Description

The Grayscale Bitcoin Trust (GBTC) is trading at 31% discount to its NAV, and I like it long, especially hedged with bitcoin futures. I’m sure GBTC is well known amongst this crowd, but for those that are less familiar with the background and dynamics of the entity, here’s a brief synopsis: 

Grayscale Bitcoin Trust started as a unit trust in 2013 to give institutional and individual investors exposure to bitcoin without having to go through the trouble of setting up a crypto wallet and owning bitcoin (since you can’t open a Coinbase account for your IRA). For the privilege of this exposure, GBTC charges a 2% annual management fee–expensive in asset management, but not insane when compared to crypto fees. Today, Coinbase still charges 0.60% for market orders less than $10k in value, plus fees for wiring money that can easily lead to spreads above 2% for retail-sized orders. In 2015, the trust was eventually listed on OTC markets as a closed-end fund under the symbol GBTC, and immediately traded at premium occasionally as high as 100%. This premium persisted until the beginning of last year, and as the enthusiasm from retail/meme traders has faded, the discount has continued to widen. GBTC raised AUM substantially by offering private placements for restricted units to purchase units at NAV that became registerable into GBTC shares within 6 months, so, even at the huge discount and bitcoin getting crushed, the market cap for GBTC is over $12 billion. In January 2020 they became an SEC Reporting Company, which increased their regular disclosure requirement and reduced the restriction holding period from 12 to 6 months. 

The SEC approved a bitcoin futures ETF in October 2021, and in the same month, GBTC filed a form 19b-4 with the SEC to apply to be converted into an ETP–which, if accepted, would immediately close the discount, resulting in a windfall 44% return on investment at current prices. The application was initially denied, with the SEC’s explanation that an ETP has to have the exchange on which the underlying ETP assets trade be “designed to prevent fraudulent and manipulative acts and practices and to protect investors and the public interest,” and cryptocurrency exchanges did not satisfy that requirement. 

Grayscale has begun funneling people on their website to write to the SEC to petition for allowing the conversion: https://grayscale.com/comment/. They are currently in a 240 day review/comment period, and the SEC will make a ruling again on July 6th. Grayscale has posted their presentation to the SEC from late April, making an argument for why they should be able to register, which you can take a look at here: https://grayscale.com/wp-content/uploads/2022/05/Grayscale_SEC-Meeting_April.pdf. The main counterargument seems to be that bitcoin futures are derivatives on the same underlying exchange (manipulation of bitcoin spot on an unregulated exchange would in essence be a manipulation of the bitcoin futures, which are priced off of spot), so it doesn’t make sense to approve a futures ETF without also approving a spot ETP. Since investors are already exposed to this risk, it’s difficult to argue that investors are not more harmed by the current wide discount than by the risks of manipulation of the spot price they already bear.

It is highly uncertain if an ETP conversion will happen or, if it does, when it happens given the reliance on the whims of regulators. Still, there is momentum among the large crypto institutions like Coinbase to call for more regulation of cryptocurrency exchanges. One of the SEC’s commissioners, Hester Peirce (nicknamed “Crypto Mom”), has been quoted saying that she thinks the reasoning for rejecting the application is “outdated”, noting that crypto exchanges don’t function like regular securities exchanges. There’s a bit of an institutional stalemate with SEC chair Gary Gensler, though, who believes there needs to be more SEC oversight of the crypto exchanges themselves. 

Since we all like a good “value” trap now and then, why not take a stab at buying the next generation's gold at the crazy special discount price of 30% off of the already discounted price of over 50% off of all time highs? An outright long GBTC trade could return over 200% if the underlying asset rallies to new highs and the discount closes (or even turns positive) due to buying pressure from retail investors.

If you’re not in the mood to catch a falling knife, but still think the sentiment is pretty washed out and the discount is likely to narrow, you can still structure a trade long GBTC against a short in the CME exchange traded bitcoin futures. The futures are normally in backwardation, and depending on the months (using the midpoint price) you can get most if not all of that management fee back in the form of positive roll yield from your short. For example, at the time of writing, the August BTC futures contract is 30415 bid/30495 offered, while spot bitcoin is at 30285, which annualizes to just over 2% roll yield, so depending on the structure of your trade  the carry is close to zero. There have been times in the past when the spot has blown out lower, allowing you to lock in an even higher roll yield and get a positive carry from this trade.

Risks

Liquidity / shape of futures curve

Stays on OTCQX

Bitcoin declines further (if outright long)

Catalyst

SEC approval of spot bitcoin ETF/ETP, maybe as soon as July

Renewed enthusiasm, especially amongst US investors required to trade on-exchange for bitcoin… eventually