OKEx Research: The mystery of the high premium of gray funds

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In the crypto asset market, if you want to ask which institution has received the most attention in the near future, many people may choose gray funds. Grayscale Investments is a subsidiary of the digital currency group DCG (Digital Currency Group) established in 2013. Grayscale Asset Management provides investors with a legal way to buy and sell cryptocurrency. The main operation method is to establish a cryptocurrency trust fund so that investors can participate in the purchase.

According to the latest data, as of the end of October, the total scale of cryptocurrency management has exceeded 7.5 billion U.S. dollars, making it the world’s largest digital asset management institution. At the same time, according to the third quarter data released by Grayscale Assets, the asset size in March 2020 was only 2.2 billion US dollars, and the asset management scale increased by 240.91% in the past six months.

Figure 1. The total scale of assets of Gray Asset Management Company

Source: Grayscale Fund’s official website

Of course, another important reason why Grayscale Fund has attracted the attention of the market is its high price premium. For example, according to the data on November 19, the price of GBTC per share is US$20.01, and the current value of BTC corresponding to one GBTC share is US$16.98, which is equivalent to a 17.84% higher GBTC price relative to the spot price, and there is a significant premium. . And since 2017, GBTC has had a long-term and stable high premium.

Figure 2. Market price and net worth of GBTC

OKEx Research:灰度基金的高溢价之谜

Source: Grayscale Fund’s official website

Many people are wondering where the high premium of Grayscale Fund comes from, and they often draw conclusions based on market experience that people are stupid and rich. In fact, if you analyze carefully, you will find that the above conclusions are not tenable. According to the first quarter report of Grayscale Assets, 88% of investors are institutional investors and 5% are high-net-worth qualified investors. The user portraits of these investment groups are difficult to match with “people are stupid and rich in money”.

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OKEx Research:灰度基金的高溢价之谜

Figure 3. Types of gray asset investors

Before understanding the reasons for the high premium of gray funds, we must first know what the premium of gray funds is.

Take the Bitcoin trust fund GBTC under Grayscale Fund as an example. GBTC is a trust fund product similar to ETF, which can be purchased and redeemed in the primary market and traded in the secondary market at the same time, so it has real-time net worth and real-time market price. Kind of price. When the net value is less than the market price, it is called a fund premium, but when the net value is higher than the market price, it is called a fund discount.

For general ETF funds, there will be no high discounts or premiums because of the ETF’s arbitrage mechanism:

ü When net worth> market price, arbitrageurs will buy ETF fund shares in the secondary market, and then use ETF fund shares in the primary market to redeem the underlying assets (such as a basket of stocks or other assets) to earn the difference

ü When the market price> net value, the arbitrageur will use the underlying assets to purchase ETF fund shares in the primary market, and then sell ETF fund shares in the secondary market to earn the difference

It is precisely because of the simultaneous deposit of fund transactions in the secondary market and the purchase and redemption mechanism in the primary market that arbitrage transactions can be carried out when the net value of the fund and the market price are different, so the discount and premium of ETF funds are very small.

So where does the high premium of Grayscale Fund come from? There are two main reasons: one is the failure of the arbitrage mechanism, and the other is market speculation.

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(1) The arbitrage mechanism is not smooth

In traditional ETF fund transactions, the T+0 or T+1 trading system is usually adopted, that is, the ETF fund shares purchased on the same day can be sold on the same day or the next day; however, for funds under Gray Assets, GBTC is used as For example, an investor purchases GBTC shares in the primary market with cash or BTC, and the acquired shares must be locked for 6 months before they can be sold in the secondary market, which extends the time for arbitrage transactions.

On the other hand, in 2014, the SEC investigated and dealt with GBTC. Since then, Grayscale Fund has deliberately suspended the redemption mechanism of GBTC on the ground that the SEC will not approve it. As a result, investors can only sell and leave the market through the secondary market. .

Therefore, the high premium of GBTC funds is largely due to the market’s premium to risk: investors can only leave the market through the secondary market after purchasing GBTC fund shares, and the trading time is limited to 6 months later. This means that investors must take up to 6 months of risk-even if Bitcoin plummets during this period, GBTC investors cannot sell. The following simple case can reflect the problems caused by the unsmooth arbitrage mechanism:

Scenario: At a certain moment we have a trading opportunity of $100

Option 1: Trade immediately and get a profit of $100

Option 2: Trade after 6 months, the profit opportunity of $100 is uncertain whether it exists

Option 3: Pay 30 USD in advance and wait 6 months before trading, the profit opportunity of 100 USD is uncertain

From the perspective of behavioral economics, most investors will choose option 1 to avoid future uncertainty; if the transaction cannot be completed immediately, they must pay a certain risk premium to investors, that is, option 3. Otherwise, most investors will have doubts and choose not to buy GBTC funds due to the need to avoid risks.

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(2) Market sentiment

If we just classify the high premium of the Grayscale Fund as a risk premium, obviously we cannot fully explain other phenomena. According to relevant reports, since the beginning of this year, the current LTC premium of Grayscale Fund has reached 3687%, which obviously cannot be fully explained by the risk premium.

As we mentioned earlier, the risk premium arises from uncertainty about the future. But what if investors remain optimistic about the future? Obviously, in the eyes of investors at this time, the risk premium part is completely risk-free and has become a rare “arbitrage” part.

This is also what is happening in the market at present, because we are currently in a bull market in the cryptocurrency market, which makes investors very optimistic about the price of cryptocurrencies in the future.

After making the assumption that the price of the currency will rise in the future, in the eyes of many investors, the high premium in the secondary market of Grayscale Funds is completely a free return. For this reason, they have bought Grayscale Fund shares, which is too high. Demand has resulted in higher and higher fund premiums. Therefore, the high premium of gray funds also has a strong market sentiment component.

Generally speaking, the high premium of gray funds is the product of the imperfect arbitrage mechanism of gray funds and the influence of market sentiment. Due to the secondary market lock-up policy of Grayscale Funds and the inability to redeem assets in the primary market, the market must pay a certain risk premium to investors; and due to rising market sentiment, most investors are Optimistically, in order to proactively obtain this part of the risk premium, one after another bought gray fund shares, further raising the premium of the fund in the secondary market.