The clock is ticking on a limited-time offer to get bitcoin on the cheap. Whether it turns out to be a bargain or a bad deal depends on the actions of an intransigent regulator.
By Steven Ehrlich, Forbes Staff and Nina Bambysheva, Forbes Staff
After more than two years of unintentionally offering a way to buy bitcoin for less than its market price (sometimes a lot less), the world’s most popular cryptocurrency investment fund is advancing in an attempt to change its format—thanks to a court victory that could provide an overnight bonanza to investors. Logically, the question should be more when, than if, the $16 billion Grayscale Bitcoin Trust (GBTC) will transform into an exchange-traded fund from its current restrictive format. But it is not entirely clear that the U.S. Securities and Exchange Commission is ready to abandon a position that stands in the way of that change.
Right now, GBTC units trade at $19.26 but represent a claim on $23.33 worth of bitcoin. The trust, similar to a closed-end mutual fund, can change hands above or below its net-asset value (NAV), allowing investors to place a premium or discount on the value of its holdings. The design allows institutional and wealthy individual investors to buy fund shares at the NAV, and in previous years this provided a perverse incentive for it to trade at a premium that reached as high as 100% and spent most of 2019 to 2021 at about 30%.
After a period of 12 months, the NAV purchasers could dump the shares on retail investors in over-the-counter trading at massive premiums, reflecting a lack of ways for individuals to invest in bitcoin without exposure to hackers and the complexity of crypto wallets and irreplaceable passwords. Then the sellers used their profits to buy more GBTC at face bitcoin value and do the whole process again. Rinse and repeat. Sophisticated traders could also protect their downside by simultaneously shorting bitcoin in the futures market. Meanwhile, Grayscale collected annual management fees of about 2%.
GBTC HAS TRADED AT A SIZABLE DISCOUNT SINCE EARLY 2021
GBTC’s discount narrowed after a favorable judicial ruling in August, but it still remains at 17%.
The premium persisted until February 2021 when it abruptly disappeared after spot bitcoin ETFs appeared in Canada, rapidly reaching a discount of 17% in May, according to Y Charts. That caught the eye of Forbes investing columnist William Baldwin, who suggested in July of that year that investors who thought that Grayscale might decide to seek ETF status for the trust, and that the SEC might be amenable to granting it, should load up on GBTC. At the same time, he wrote, buyers could protect themselves from a bitcoin downdraft by shorting the cryptocurrency in the futures market.
That advice remains sensible today, but while the discount is still 17%, it has not flatlined its way here. As a series of crypto-related bankruptcies in 2022 that reached a crescendo with the failure of FTX in November wiped away two-thirds of the value of digital currencies, the discount grew to almost 50%.
Grayscale, part of Barry Silbert’s Digital Currency Group, did decide to apply for the ETF status in October 2021. If granted, that would have the effect of immediately bringing the trading price in line with the NAV. Like the trust, ETFs also have one set of large investors who transact directly with the fund, but they can buy and sell the underlying assets—bitcoin in the case of GBTC—on demand. They would be able to cash in their shares for bitcoin if the trading price fell more than fractionally below the NAV and force the fund to give them shares in exchange for the cryptocurrency if a premium developed. That mechanism ensures the NAV doesn’t diverge very far from the market value of the ETF’s portfolio.
At the current discount, buying into GBTC today would be like giving the U.S. Treasury eight dimes and three pennies and getting a crisp $1 bill in exchange after the conversion. But for that to happen, the SEC has to accept the concept of ETFs based on the spot-market price for bitcoin, which it has steadfastly refused to do, turning down more than 30 applications for new funds since Gemini crypto exchange founders Cameron and Tyler Winklevoss first filed for one in July 2013.
The SEC rejected Grayscale’s application in June 2022 on the same grounds as the 30-plus spot bitcoin ETF proposals that preceded it: a belief that neither sponsors of the funds nor the equity exchanges on which they planned to list them could prevent fraud and manipulation in the cash market for the cryptocurrency. While that concern is reasonable, the agency has allowed multiple ETFs based on bitcoin futures contracts, which trade on the regulated Chicago Mercantile Exchange, the world’s largest commodities bourse. In an act of regulatory cognitive dissonance, the SEC seems to ignore the fact that no matter how clean the trading in those contracts may be, if the underlying bitcoin spot price is being manipulated that will surely be reflected in the futures.
