Representations of cryptocurrencies
GBTC stumbled to a sharp discount after the emergence of the first North American bitcoin ETF in Canada in February © REUTERS

The North American rollout of bitcoin exchange traded funds appears to have tipped the world’s largest crypto fund into a seemingly permanent discount to its net asset value.

The $32bn Grayscale Bitcoin Trust (GBTC), which owns 3.5 per cent of the world’s bitcoin, currently trades 15 per cent below the value of its underlying assets.

It had traded at a substantial premium to NAV for much of its existence but stumbled to a sharp discount after the emergence of the first North American bitcoin ETF in Canada in February.

The flip from premium to discount has hit investors in the pocket. While GBTC’s share price rose 42 per cent in the first 10 months of this year, its NAV jumped 92 per cent and the price of bitcoin 95 per cent, according to Morningstar. In the 12 months to the end of October, while bitcoin surged 340 per cent, GBTC’s share price was up 220 per cent, Morningstar found.

Some 47 funds, including the $5.5bn Ark Next Generation Internet ETF, separately managed accounts and model portfolios, held GBTC as of September, according to Bobby Blue, senior manager research analyst at Morningstar, making it the most widely held crypto-related product.

GBTC has tumbled to a discount to NAV

“I think it’s a problem [for GBTC],” said Blue. “Competing products, some with better fee structures, some with better ways of tracking bitcoin, have come to the market and that will pose a challenge to them to narrow the discount.”

Todd Rosenbluth, head of ETF and mutual fund research at CFRA Research, said GBTC was “previously a good way to get exposure to bitcoin,” but that new products had muscled into its territory.

“The initial launch of a bitcoin ETF in Canada was a key milestone for investors and a key milestone in the history of GBTC because there is now an alternative that has the benefits of the ETF structure,” Rosenbluth said.

GBTC is a closed-end fund, which means it cannot easily add or remove shares to deal with inflows and outflows. As a result, its share price is determined by supply and demand, rather than being tied to the underlying value of its assets, as would be the case with an ETF, where new shares are created and redeemed seamlessly.

Between early 2020 and February 2021, Grayscale filed 35 reports with the Securities and Exchange Commission indicating it had created and sold additional shares to accredited (largely institutional) investors in private placements, according to Morningstar.

Line chart of Cumulative return (%) showing GBTC's returns have undershot bitcoin

Demand was buoyed by the premium to NAV that GBTC traded at during this period, which facilitated an arbitrage trade that saw hedge funds buy new shares at NAV then, after the expiration of a lock-up period, sell them at market price. This helped fuel demand that saw GBTC’s assets soar from about $3bn at the start of 2020.

Blue said that dynamic “flipped” in February 2021, when the Purpose Bitcoin ETF, the first Canadian spot bitcoin ETF, launched, amassing more than $1bn in assets within a month.

“Its management fee of 1 per cent is half that of Grayscale Bitcoin Trust, and its structure as an ETF allows it to track bitcoin more closely, making it more appealing than Grayscale’s offering,” he argued.

Although US retail investors are not able to invest in Canadian ETFs, US institutions are, “so there was some rotation to that product”, Blue said.

Additionally, he said Grayscale “might have simply issued too many shares”, throwing supply and demand out of kilter.

What happens next is unclear. Existing investors face either selling at a discount or sitting tight and hoping for the best, while paying a 2 per cent annual fee. This is above the 65-95 basis points charged by recently launched US-listed bitcoin ETFs although, as these ETFs are based on bitcoin futures, the roll fees they face could be 5-10 per cent a year.

New investors could, in theory, buy the closed-end fund because its discount to NAV represents an arbitrage opportunity, but only if there is a path to close the discount.

“Right now, absent a redemption programme or, the elephant in the room: converting to an ETF, you are never going to realise that discount,” said Blue. Meanwhile “as other newer products draw more money out of the trust, there is the possibility of wider discounts”.

A redemption programme would involve Grayscale offering to cancel some shares, with exiting investors being paid at NAV.

The downside for Grayscale is that it would mean a loss of assets, and therefore fee income. Its filings with the SEC say it “currently has no intention of seeking regulatory approval” to start one.

Converting GBTC into an ETF is Grayscale’s professed goal, and it has filed with the SEC to do so. But the SEC has so far shown no willingness to approve spot bitcoin ETFs.

Rosenbluth noted that “anyone who has held GBTC for a year or more is still likely to have made significant total returns”, given the soaring value of bitcoin.

Grayscale said the price at which GBTC trades at is “subject to market forces, a risk inherent in any publicly traded investment product,” and denied it had issued too many shares.

Grayscale argued that “the most efficient way to resolve any discrepancy between GBTC’s share price and the NAV,” would be for it to be able to convert into a spot ETF, something “the US investment community is eager for . . . is ready for and deserves”. 

In that eventuality “we would expect the redemption mechanism inherent in the ETF structure to remove any premium or discount on GBTC’s share price. With that frame of mind, the discount may represent a buying opportunity for opportunistic investors.”

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