The World’s Largest Bitcoin Fund Is Troubled. Here’s Why.

Bitcoin just can't seem to get out of its funk. On Tuesday, the world's most valuable cryptocurrency was selling at roughly $57,300, down 1% from its all-time highs of $69,000.

Grayscale Bitcoin Trust (GBTC) investors, on the other hand, may be doing even worse.

The Grayscale trust is the world's largest Bitcoin fund, with $37 billion in assets. It dwarfs all other mutual funds on the market. Since its introduction in October, the ProShares Bitcoin Strategy (BITO) exchange-traded fund has amassed $1.3 billion in assets, making it its closest competitor.

Because the Grayscale trust owns Bitcoin directly, investors have flocked to it, whereas the ProShares ETF and others obtain exposure through futures contracts. The Securities and Exchange Commission recently rejected an application from VanEck for a spot-based Bitcoin ETF.

A Grayscale spokeswoman states, "An ETF is the most economical approach to address any disparity between our products' share price and the NAV." "Investors desire Bitcoin exposure in the form of a Bitcoin Spot ETF, and Grayscale believes they are entitled to it."

The Grayscale trust is home to several institutional investors who possess Bitcoin. Ark Invest, Cathie Wood's fund shop, is the trust's largest shareholder, with $375 million invested in the trust, including assets held in its Ark Next Generation ETF (ARKW). According to Morningstar, the trust is owned by at least 47 mutual funds and separate accounts.

Many of those investors might have been better off buying Bitcoin directly, according to a Morningstar report released Monday.

Through Oct. 29, shares in the over-the-counter trust were up 42 percent this year, compared to a 95 percent gain for Bitcoin. According to Morningstar, the stock has gained 220 percent in the last year vs 340 percent for Bitcoin. The chasm has grown wider over time. The Trust has gained 648 percent and 4,048 percent over the last three and five years, compared to 876 percent and 8,427 percent for Bitcoin.

The trust's yearly expense ratio of 2% accounts for some of the performance disparity. This is far more than the roughly 1% cost imposed by ETFs and mutual funds that invest in Bitcoin through futures contracts.

The main issue is that the Grayscale Bitcoin Trust is set up as a closed-end fund with a set amount of shares available on the market. Depending on market demand, the shares may trade at a premium or a discount to the fund's underlying net asset value, or NAV.

The stock is currently trading at a 14% discount. This translates to investors purchasing $1 of Bitcoin for 86 cents on the dollar if they buy on the open market.

That appears to be a good value, but the NAV discount isn't going to decrease anytime soon. Investors buying Bitcoin on the open market have overpaid for it since the fund has traded at a high premium.

From November 1, 2018, to March 1, 2021, the fund traded at a premium to its NAV before switching to a discount.

An investor who bought the fund on the open market on Dec. 22, 2020, when the premium was at its highest, would have made a 64 percent profit through October, according to Morningstar. During that time, though, Bitcoin increased by 160 percent.

"Those who rushed into GBTC at a premium were severely scorched," says Morningstar analyst Bobby Blue.

Accredited investors with a net worth of at least $1 million or an annual income of more than $200,000 may have done better. Such investors are eligible to purchase Grayscale's shares at the NAV price. According to Morningstar, Grayscale filed for 35 private placements in 2020 and early 2021.

Buying at the NAV may have paid off handsomely when the trust traded at a premium, since investors obtained access to assets at a discount to their market price.

Grayscale received $1.2 billion in assets from accredited or institutional investors in December 2020, a period when the Trust traded at premiums of 19% to 40%, according to Morningstar.

"Those who were forced to buy on the open market had to pay a much higher price," Blue explains. He points out that premiums skyrocketed from October 2020 to February 2021, when meme stocks climbed and the price of Bitcoin skyrocketed.

In October, Grayscale filed an application with the Securities and Exchange Commission to convert the Trust to an ETF. The SEC's recent rejection of a spot-Bitcoin ETF, however, indicates that authorities are still wary about the underlying spot market. According to SEC Chairman Gary Gensler, Bitcoin ETFs will be regulated through the futures market.

In October, Grayscale's parent firm, Digital Currency Group, said that it will buy back up to $1 billion in market trust. DCG stated it has already repurchased $388 million in stock. However, the discount has remained unchanged, owing to the fact that it accounts for less than 1% of the fund's assets.

Another reason the discount hasn't shrunk is that Grayscale is facing increased competition. Several Bitcoin futures ETFs, as well as certain spot-based ETFs on the Canadian market, are now trading in the United States, all of which have lower costs.

Grayscale has its own reasons for not converting to an ETF. At recent asset levels, the 2% expense ratio generates $740 million in yearly fee income. Grayscale earns its fee on the NAV, not the underlying share price, which may be lower. ETFs charge around half that expense ratio.

Grayscale did not respond to a request for comment immediately.

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