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The Trouble With the Grayscale Bitcoin Trust: Morningstar

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What You Need to Know

  • It trades at a deep discount to NAV and has high fees.
  • Conversion to a Bitcoin ETF would solve GBTC's problems, but that requires SEC approval.
  • In the meantime, a redemption program could help eliminate the trusts' deep discount.

The $37.1 billion Grayscale Bitcoin Trust (GBTC) is the world’s largest Bitcoin fund and a favorite among financial advisors, mutual funds and ETFs investing client assets in crypto, but it is not a good proxy for actual Bitcoin.

The fund, which invests directly in the cryptocurrency, has been trading at sizable discounts to its net asset value since February 2021 when Purpose Bitcoin ETF launched the first Bitcoin ETF, in Canada, and GBTC began to labor under the weight of excessive share issuance, according to Bobby Blue, senior research analyst at Morningstar.

Between early 2020 and late February 2021, Grayscale filed 35 reports with the SEC indicating the sale of additional shares to accredited investors, Blue wrote in a recent report. Year to date,  GBTC has gained 40%, but Bitcoin has doubled in price.

GBTC essentially trades like a closed-end fund, which has no flexibility to create or redeem shares. A Bitcoin ETF, which by its very structure, has that flexibility through its market makers, would provide that flexibility.

Grayscale has an application pending at the SEC to convert its Bitcoin trust to a Bitcoin ETF, but to date, the agency has not approved any spot Bitcoin ETF application among the many it has received over the years.

The SEC has, however, allowed several Bitcoin futures ETFs to trade, which irks Grayscale and its lawyers. The SEC could decide in late December whether the NYSE’s application to trade the Grayscale Bitcoin ETF can proceed, according to reports.

Grayscale CEO Michael Sonnenshein told ThinkAdvisor in October that the SEC, in approving a Bitcoin futures ETF, was “inherently giving a blessing to the entire Bitcoin market” because the derivative Bitcoin futures market and Bitcoin spot market are “inextricably tied to one another.”

Earlier this week, the company’s attorneys at Davis Polk acknowledged in a letter to the SEC that Grayscale Bitcoin Trust shares “usually trade at discounts below or premiums over the net asset value of the Bitcoin it holds, and these discounts and premiums have at times been substantial.” They pushed for approval of a Grayscale spot Bitcoin ETF.

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In the comment letter, sent in response to the NYSE’s application to list the Grayscale Bitcoin ETF, the attorneys argued that the SEC has no basis for holding the position “that investing in the derivatives market for an asset is acceptable for investors while investing in the asset itself is not.” That position violates the Securities Exchange Act of 1934, as amended, as well as the Administrative Procedure Act (APA), according to the letter.

Bitcoin Futures vs. Grayscale Bitcoin Trust

The availability of Bitcoin futures ETFs eats into Grayscale’s market. Their fees are sharply lower than GBTC’s 2%, ranging from 0.65% to 0.95%, as are their discounts to NAV — currently 1% or less versus 17% for GBTC.

But Bitcoin futures have their own complications, including the additional cost of rolling from one futures contract before expiration date into a more current contract, which in the current market structure involves selling a cheaper contract to buy a more expensive one. Estimates for the roll costs range between 10%-15% a year, said Morningstar’s Blue.

Still, said Blue, “having a trust like GBTC with its inherent disadvantages is too much for investors to overcome. It becomes easier and easier to access different crypto vehicles. As more options come, GBTC will look less and less palatable.”

How to Solve GBTC’s Deep Discount Problem

While Grayscale awaits an SEC decision on its Bitcoin ETF proposal, which would erase some of those disadvantages, it has the power to address one shortcoming now. It can institute a  redemption program, whereby investors could redeem shares with GBTC at NAV, which would eliminate the shares’ discount to NAV, Blue wrote.

Grayscale tried such a program previously, but it was halted by the SEC in 2016 on the grounds that it violated Regulation M, which bans share repurchases at the same time that a firm is offering shares through private placements. Such a program now would not violate that  regulation because Grayscale is not currently offering new shares, Blue wrote.

But it would reduce Grayscale’s assets under management and thus the collection of fees charged on those assets.