Original compilation: Leo, BlockBeats

Original compilation: Leo, BlockBeats

Genesis is the only full-service provider of prime brokerage in the encryption field, and it is also the signboard of DCG (Digital Currency Group). Its role is to enable large institutions to access and manage risks. Previously, the question of Genesis seeking $1 billion has not yet been resolved, and where will it go. Next, let’s talk about Prime brokers (PB) and Genesis.

What is Prime brokerage? Simply put, it is the prime brokerage business, which is mainly responsible for three aspects:

-Custody assets

-OTC(such as the ability to buy and sell unlisted securities on trading platforms and block trades)

-provide credit(Derivatives and research reports are also available)

Prime brokerage is no different than your own brokerage firm. You can buy/sell, borrow, short, hedge, derivative positions. Brokers charge transaction fees and are regulated. Prime brokers primarily target large and complex institutions: hedge funds, institutions, sovereign wealth funds, large family businesses and governments. For example: Bank of Merrill Lynch, Morgan Stanley, Goldman Sachs, Jefferies, Citigroup, Credit Suisse, etc.

The difference between traditional prime brokers, which provide access to listed securities, which they finance with bank funds such as margin loans, and OTC deals that involve unlisted securities is important because OTC Not centralized clearing. Centralized clearing means there is one clearinghouse where trades are matched 1:1, netted and cleared. (Examples: ICE and CME)

The trading platform is not only the buyer of the seller, but also the seller of each buyer. The liquidation company has a large amount of capital, strong supervision, and is rock-solid.Prime brokers benefit from the "interdealer market". One prime broker can hedge the risk by selling or buying to another. OTC platforms seek to run "matched books," which means that each position has an offsetting position with a counterparty.

In fact, matching books in OTC products never really existed. This was mentioned on Odd Lot, an economics podcast channel. Clients expect traders to open up the market, and traders temporarily stand on the side of holding a trade until they hopefully find the other side and then stand on the other side. Traditional prime brokers have a strong inter-dealer market. Since they are not listed on an exchange and have no central clearing, this market is critical for OTC products, meaning they can avoid directional exposure and focus on capturing bid-ask spreads or financing fees.

CeFi infrastructure has a deep ecosystem that enables these prime brokers and clearing firms to access and manage risk: FIX protocol (trading API), DTCC, ISDA framework, trading desks, options clearing firms, Bloomberg terminals, etc. Genesis, a pioneering brokerage in the crypto space, does not benefit from the liquidity, standards, inter-dealer relationships, clearing houses, and deposit financing enjoyed by traditional prime brokers.

This reveals two important things:

1. Genesis must seek to match the maturity of assets (loans) and liabilities (borrowings).Banks can borrow short-term money (like your checking account) and lend long-term money (like a 7-year big mortgage). Banks don't need "term funding," a bank-backed PB can allow a mismatch in the maturity of its assets and liabilities, it has the FDIC, lenders of last resort, and a liquid market with standardized contracts. Non-bank-backed prime brokers must seek "maturity matching" parties, which is not easy to do.

Genesis' funding sources include deposits through wealth management products such as Gemini Earn and Circle Yield, which are short-term funding sources, and if these funding sources dry up, Genesis will be forced to liquidate its loan book (at unattractive or very low price). In addition, long-term loans are illiquid and may not be redeemable by market standards, which also exposes Genesis to a "bank run risk" in which Genesis cannot liquidate its assets quickly enough if everyone withdraws their deposits at the same time (due to contractual, operational, or lack of fluidity).

2. In derivatives and OTC books, Genesis is both buyer and seller, Genesis bears counterparty risk, Genesis will seek to run a "matching book" on time, but if their counterparty (eg 3 AC) fails , then Genesis has exposure.Counterparty risk exists because: no CeFi or DeFi clearing house can sell risk to it;There is no inter-dealer market consisting of higher quality parties.(Note: Even TradFi players with strong infrastructure like Credit Suisse can crash - see Archegos blowout)

The insolvency of the counterparty means that Genesis now faces directional exposure and capital losses. When 3 AC goes bankrupt, market participants can review 3 AC's bankruptcy filing and determine the size of the capital loss. This could lead to a loss of confidence in markets and bank runs. A prime broker is inherently an attractive fee machine, provided the ecosystem and conditions discussed previously are in place. Without these conditions, it is just a fragile business, prone to counterparty risk, bank runs and asset-liability mismatches.

According to my estimates and public reports, Genesis has lost more money (due to the bankruptcy of 3 AC and FTX) than Genesis has made since its inception. Losses at 3 AC alone are said to have exceeded $1 billion. So what's next for DCG?

There are two ways to raise funds at the DCG holding company level. Then inject capital into the subsidiary and restore confidence. However, Genesis is capital-intensive, it relies on capital and borrowing to make loans, its ROE has declined as funding sources have dried up, and its net present value (NPV) is negative;

In order to really salvage Genesis' status quo and fill a void in the market, it needs a cheap and reliable source of funding, and more capital, a network of dealers, and the right thing for Genesis to do is to be acquired.

Potential acquirers could be GS, ICE or a syndicate of investment banks. It won't be easy - existing risks, regulatory scrutiny, asset quality issues, risk-off climate, etc. (Microsoft, Merrill Lynch, CS, Deutsche Bank, and Jefferies wouldn't do this for various reasons) If there is no acquirer, then DCG will be needed to plug this hole, but I don't think DCG will do it at high rates Adding capital to a negative NPV business would mean that Genesis would go bankrupt.

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