Today: 19-04-2024

New York sues crypto firms for alleged $1 billion fraud, citing hedge fund SBF's bet

Cryptocurrency companies Digital Currency Group and Gemini defrauded over 230,000 investors out of a total of $1.1 billion, according to a lawsuit filed by the New York state attorney general on Thursday in Manhattan. They cited a series of missteps, including an inability to adequately manage the risk tied to the collapse of bankrupt and allegedly fraudulent crypto trading firm Sam Bankman-Fried.

According to the attorney general's claims, in perpetrating the alleged fraud, Digital Currency Group and its subsidiaries and affiliates, including Genesis Global Capital and Genesis, lied to investors, created fake financial documents, and concealed information from creditors.

Genesis was once the flagship of crypto magnate Barry Silbert's empire. As an over-the-counter trading desk, principal broker, and lender, it gathered cryptocurrency from its clients and lent it to other parties, profiting from the interest it charged its clients. This was highly profitable for a time, until crypto hedge fund Three Arrows Capital defaulted on its loans and sent much of the crypto world into a tailspin.

Genesis and DCG have since acknowledged their significant exposure to "Three Arrows" or 3AC. However, New York prosecutors claimed that Genesis failed to conduct proper audits of 3AC for over two years and that when 3AC collapsed, Genesis and its parent company DCG conspired to conceal the details of the crisis from investors and the public.

Among these investors was Gemini, founded by Cameron and Tyler Winklevoss, and its clients. Prosecutors allege that Gemini operated a high-yield program called Gemini Earn, which allowed retail customers to lend their Gemini cryptocurrency in a "low-risk" model. Gemini then passed this client cryptocurrency on to Genesis for further lending, earning a portion of Genesis' interest. The program launched in February 2021 when interest rates were still low, and many investors were seeking yield.

One of Genesis' largest counterparties was Sam Bankman-Fried's trading firm Alameda Research. In a broader sense, prosecutors claim that this meant Gemini also had dealings with Alameda, and presumably knew they did.

New York prosecutors in the same lawsuit also accused Gemini of failing to eliminate the "risky" impact on Bankman-Fried's Alameda Research through its relationship with Genesis. Prosecutors claim that Gemini conducted a risk analysis of Genesis' loan portfolio, which purportedly showed significant exposure to Alameda, reaching 60% at one unspecified point, and downgraded Genesis' internal creditworthiness to junk status, according to prosecutors.

However, despite this internal analysis, prosecutors allege that Gemini did not cease its significant influence over Genesis and Bankman-Fried, even though one Gemini board member likened Genesis' financial condition to Lehman Brothers before its collapse.

New York prosecutors seek to permanently ban Gemini, Genesis, DCG, Silbert, and various officers from dealing in securities and commodities in New York and to obtain restitution and asset recovery. "Hardworking New Yorkers and investors nationwide lost over a billion dollars because they were fed egregious untruths that their money would be safe and grow if they invested it in Gemini Earn," said New York Attorney General Letitia James in a statement. "Instead, Gemini hid the risks of investing in Genesis, and Genesis lied to the public about its losses."

This is not the first time James has gone after crypto firms. Earlier this year, her office sued Alex Mashinsky, former CEO of bankrupt cryptocurrency exchange Celsius, alleging he defrauded hundreds of thousands of investors. In July, federal prosecutors charged Mashinsky with fraud, and if convicted, he faces prison time.

DCG did not immediately respond to CNBC's request for comment.

"We strongly disagree with NY AG's decision to sue Gemini as well," Gemini said in a statement on X, formerly known as Twitter. "It makes no sense to accuse the victim of being defrauded and lied to, and we look forward to the opportunity to defend ourselves against this inconsistent position."

The lawsuit "confirms what we've been saying all along — that Gemini, Earn users, and other creditors have fallen victim to a massive fraud," the companies added.