NYDIG Research Weekly: Record Discount to NAV in GBTC Draws Trader Interest
by Greg?Cipolaro, Global Head of Research?and Ethan Kochav, Research Analyst
A weekly digest of Bitcoin news and insights.
IN TODAY'S ISSUE:
Record Discount to NAV Entices Traders to GBTC
The world’s largest bitcoin fund, the $27.1B Grayscale Bitcoin Trust (GBTC), dropped to a record discount to its net asset value (NAV) this week. At one point, the shares traded 28% below the underlying value of the bitcoin held within the trust. As a reminder, GBTC is a grantor trust that is only occasionally open for subscriptions at NAV and does not allow investors to redeem at NAV, which means that the share price can trade at significant premiums or discounts. GBTC had historically traded at a premium but moved to a discount early last year following the launch of open-ended ETFs in Canada. It goes without saying, but this price move has caused significant pain for its holders. Because of this dynamic, GBTC investors were only up 7% last year despite gains of 57% for bitcoin. Things have only gotten worse in 2022 as the discount has continued to widen.
Grayscale recently filed to convert GBTC into an exchange-traded fund. If approved, authorized participants could redeem shares at the net asset value and the discount to NAV would be expected to disappear. The SEC’s last date to respond to the request is July 6, 2022, but expectations for approval are low. The SEC has rejected five similar applications in recent months and has given no reason for us to expect it to deviate from its established behavior. Apart from waiting for regime change at the SEC, one interesting wrinkle is the potential for a lawsuit by Grayscale. Late last year, following the conversion application, the crypto asset manager’s lawyers at Davis Polk sent a letter to the SEC arguing that its approval of futures-based ETFs and rejection of spot-based ETFs is arbitrary and capricious. The law firm argued that this could constitute a violation of a post-New Deal law called the Administrative Procedures Act (APA) that governs the decision-making processes of government agencies.
As the discount continues to grow, “arbitrage” traders have expressed interest in taking advantage of this discrepancy by buying GBTC and shorting spot to take advantage of a potential conversion. There’s another attractive element to this trade; while there is a 2% annual management fee charged to holders of GBTC, current market dynamics for borrowing spot are such that borrowers are paid a rebate. This rebate could then be used to offset the GBTC management fee. However, while the industry colloquially calls this trade an “arb”, it is anything but a riskless endeavor. Which is to say, it’s not arbitrage at all. That’s because there is no theoretical floor in the discount to NAV. With no redemption features, shares of GBTC traded on secondary markets are subject only to supply and demand. The discount may look unsustainable, but in practice, there’s no limit on potential losses.
Bitcoin Proxies Underperform to Start the New Year
GBTC has not been the only bitcoin proxy to have a rough start to the year. Below, we look at market-cap-weighted performance across various crypto sub-sectors. These instruments are often used by investors as proxies for exposure to bitcoin itself.
For digital asset ETFs and CEFs, this underperformance is a continuation of a trend from 2021. U.S. digital asset ETFs continue to underperform because of the upward-sloping bitcoin futures curve, and we discussed the widening discount in GBTC in the prior section, a dynamic experienced by other CEFs. Miners and digital asset companies, however, outperformed bitcoin last year. In some cases, they did so handily. This has reversed as bitcoin has fallen in 2022. While some of this is due simply to tracking error, it does appear that some of these bitcoin replacements act as levered bitcoin plays. Now with bitcoin trending downwards, investors are experiencing the ill effects of this leverage.
House Hearing on Mining Results in Spirited Debate
The House Committee on Energy and Commerce’s Subcommittee on Oversight and Investigations hosted an investigative hearing on Thursday titled “Cleaning Up Cryptocurrency: The Energy Impacts of Blockchains.” Across the political spectrum, blockchain technology was acknowledged as being innovative and yielding multiple societal benefits. However, the proof-of-work consensus mechanism used by Bitcoin and, currently, Ethereum received greater scrutiny. Democratic committee members were concerned about proof-of-work mining’s potential to contribute to climate change, particularly by restarting dirty energy plants or saving doomed ones. Concern was also raised that the demand on the grid could raise electricity rates for ordinary customers. Several of the witnesses, though, pointed out the demand-response features of mining. That is, miners can turn on in times of high supply and turn off in times of high demand, thus supporting the economics of clean energy generators. This feature would also alleviate anxieties about putting undue pressure on the grid. Proof of stake was also proposed as a potential solution to the entire energy discussion, though there was disagreement among the witnesses as to the level of security provided by proof of stake to the network. In all, while there was certainly disagreement, the debates were not exceptionally hostile. In fact, the committee members seemed eager to gain a better understanding of the industry and its nuances. One takeaway was the clear need for better communication between miners and public utilities. Both the mining community and public utilities would be better off working together.
Market Update
Bitcoin?fell -0.2% on the week. Equities also fell, with the?S&P 500?down -3.8% and the?Nasdaq Composite?down -4.4%.?Gold?gained by 1.1%. Bonds decreased on the week, with?Investment Grade Corporate Bonds?falling -1.7%,?High Yield Corporate Bonds?depreciating -0.9%, and?Long-Term U.S. Treasuries?decreasing -1.6%. Real yields modestly increased and inflation expectations modestly decreased.
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