If you watched TV during 2022, chances are you saw the ubiquitous commercials for Grayscale, which manages the world’s largest Bitcoin investment fund. These ads touted Bitcoin as “the future” and a must-have asset in every retiree’s portfolio. However, investors in Grayscale Bitcoin Trust (GBTC) are currently facing both a problem and an opportunity.
The problem is that GBTC is currently trading at a 46% discount to its underlying holdings as of Feb. 24. This means that the per-share value of the fund is 46% less than the Bitcoins held in the fund’s portfolio. The ongoing legal issues facing Digital Currency Group (DCG), the parent company of Grayscale, is one factor in this significant discount.
However, the opportunity for investors is that if the fund were to trade up to its net asset value, they could realize an 84% gain. While non-traded funds like real estate investment trusts (REITs) and business-development companies pricing below asset value isn’t a new phenomenon, a discount of up to 50% is almost unheard of and amounts to around $7 billion of trapped value.
The primary reason for such a wide spread is that investors are concerned about challenges at DCG, a cryptocurrency conglomerate backed by SoftBank, which has its hand in a number of failed or failing startups. DCG owns Grayscale, crypto news media CoinDesk, Bitcoin miner Foundry, a small London-based crypto exchange named Luno, and crypto brokerage and lending giant Genesis Capital. The last company, Genesis Capital, is currently under Chapter 11 bankruptcy protection, after its lending arm blew up after last year’s crypto rout and FTX’s collapse.
DCG has been selling its stakes in various investment vehicles run by Grayscale, according to regulatory filings. Despite GBTC and its Ether-focused fund trading below their asset values, DCG presumably has needed to raise cash by all means necessary to support Genesis during bankruptcy. The Financial Times also reported that DCG retained investment bank Lazard to explore a sale of CoinDesk.
On the other hand, a competitor has also targeted Grayscale. Osprey Funds, which also runs several crypto-focused investment funds, sued Grayscale in January for putting out misleading marketing statements to gain market share.
One way Grayscale can eliminate this massive discount is to convert to an ETF. GBTC is not an exchange-traded fund (ETF) and holds actual Bitcoins. Unlike GBTC, Bitcoin-focused ETFs invest in Bitcoin futures, not Bitcoin itself, and are regulated by the Commodities and Futures Trading Commission (CFTC) in the United States. Grayscale (and many other asset managers) has tried to convert its GBTC fund to an ETF for years without success. The SEC argues that, unlike futures, the spot Bitcoin is unregulated and the market is ripe with manipulation and potential fraud.
However, Grayscale has sued the SEC to force its hand, with oral arguments set to begin in Washington, D.C., in early March. If successful, it may be a pathway to unlock the approximate $7 billion.
In the meantime, institutional and activist investors are circling Grayscale. One group of investors, called RedeemGBTC, wants the fund manager to reduce its 2% management fee, which is calculated on the underlying Bitcoin holdings, not the discounted share price, which inflates the fees earned by Grayscale. Hedge Fund Fir Tree filed a lawsuit against Grayscale in December alleging mismanagement and severe conflicts of interest.
The current financial and competitive difficulties at parent company DCG are not lost on GBTC investors and contribute to the giant discount. It remains to be seen if the $7 billion of trapped value in GBTC will ever be fully unlocked, but the potential gain for investors is too significant to ignore. The ongoing legal battles and challenges facing DCG and Grayscale have certainly contributed to the discount, but the possibility of converting to an ETF may provide a way out.
The outcome of Grayscale’s lawsuit against the SEC will be closely watched by investors, as it could pave the way for unlocking the trapped value in GBTC. However, until then, investors may want to consider alternative crypto investment options or wait and see how the situation develops before making any significant moves.