Author: indiGO
On November 21, 2020, the price of Bitcoin broke through US$18,960, approaching the historical highest price of US$19,763.
The data shows that in the six months since the Bitcoin halving on May 13th, the amount of Bitcoin that Grayscale increased its holdings was basically equal to its mining amount during the same period. On November 20, Grayscale Bitcoin Trust once again increased its holdings of 10550 BTC, and its total holdings reached 526,765 BTC…
It is said that 2017 is a bull market for retail investors, and 2020 is a bull market for institutions, and Grayscale is considered to be the biggest engine of this bull market.
The name Grayscale is no stranger to investors, but there are still many questions surrounding Grayscale that linger in everyone’s mind: Why does Grayscale keep increasing its holdings of BTC? How does an institution make arbitrage through Grayscale GBTC? Will grayscale hit the disk?
Next, we will use ten questions to reveal the grayscale.
What is Grayscale?
The prototype of Grayscale Investment is a Bitcoin investment fund owned by SecondMarket, a private equity trading platform. In 2014, Barry Silbert, the founder of SecondMarket, separated the Bitcoin investment fund from the original company and established Grayscale Investments.
In 2015, Grayscale Investment Company was merged into the newly established Digital Currency Group (DCG). In addition to Grayscale Investment, DCG also has two subsidiaries, including Genesis, an over-the-counter cryptocurrency trading broker, and CoinDesk, a blockchain media platform, as well as more than 150 other blockchain companies/projects.
In addition to Bitcoin trust funds, Grayscale Investment has also launched trust funds for ETH, BCH, ETC, LTC, XRP and other cryptocurrencies, as well as a complex cryptocurrency trust fund (Grayscale Digital Large Cap Fund) containing mainstream currencies.
Timeline for the establishment of Grayscale Products Source: “Grayscale Investor Deck October 2020”
What is Grayscale Bitcoin Trust (GBTC)?
Grayscale Bitcoin Trust (GBTC) is Grayscale’s largest encrypted digital asset trust product, and its scale accounts for more than 90% of Grayscale’s overall asset management scale.
GBTC is essentially a private equity trust fund, which was launched for the first time in 2013 and opened for subsequent primary market subscriptions from time to time. Initially, only qualified investors can participate, and the minimum subscription amount is US$50,000. In March 2015, GBTC was publicly traded on OTCQX, officially announcing that the share of GBTC private equity trust funds will be listed in the secondary market, and public investors can participate.
Investment in GBTC is divided into cash contributions and in-kind contributions (Bitcoin). Buying GBTC is equivalent to buying the corresponding share of Bitcoin in a gray position. Since GBTC was investigated and dealt with by the SEC in 2014, Grayscale suspended the redemption mechanism of GBTC on the grounds that the SEC would not approve it. Therefore, the shares of GBTC subscribed by investors of the two capital contributions cannot be redeemed.
In addition, Grayscale will also charge a 2% hosting fee, which is also its main profit method. The collection method is deducted from the number of bitcoins held, that is, the currency-based method collects management fees. Statistics show that according to its current asset management scale, Grayscale collects about 7,000 bitcoins in custody fees each year.
Investor participation in GBTC share subscription model
Grayscale announced the latest asset management scale
Why does Grayscale keep increasing its holdings of Bitcoin?
According to the latest data officially released by Grayscale, as of November 20, excluding the lost bitcoins, the total holdings of Grayscale Bitcoin Trust are close to 3.4% of the BTC circulation, reaching 526,765, which continues to push BTC toward March to the highest price in history.
In fact, GBTC does not “should timing” its investment in Bitcoin, but aims to track the trend of its price itself and serve its investors. Therefore, its Bitcoin investment strategy is “passive”. Why?
1. The source of demand for increasing holdings of BTC is the continuous entry of large funds from arbitrage institutions. After buying out the share of GBTC, it promotes gray holdings. But the ultimate source of demand still comes from the secondary market. The extremely high premium has attracted many institutions to carry out arbitrage activities. This situation is often more obvious in a bull market. Therefore, when Grayscale continues to increase its holdings of Bitcoin, it means that arbitrage institutions are optimistic about the GBTC premium.
2. The unredeemable mechanism of Grayscale Bitcoin Trust will make it manage more and more positions. The 2% management fee makes Grayscale earn a lot of money.
