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Bitcoin ETF on the rise, Grayscale death spiral forming, will it turn to a new battlefield?

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Bitcoin ETF on the rise, Grayscale death spiral forming, will it turn to a new battlefield?

Earlier reports indicated that Grayscale, the world's largest cryptocurrency trust fund company, has seen its Bitcoin Trust Fund (GBTC) hit a record high negative premium of -14.34%. With the emergence of competitors and Bitcoin ETFs, Grayscale's Bitcoin Trust Fund has gradually lost its appeal to users. In response, Nic Carter, the founder of Coin Metrics, suggested that Grayscale is likely to transition into a Bitcoin ETF.

As the classic line from "Peach Blossom Fan" goes, "One sees him rising to grandeur, one sees him feasting his guests, one sees the building collapse," which may aptly describe Grayscale's current situation.

Grayscale Fund is a subsidiary established by Digital Currency Group (DCG) in 2013, specializing in managing trust funds for crypto assets.
Undoubtedly, Grayscale has been one of the biggest beneficiaries of Bitcoin's rise. According to Bybt data, in June of last year (2020), Grayscale's Bitcoin Trust held only 365,000 bitcoins, valued at around $3.5 billion at the time price of $9,700 per bitcoin; today, the holdings of Grayscale's Bitcoin Trust have increased to about 655,000 bitcoins, with a total value of $34.1 billion.

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Why Does GBTC Have a (Negative) Premium?

In conclusion: The premium on Grayscale Bitcoin Trust (GBTC) is due to the ineffective arbitrage mechanism, market speculation, and most importantly, the immaturity of Bitcoin as an asset.

Grayscale's GBTC is a trust fund product similar to an ETF, which can be subscribed and redeemed in the primary market and traded in the secondary market. This mechanism creates two prices: the real-time net asset value and the real-time market price. Qualified investors in Grayscale can purchase GBTC shares with cash or Bitcoin (BTC), lock them up for six months, and then sell them in the secondary market.

When Grayscale initially had a negative premium, some in the market believed that this situation would also occur with ETFs and was nothing to worry about. However, they did not realize that this is completely different from traditional ETFs.

In traditional financial markets, ETFs can usually be sold the day after they are purchased in the primary market. Therefore:

  • When the net asset value is greater than the market price, investors buy ETFs in the secondary market and redeem them based on the net asset value the next day to arbitrage.
  • When the market price is higher than the net asset value, investors subscribe first and then arbitrage in the secondary market the next day.

However, GBTC has a lock-up period of up to six months, which means that if Bitcoin plunges after purchase, investors cannot sell and can only watch their assets depreciate.

Why Would Someone Buy at a Premium?

But why would someone subscribe to GBTC?

The first reason is that the Bitcoin market is still immature.

As one of the oldest cryptocurrency funds, Grayscale provides a "compliant" opportunity to invest in Bitcoin. For many funds, such as pension funds, purchasing Bitcoin is not allowed. Through Grayscale, investors can subscribe to GBTC shares and arbitrage in the secondary market.

As Bitcoin becomes more popular, many users of funds may want to invest in Bitcoin, and Grayscale's GBTC is the only compliant option available. In the initial stages, as GBTC continued to have a positive premium, compliant investors became more confident in investing more funds.

Another reason for the premium is the overly optimistic market sentiment.

The chart below shows the premium of Grayscale GBTC according to Bybt:

During last year's March pandemic outbreak, Bitcoin plummeted by 50% in two days, causing GBTC's premium to drop from 21% to 3.37%. As Bitcoin strengthened, GBTC's premium gradually increased, reaching a peak of 40.2% on December 22, and then gradually declined until the first negative premium appeared on March 5 this year.

From March to December last year, the premium roughly followed the growth of the Bitcoin price. During this period, there were no other Bitcoin funds or similar products on the market, and the market consensus was that Bitcoin would continue to rise. In such a sentiment, accredited investors naturally felt confident in subscribing to GBTC because Bitcoin kept rising, and Grayscale continued to have a premium.

As a result, primary market investors could profit from both the rising Bitcoin price and the "premium profit," continuously using these premium profits to subscribe to GBTC for arbitrage. Secondary market investors had a compliant environment to trade Bitcoin, and as long as Bitcoin continued to rise, they had arbitrage opportunities.

In theory, if no competitors emerge, this premium will continue until the bull market ends, the secondary market has no arbitrage opportunities, the premium gradually flattens, and only long-term investors willing to continuously purchase GBTC remain.

