How to profit from Bitcoin funds

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Price differentials arise on cryptocurrency trusts. It pays to understand them.

Stock price in grayscale

Forbes

Bitcoins worth $ 2.5 billion lie on the sidewalk. Who will pick them up?

Grayscale Bitcoin Trust, the grandfather of crypto funds, owns 654,600 coins, worth $ 20.7 billion. But the shares of the trust are trading at a combined value of $ 18.1 billion, a 12.3% discount.

Even stranger than this discount is the premium on a rival fund. Newer and much smaller Osprey Bitcoin Trust is trading at a premium of 27%.

Is that crazy price, or what? If you want a dollar of bitcoin, you can buy it here for 88 cents or there for $ 1.27. Someday, these discrepancies will disappear if and when the Securities & Exchange Commission allows exchange-traded funds to track crypto.

A coins ETF would allow market makers to respond to a request for redemptions by handing over fund shares and obtain cash or coins, and to respond to a demand for new fund shares by submitting coins or cash and getting new shares in return. This revolving door would cause bitcoin funds to trade at prices very close to their asset value. Discounts and bonuses would almost disappear.

The operators of Grayscales and Ospreys have pledged to convert their trusts into ETFs if the government ever allows these things. At that point, investors in Grayscales would reap a windfall and Ospreys would suffer a severe bombardment.

Do investors understand this? We are wondering.

Were in the Wild West of financial products for digital assets, says James Elbaor, who runs Marlton LLC, a Chicago-based investment firm that has invested in several Grayscale products. The menu includes, in addition to the flagship bitcoin, funds for Ethereum and an assortment of lesser cryptocurrencies.

Elbaor complains that Grayscale is dragging its feet on the ETF front. SEC’s box contains a dozen apps from Ark Invest, Fidelity, Van Eck and other companies for crypto ETFs; anything conspicuously missing is from Grayscale or its parent company, Digital Currency Group.

This is not a fair criticism, replies Michael Sonnenshein, managing director of Grayscale Investments. His company, he says, will join the ETF parade as soon as the SEC signals it is ready to act. Grayscale already has a bank lined up for the back office work of running an ETF. And when an ETF format for Grayscale Bitcoin Trust is approved, it promises, Grayscale will reduce the annual management fee by 2% on the fund, although it does not say by how much.

There’s a lot of loot at stake. In the first quarter of this year, that 2% fee brought in $ 144 million in revenue for the Grayscales Bitcoin fund. Sonnenshein can find a way to preserve most of that gravy train while competing with newcomers via a second fund.

There would be ample precedent for such a double game. When Vanguard introduced discounted ETFs for S&P 500 stocks and emerging market stocks, State Street and BlackRock left their respective overvalued ETFs in place for these. categories while opening discounted versions on the side.

Why, you might ask, would people stay in the original grayscale Bitcoin at, say, 1.9% per year when a grayscale Bitcoin II can be bought for maybe the half the price? Because they don’t like paying capital gains taxes.

Take a look at Grayscale Bitcoins’ first quarter report, a document that amusingly recaps its holdings of coins down to satoshi (one hundred millionth of a coin). He notes that shares worth $ 38 billion as of March 31 had been acquired for $ 7 billion.

For most of their glorious history, during which their net asset value soared 21,200%, Grayscale Bitcoin Trust shares traded at a premium to their net asset value. This allowed investors who subscribed for new stocks at NAV to end up with double wincoin appreciation plus the premium. It also allowed for a lucrative trade-off between coins and stocks.

There was an entire ecosystem that fueled Grayscale with assets, says Tyler Odean, editor of Something Interesting, a perceptual newsletter from Substack on crypto. He explains: An asset manager would offer interest-bearing bitcoin accounts, offer Grayscale coins in exchange for trusted stocks, wait for the required six-month cooling-off period, unload the trusted stocks at an attractive premium over the value of their coin, then would use the proceeds of that sale to purchase coins.

The exhibits would be available for delivery, with interest, to the depositor. In a bull market, everyone was making money: the depositor, Grayscale (with his 2%) and the arbitrageur.

The ecosystem collapsed this year when Grayscale Bitcoin stocks fell at a discount to their asset value. Possible Explanation: Too many people playing the spread game crowded into the exit door at the same time.

What could a daredevil arbitrageur do now? I have two schemes to suggest.

The first is a bet on the SEC, not the currency. If you think the federal authorities will turn to ETFs, buy grayscale (symbol: GBTC) on the over-the-counter market. Protect yourself against falling crypto prices now by short selling bitcoin futures on the Chicago Mercantile Exchange.

If the SEC clears coin-operated ETFs, and if Grayscale keeps its promise, the discount will evaporate. This will give you a windfall equal to 12% of the coins involved. You could make additional profit from the contango in futures.

Contango is the spread between a spot price and a higher futures price; it reflects the cost of financing and storing a treasure trove of precious goods (coins, gold, etc.). Recently, the bitcoin contango, as measured by the price difference between the contracts for the next month and the next month, reached an annualized rate of 7%.

Expected outcome: In a year, the SEC reluctantly approves crypto ETFs. You roll 7% on the futures for 12 months plus 12% from the close of the rebate on the grayscale trust. You lose 2% on the management fees of the trusts. Net gain, before taking into account transaction costs: 17%.

This arbitration is not a lock. One or both stages of the transaction could backfire on you. Maybe a year from now the SEC is still spinning and the GBTC rebate is languishing at 12% or something worse than 12%. It is also possible that CME futures contracts may shift from carry to offset, the phenomenon in which commodity futures are valued below the spot price. If this happens, keeping the hedge in place makes you a little poorer each month.

In short, there is a 17% chance of winning but some risk of getting hosed.

The second game is for speculators who want to be crypto long. Instead of buying coins or grayscale stocks, you can subscribe to new stocks at Osprey Upstart. You do this by sending money to the trader, getting trusted stocks that cannot be sold for 12 months. (Osprey is asking permission to reduce his blocking period to six months.) You must overcome a modest equity or income hurdle to qualify for this trade.

It is quite possible that at the end of your lock-up, Ospreys 27% premium has disappeared. No great harm. You have simply acquired a crypto for a fair price and are holding it in a fund which is one of the best buys in the market. Ospreys expense ratio of 0.8% is less than half of grayscale.

If, on the other hand, there is a premium left, you can cash out your Osprey shares (ticker: OBTC) and restart the process.

As Chicago investor Elbaor argues, the digital asset market is at an early stage, where irrational behavior can persist. Earlier this year, Osprey’s shares were changing hands with a comedic 100% premium over their asset value. Who could have bought?

But at some point, if virtual currencies continue to gain the attention of retail investors and the legitimacy of institutional investors, transaction costs will go down, fund management fees will go down, and price differentials will evaporate.

What to do while waiting? If you’re optimistic about the future of crypto, don’t wait for things to settle down, advises Tyler Odean, who bought bitcoin in 2014, during the dark days of Mt. Gox Hack Scandal: By the time the SEC approves an ETF, you’ve probably missed out on a lot of the benefits.

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