Why buy GBTC instead of buying Bitcoin directly?
The purpose of GBTC is to reduce asset management costs for investors. By purchasing GBTC directly in the U.S. stock market, investors can purchase and hold Bitcoin in a simplified and safe manner with no learning threshold. While enjoying the investment opportunities brought by the high volatility of Bitcoin prices, there is no need to bear certain risks that may exist in trading Bitcoin on your own:
1. There is a risk of information leakage when opening an account on a digital currency trading platform: every day you may receive harassing calls from fake customer service of major trading platforms, and even your personal privacy is stolen or used in violation of regulations.
2. Buying and selling bitcoins on digital currency trading platforms has risks such as price manipulation, currency withdrawal restrictions, and exchange “running”: opacity is a common problem of centralized platforms.
3. There are risks of losing and stolen wallet private keys when storing bitcoins.
In addition, GTBC operates in a similar way to stocks and bonds, which can provide investors with tax convenience and can be easily transferred to beneficiaries under the inheritance law.
Who is buying Bitcoin through Grayscale?
The data shows that 80% of GBTC purchases are institutional investors, and as of November 2020, a total of 23 companies (a total of 29 institutional-level accounts) hold shares of Grayscale Bitcoin trust. Encrypted asset lending company BlockFi is the largest holder of Grayscale Bitcoin Trust, holding approximately 24,235,500 trust shares; the second holding position is Three Arrow Capital, which is currently one of the most active cryptocurrency hedge funds.
It is worth noting that the institutions hidden in this list have accounts of well-known private wealth management institutions or family offices, including the famous Rothschild Investment Corp (Rothschild Investment Corp).
Grayscale Investor Structure by Type Source: “Grayscale Digital Asset Investment Report Q3 2020”
As of November 9th, a total of 23 institutional investors have publicly held positions. Source: Fintel. Drawing: Chain Hill Capital
Why does GBTC have a long-term high premium relative to BTC prices?
Since GBTC can be traded in the secondary market, its share price has a long-term premium over BTC itself. The current GBTC latest net value (NAV) is $17.46, and the price of Bitcoin per share in the same period is about $21.24, with a premium rate of 21.56%.
The premium arises from the market circulation value of each GBTC> the value of the embedded Bitcoin, for the following reasons:
1. Low flexibility and no substitutes. The U.S. stock market lacks investment tools for Bitcoin and encrypted assets. As long as the SEC does not approve Bitcoin ETFs, GBTC basically has no competitors.
2. The mechanism that GBTC is sold regularly, cannot be redeemed, cannot be resold with a 6-month lock-up period, and the market sentiment continues to be optimistic, resulting in a higher risk premium.
Two factors have caused the supply of GBTC to exceed demand, resulting in a long-term premium to the price of GBTC relative to Bitcoin.
Data shows: GBTC has a long-term premium over BTC
How to use GBTC premium arbitrage?
In the past 5 years, the average premium of GBTC was 38%, reaching 132% at the highest point. There is considerable room for arbitrage.
There are currently four common GBTC arbitrage models: cash loan arbitrage, physical loan arbitrage, share loan arbitrage and locked premium arbitrage:
1. Cash loan arbitrage. Investors buy GBTC shares with cash or Bitcoin, and after the 6-month lock-up period, they sell in the secondary market. The risk of this approach is greatly affected by the fall in the price of Bitcoin. Only when the price of GBTC is higher than the initial cost, can it be profitable.
2. Physical loan arbitrage. Institutional investors borrow bitcoin on the lending platform and hand it over to Grayscale to replace the primary market share. After the 6-month lock-up period, sell at a certain time, and at the same time buy bitcoins and return them to the lending platform. At this time, the premium income from the sale of GBTC minus interest and other expenses is arbitrage profit.
3. GBTC share loan arbitrage. Investors directly borrow GBTC shares and sell them in the secondary market. At the same time, cash or Bitcoin is exchanged for GBTC shares in Grayscale, and the borrowed GBTC shares are repaid after the lock-up period. There are two fees involved here, one is the borrowing cost of GBTC, and the second is the 2% custody fee. If the GBTC premium exceeds the sum of the two types of fees, it will be profitable.
