Alameda Research, the FTX hedge fund, is suing Grayscale Investments LLC and its parent company Digital Currency Group over the structure and management of Grayscale’s two digital asset trusts, the Grayscale Bitcoin Trust (GBTC) and the Ethereum Trust (ETHE).
DCG chair Barry Silbert and managing director Michael Sonnenshein are also included in the complaint.
The complaint accuses Grayscale and DCG of “brazen abuse of their control over nearly $19 billion of digital assets held in two trusts to enrich themselves at the expense of trust shareholders.” It alleges that the defendants violated their contractual and fiduciary obligations by failing to reduce their management fees over the Trusts to “commercially competitive levels,” which it says are “many multiples higher than what other managers charge to perform similar functions.”
They also allege that further breaches by the defendants in their refusal to permit the redemption of Trust shares for the corresponding amounts of BTC or ETH. Such refusal has created the unique state of affairs whereby GBTC shares on the secondary market often trade well below the Trusts’s net asset value (NAV).
For years, Grayscale has cited the U.S. Securities and Exchange Commission’s (SEC) Regulation M as the reason it can’t redeem Trust shares, but backtracked on this position in its 2022 investor letter where it acknowledged that Regulation M only prohibits the simultaneous creation and redemption of shares.
Alameda’s suit takes aim at this ‘false pretense’:
“As Defendants have recently been forced to admit, Regulation M under the federal securities laws provides regulatory approval to implement redemptions in precisely the current context where there is no ongoing share creation (as there has not been for either Trust for over two years.)
“Defendants’ true motivation in refusing redemptions is to artificially hold their investors’ assets hostage so as to protect Grayscale’s Sponsor Fees, which would be diminished by investor redemptions that reduce the size of the Trusts.”
Alameda is seeking damages and an injunction requiring that Grayscale reduce its fees and begin offering redemptions, which would thereby “remedy the harm that Alameda and over a million other shareholders have suffered and continue to suffer as a result of Defendant’s self-dealing.”
Alameda owns 22 million shares in GBTC and 6 million in ETHE, amounting to 3% and 2% of the total shares for each Trust respectively. According to the complaint, Alameda has eaten a $250 million loss from the declining market value of each Trust.
The lawsuit is part of the ongoing battle by John Ray III, the CEO appointed to guide the FTX Group through its protracted bankruptcy, to recover as much money as possible for FTX’s creditors. In a statement, Ray said:
“We will continue to use every tool we can to maximize recoveries for FTX customers and creditors. Our goal is to unlock value that we believe is currently being suppressed by Grayscale’s self-dealing and improper redemption ban. FTX customers and creditors will benefit from additional recoveries, along with other Grayscale Trust investors that are being harmed by Grayscale’s actions.”
A bad 12 months for Grayscale
Since launching to much fanfare in 2013, the gloss has only come off Grayscale’s digital asset trust model.
The Trusts were initially conceived as a way for investors to gain exposure to digital assets such as BTC without having to grapple with the complexities of direct asset ownership. As of right now, investors are unable to redeem their shares for the underlying assets: Grayscale has long promised that redemptions could only begin once it secured ETF approval from the SEC. However, the regulatory approval does not believe Grayscale has been forthcoming, with the SEC citing concerns over the risk of market manipulation, wash trading, insider trading and fraud inherent in BTC.
The SEC’s concerns have been borne out over the past 12 months: the digital asset market has been in turmoil since mid-last year following a string of high-profile collapses, driving asset prices down across the board.
Ironically, the highly interconnected Digital Currency Group empire appears to have played its own role in this turmoil: it engaged in a borrowing scheme with collapsed digital asset hedge fund Three Arrows Capital (3AC) whereby 3AC would borrow BTC from DCG-owned Genesis which it would then use to create GBTC shares. It would use those shares as collateral to take USD loans from Genesis. As long as GBTC continued to trade at a premium to NAV, these loans would be worth more than the initially borrowed BTC—but should GBTC slip below NAV (which, of course, it did) then 3AC is doubly screwed. When GTBC prices did slip below NAV (where they’ve stayed), 3AC collapsed spectacularly.
In addition to intensifying the SEC’s concerns, the tumult has also had the effect of suppressing the value of Trust shares on their limited secondary markets: GBTC currently trades at a whopping 42% discount to the value of all BTC held by the Trust.
This discount will no doubt be fueling the growing discontent among Trust shareholders. Indeed, Alameda’s lawsuit echoes much of what was contained in another suit filed against Grayscale in December. Fir Tree, a family of hedge funds, alleges similar contractual breaches by Grayscale. Fir Tree’s suit also shined a spotlight on the deep interconnectedness between Grayscale and the rest of Barry Silbert’s Digital Currency Group Empire. It highlighted that the creation, distribution, Bitcoin purchasing and value calculation of GBTC shares are all done using DCG’s other wholly owned subsidiaries, creating massive conflicts of interest which the lawsuit alleges have served only to enrich the owners of Grayscale’s trusts at the expense of shareholders.
Greyscale is now facing multiple lawsuits over the Trusts, and while it is currently fighting the SEC in the courts in order to force ETF approval, it remains a pipe dream. Given that the Trusts could fold tomorrow, and Grayscale would have already skimmed more than a billion dollars in fees from its shareholders, the likes of Barry Silbert and DCG probably aren’t all that concerned.
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