anywhere. What's the point of that? It's another DTCC-type database. And so now there's testing of this hybrid. By the way, Depository Trust Clearing Corporation, this is the traditional way that U.S. equities get cleared here in the United States, like 99 % or so.

14:21Exactly right. So now we have this middle ground of testing tokenization on these subnets, on AVAX and MATIC. So I'm very excited about that. It would address the kinds of real world issues that banks have today with trying to liquefy their CRE debt and sell off other securities in a broader market. CRE, by the way, for those who may not know, is commercial real estate debt. This obviously is a big macro point. We were just talking about this earlier in the micro context by the empty co-working space that you're coming to us from today. That's right. That's right. Now, I take a quick look here.

14:56We've got a lot of empty seats around. I'm trying to do my part to support the New York City commercial real estate market. It's a small part. Someone's got to do it. So ZK roll-ups, another one, zero knowledge proofs. Now, this is a technology that allows, say, an app to interrogate or query a smart contract and generate a result, say true or false, without revealing the private contents of the smart contract. for example, could say, Ron is a US citizen and it returns true without revealing personal details. In other words, proving that you know something without revealing what that thing is.

15:34The other general way that we hear for the Ethereum L2 networks is optimistic rollups, assuming that something is true until there's a challenge. All types of ways, essentially, trying to get greater speed, efficiency, and cost savings on these networks so that you can do these things at scale. That's right. And think about the Equifax data breach from a few years ago. The fact that you have third parties have access to private personal data that they're monetizing without our permission that have clearly experienced security breaches. Can't think of a better use case. And of course, applying ZK technology to healthcare data, which is begging for technical innovation as well.

16:15So this was the best idea from a co-founder of consensus and they estimate the market opportunity as substantial as trillion. So I'm very excited about it. I met with a technical... By the way, we should also say, I mean, other folks are doing this. KKR did an AVAX tokenization product. We were just talking about this with Rob Frasca earlier this week, this idea that these large financial services behemoths do not want to be left behind. So they dip their toe in the water. You know, you, Ram, you now know these kinds of folks. And, you know, they obviously don't want to bet the farm on any one technology, but they want to dip their foot in just so that they don't wake up one morning and find out that their shop is a decade behind on technology.

17:01That's the rub here. And that why you see, I think, so much of these little sort of little mini beta projects. They're not being done because they think they're going to make a ton of money on them. They're being done because they know that this is a potential future direction that the industry may head in and nobody, nobody wants to be left behind. 100%. That's another key theme, which is that the institutions are still here and they're still coming. And as you said, there are a number of these test projects out there. The KKR has inspired follow-on projects as well. You know, Apollo, we know Christine Moy left JP Morgan.

17:39She was leading the crypto group there. She's at Apollo now. Consider the various assets that Apollo has and the opportunity that they can take advantage of with tokenization. So I'm very excited about Real World Assets on Chain. It enables crypto to have a more relevant day-to-day impact to American capital markets and ordinary Americans, which helps set a positive vision and tone for crypto with Congress and the American public. Okay, speaking of institutions, I want to say first, we checked Coinbase International headquartered in Bermuda. Second, talking more broadly about institutions, something that I know that you're following very closely, Ram, something that we've talked about here on this show a number of times, is what's happening right now with DCG Genesis Gemini.

18:27This is a very large story in the market, something that came up last week because there's a risk of a default here. Let's explain to folks who haven't been following this story closely because it is a complicated one. And frankly, the names sound a lot alike, and I think it's confusing to a lot of people. What's happening here, big picture? Where are we? 50 ,000 foot with DCG Genesis Gemini. Okay, let me introduce the cast of Shakespearean characters here and then unpack the drama and what happens next year. So you've got Digital Currency Group, which is a blue chip storied institution, which has done something like$600 million plus in venture investments.

19:04And they have a number of wholly owned subsidiaries. That includes Grayscale, the issuer of Grayscale Bitcoin Trust, as well as other trusts linked to Ethereum and other tokens. and DCG also spawned Genesis, which was the world's leading prime broker for crypto, meaning that they extend credit, provide trading services for institutions, high net worth individuals. So DCG, in the run-up of the bull market, acquired$780 million of GPTC, which again was issued by the subsidiary Grayscale on leverage. That leverage was extended by Genesis Prime Broker, and they were betting presumably on the GBTC discount, narrowing closer to fair value because the GBTC, much like other closed-end funds, generally traded discount to fair value.

20:00They were making a similar trade as 3Rs Capital was making. Unfortunately, spreads widened last year. 3Rs Capital had a margin call. They couldn't deliver. 3Rs Capital defaulted. That then led to Genesis defaulting over the summer of last year, and that created a$1.1 billion hole in the Genesis balance sheet. At that point in time, DCG had a game time decision to make. they could either let genesis file for chapter 11 because they would have been insolvent or they could step into the breach and assume that defaulted loan obligation they made decision number two they assumed the 1.1 billion dollar defaulted loan onto the dcg balance sheet and they swapped that with a 1.1 billion dollar loan the dcg and the genesis balance sheet to take a step back.

