Post FTX: GBTC Trades At Historic 42% Discount!

The Greyscale Bitcoin Trust (OTC:GBTC) set a trust record after the FTX collapse by trading at a 42% discount to the net asset value of its Bitcoin (BTC-USD) holdings . While closed-end funds and trusts often trade at small discounts to their net asset or liquidation value, it is extremely rare that any fund trades at a 42% discount.

The Mechanics Of GBTC’s Discount

The Greyscale Bitcoin Trust is not an ETF (it wants to be), thus it does not trade based on the value of its underlying value of its holdings like an ETF would. Rather, its trust structure causes it to trade like a closed-end fund, subject to the price that investors are willing to pay for it.

In addition, for the unfamiliar, you cannot take Bitcoin out of GBTC by being an owner of GBTC units. It is not a brokerage like Coinbase

So, while the value of the Bitcoin in the trust was worth 42% more than the trust’s trading price on the exchange the other day, that’s what investors were willing to pay, so that’s what the price was. A simple supply and demand equation.

When GBTC was only bitcoin game in town, market demand outstripped supply, shares of GBTC was trading at a premium or for more than the underlying bitcoin it represents. This was the case for much of 2015 to 2019.

When supply outstripped demand (roughly around the time Bitcoin ETFs became available), shares of GBTC flipped to trading at a discount.

Closed-end fund firm Nuveen explains that closed-end funds trade at discounts frequently, especially during volatile times. If that’s the case, why wouldn’t you buy a closed-end fund or trust trading at a discount? That’s actually a good question with a legitimate answer.

The Reasons GBTC Trades At A Discount

A CEF or trust might trade at a discount because people anticipate there is a high risk that the underlying assets could trade lower in value. In essence, this is the market partially anticipating a price decline in the underlying assets, in this case Bitcoin.

So, why did demand fall for the Grayscale Bitcoin Trust in the first place? Probably a combination of competition from ETFs, fear of falling Bitcoin prices and limited liquidity for the fund – both internally to dispose of assets and externally of having a large market to sell GBTC into should there be a volatility driven deeper dive in price.

A few days ago, crypto lender BlockFi said it unwound its entire position in GBTC and would not take shares as collateral, before walking back the statement hours later. Why would it do that? Well, if needs liquidity, it wants an asset that is highly liquid and has at least some semblance of stable value.

Blockfi is also a firm that suddenly announced layoffs and might be heading to bankruptcy due to its ties to FTX which filed bankruptcy last week. FTX apparently overleveraged its balance sheet and backed that leverage with its own coin which had very little real value it turns out. Now, Blockfi suddenly has a liquidity crisis.

So, you have to consider if the falling price of Bitcoin recently is part of a capitulation event caused from Sam Blankman-Field and FTX’s BankRuptcy. This event has actually mimicked the Fed’s tightening policy by sapping crypto liquidity.

With Bitcoin falling from a high of around $69,000 to slightly under $16,000 in about the past year, it’s understandable that people are scared of a further decline in Bitcoin prices. Add a lower liquidity threshold for GBTC and it trades at a deep discount.

And, as mentioned, there is a lot of fully liquid Bitcoin ETFs available now – 18 by my count. All are currently futures based products, which is interesting to me when considering how crummy futures based commodity ETFs have treated investors over the years.

Will GBTC Close The Discount Gap?

That depends on what you think of Bitcoin, the structure of Grayscale Bitcoin Trust, and, prepare to have your noodle twisted, what the future structure of the Grayscale Bitcoin Trust might be.

We’re not going to argue about the future of Bitcoin today, but, suffice to say, if you don’t think Bitcoin has a future in the world of finance, well, then you probably won’t want to buy any GBTC at any price. That’s easy.

If you do think Bitcoin has a future in the world of finance, then you should consider GBTC in your basket of crypto investments. For if Bitcoin has a future, and it’s more optimistic than current pricing, then the pessimism and concerns that drove GBTC demand down, should reverse to at least some extent.

We know GBTC is not cheap with an expense ratio of 2% on top of trading expenses. That works against it versus ETFs and direct Bitcoin ownership.

And, as covered in Axios, “Grayscale may have misstepped and overissued shares to the market.” Simply put, there could be too much supply of GBTC units. I don’t find this particularly compelling if you think Bitcoin indeed has a role in global finance.

This is where it gets very interesting. Grayscale is trying to change the structure of the trust to be a Bitcoin physical, aka, spot, ETF. This is akin to the Sprott Physical Gold ETF (PHYS) and other physical commodity ETFs.

So far, the SEC has said no, then softened, then hardened again on allowing Bitcoin spot ETFs that hold actual Bitcoin. What you think about the future of Bitcoin spot ETFs plays a direct role in whether or not GBTC might be a good investment for you.

A Bitcoin spot ETF approval would allow Grayscale to convert its trust into an ETF, closing the gap between price and the underlying bitcoin. That is because of the unique ETF share creation and redemption mechanism using authorized purchasers. The result is that ETFs tend to only impact the price of underlying assets during especially high volume.

If GBTC is allowed to become an ETF, then its price should close the discount gap rather quickly via the standard ETF share creation and redemption process.

Will GBTC Become An ETF?

So, that begs the question whether GBTC will become a Bitcoin spot ETF. Nobody knows the answer yet. But, if I were to wager, I would say it is likely it will.

According to Michael Sonnenshein, CEO of Grayscale: “Because the SEC has disapproved the application to convert GBTC to an ETF, the next point of escalation is to go through the judicial branch.”

And that’s exactly what is happening. Grayscale is suing the SEC to allow for it to convert its trust to a Bitcoin spot ETF.

At this point in the process, Grayscales Amicus briefs have been filed and the SEC is about 3 weeks away from having to file their briefs. Here is the timeline of the legal process as we know it now:

To get Grayscale’s case updates go here.

If Grayscale wins its case, then the futures based ETFs would now face a formidable competitor. I suspect the SEC is protecting the futures firms or trying to control volatility. But, if trying to control volatility is its aim, clearly the past year speaks loudly against its approach.

At this point, it seems as though a court decision could occur. I think it is more likely there is a settlement with the SEC that allows GBTC to become a Bitcoin spot ETF. Why?

I think that Grayscale has convincingly argued that the SEC rejection of the Bitcoin spot ETF was arbitrary. You can read what Grayscales suits said here. The claim includes that the order to reject an ETF was “arbitrary, capricious, creates “unfair discrimination between . . . issuers…”

I think that is likely true. But, I think the SEC knows that. So, if they know that, why did they do it? Could it have simply been a way for the SEC to buy time to figure out how to actually regulate their corner of the crypto world, which will surely be shared with other alphabet soup agencies, such as the CTFC and FTC.

I could be wrong, but if physical spot gold ETFs exist, and Bitcoin is legal, then spot Bitcoin ETFs have to be allowed to exist. The trick is how to regulate that market then.

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