Potential Paths Forward For The Grayscale Bitcoin Trust

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Although it feels like a lifetime ago, only two months have passed since Genesis announced their need for a $1 billion liquidity injection in the aftermath of the FTX and Alameda fallout. As weeks dragged on without a resolution, details of the story have become more public, building up to fraud allegations against Digital Currency Group (DCG) that were announced by Gemini co-founder and president, Cameron Winklevoss. Gemini is still trying to recover $900 million in assets from Genesis that were used to generate yield for their Earn customers.

Left unresolved and only growing larger, DCG and Genesis problems weigh heavily on the bitcoin market as there are many answers needed and various possible outcomes that have yet to play out.

The biggest question of all is what will happen to the Grayscale Bitcoin Trust (GBTC) and how these issues will potentially impact the bitcoin price. GBTC has been the preferred vehicle for many to obtain regulated bitcoin exposure and it has also been a breeding ground for speculative arbitrage strategies throughout the previous swings going from a premium to a discount to net asset value (NAV). An approved bitcoin spot ETF in the United States would have likely solved these issues, but we’re still far from that happening.

It’s easiest to start with the GBTC shares on DCG’s balance sheet which are estimated to be around 9.67% of the entire supply. In the event that DCG needs to raise cash or goes down the path of Chapter 11 bankruptcy, selling these shares is potentially an option. Selling into an already illiquid market puts more pressure on the historically low GBTC discount. DCG holds approximately 67 million shares in a market that trades less than 4 million shares a day. However, a more important factor is that by law, DCG can sell no more than 1% of shares outstanding every quarter. It would take them around 2.5 years of constant selling to sell their entire stake.

Another path — the most likely one — is that the GBTC, along with Grayscale’s other trusts, find their way into the hands of a new sponsor and manager. Valkyrie has already proposed to do exactly this:

• Give an option for investors to redeem shares at NAV through a Regulation M filing request (although it’s not clear a Regulation M request would get approved by the SEC).
• Lower fees from 200 basis points to 75.
• Attempt to offer investors redemptions in both cash and spot bitcoin.

The option for a new manager gives investors an opportunity to get out of investments at NAV.

The GBTC product is still a cash cow for Grayscale and DCG, raking in 2% management fees — in perpetuity. Across all major trust products, Grayscale is collecting over $300 million this year from management fees alone. Rather than liquidate the entire trust in the worst case scenario, there will be many willing buyers to take on management of the vehicle without a U.S. spot bitcoin ETF available in the market.

However, liquidation is not a non-zero possibility. In the event of a Grayscale insolvency or bankruptcy, voluntarily liquidation could be pursued unless 50% of shares vote to transfer to a new sponsor. There is upside to DCG liquidating the trust as there’s money to be made from their shares closing to NAV, but that likely results in selling bitcoin on the open market. No one wants to see 632,000 bitcoin — approximately 3.3% of current supply — become selling pressure in the market. In the unlikely scenario where complete liquidation of the trust is undertaken with USD cash being returned to shareholders, one could presume that much of the selling would be absorbed through OTC deals with interested investors. At this point, this is purely hypothetical.

New information is coming to light that has the potential to change the superstructure in regard to the dynamic between Grayscale and the shareholders of Grayscale products. We will continue to write about developments in the coming weeks.

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