Negative GBTC premium exposes inherent flaws and need for Bitcoin ETF

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The current GBTC discount has attracted a lot of attention from institutional investors and cryptocurrency market participants.

The Grayscale Bitcoin Trust (OTCMKTS: GBTC) premium went negative on Feb. 23, 2021, for the first time since 2015. The negative premium only briefly returned to levels above zero on March 1 before falling to a staggering minus 12% on March 4, as per data from Bybt

As of March 11, the market price of its shares on the secondary market is still more than 5% lower than the net asset value of its shares, and the Grayscale Bitcoin Trust continued to reduce its holdings by 249 BTC over the last seven days. 

The market price of GBTC is still at a 5.25% discount from its NAV, as of March 11. Source: TradeBlock

GBTC makes bull markets

GBTC has historically traded at a premium. As OKX Insights explained in a previous article, the long-time positive premium for GBTC has created an arbitrage opportunity between the primary and secondary markets — attracting many institutions to a market-neutral strategy. As a result, Grayscale played an important role in the 2020 Bitcoin rally because its non-redeemable mechanism makes it impossible for its investors to escape from actually buying BTC on the market.

The price of GBTC is, after many years, at a negative premium. Source: Bybt

The inherent flaws of GBTC

After reviewing Grayscale’s operating mechanisms, we can clearly perceive the disadvantages. 

Grayscale lists its shares for public exchange and sells new shares to the public after investors contribute more digital assets to its trusts. This mechanism means that Grayscale essentially acts as a closed-end fund, as it has no mechanism to remove shares from the marketplace. Therefore, its share price is largely determined by supply and demand. 

This closed-end structure gives rise to discounts and premiums. Since Grayscale does not have to hold excess cash for redemption purposes under this structure, the liquidity of its shares is at greater risk. 

The only way for investors to exit is by selling over-the-counter on the secondary market, OTCQX U.S., which requires buying power in the equity market — especially when the trust is in the midst of an unlocking period following a large number of contributions, as it is now. As of March 10, there are 452 million unrestricted outstanding shares that can be sold, which equals roughly $23 billion. 

After the lock-up period, unrestricted outstanding shares may create significant sell pressure. Source: OTC Markets

Due to the turmoil in the capital markets since mid-February, the tech-heavy Nasdaq Composite Index has experienced a pullback of 10%. In such a bad macro environment, there is a clear lack of buying interest in GBTC. The increased uncertainty may also force investors to sell their shares for cash. 

While the constant sell pressure leads to a lower premium, it also dissuades arbitrageurs from contributing to the trust — which could create a death spiral. The negative premium, which has now extended for nearly three weeks, has raised concerns on the market about the possibility of big losses hitting institutions that were heavily involved in the market-neutral strategy.

Another reason is that, in the past year, there have been more and more venues to buy cryptocurrencies — such as two institutional-grade Bitcoin ETFs approved in Canada — and investors may even maintain exposure by investing in companies, such as MicroStrategy, that have put a large amount of BTC on their balance sheets. As more options are made available for institutions, we may never again see GBTC able to trade at last year’s high premiums. 

Repurchasing to help the GBTC premium recover

To address the issue of negative premiums, Digital Currency Group, the parent company of GBTC, has been authorized a purchase of up to $250 million worth of GBTC shares in compliance with Rule 10b-18 of the Securities Exchange Act of 1934. This repurchase operation may reduce, to some extent, institutional losses from those that carried out a market-neutral strategy. In the announcement, DCG also seeks potential regulatory approval to operate a redemption program. 

While reverse arbitrage for the current negative premium situation is feasible — i.e., buying spot GBTC shares while shorting futures in the same BTC amounts and waiting for the premium to return back to normal — this strategy carries significant risk.

The GBTC discount has also demonstrated the urgency of the U.S. market for an open-ended Bitcoin exchange-traded fund. A real Bitcoin ETF product features the ability to redeem shares, as well as lower management fees, better liquidity and lower investor risk.

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