Introduction
Cryptocurrencies like Bitcoin were introduced as a replacement for fiat currencies. Therefore, Bitcoin should be able to offer all the financial services that are available with fiat currencies.
Today, Bitcoin is used as part of several passive financial instruments just like its fiat rival. This article is going to discuss one such Bitcoin-based financial vehicle called Grayscale Bitcoin Trust and how it fairs against the available market alternatives.
What is Grayscale Bitcoin Trust or GBTC?
It is important to mention that a Trust fund is a type of fiduciary agreement that allows the users to delegate their assets to a third party. There are several types of Trust funds such as revocable, irrevocable, Asset protection, Grantor Retained Annuity Trusts, etc.
GBTC is a trust that is based on cryptocurrencies with the central investment figure as Bitcoin. It is an investment trust and it is traded on the stock market rather than cryptocurrency exchanges.
It is a method for institutional investors and retail traders to gain exposure to Bitcoin trading without directly purchasing or selling Bitcoin. It is also the largest Bitcoin fund in the world which is also publicly traded.
Typically, investment trusts and funds are listed on public exchanges in the form of a share. The ticker for Grayscale Bitcoin Trust is GBTC. The value of GBTC is not derived from the performance of any company just like regular stocks.
On the contrary, GBTC’s share value is estimated based on the cryptocurrency price traction in the main market. In usual cases, the price of an investment trust is based on the Net Asset Value or NVT based on the demand for the underlying assets that it is based on.
When the investors are buying the shares of the GBTC or any other trust they are purchasing the ownership of a portion of the basket of cryptocurrencies or any other assets that are present in the trust.
How does Grayscale Bitcoin Trust Work?
To attain the status of a reporting company a Bitcoin investment vehicle like GBTC has acquired official approval from the Securities and Exchange Commission (SEC). In its current form, GBTC allows accredited investors to purchase shares issued by GBTC to gain liquidity opportunities.
Each share of GBTC represents 0.001 Bitcoin for the buyer. An investor has to possess 1000 GBTC shares to invest in one full Bitcoin unit using the trust fund. It is important to note that investors are only gaining indirect exposure to the Bitcoin reserve that is owned by Grayscale Institutional Trust.
The retail index of GBTC is sold in the open markets or over-the-counter platforms. GBTC is very similar to an ETF or Exchange Traded Fund. An ETF is a financial instrument that allows users to create a position in a given asset without purchasing it directly from cryptocurrency exchanges or other forums.
In other words, GBTC pools the monetary resources submitted by its investors to acquire more Bitcoins and charges them a management fee for investing in the fund. The minimum investment limit at GBTC is $50K issued at a 2.0 percent management fee per day. This limit is set for the investors who are using GBTC as a private placement Trust.
On the other hand, the average cryptocurrency investors are allowed to purchase one GBTC share. Investors who are using GBTC as an investment vehicle get to gain exposure in Bitcoin without taking the risk of storing and securing Bitcoin directly. The firm maintains that its handling of this trust is worth more than the current annual charges.
GBTC shares are also regulated and sold just like any other security in the US stock markets. Investors may also acquire GBTC shares through brokers or use them as tax-advantage accounts such as IRA or 401(k).
Origin of GBTC
GBTC is a trust that is owned and operated by the Digital Currency Group or DCG. It was introduced in 2013 as Bitcoin Investment Trust. At the time of its introduction, it was presented as a private placement for accredited investors. The trust was able to gain a certificate from FINRA that allowed it to issue shares and trade them publically.
It is important to note that GBTC started out by collecting financial resources from institutional investors to purchase a considerable amount of Bitcoin. This is how the trust fund was created. Only accredited investors with a required risk appetite were allowed to purchase Bitcoin as an investment vehicle.
After getting its FINRA approval, the fund issued GBTC shares and which meant that retail investors were able to purchase as little as one GBTC share. According to Grayscale, GBTC is modeled on commodity investment vehicles like SPDR Gold Trust which is a gold-backed ETF.
GBTC is publically traded on an OTC platform called the OTCQX. On this forum, GBTC does not have to get registration approval from the Securities and Exchange Commission. The performance of GBTC depends on the price traction of Bitcoin alone.
Comparison Between GBTC and Bitcoin ETF
There are some dedicated Bitcoin-based ETFs in the world such as Purpose Bitcoin ETF. However, investors should learn about the difference between GBTC and a regular Bitcoin ETF mentioned before. The main difference is that an ETF tracks the market prices and fluctuations in the price of its underlying assets more closely than an investment trust.
