The Grayscale Dilemma: A Record Discount and a Golden Goose

Grayscale Investments’ Bitcoin Trust has been selling at a record discount in recent days, though some industry watchers don’t expect the trust to liquidate.

The ongoing crypto market volatility, most recently fuelled by the crash of crypto exchange FTX and its filing for bankruptcy earlier this month, would likely not in itself force liquidation of the trust (GBTC), Bloomberg Intelligence Analyst James Seyffart said in a research note. 

“That’s because of GBTC’s value generating fees for its parent, hurdles for shareholders to force such a move and a requirement that any liquidation be distributed in cash, not bitcoin,” he said. “Plus, liquidating GBTC would also mean open-market selling bitcoin currently worth $10.5 billion at a 45% discount.”

GBTC’s discount reached 45% on Friday — up from about 42.7% the day before, according to YCharts.com. The discount was hovering around 35% at the beginning of November. 

Seyffart tweeted that GBTC’s discount reached 50% on Monday morning before retreating back to roughly 48%. 

Bryan Armour, director of passive strategies research at Morningstar, said that GBTC’s record discount is a “huge concern” for investors already feeling the sting from bitcoin’s year-to-date drop of more than 60%. Grayscale has the option to offset some of the pent-up supply of GBTC by allowing redemptions of shares, which could ease the discount, he added.

“They haven’t shown any willingness to pull this lever because it would create costs and lower future revenue from management fees,” Armour said. 

A Grayscale spokesperson did not immediately return a request for comment. 

Armour also does not expect the fund group to liquidate GBTC, as according to his estimates, Grayscale made about $900 million in management fees since the beginning of 2021. GBTC carries an annual management fee of 2%. 

“They may not be willing to kill the golden goose,” Armour said.

What happens in the case of liquidation

Seyffart noted that Grayscale’s insolvency or bankruptcy would constitute a reason for liquidation unless 50% of shares in the trust vote to transfer to a new sponsor.

If forced to liquidate, Grayscale would engage directly with bitcoin exchanges or over-the-counter bitcoin markets to liquidate the trust’s bitcoin “as promptly as possible while obtaining the best fair value possible,” according to SEC disclosures.

The lending division of cryptoasset manager Genesis halted customer redemptions and new loan originations last week. How Grayscale could be impacted by a potential Genesis bankruptcy is unclear, Seyffart said.

A spokesperson for Digital Currency Group — the parent company of Grayscale and Genesis — did not immediately return a request for comment. 

All digital assets in Grayscale’s products are held by Coinbase Custody Trust Company, the company said in a blog post Friday. The documents governing each offering prohibit the assets from being lent or borrowed, it adds.

“Custody of the digital assets underlying Grayscale’s digital asset products is unaffected, and our products’ digital assets remain safe and secure,” the blog says. 

A quicker solution to reduce the discount?

Grayscale Chief Legal Officer Craig Salm has said previously that GBTC converting to an ETF would close the trust’s discount. The company sued the SEC earlier this year after it denied GBTC’s proposed conversion to a spot bitcoin ETF. The regulator has only approved derivatives-based products.

“Recent events — while unfortunate for the entire crypto ecosystem — should strengthen our case before the D.C. Circuit Court of Appeals,” he told Blockworks in an email after FTX filed for bankruptcy.

Armour said that he does not expect GBTC to convert to an ETF — a sentiment shared by other industry watchers who said FTX’s blow-up would likely prevent progressive crypto regulation anytime soon.

Even without SEC approval, though, other industry members say the firm should try for Regulation M relief, a rule the agency designed to prevent manipulation. It could be a last-ditch effort for parent company DCG to save assets, according to Andrew Parrish, co-founder of Arch Public Inc.

“I don’t think there’s any benefit to investors, I think there’s benefit to Genesis and DCG covering a hole on their balance sheets, covering losses on their balance sheets,” Parrish said. “I think that’s the whole reason for any sort of Reg M usage in any sort of ‘restructuring,’ and restructuring is the best case scenario.”

Regulation M, if granted, allows for a fund to simultaneously create and redeem shares, Grayscale said in a Q&A detailing how such a conversion would play out. If the SEC approves GBTC’s transition into an ETF, Regulation M would automatically be granted, Grayscale said. 

But, Grayscale could opt to apply for Regulation M approval now, before the lawsuit is settled, which would eliminate the discount to net asset value, according to Messari CEO Ryan Selkis.“

The odds of Grayscale winning its case vs SEC in light of related party transactions with Genesis Trading, Genesis Capital, and at least two bankrupt counterparties (BlockFi and 3AC) are now 0,” Selkis said on Twitter. “Delays in pursuing a Reg M program hurt shareholders while enriching DCG/Grayscale.”

---

Start your day with top crypto insights from David Canellis and Katherine Ross. Subscribe to the Empire newsletter.

Explore the growing intersection between crypto, macroeconomics, policy and finance with Ben Strack, Casey Wagner and Felix Jauvin. Subscribe to the Forward Guidance newsletter.

Get alpha directly in your inbox with the 0xResearch newsletter — market highlights, charts, degen trade ideas, governance updates, and more.

The Lightspeed newsletter is all things Solana, in your inbox, every day. Subscribe to daily Solana news from Jack Kubinec and Jeff Albus.