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GBTC is helping drive the BTC bull market, but its influence may decrease
This year’s BTC bull market has coincided with high-profile entries from institutional investors, which has thrust Grayscale Bitcoin Trust into the spotlight. As an over-the-counter exchange-traded fund and the first digital currency investment vehicle to attain the status of a United States Securities and Exchange Commission-reporting company, GBTC has come under the spotlight. Its total amount of assets under management has repeatedly hit all-time highs — and, with this in mind, OKEx Insights has decided to take a closer look at some of GBTC’s features in an effort to help retail traders better understand this “black hole” in the BTC market.
Grayscale is a gateway for institutional BTC exposure
The objective of GBTC is for the net asset value. or NAV, per share to track the Bitcoin market price per share, minus the Trust’s liabilities. Because it meets the compliance needs of traditional financial institutions and helps avoid the challenges of buying, storing and safekeeping BTC directly, it has become a gateway for institutions to gain and maintain exposure to the leading digital asset.
However, it is worth noting early on that GBTC does not currently operate a redemption program. Shares are only eligible to become unrestricted and resold in the public market after a six-month holding period.
As of Dec. 15, GBTC holds 565,633 BTC or $10.94 billion in assets under management. The number of new coins added in only the last six months reached nearly 200,000 BTC.
According to Capital IQ, the main institutional holders of GBTC are currently crypto lending company BlockFi, hedge fund Three Arrows Capital, trust fund Horizon Kinetics as well as ARK, a fund headed by American investor Cathie Wood. ARK’s exposure to BTC dates back to September 2015, when its ARKW Fund was the first ETF to purchase GBTC. All four of these institutions hold market values in excess of $100 million — with BlockFi’s reaching $500 million.
Additionally, a growing number of institutional investors are looking to GBTC for their BTC exposure. Guggenheim Partners, with over $230 billion in assets under management, has filed an amendment with the SEC to allow its $5 billion Macro Opportunities Fund to invest up to 10% of its net asset value in GBTC.
According to Grayscale’s 2020 third-quarter report, 81% of its investors are institutional investors. Another fast-growing group is that of family offices, which represents over 8% of the total.
GBTC’s premium and redemption mechanism make it a black hole
GBTC currently trades at a 26% premium relative to its NAV. It hasn’t traded at a discount to its NAV in four years.
Much of the high premium comes from the market’s pricing in risk, as investors can only cash out through the secondary market after purchasing GBTC shares. This mechanism forces investors to take on up to six months of risk — during this period, even if BTC plunges, investors will not be able to sell. GBTC will never sell any BTC under the current mechanism.
Furthermore, since GBTC is one of the very few gateways currently available for institutional investors to participate in BTC investing and meet compliance requirements, it creates huge demand — enabling premiums to persist.
Due to the high premium, many investors are trying to use a market-neutral strategy. According to Grayscales’s 2019 third-quarter report, nearly 80% of inflows were associated with contributions of digital assets in exchange for shares — an increase from the previous 12 months. Although it has not revealed this number since that time, we were able to see that the majority of investors were using “in-kind” in exchange for GBTC shares, but not using cash to purchase shares directly.
The “in-kind” approach is to exchange GBTC shares by borrowing BTC from lending companies and contributing to the Trust. After the lockup period, investors sell their GBTC shares on the secondary market and then buy back BTC from crypto exchanges to return to the lending company. In order to remain market-neutral, they can hedge their exposure to their BTC holdings by opening short positions on regulated exchanges. In this way, they still generate arbitrage gains after throwing out borrowing and management fees.
In this arbitrage process, Grayscale’s non-redeemable mechanism makes it impossible to escape from actually buying BTC in the market — whether investors borrow BTC or fiat. The purchaser would be the arbitrageur if borrowing BTC first, or Grayscale would be if borrowing money first. This black hole of sorts has also led to the emergence of a number of institutions that target arbitrage but actually buy large amounts of BTC on the market, which results in some long-term price floors.
The GBTC premium has become a BTC price indicator
Due to strong inflows into GBTC this year, we can see that changes in its premium have a role to play in predicting BTC’s short-term price movements.
In general, the premium varies between 10% and 30%, beyond which there is a high probability of price reversal. We may interpret premiums above or below those percentages as meaning BTC is overbought or oversold. A rapid rise in premiums is usually the result of a rapid price increase. The rapid rise in price may trigger profit-taking by large institutions looking to rebalance their positions — which, in turn, causes the market to move in the opposite direction.
As a public exchange-traded fund, ARK publishes daily position movements. This gives us a glimpse of its GBTC holdings. According to the position changes in ARKW, it sold 141,000 GBTC shares on Nov. 25 and 518,202 GBTC shares on Nov. 30. On Nov. 26 and Dec. 1, the BTC price dropped by 8% and 5%, respectively. While the shares ARK sold are not a large percentage of its total positions, its reduction may be magnified as traders could watch the leading fund’s holdings at all times.
Although the change in GBTC’s premium is still a valid indicator, it may gradually fail to act as a reliable one via the expansion of the cryptocurrency’s influence and the possible approval of other Bitcoin ETFs. Grayscale could conceivably lose its dominance as the go-to place for institutional BTC exposure, which will also cause its premiums to decline.
Moreover, with over $1 billion inflows to GBTC in the first half of the year, there could also be a compression of the NAV premium when these large lockups end. If the premiums narrow to near parity, then the creation of new shares will be significantly reduced because arbitrageurs would not turn a profit. This could result in selling pressure on the secondary market.
Previous bull-market premiums are gone
Positive premiums for GBTC have been in the market for years. However, other premiums that existed in 2017 and 2018 have disappeared. For example, the Kimchi premium in the Korean market has rarely been seen after the BTC price crash in March 2020. Now, the price of the leading cryptocurrency on U.S. exchanges is generally higher than the price on Korean exchanges.
The USDT OTC premium in the Chinese yuan is another indicator of sentiment in the Asian market. Since the Chinese market banned direct fiat currency trading in the cryptocurrency market, USDT in Chinese exchanges often trades at a premium to the U.S. dollar — indicating that there is more buying demand. However, this premium turned into a discount for an extended period after March 2020, showing that the Chinese market is a weak purchaser of BTC.
All of this concludes that this year’s bull market was shaped by an influx of institutional investors, rather than global retail investors.
GBTC is a major bull-market contributor
GBTC is an important gateway for institutional investment into BTC — whether for buy-and-hold purposes or for arbitrage. Due to its non-redeemable mechanism and extremely fast-growing AUM leading to the inevitable need for funds to purchase large amounts of BTC on the spot market, GBTC has been a major driver of this year’s bull market.
The high premium of GBTC shares in the U.S. secondary market provides a lot of room for institutional cross-market arbitrage, in which arbitrage capital transfers the selling pressure to the U.S. stock market. This makes GBTC one of the most active OTC securities in terms of trading volume — but this comes at the expense of retail investors.
Additionally, when comparing the 30-day historical volatility of GBTC and the BTC price on the CME, GBTC’s huge premium leads to its volatility being consistently higher than the CME’s — which also exposes secondary-market holders to greater risk.
At the same time, we may note that institutional investors are also buying BTC through outlets other than GBTC. MicroStrategy recently raised a $650 million convertible bond at a 37.5% stock premium for direct BTC purchases. Massachusetts Mutual Life Insurance Company also announced a $100 million BTC purchase through NYDIG.
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