The First Landmine: MicroStrategy

Looking at the price trend, Bitcoin was only around $20,000 in mid-December last year, and its real surge was just beginning. But why did the premium rate gradually decline, and even turn negative in March this year?

A significant reason could be the issuance of convertible bonds by the U.S. publicly traded company MicroStrategy.

MicroStrategy (NASDAQ: MSTR) is a U.S. commercial software company that gradually acquired 475 million Bitcoins around September last year. At that time, MicroStrategy's market value was only over $20 billion, but it invested nearly a quarter of its assets in Bitcoin.

Although MicroStrategy's CEO Michael Saylor has always emphasized that they are "hedging against currency devaluation" risk, the market "votes with money." After September, MSTR's stock showed a clear correlation with Bitcoin. In November last year, while Bitcoin rose by 42% in a single month, MSTR surged by 105%. Regardless of MicroStrategy's intentions, the market clearly regarded it as "the shape of Bitcoin." MSTR became a Bitcoin concept stock.

However, MSTR's risks remained high, but the convertible bonds were different.

Both MSTR's stock and Bitcoin are recognized as "intangible assets," and price fluctuations affect the income statement. However, if a company or fund purchases convertible bonds, as long as MicroStrategy's solvency is not an issue, the convertible bonds have almost no fluctuation on the income statement.

According to data compiled by <>, MicroStrategy's average purchase price for Bitcoin was $24,212, representing a profit of over 100%, with no solvency issues.

After the maturity date, companies or funds that purchased convertibles "may" have two options (details undisclosed): redeem with cash plus interest or exchange for MSTR stock. If Bitcoin continues to rise, MSTR will likely continue to rise; if Bitcoin falls, they can exchange for cash.

MicroStrategy's corporate bonds offer a low-risk investment opportunity to capture the value of Bitcoin.

Not only has MicroStrategy provided an alternative investment method, but the oldest U.S. banks Mellon and Deutsche Bank have also offered ways for institutional investors to invest in Bitcoin, aiming for "main broker services" to increase user capital efficiency. On the retail side, Canada has successively launched three Bitcoin ETFs, and Grayscale has also launched a Bitcoin fund, claiming "no premium."

These more mature Bitcoin investment methods do not require investors to lock up their funds for six months and risk Bitcoin price drops. On the other hand, the emergence of these investment methods means that secondary market users no longer need to purchase GBTC at a premium. With fewer buyers, Grayscale's GBTC naturally enters a "death spiral."

Even though there is currently a negative premium, buying GBTC is cheaper than buying Bitcoin outside, and no one in the secondary market will easily take over because they cannot redeem, relying only on finding the next buyer.

Should There Be a Transformation?

Yes, Grayscale may be in the process of transformation.

Trading inefficiencies like GBTC cannot satisfy the market. Therefore, the only choice is to transform, with one possible path being to convert into a Bitcoin ETF.

Although there is no official news, according to <>, Grayscale released new job openings on March 10, just after the negative premium. Among them, there are nine job openings related to ETFs, including ETF compliance officer, ETF product development expert, and ETF sales director, indicating that Grayscale's next target is likely an ETF.

However, Grayscale's cryptocurrency trust still has advantages, just not in Bitcoin.

Bitcoin remains the focus of the market, but Bitcoin and other cryptocurrencies such as Ethereum (ETH) and Filecoin (FIL) have fundamental differences. Bitcoin is more like "store of value," while other cryptocurrencies may serve as payment or financial technology innovations.

After the appearance of a negative premium on Grayscale, the next step was to quickly list cryptocurrency trusts for alternative coins (Altcoins). On March 17, they simultaneously launched five cryptocurrency trusts for Basic Attention Token (BAT), Chainlink (LINK), Decentraland (MANA), Filecoin (FIL), and Livepeer (LPT).

Grayscale's total locked amount is $43.1 billion, with only about $1.1 billion remaining after deducting Bitcoin and Ethereum. Notably, among the trust stocks traded in the secondary market, only the Ethereum trust ETHE does not have a negative premium; the other five are in a negative premium. This indicates that apart from ETHE and GBTC, the market lacks interest in other cryptocurrencies.

In summary, Grayscale's era of dominance has passed. Even if the U.S. Securities and Exchange Commission (SEC) ultimately approves an ETF, it will be an era of divided power. The only way for Grayscale to gain an advantage is through ETHE. However, with increasing institutional interest in Ethereum, it's not difficult to imagine that the next target will be Ethereum. How long can Grayscale's advantage last? Perhaps we can only hope for the rise of other competitive coins.