The downfall of Gemini Trust's crypto lending program

Andrew Harrer/Bloomberg

Gemini Trust Company, the New York-based cryptocurrency exchange and custodian, has agreed to return more than $50 million worth of digital assets to consumers as part of a settlement with the Office of the New York State Attorney General.

The lawsuit against Gemini, which also included cryptocurrency firms Genesis Global Capital and Digital Currency Group, was filed by New York State Attorney General Letitia James in October of last year. James alleged that the three firms defrauded more than 230,000 investors, roughly 29,000 of whom were New York residents, of more than $1 billion through the Gemini Earn program. 

Investigations conducted by the attorney general's office purportedly concluded that Gemini executives knew Genesis' financials "were risky" and that the company's loans "were undersecured," according to an Oct. 19 press release.

A second component of the suit also alleged that Genesis, its former chief executive Soichiro Moro, Genesis' parent company DCG and the CEO of DCG Barry Silbert, defrauded investors by attempting to conceal more than $1.1 billion in losses, according to the same release.

"These cryptocurrency companies lied to investors and tried to hide more than a billion dollars in losses, and it was middle-class investors who suffered as a result," James said in the release.

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Consumers engaged with the Earn program placed their holdings in bitcoin and other digital currencies into interest-bearing accounts that were tied to loans made to Genesis Global Capital, which were then collateralized by the digital assets. In return, consumers earned interest on the investments.

As part of a settlement agreement with the state of New York last month, Genesis created a "Victims' Fund" to repay creditors allegedly defrauded through the Gemini Earn program. After initial bankruptcy payments are made to Genesis' creditors as part of bankruptcy proceedings, the company's remaining assets will be used to fund the pool. 

In the event that creditors are not made whole, the Victims' Fund will receive up to $2 billion from the firm's remaining assets to continue compensating Genesis' creditors until the fund is depleted.

Gemini suspended the Earn program in November 2022 after Genesis announced it would not allow investors to withdraw crypto assets due to liquidity issues, and officially terminated the program in January 2023, according to a complaint filed by the Securities and Exchange Commission against the two companies that same month. 

Pursuant to last week's settlement, Gemini completed the final round of "coin-for-coin" Earn distributions to investors on June 14, returning the exact amount of invested digital assets to clients in the original currency — including any unrealized appreciation. The final distribution accounted for the remaining 3%, or roughly $50 million, of assets owed to investors.

Gemini did not respond to requests for comment before American Banker's deadline.

"[Friday's] settlement will make defrauded investors whole and should remind cryptocurrency companies that deceiving investors is illegal and will not be tolerated by my office," James said in a June 14 press release. Both Genesis and Gemini are barred from operating any crypto lending programs in New York state as part of the individual settlements.

The crypto lending ecosystem has been rife with legal and regulatory activity over the last few years.

Celsius Network, Voyager Digital and BlockFi, once prominent crypto lenders, all filed for bankruptcy in 2022. Alex Mashinsky, CEO of Celsius, was sued by James in January 2023 for many of the same allegations that brought down the Gemini Earn program — misrepresenting the security of the firm.

Christopher M. Naghibi, executive vice president and chief operating officer of the $13.6 billion-asset First Foundation Bank in Irvine, California, said his institution once considered lending against cryptocurrencies but couldn't reconcile the significant credit risk it would face in doing so.

"Taking the cavalier risk of lending too heavily into a space where the laws, rules and regulations are still very much being formed is not wise," Naghibi said. "Until such time as our regulatory partners take a clear stance on cryptocurrency, it would be ill-advised to go too far down the path of lending on assets which are not as well established with the regulators as those more traditional in nature."

But those on the other side of the argument say that crypto lending is more secure than traditional loans, provided there are effective safeguards in place.

Ledn, the Cayman-based crypto lending firm, requires all of its crypto-backed loans to be overcollateralized at a two-to-one ratio using bitcoin or ether. The company's chief investment officer, John Glover, argued that crypto assets are more liquid than traditional assets.

"Unlike crypto, which has deep liquid trading markets that are active 24 hours a day, 7 days a week, 365 days a year, [traditional financial] markets are only open during specified times during the business week, and thus lenders are subject to price gaps and are unable to liquidate collateral when those markets are closed," Glover said.

Lenders are paying close attention to the ongoing litigation in order to avoid drawing the ire of regulators themselves.

"There has been some signaling from Congress and other regulatory bodies that stablecoins could potentially bridge the gap between crypto lending and traditional lending. … However, significant work needs to be done to establish regulatory certainty and widespread confidence in this area," said Stephanie Talamantez, managing director at the global compliance consulting firm Guidepost Solutions.