20:55What happened is Genesis had a whole,$1.1 billion hole. That hole, because the three years capital defaulted, was replaced with a good loan to DCG. So Genesis was made whole. Now, Genesis, after the FTX unaliving fraud, demise, whatever you want to call that, had to suspend withdrawals. And Genesis ultimately filed for Chapter 11 in January of this year. And now Genesis is going through a bankruptcy process. So it's a very complex situation. You have another entity involved, which is Gemini, of course, founded by the Winkervoss twins, another leading crypto exchange. And Gemini had created an earned product.

21:44and that earned product delivered yield to retail accounts and high net worth investors. And the primary credit there was Genesis. So, you know, you have, that's where we are now. And there are a set of issues and conflicts at play here. First off, on May 9th, 10th and 11th, the DCG had an obligation to pay approximately$620 million in debt due to its subsidiary Genesis. It did not meet those debt payments. That's one. Let's come back to that. DCG is now entered into a 30-day mediation period with its subsidiary Genesis, as well as the creditors of Genesis, which include Gemini and also direct creditors to Genesis.

22:33That 30-day period should conclude in the next one or two weeks, let's say. There may well be a cure period around these defaulted loans, meaning if you default on a loan, you have a cure period whereby you have an opportunity to make that payment as well. So a lot is coming to a head in the next one to two weeks. What's happened fundamentally is there's a lack of trust from the creditors to DCG, and that lack of trust stems in part because genesis management allegedly uh current some of the current genesis management including the interim ceo uh signed off on allegedly false balance sheet statements statements which induce creditors to either make a deposit or roll over their financing so they're irate and then second there's no transparency into the dcg balance.

23:28You know, DCG doesn't have an obligation to share that. So the game theory around this is like a, it's like a mutually assured pain and it's extremely unfortunate. And I hope all parties can arrive at a settlement as opposed to having another legal proceeding open on DCG, which would delay recovery for Gemini Earn, as well as the creditors, and reduce the value of the pie. Because in the background, of course, Gravescale seeks to convert to an ETF. Gravescale is suing the SEC. And should that happen, and I hope that happens, we should all hope that happens, that would also at the same time reduce the revenue generating power of Gravescale, which hurts the ability of DCG to honor the$1.7 billion in debt that it owns to Genesis.

24:28So it's complicated. I'll pause there. One last thing I should add to this, Ash, to this drama is there's a tension between Gemini Earns. Gemini Earns about 350 ,000 creditors, again, primarily retail creditors, and the direct creditors to Genesis. Now, the Winklevoss twins, to their credit, did secure collateral to back up their loans in August. And so the Gemini Earn creditors are in a far stronger position. In fact, they may not need to rely on any kickers from DCG to need made hold. Hey, everyone, we're going to take another quick break and hear a word from our partners. We'll be right back to the Real Vision Crypto Daily Briefing.

25:17and so let's break in and just and we're talking about that because i want to talk a little bit about the structure of what's going on who all the players are but first ram i have to say uh you described that brilliantly that's about as well as i've ever heard it described obviously this is complicated there are a lot of moving parts but you really framed all the issues that are in play how the macro uh in terms of the uh fallout from ftx and terra luna prior to that has had the impact on these companies and therefore the downstream effects that we're talking about here. But let's back up a little bit here and describe the general situation, what's happening right now today in terms of who the players are, who the stakeholders are, what their risks are, what their goals are.

26:00I read your note that you wrote earlier where you framed this very well, where you talk about how the UCC, this is the Unsecured Creditors committee has lost trust in dcg in your view let's talk about who all of those players are what their outcomes are as you say the game theory where they're trying to get with this and what the probability is of them getting there so so let's start with dcg the key actor there the julius caesar and the shakespearean drama drama is barry silbert and his goal is to buy time because with enough time, the Grayscale cash flow can help to fill the hole, but they need time.

26:38The reason they need time is because they have payments due yesterday, weeks ago,$620 million, and Grayscale doesn't generate enough cash flow fast enough. They would love to refinance if they could, refinance their debt obligations, but Genesis, the creditor, doesn't have an interest and refinancing them. That's the game theory. And they can't get refinancing from a third party, presumably due to the overhang of litigation and alleged fraud that's in the backdrop. And of course, Barry doesn't want to take DCG into a default scenario. He wants time. That's his interest. He also - And the creditors don't seem to have a desire to push him into a default scenario in the short term, at least, based on what we've seen, right?

27:25It's mixed. It's mixed. I've talked to various creditors and, you know, the Gemini Earn group likes the deal on average. There was a term sheet that was exchanged a few months ago. They like that deal because they believe they will be made whole. However, the direct creditors to Genesis don't like that deal for various reasons. Can you break that out for us? Can you explain those creditor classes? Because this is always the rub in understanding any, I don't want to say bankruptcy situation, but any potential default situation is understanding the different creditors, different creditor classes, how their interests align or don't align depending upon the structure of the deal.

28:05So there are actually four or five creditor classes. I'll focus on the two principal creditor classes. So the two principal creditor classes are the direct creditors to Genesis that have an unsecured claim. And this consists of something like 75 high net worth, ultra high net worth, creditors, KGenesis. And there's another class that is the Gemini Earn program. And that Earn program consisting primarily of 340 ,000 retail investors is represented by Gemini as agent. That claim is about$1.1 billion or so. So they have differing interests because Gemini secured collateral to protect against exactly this scenario, a default.