This Bitcoin fund has an additional $7 billion in untapped value. Too bad investors can’t get to it.

Some investors see it as a bargain. GBTC makes up more than 5% of Cathie Woods

ARK next generation Internet

exchange-traded fund (ARKW). “When there’s money to be made by closing the discount, somebody’s going to find a way to make it happen,” said senior portfolio strategist Pat Tschosik at Ned Davis Research, who sees GBTC potentially doubling by mid-year as Bitcoin rallies.

Still, GBTC’s discount has proven impregnable. The fund’s corporate sponsor, Grayscale Investments, has largely insulated itself from proxy campaigns by hedge funds — which would normally attack such a broad discount in a closed-end fund. And GBTC’s discount has only increased as other Bitcoin funds have emerged — especially ETFs like

ProShares Bitcoin Strategy

(BITO), which holds Bitcoin futures, for a much lower annual fee.

Grayscale says it wants to convert GBTC into an ETF, claiming it’s the best way to close the discount. ETFs use market arbitrage mechanisms to eliminate discounts to their NAV; in theory, it could unlock $7 billion for GBTC holders.

There’s a problem, though: The Securities and Exchange Commission has repeatedly rejected applications from fund companies for ETFs that want to own Bitcoin directly, rather than through futures. In June, the SEC rejected Grayscale’s bid to convert GBTC into an ETF, prompting Grayscale to sue the agency to overturn the decision.

Oral arguments are scheduled to begin March 7 in the U.S. Court of Appeals for the District of Columbia. Greyscale’s lead attorney is Donald Verrilli, who was attorney general in the Obama administration. Verrilli said in an interview that the SEC has no reason to treat spot Bitcoin ETFs differently than futures-based ETFs, arguing that the agency is using a double standard that violates the law.

“Administrative agencies have an obligation to treat like cases equally, and the SEC violated that obligation,” Verrilli says, adding that he doesn’t know of an exact parallel to this case. The court can decide in the autumn.

The implications go far beyond GBTC. Legions of fund companies, including Fidelity Investments, VanEck and WisdomTree (WT), have tried to persuade the SEC to approve a spot-based Bitcoin ETF, and have been rebuffed each time.

A ruling allowing GBTC to become an ETF could open the floodgates to far more Bitcoin funds, something the SEC appears unlikely to allow. The agency claims that, unlike futures markets, the spot Bitcoin market does not have adequate measures in place to prevent fraud and manipulation, and is not properly monitored. That leaves a spot Bitcoin fund vulnerable to manipulation, putting investors at risk, the agency says.

“All of the markets for spot Bitcoin underlying Grayscale’s product are unregulated,” the SEC wrote in a brief, arguing that “different treatment under these circumstances was reasonable.” The agency declined to comment.

As the lawyers argue in court, hedge funds and other investors are trying to force Grayscale to give up managing the fund or find other ways to unlock the $7 billion.

Fir Tree Capital Management, a hedge fund manager, sued Grayscale in December, accusing the firm of “mismanagement of the trust.” Fir Tree says Grayscale quietly changed GBTC’s governing documents to make it more difficult for shareholders to take over the fund. Fir Tree also says Grayscale’s corporate parent, Digital Currency Group, has “significant conflicts of interest” that incentivize it to maintain GBTC’s status quo.

Fir Tree and other investors claim that the conflicts arise in part because DCG earns so much in fees. ETFs holding Bitcoin futures charge about 1%, compared to GBTC’s 2% annual fee. Since GBTC’s management fees are a percentage of the trust’s assets, they bring in more than $300 million a year at recent prices.

“They make a lot of money from this. They need to keep pushing capital into their parent company,” said Steven McClurg, chief investment officer at Valkyrie Investments, which runs a hedge fund that owns GBTC and had its own application to launch a spot Bitcoin ETF denied by the SEC. McClurg says he plans to continue pressuring Grayscale to close the discount.

Another company challenging GBTC is Osprey Funds, which runs the Osprey Bitcoin Trust (OBTC), a much smaller fund with $68 million in assets. Osprey has also sued Grayscale, claiming that the firm achieved dominance in over-the-counter Bitcoin funds in part by lying about its ability to convert GBTC into an ETF.

Grayscale has said the Osprey lawsuit is frivolous and disputes the activists’ other complaints. CEO Michael Sonnenshein says he will cut GBTC’s fees as soon as it becomes an ETF.

Another tactic advanced by activists — for Grayscale to return underlying Bitcoin to shareholders — would require regulatory approvals similar to what the firm is seeking with the ETF conversion, he says. Grayscale says it is open to a tender offer of up to 20% of GBTC’s shares if the legal strategy fails, including a potential appeal to the Supreme Court.

Seeking SEC approval for a tender offer at the same time Grayscale is suing the agency “is not something we believe is in the best interest of shareholders,” Sonnenshein says.

All the legal jockeying has left investors in a crypto purgatory. A win in court could be a $7 billion windfall, but it could take years, if ever. Bitcoin, meanwhile, is up 43% this year. GBTC, whose discount has increased, is up 39%, falling behind the crypto it is meant to track again.

Write to Joe Light at [email protected]