For the Grayscale Bitcoin Fund, which accounts for 81% of institutional transactions, what impact will the discount transaction have on the market?

The entry of institutional investors into Bitcoin has always been a major event that has disrupted the pattern of the crypto industry. The last Bitcoin halving was a year ago, and after that, the amount of Bitcoin purchased by institutional investors exceeded the amount produced by miners. Among all the reasons for Bitcoin’s strong market momentum in recent months, institutional demand is at the top of the list.

Since the last Bitcoin halving on May 12, 2020, miners have mined a total of 309,557 Bitcoins, while institutional investors have bought a total of 380,644 Bitcoins. Therefore, it can be calculated that another net amount of 71,088 bitcoins comes from the secondary market.

More buyers than sellers

Bitcoin purists are dismissive of the idea of ​​investing through funds-too stupid, they only need to have a wallet! For private investors, this is easy to do, but for large or institutional investors, it is impossible. To store bitcoins in personal digital wallets, blockchain capabilities are required and there is no need for audit trails.

For many people, this is an unrealistic proposal. Instead, they want to own Bitcoin in the form of a security that can provide legal clarity and integrate with existing systems. The Bitcoin family should not complain, because the institution has strong financial resources, which means that Bitcoin “prices”.

Fund frame structure

The United States has the world’s largest bitcoin-related fund, Grayscale Bitcoin Trust (GBTC US), which holds approximately 646,000 bitcoins. The world’s second largest bitcoin asset management institution, CoinShares, is located in Sweden, which owns CoinShares. The two Bitcoin Tracker One funds under management (COINXBT SS and COINXBE SS) were both launched in 2015. CoinShares recently went public in Sweden with a market capitalization of US$840 million, and the institution holds approximately 57,000 bitcoins.

In the second half of 2018, 21Shares AG (called Amun at the time)-launched an encrypted basket of exchange-traded products ETP (HODL SW), the basket includes a total of five cryptocurrencies, these five tokens are currently: Bitcoin, Polkadot , Ethereum, Cosmos and Stellar. After that, the agency launched 12 different crypto ETPs, including the Bitcoin ETF (ABTC SW) launched in early 2019. 21Shares has the most diversified crypto fund, and its assets have grown to $1 billion.

Later in 2019, WisdomTree launched the Bitcoin Fund (BTCW SW) in Switzerland, and German institutions VanEck (VBTC GY) and HAN (BTCE GY) also launched similar products last year. Then CoinShares Physical (BITC SW) was launched in January this year. Today, the ETP products of the Bitcoin Fund in Europe alone hold approximately 99,000 Bitcoins, with a total value of 5.5 billion U.S. dollars.

New Bitcoin funds are also emerging in North America. 3iQ (QBTC-CN) launched the Canadian Bitcoin fund in the second half of 2020. After that, ninepoint launched BITC-U CN, Purpose launched BTCC/B CN, and Galaxy launched BTCG/U CN. Osprey (OBTC) was launched in the United States this year, followed by Bitwise 10 Crypto Index Fund (BITW US). North American funds that only invest in bitcoin currently hold approximately 689,000 bitcoins, worth a total of approximately 38.5 billion U.S. dollars.

ETF Vs. Closed-End Fund

All Bitcoin funds in Europe are exchange-traded products, or ETPs. These products are essentially exchange fund ETFs, but in Europe, traditionally when a trading tool is more complex, it will be called ETP rather than ETF in the specific description.

In addition to similar ETF purposes, North American Bitcoin funds are closed-end funds, usually called investment trusts. This means that these funds hold a fixed amount of Bitcoin, and the price of their shares floats freely. The share may be higher or lower than the bitcoin it represents. When it is higher than the value of its holdings, we call it a premium; when it is lower, it is called a discount/discount.

For example: Grayscale’s GBTC fund has a total of 692,370,100 outstanding shares, and the fund holds a net 0.00094632 bitcoin per share. The fund holds a total of 655,204 bitcoins on behalf of its shareholders. Yesterday (March 16), the closing price of GBTC stock was 49.86 US dollars, and the actual Bitcoin holdings of the fund were 52.13 US dollars per share. This means that GBTC shares are traded at a discounted price equivalent to 95.7% of its net asset value (NAV).