The lack of consistency led Grayscale to sue the regulator in October 2022, claiming that it was contravening the federal Administrative Procedures Act, favoring futures-based funds for no logical reason.
A three-judge panel of the U.S. court of appeals for the District of Columbia agreed with Grayscale. In surprisingly terse language, Judge Neomi Rao vacated the SEC’s rejection of Grayscale’s application on August 29, writing on behalf of a unanimous panel that the decision was “arbitrary and capricious.” The remaining 21 pages of the decision amounted to a systematic takedown of every rationale used by the SEC to approve a bitcoin futures ETF, but reject one based on the spot market.
The ruling encouraged bitcoin bulls, especially after major asset managers including BlackRock, Fidelity and Invesco had filed for new spot ETFs of their own in recent weeks, albeit with new surveillance arrangements apparently meant to overcome the SEC’s objections. Bitcoin rose 7% after the ruling and the GBTC discount narrowed to 17% from 29%, but the SEC, which has been waging a battle against the cryptocurrency market with increasing fervor this year, said on September 1 that it would not consider the applications until mid-October. That took some of the wind out of bitcoin’s sails, knocking the price down to $25,926 as of yesterday, but GBTC’s discount remained steady at 17%, an indication that investors think it is more likely that the trust will be granted ETF status than it was before the court ruling.
More likely, but maybe not inevitably.
For one thing, the vacated decision does not mean the SEC has to approve the Grayscale application; it just has to provide a rational explanation as to why it will not allow spot bitcoin ETFs but thinks that futures-based funds are okay.
The agency can also appeal, and it has until mid-October to do so. Its intentions remain unclear. “We are in uncharted waters,” says Greg Xethalis, general counsel and chief compliance officer of Multicoin Capital, who worked on the initial Winklevoss ETF application. “There isn’t a procedural posture, or to my knowledge, any history as far as precedent for this situation.”
Grayscale is not waiting for the appeal period to expire. It sent a letter to the SEC last week asking the agency to immediately move toward listing GBTC as an ETF, arguing that the timeline for rejecting the application has lapsed. The SEC typically has 240 days to accept or deny an application, a period that would have run out in the middle of 2022. “We don’t think there’s another reason for the Commission denying GBTC to convert into a spot bitcoin ETF,” says Grayscale Chief Legal Officer Craig Salm, suggesting the agency would have provided additional rationales in its denial. Still, Grayscale finds itself hamstrung until the appeal period lapses, and the regulator could also provide another explanation to deny the application—or, in a nuclear option, revoke the futures ETFs’ ability to trade—though both tactics seem unlikely.
The clock matters very much in this instance. David Martin, head of institutional coverage at crypto prime broker FalconX, said that even if investors believed they could earn a 17% gain going long GBTC, it may not be worthwhile if it takes more than a few months. In addition, given the uncertainty about the GBTC application, it is unclear whether the restructured fund would be able to come to market before the slew of new ETFs that have applied to launch. Such a situation could play havoc with the GBTC discount.
Being first is worth a lot in the crypto ETF world. ProShares launched the first bitcoin futures ETF in November 2021, and it dominates more than 90% of the market despite similar products going live shortly thereafter. “Being first matters and liquidity begets liquidity,” said ProShares CEO Michael Sapir about his company’s success in the market.
Maybe Grayscale’s size will protect it—after all it still contains $16.2 billion worth of bitcoin that cannot leave this crypto Hotel California until redemptions become available. “Don’t underestimate the power of incumbency,” says Hector McNeil, co-CEO and founder of London-based HANetf, which helps asset managers create exchange-traded funds. (Grayscale sponsors one such ETF that offers exposure to publicly traded companies in the digital asset industry such as Coinbase and multiple bitcoin mining companies) Additionally, Grayscale could choose to take further court action.
There are at least some people within the SEC that think it is high time for the regulator to approve an ETF, first among them Commissioner Hester Peirce, a Republican who is known as ‘Crypto Mom’ in the industry and who has dissented on many rejections. “I think anyone dealing with the SEC on bitcoin exchange-traded products is probably banging their heads against the wall, because every time they come in the goalposts move,” Peirce told Forbes in July. “The standards being used here are different from the standards that are used for similar products, and it’s really hard not to see this as a bitcoin spot-specific thing.”
Until GBTC is able to convert to an ETF, however, investors are playing a tense waiting game holding onto discounted coupons for the leading cryptocurrency and hoping they can cash in their winnings before too long.
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