Grayscale Trusts - What Should Be Done And Why!

Grayscale has two main trusts that trade under the tickers GBTC and ETHE.

As of the close of U.S. trading at 4pm on Friday, both ETFs were trading at discounts to Net Asset Value (NAV) of about 45%. That is an extremely large discount to NAV for any fund and is particularly disconcerting since prior to February 2021, they had traded at premiums!

This shift from premium to discount has caused a lot of questions and I think what happens next could be critical for not only investors in GBTC and ETHE. but for the entire crypto community.

Worst Case Scenario

From my perspective, the worst case scenario is that somehow the trusts do not have ownership of the cryptocurrencies they report they have. @Grayscale had a twitter thread this weekend which included purported screenshots from Coinbase (COIN) that they were acting as custodian for the amount claimed. There has been some questions about the letter (the positions were from the end of September, for example) and the hardcore crypto players want to see actual wallets so that they can verify the amounts.

Given the efforts by Grayscale this weekend and the WSJ reporting on the subject, this seems like an unlikely scenario.

If, for some reason it turns out that the cyrpto isn’t there and/or isn’t accessible, it would be disastrous for the crypto industry. It would call into question anyone’s assertion that they hold crypto. If players with the size, scope and even regulatory scrutiny of Grayscale and Coinbase can’t keep their holdings safe, secure and accessible, than who could?

Yet, for many, it is difficult to look at 45% discounts to NAV and wonder if someone knows something nefarious is at play here?

I’m assuming this is a virtually 0% probability scenario, but if it occurs, there will be carnage in the space.

Best Case Scenario

At this point, some unwinding of the trusts seems to be the best case outcome.

As of Friday, GBTC for example had over 630,000 bitcoins. At Friday’s price of $16,500 per bitcoin, the theoretical value of the assets of the trust would be just over $15 per share (well above the $8.35) closing price.

GBTC’s bitcoin is just over 3% of the bitcoin outstanding (part of the reason these trusts are such an important part of the crypto discussion).

Could Grayscale, sell the 630,000 or so bitcoin an achieve an average price of more than $9,200? If so, there would be enough money to pay off the shares at Friday’s close. If they realized more than that, the shareholders would net more money (ignoring some likely legal, accounting and other transaction related fees).

If Bitcoin
liquidity is anything less than abysmal, it seems that they should be able to sell even that relatively large slug at an average price of $9,200 (if they can’t, what does that say about bitcoin? – nothing good in my opinion).

If the market knows they are selling, then that would impede liquidity, but they could have been entering into hedges or other mechanisms ahead of the announcement to alleviate the risk that the market drops all liquidity.

Some ask, why would Grayscale do this, since it would stop their cash cow. The funds charge at least 2%, so generate over $300 million annually for Grayscale. That is a lot of money to give up, by unwinding the trust. I see two reasons for them to do it:

1) They could face legal challenges down the road, meaning that they won’t keep those fees until the money runs out, so maybe doing the “right thing” by customers doesn’t cost as much as it looks and keeps you positioned to gain assets in future vehicles.

2) If they own enough of GBTC (or their affiliates or related entities) then they would profit on the unwind themselves, if they can get a good price for the Bitcoin and Ethereum
they would have to sell. Digital Currency Group (DCG), the owner of Grayscale, owned 28 million shares of GBTC as of February 2022 (according to Bloomberg based on annual filings by DCG). We don’t know how much DCG owns, but they would be in position to accumulate more and short bitcoin or bitcoin futures to make the unwind of the trust go more smoothly. If they owned $2 billion of GBTC and did the unwind with minimal price disruption on Bitcoin, they could $800 million themselves, which covers 4 full years of $200 million from fees for Grayscale.

The 2% fees are not certain in perpetuity (Grayscale claims to be trying to become an ETF which would like cut those fees) and the entities around Grayscale stand to profit if an unwind or resolution was well executed.

This is my base case and think would provide a pop to GBTC and ETHE as their prices rose somewhat as the liquidation values would be at less of a discount than is priced in.

The “Meh” Scenario

More of the same. The discount grows as investors speculate that:

1) The crypto is just not there and/or is just not accessible.

2) The company just wants to grind out the 2% fees for as long as possible.

This scenario will remain an overhang for crypto as it will allow, even encourage, too many negative stories, not just about GBTC and ETHE, but the parties involved, the safety of wallets, etc.

Bottom Line

I’d like to see progress towards unwinding the trusts and paying people out at liquidation value. I think that would be the best thing for those involved and the industry as a whole.

Until that happens, there will be a big overhang.

If the almost unthinkable happens and somehow the assets turn out not to be accessible, then this will make the the so-called “crypto winter” look like just a brief snow flurry!

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