4. Lock in premium arbitrage. Investors use cash or bitcoin to convert to GBTC in Grayscale, and at the same time, when the market price of GBTC is higher than the net asset value, they borrow GBTC off-market and go short. In the end, regardless of whether GBTC rises or falls, profits are fixed. The final premium minus the borrowing cost and custody fee is the profit margin.
Summarizing the four arbitrage methods, the first situation is more dependent on the current price of Bitcoin. The higher the price of Bitcoin, the higher the profit. The second and third strategies rely more on the GBTC premium. The higher the premium, the more people realize arbitrage, and the higher the demand for Bitcoin at this time. The fourth situation is very suitable for hedge funds, the operation is relatively complicated, but the premium income can be locked in advance, and the market risk is small.
Why is Bitcoin ETF not approved, but GBTC can exist?
The existence of GBTC is inseparable from the regulatory environment in the United States. Because the SEC believes that the price of Bitcoin can be manipulated, the application for Bitcoin ETF has never been approved, but why did GBTC pass the approval? The reasons are as follows:
1. The United States allows trusts to invest in crypto assets such as Bitcoin and Ethereum, and allows such trust shares to land on the OTC market.
2. The United States allows digital currency trading platforms to operate in compliance and accept Bitcoin quotations (the current quotations used by GBTC include Coinbase Pro, LMAX Digital, itBit, Kraken and Bitstamp).
3. The United States allows digital currency custodians to operate in compliance. GBTC’s custodian, Coinbase Custody, is a trustee in compliance with the “New York Banking Act” and a qualified custodian for the purposes stated in the US “Investment Advisors Act”.
4. Many law firms and audit firms are willing to provide services for GBTC.
Will grayscale hit the disk?
First of all, the long-term positive premium of GBTC has formed a space for arbitrage between the primary and secondary markets. As long as institutions maintain optimistic expectations about the risk premium of GBTC, the holdings managed by Grayscale will become larger and larger. In addition, GBTC has an “unredeemable” mechanism, which directly eliminates the liquidity crisis of Bitcoin sellers, and does not give GBTC investors the opportunity to sell or hit the market.
Secondly, the management fee for currency-based settlement will reduce the number of bitcoins corresponding to each GBTC share held by investors. Therefore, Bitcoin will also slowly be transferred to Grayscale. In the long run, Grayscale will become one of the largest Bitcoin holders in the market.
It can be seen that Grayscale actually controls the “life and death” of Bitcoin trading.
If the price of bitcoin continues to rise, the cost of institutional arbitrage will become higher and higher, and the high premium of GBTC will always exist, which will lead to a short-term game between the demand for bitcoin generated by institutional arbitrage and the number of bitcoin cashed out in gray scale; You can also lower the premium yourself to balance the impact of Bitcoin supply and demand and stabilize market sentiment.
If a bear market comes, Grayscale can pay to maintain the premium, continue to attract institutional arbitrage, and use the 6-month GBTC lock-up period to sell; or directly hit the Bitcoin price to the lowest level and continue to wait for a new round of bull market.
At present, as long as institutions maintain optimistic expectations about the premium of GBTC in the bull market, Grayscale will not have any motivation to hit the market.
How to evaluate “gray cattle”
Based on the mechanism that Grayscale Bitcoin Trust cannot redeem, the two forms of capital contributions in cash and in kind, and the clever separation of issuance and circulation across markets (cryptocurrency market and US stock market), the share of GBTC in the secondary market of US stocks is high. The premium has provided a lot of room for institutional cross-market arbitrage, and the participation of arbitrage funds has successfully realized the ideal closed loop of “sell pressure (GBTC) transferred to US stocks and capital back to Amber”.
If there is no global factor to smooth out the GBTC premium in the short term, Grayscale will continue to increase its holdings of Bitcoin without any surprises. This makes Grayscale Bitcoin Trust a “buy but not sell” long power in the market, and Bitcoin will also maintain an upward trend in the short term.
Reference materials:
“Depth | Exploring Grayscale GBTC: The Biggest Whale in the Bitcoin Market”, source: Guosheng Blockchain Research Institute.
“Depth | Deconstructing Grayscale Bitcoin Trust”, source: Qianfeng Capital.
“Depth: Demystifying the Truth about Grayscale’s Always Buying, Buying and Buying”, source: Babbitt.
