Disclaimer: Opinions expressed in this article do not constitute investment advice from Bitcoin Reserve.
With a stated $3.5 billion in bitcoin under management, Grayscale Investments has grabbed headlines of late for being one of the most significant accumulators of bitcoin. However, due to a gross misunderstanding of how Grayscale operates, this is likely a false narrative.
Formed in 2013, Grayscale was one of the first institutionally-primed digital asset management firms on the cryptocurrency scene. Its Grayscale Bitcoin Trust (GBTC) product—a quasi ETF—is a well-known vehicle for accredited exposure to bitcoin.
GBTC, formally a privately traded instrument, went public in 2015 after receiving FINRA approval. Since then, GBTC has primarily traded on the over-the-counter market, OTCQX. However, while arguably opening up the bitcoin market to accredited and institutional investors, the Trust doesn't come without its pitfalls. One, in particular, is how many shares it takes to gain exposure to bitcoin. For illustration, in 2013, each share of GBTC represented a little under 0.0001 bitcoin, requiring the purchase of more than 1,000 shares of GBTC to own one bitcoin. This issue is made even worse, thanks to the Trust's significant premium.
Buying Up the Bitcoin Market
Since its emergence, GBTC has almost always boasted a premium over the net asset value (NAV) of bitcoin. As of the time of writing, one GBTC share holds 0.0009718 BTC, rendering a NAV of $8.82. With a current market share price of $9.77, GBTC shares carry a premium of approximately 10.7%—a figure which, believe it or not, pales in comparison to past premiums.
This premium derives, in part, from the sheer volume of bitcoin that Grayscale alleges to buy. According to multiple reports, Grayscale purchases anywhere from 70% to 150%+ of all newly mined bitcoin—more, apparently, than miners can produce. This seems to be reflected in Grayscale’s latest 8-K filing with the SEC. The filing notes that back in June, the Trust added 19,879 BTC to its coffers in the space of a week.
Since bitcoin's halving in May, the network now produces 6.25 BTC per block mined. Given that 144 blocks per day are mined on average, weekly production of bitcoin currently stands at 6,300 BTC—meaning that based on the aforementioned filing, in just one week, Grayscale accrued more than three times the weekly average of mined bitcoin.
This so-called cornering of the bitcoin market has been met with bullishness, trepidation, and doubt in equal measure. The latter arose after lackluster price performance in the spot market. Many opined that with over 50,000 BTC allegedly accumulated by Grayscale since the bitcoin halving in May, the market should have witnessed at least some movement. In reality, it's been a somewhat stagnant few months.
Per Ryan Watkins, an analyst with blockchain analytics firm, Messari Research, Grayscale's buying power has been severely overestimated. First and foremost, dispelling the rumors that Grayscale buys more bitcoin than miners produce, Watkins points to GBTC inflows. The analyst submits that most purchases are "in kind," referring to the fact that many GBTC shares are obtained using bitcoin or other cryptocurrencies. Backing this notion up, Grayscale's Q3 2019 report states the following:
"Nearly 80% of inflows in 3Q19 were associated with contributions of digital assets into the Grayscale family of products "in-kind" in exchange for shares, an acceleration of the recent trend, up from 71% in 2Q19."
In other words, 80% of GBTC inflows in Q3 of 2019 originated via bitcoin already in circulation—as opposed to newly created bitcoin. Messari proposes that the real amount of bitcoin bought by Grayscale since the halving is closer to 30%.
Playing the Market
As for the premium, it seems some GBTC investors are taking advantage of Grayscale's lock-up period. According to the SECs Rule 144, restricted securities issued by an SEC reporting company—which Grayscale became in earlier this year—are subject to a minimum holding period of 6 months. GBTC shares classify as "restrictive" securities, meaning investors can't sell within the lock-up period unless exempted by the SEC. After this initially barred period, investors are free to sell their shares to the public in the secondary markets.
As Watkins outlines with many buyers and few sellers, investors in the secondary market can push the price of the shares beyond the value of the underlying asset. Instead of new shares being purchased, investors are simply "recycling" GBTC—resulting in a distinct lack of bitcoin inflows and thus creating a significant premium.
This, in turn, creates an arbitrage opportunity for accredited investors who can generate new shares (at NAV) in the primary market and shift them—6 months later—in the secondary market.
Expanding this theory, others have proposed that accredited investors may even be using bitcoin borrowed on margin to buy GBTC shares. In this instance, investors would be able to cash the GBTC shares out six months on, pay back the margin loan, and pocket the additional premium.
While still only theories, it would go a long way to explain the lack of movement in the underlying spot markets.