Therefore, the market value of a Bitcoin ETF is often more similar to the actual price of Bitcoin in the investment markets in comparison to GBTC shares. The same cannot happen for GBTC because the management is liable to charge the management fee of 2% and it is also subjected to a premium in some instances.
It means that the price of one GBTC share is going to be higher in comparison to the spot purchase of Bitcoin from a cryptocurrency exchange. At present, most Bitcoin ETFs are based on Bitcoin futures that are issued by the CME and regulated by the CFTC.
Therefore, Grayscale has been trying to get approval as the first spot Bitcoin ETF to allow it to track the prices of Bitcoin closer than the existing Bitcoin futures ETFs. GBTC became a public fund in 2015 and at present, it holds around 643,572 Bitcoins.
What are Discounts and Premiums on GBTC shares?
As mentioned before, Grayscale has pooled money from institutional investors to create a massive Bitcoin reserve. The organization got registered with FINRA to issue shares and list them publically.
The investors can purchase these shares from the OTC market and it means that GBTC does not have to acquire a permit from SEC like other publicly traded companies. When an investor purchase or sells their GBTC shares, Grayscale does not increase or decrease their Bitcoin reserve.
To balance the price difference between total shares and outstanding shares, GBTC uses the concept of premium and discount.
To understand these concepts imagine that GBTC owns 100 Bitcoins and all of them are acquired by investors by purchasing the shares. For this example, let’s assume that each GBTC share represents 1 Bitcoin.
Now, 2 more share buyers arrive and purchase 50 more GBTC shares. Grayscale will sell the shares but it will not use the money obtained from new shareholders to purchase an additional Bitcoins 50 Bitcoin. The purchase is going to increase the total value of GBTC which confirms increasing demand for GBTC shares which is more than the Bitcoin supply.
Under such a scenario, Grayscale will add a premium to the Bitcoin price meaning that anyone who wishes to purchase new shares now has to pay the additional premium in addition to the assigned share value.
On the other hand, in case some existing investors sell their GBTC shares. The supply of GBTC shares increases in comparison to the total Bitcoins in the reserve. Now, Grayscale will add a discount to the Bitcoin prices meaning the new buyers will be able to make their GBTC share purchases at a discounted price.
These price changes happening on account of premiums and discounts mean that investors can gain indirect exposure to Bitcoin at a different price than the spot market. Therefore, there is a considerable difference between the market value of Bitcoin and the GBTC shares.
Since GBTC shares are purchased from regular exchanges, it means that they can only be traded during business hours.
Advantages of GBTC
Here are some of the most noteworthy advantages that investors can benefit from if they aim to invest in Bitcoin using GBTC shares:
Higher Security
The most common scenario for creating a position in Bitcoin is to purchase it from cryptocurrency exchanges. Some cryptocurrency exchanges are centralized while others are also present in decentralized forms. However, investors can face issues with properly securely storing their Bitcoin reserves.
At any time, the users are exposed to threats such as cyber-attacks and hacks. Investors can lose their funds if the non-custodial wallet services provider goes out of commission. On the other hand, if the users are unable to securely store their private keys, lose them, or forget them they can be locked out of the Bitcoin reserves forever.
Therefore, Grayscale charges a management fee from the users and keeps the funds secure in cold storage.
Tax Advantages
One of the most important benefits of GBTC shares is that they can be used as a tax break. In case, the investors want to purchase their GBTC shares using a tax-advantaged account such as 401K or IRA.
It means that they can apply for tax relaxation in case of a downtrend in the prices of GBTC shares or premium inflation per share. Using this method, the investors can also file their taxes more easily because GBTC is a publically traded stock that is approved by SEC.
Financial Audits
There is no warranty from the DEX, AMM, oracles, smart contracts, on-chain data, or cryptocurrency exchanges about their stability and financial management. It is only after the debacle of FTX that cryptocurrency exchanges have decided to share the Merkle Tree report to account for their total liquidity.
However, the authenticity and reliability of this report are still disputed. The Grayscale Bitcoin Trust on the other hand issues detailed audit reports regularly. This report is submitted and screened by SEC to ensure that all the Bitcoins purchased by shareholders are accounted for.
Management Efficiency
Many people are only familiar with the idea of purchasing Bitcoin directly from a cryptocurrency exchange. However, when a person first purchases Bitcoin they can face several issues such as finding an authentic exchange.