The price of Bitcoin is constantly changing, and there is no formal correlation between GBTC’s stock price and the price of Bitcoin it holds. If there are more sellers than buyers who want to sell GBTC, its stock price will fall regardless of the price of Bitcoin. However, when the data was released, there was an informal relationship between the two. Aside from the madness of the investment crowd, investors are usually attracted by discounts and avoid premiums.

Unfortunately, we cannot leave behind the madness of the investing crowd.

The power of premium

A premium means that investors are prepared to pay higher fees for asset risk exposure than asset value. They do this because of limited options (no other funds) or just hype (buy bitcoin). Until recently, GBTC was one of the only ways for U.S. investors to buy Bitcoin through funds. And there is a lot of hype around grayscale.

The GBTC premium (or discount) is shown in gray in the figure below. Most of the time, GBTC is a premium transaction, and sometimes the premium is very high. In 2017, the trading price of GBTC stock was sometimes twice its fair value.

Grayscale Bitcoin fund premium decays

You can invest in GBTC directly through the stock market. In addition, qualified investors can subscribe to the fund with NAV and get GBTC shares in six months. If the price of GBTC is at a premium within six months, you will benefit from it.

For example, you can call the gray sales team to subscribe for 1 million US dollars of GBTC stock. Grayscale buys $1 million in Bitcoin, and you will get GBTC stock after six months. Assuming that the price of Bitcoin has not changed during this time period, and the GBTC stocks in the market are trading at a 50% premium, you now own $1.5 million in stocks. Pretty.

When the premium is high, this type of transaction is naturally extremely popular. Qualified investors can borrow bitcoins from bitcoin lending institutions at an annual interest rate of PA 7% and deposit them in Grayscale to hedge their positions in the futures market to obtain a premium, while the cost of holding is lower. When GBTC shares are traded at a premium, many investors subscribe to GBTC’s new share issuance, and when the premium drops, the inflow of funds slows down. The inflow of gray funds hit a record high in 2020, and the average premium for the year was 30%. The bad news is that GBTC stock has now become a discount transaction. More investors than buyers want to sell GBTC shares.

The problem is that there is no way to prevent the discount from expanding further. Grayscale announced that it will spend US$250 million to repurchase shares. This is good, but the scale is too small to really affect a US$33 billion fund. Grayscale really needs to take it seriously, and it needs to ensure that it repurchases that amount of stock every week. To do so, you need to sell Bitcoin and buy back GBTC shares to write off. But I think their legal structure prevents this practice.

Gray’s solution is to launch an ETF to invest in GBTC in a structure of connected funds (or sub-funds). I’m not entirely sure of the benefits of this, but it does add another layer of fees for investors. When Osprey (OBTC) provides Bitcoin risk exposure at a fee standard of 0.49% per year, you may think that GBTC will reduce its fee standard from 2%; considering the new pattern of competition, the fee of GBTC is too high Up.

The importance of GBTC

As I wrote earlier, institutional investors have purchased 380,644 bitcoins since last May. About 308,446 bitcoins were purchased through GBTC. That is to say, in the current bitcoin trading market, 81% of the total institutional transactions are completed through GBTC, and GBTC shares are now traded at discounted prices. The discount means that institutions will no longer subscribe for new shares of GBTC, which means that GBTC will no longer buy new bitcoins.

If you are lucky, this is just a problem with GBTC and will not spread, but I think it is very important for the encryption field to hold its service providers accountable. Unless GBTC takes action to eliminate the discounted price and maintain a situation of no less than the net value, it will create selling pressure, which may evolve into a systemic risk to the Bitcoin price.

The ETF solves this problem. In view of the fact that many institutions have already requested regulatory approval of their ETF products, I think they will be introduced to the market sooner or later. Like European ETPs, they will be traded at net asset value, and investors hope so. ETF fees will be lower. All in all, ETF will be a more attractive package. When ETFs arrive, the only reason investors can stay in GBTC is to avoid capital gains tax.

When GBTC first traded at a discounted price a few weeks ago, some people clamored to buy bottoms. I am not so sure. For the benefit of the Bitcoin field, I very much hope that Grayscale can quickly restore investor confidence.