According to JP Morgan analysts, optimism over the US Securities and Exchange Commission (SEC) approving a Bitcoin (BTC) exchange-traded fund (ETF) has grown due to the likelihood of a new commissioner being appointed this year. While this would be a long-term BTC positive, in the short term it could hurt its price as it would draw institutional money from the Grayscale Bitcoin Trust (GBTC), currently the only way for some institutional investors to gain BTC exposure. It could also undermine a popular GBTC premium monetization trade that may be pumping up BTC prices (see below).
The Grayscale Bitcoin Trust is a closed-end fund (CEF) passively invested in Bitcoin (BTC), offering investors exposure to BTC in the form of a security. BTC is the fund’s only asset and thus GBTC’s price should, in theory, mirror the value of BTCs held in the fund. While GBTC issues new shares periodically similar to other CEFs, there is a six-month lockup period during which investors can’t redeem their shares for BTC. While investors can buy bitcoin directly on a crypto exchange, many investors find it easier to trade bitcoin via the stock market, fueling excess relative demand for GBTC, causing its price to sometimes significantly exceed its native asset value (NAV).
While US investors wait for a Bitcoin exchange-traded fund (ETF) trusts like Grayscale’s are the next best thing for institutional investors. As a publicly-traded trust, which reports to the SEC, the Grayscale Bitcoin Trust makes it easy for institutional investors to forget about storage, custody and security of their holdings. Also, publicly-traded BTC trusts come with various tax advantages. Certain IRA, Roth IRA and other brokerages and investor accounts that won’t give tax breaks on investments of Bitcoin, will give them for investments of publicly traded trusts.
Price premia over NAV occasionally appear in the ETF universe, particularly in periods of heightened volatility, but rarely surpass 3% or so. When they do, authorized participants step in to arbitrage the gap away by creating or redeeming shares of the ETF. But GBDC doesn’t allows for redemptions, meaning that a fixed number of shares are issued, though secondary offerings are allowed by GBTC for institutional investors who contribute Bitcoin. In fact some institutional investors buy GBTC this way, effectively at its NAV, with the intent of selling after the mandatory six-month lockup period expires to capitalize on that premium. From the JP Morgan report:
The typical GBTC premium monetization trade involves borrowing bitcoin (typical cost of 5-7% per annum), placing these bitcoins to GBTC at NAV via private placement for in-kind shares locked up for 6 months, and hedge the exposure during the lockup period by borrowing GBTC shares (typical cost of 7-10% per annum) and selling them short. Alternatively one could hedge via shorting CME futures, but this entails some basis and rollover risk. The cost of this GBTC premium monetization trade is around 10-15% per annum and this is why it has been difficult so far for the GBTC premium to NAV to fall below this threshold.
This unwinding of the GBTC premium monetization trade could become violent if a bitcoin ETF is approved in the US. The introduction of a bitcoin ETF would erode GBTC’s effective monopoly status and cause a cascade of GBTC outflows and a collapse of its premium. ETFs allow for daily creation and redemption of shares and thus a more efficient arbitrage of the premium to NAV. A cascade of GBTC outflows and a collapse of its premium would likely have negative near-term implications for bitcoin given the flow and signaling importance of GBTC.
Why doesn’t Grayscale offer an on-demand redemption option to shareholders? First, Grayscale collects 2% of NAV and so all else equal, the more shares in the fund, the greater the fees Grayscale collects. Second, the six-month lockup also makes possible a scenario in which Grayscale could profit if the closed-end fund ever trades at a discount. Grayscale could buy its own stock in the market at a discount. For example, Grayscale could accumulate shares at, say, a 30% discount to NAV, and then offer a redemption feature. The result would be an immediate 30% gain.
* The views expressed herein are those of the author and should not be attributed to the International Monetary Fund, its Executive Board or its management.