They may also have to go through the registration process and move their Bitcoin reserves to a custodial wallet which can increase their cost. On the other hand, purchasing GBTC shares is easy and there is little chance of theft. The management of Grayscale is responsible for securing Bitcoins.
Portfolio Diversification
GBTC is a great way to diversify the cryptocurrency portfolio. Many investors may not be able to get the tax advantage by directly investing in Bitcoin. However, many investors are advised to diversify their investment portfolios by seeking a position in GBTC shares.
Limitations of GBTC
In addition to the benefits, investors should always keep in mind the following drawbacks that are associated with GBTC shares:
Retail Investment Risk
GBTC shares are subject to a minimum management fee of 2% annually. It means that when retail investors are purchasing GBTC shares they are always paying more cost to gain exposure to Bitcoin in comparison to the spot market purchases.
On the other hand, there is a minimum limit of at least $50,000 to get an initiation in the Grayscale Bitcoin Trust. It means that it is not ideal for small investors. On the other hand, if the investors are buying when premiums are rising they can incur massive losses.
Ownership of Bitcoin
The actual owners of Bitcoins of the Grayscale Trust are the institutional investors who have pooled the money to purchase them. The shareholders can gain exposure to the price movement of the said Bitcoins backing GBTC but they cannot redeem Bitcoins by selling their shares.
The private keys to the Bitcoin reserve wallet are always under the possession of Grayscale management.
Performance Gap
GBTC shares do not track the price fluctuations of Bitcoin in spot markets as closely as ETFs. Therefore, the gap between the prices of the GBTC shares and the market value of Bitcoin has kept growing bigger over time. The GBTC shares can add a premium or discount to the price of the GBTC shares based on the difference between the demand and supply.
Therefore, investors can earn more profits by directly purchasing Bitcoins rather than investing in GBTC shares. During 2020-2021, GBTC prices rallied by 220% while Bitcoin spot prices appreciated by 340%.
No Proof of Reserves
After the harrowing demise of FTX, most cryptocurrency organizations agreed to issue a proof of reserve report. This report worked as a DeFi version of a financial audit. It ensured the investors that the firm was stable and accounted for the total cryptocurrency reserves that it claimed to hold.
However, Grayscale management stated in 2022 that it will not issue a PoR report that raised the concerns of its stakeholders and aired the doubts of the cryptocurrency investors about fair market practices in the crypto sector.
Major Controversies Connected to GBTC
GBTC is a regulated cryptocurrency organization and just like any other financial enterprise it has come across major controversies since its inception. Here are some of the noteworthy incidents that inflicted Grayscale:
Premium Inflation
As mentioned before that GBTC shares are subject to premiums. There are many instances where the increasing demand for GBTC shares resulted in unprecedented premium inflation. At one point, the premium for GBTC shares raised as much as 80% which meant that new investors had to invest heavily to acquire smaller proportions.
On the other hand, the decrease in GBTC premium when Bitcoin prices are still increasing is seen as a marker for bearish development for Bitcoin and decreasing appetite among institutional investors.
Proof of Reserve Denial
It is important to note that Grayscale is a public company that is registered and regulated with SEC. The firm is obliged to issue regular audit reports to SEC to ensure that all the Bitcoin purchased by shareholders are priced in and available.
However, the cryptocurrency firm was surrounded by criticism and backlash when its management refused to issue a PoR report. The firm stated that it decided to secure the private information of its stakeholders. However, the members of DeFi markets did not take it well and saw it as a sign of increasing unreliability towards crypto firms in the wake of the FTX scam.
Gemini Scuffle
The parent company of Grayscale, Digital Currency Group also owns a crypto lending firm called Genesis. Following the demise of FTX, a majority of cryptocurrency investors moved their reserves from crypto organizations. It resulted in a bank run effect that drained the liquidity from several crypto firms and brought them to the brink of bankruptcy.
Genesis is among the firms that were affected by this situation and it is said to withhold the payment for the Gemini exchange users. The founders of Gemini and the management of Grayscale have entered into a public altercation that has increased doubts about the stability of GBTC among investors.
Conclusion
Grayscale is generally not considered a good investment option on account of several factors. At present, GBTC shares are trading at a discount of 45% on account of the bearish market movement. The shareholders do not acquire any voting rights or real ownership of Bitcoin.
The private key of GBTC is reserved with Grayscale management. All the transactions taking place are sanctioned by the government which ousts it from the DeFi sector. However, investors can use it for diversification and tax advantages.