Bitcoin is flying. Prices for the digital currency briefly topped $2,800 in May, the latest milestone in what's become a parabolic move higher. Consider these figures: In the past month, bitcoin is up 68%; year-to-date, it's up 154%; over the past year, it's up 350%; and over the past two years, it's up 973%.
But as incredible as those moves have been, the performance of one bitcoin fund makes them look paltry by comparison. That fund is the Bitcoin Investment Trust (GBTC), which has more than tripled in the past month alone, while rising an eye-popping 1,600% over the past two years.
2-Year Returns For Bitcoin And GBTC
The market value of the trust ballooned to as much as $1.1 billion in May, compared with $224 million at the beginning of the year.
Dangerous Premium To NAV
GBTC is an "open-ended trust" and the first publicly traded bitcoin investment vehicle. The fund made its debut on the OTC market in May 2015, and since then has been doing its best to track the price of bitcoin―with limited success.
Indeed, even though GBTC is a self-proclaimed open-ended trust (and its sponsor Grayscale has periodically created new shares), it's acted more like a closed-end fund, with huge premiums the norm.
The share price of GBTC was last trading at double the value of its underlying bitcoin holdings. At 131%, GBTC's premium to its net asset value is astronomical by any measure, and close to the highest level it's ever been. For investors buying into the fund, such large premiums are a disaster waiting to happen.
Premiums are a fickle thing, and can fluctuate wildly depending on the supply and demand for shares. For example, GBTC's premium has ranged from zero to 142%, with an average of 40%, since May 2015.
Not An ETF
For investors used to buying exchange-traded funds, such large premiums are almost unheard of. In an ETF, large premiums and discounts are arbitraged away through the creation/redemption mechanism. When a premium becomes large, authorized participants will buy up the underlying, deliver it to the ETF provider in exchange for ETF shares, and sell them for a profit, pushing the ETF market price back towards the fund's NAV.
But GBTC isn't an ETF. It doesn't abide by the stringent regulations and disclosure requirements of the Investment Company Act of 1940, and currently, its only AP is Genesis Global Trading, an affiliated company that has only offered shares to investors in private placement transactions, according to Spencer Bogart, managing director and head of research for BlockChain Capital.
Up until early this year, share creations for GBTC took place through private transactions with accredited investors. Those new shares were subject to a one-year lockup period before they could be sold on the public market, hindering the ability to arbitrage any premium above NAV.
After Jan. 19, Grayscale completely stopped issuing shares in connection with an SEC filing it made (more on that later), which means that what little ability to arbitrage the premium away before is now completely gone.
Meanwhile, redemptions for GBTC have been completely suspended since 2016 after the trust and its AP were found to be in violation of an SEC rule.
Put that all together and you have a product that can't be considered an ETF even by the loosest definition. Grantor trusts, '40 Act funds, '33 Act commodity pools and even ETNs are often lumped together under the ETF umbrella. They all hold securities with a fluid, unrestricted creation and redemption mechanism that serves to keep the traded price close to the underlying fair value. GBTC fails that test (not to mention it doesn't trade on an actual exchange).
Only Game In Town … For Now
Even with its flaws, clearly there's been a lot of demand for GBTC. Currently, the trust has a market value of nearly $1 billion and even counts two ETFs among its holders: the ARK Web x.0 ETF (ARKW) and the ARK Industrial Innovation ETF (ARKQ).
For investors who don't want to go through the hassle and risk of buying bitcoin directly from a digital currency exchange and storing it themselves, GBTC is, in many ways, the only game in town.
But it doesn't have to be. The Winklevoss Bitcoin Trust ETF (COIN) was rejected by the SEC in March. The commission didn't allow the ETF to see the light of day because it was concerned about the lack of regulation in bitcoin markets, which could harm investors. Yet COIN would be vastly superior to the readily available GBTC, which is likely to burn investors who buy at premium prices.
GBTC's sponsor Grayscale is well aware of the deficiencies of its product. In January, the firm made a filing with the SEC to do an initial public offering on the NYSE. Grayscale also lined up three APs to replace its affiliate Genesis, if the filing is approved.
In other words, the sponsor hopes to convert GBTC into a fully fledged ETF.
That's probably a smart move. If COIN or another bitcoin ETF comes to market and competes with GBTC in its current form, the latter will likely see an exodus of assets as investors gravitate toward the superior ETF structure.
Indeed, in March, when it looked like the SEC could green-light the Winklevoss ETF, GBTC's premium briefly dropped to zero as demand for the product waned.
Stark Choice For SEC
Currently, the SEC is reviewing its disapproval of COIN. There's no timetable for when the commission will reach a decision. The SEC is also considering the Grayscale filing to IPO GBTC shares on the NYSE; that decision will be reached by Sept. 22.
There's plenty of skepticism about whether the SEC will turn around and finally approve a bona fide bitcoin ETF after already rejecting two [along with COIN, the SEC rejected the SolidX Bitcoin Trust (XBTC)].
But as the massive inflows into bitcoin in general and GBTC in particular indicate, investors are going to buy up the digital currency regardless of what the commission does. The SEC can either help investors by allowing a regulated ETF that trades close to NAV come to market, or stand in the way and see those same investors hurt when they buy bitcoin directly from untested exchanges or through the flawed GBTC.
At the time of writing, the author did not hold any positions in the securities mentioned. Contact Sumit Roy at [email protected].