Here is why I just bought this Bitcoin option

I made an unusual investment last week when I picked up some stocks Grayscale Bitcoin Trust (GBTC -1.99%). I’ll show you what made this purchase so different from my typical shopping, and then I’ll show you exactly why I couldn’t help but hit that buy button.

Long story short, I think Grayscale Bitcoin Trust is deeply undervalued these days. Read on to learn more about this unique earning opportunity.

What’s So Weird About Buying Grayscale Bitcoin Trust?

There are a few qualities that set this transaction apart from anything I would normally buy.

• I like to invest in stocks, exchange traded funds (ETFs) and cryptocurrencies. This transaction did not fall into any of these categories.
• This investment fund is a roundabout way to gain more exposure Bitcoin, which I already own directly on another account. What happens to the dual approach?
• I’m willing to take extra risk beyond just taking a little more Bitcoin. In exchange, I get a deeply discounted share price. How can I be sure that the risk/reward equation is leaning in my favor?

There are other quirks that make my involvement with Grayscale’s Bitcoin fund less likely, such as a hefty 2% annual management fee and the stock’s over-the-counter trading platform. However, these are only minor quibbles. The three points above deserve a closer look.

The grayscale car isn’t even a mutual fund, which would be the next best thing to a practical ETF format. Instead, it’s a mutual fund—registered as a financial reporting company, but lacking the stock exchange tools that are so essential to running an effective ETF.

Grayscale is trying hard to convert Bitcoin Trust into a proper ETF. Doing so will unlock the ability to control the fund’s market price. Grayscale’s investment vehicle strives to keep the market value of each share as close as possible to the value of the Bitcoin tokens associated with each share. ETFs achieve this through sophisticated share swaps with a special type of counterparty. Without that tool, Grayscale can only hope that the free market maintains a reasonable price compared to the related Bitcoin holdings.

It’s been a losing battle so far. The trust used to trade at a premium to Bitcoin’s price. However, the increased price turned into a discount when the trust stopped taking new equity investors in early 2021 (the Grayscale Bitcoin Trust shares you buy today are technically being resold by your stockbroker).

That discount explains the next two points. Investors are losing hope that this trust will ever become a properly regulated ETF, which will unlock the full value of the underlying Bitcoin assets. That event would almost double the trust’s share price overnight, as current price levels represent a 40% discount.

The Securities and Exchange Commission (SEC) has rejected Grayscale’s petition to restructure Bitcoin Trust as an ETF. The fund manager is suing the SEC, claiming the denial was “arbitrary, capricious and discriminatory.” After all, the SEC has allowed fund managers to form ETFs based on Bitcoin futures rather than Bitcoin itself — a more convoluted and arguably less stable method to ultimately achieve the same effect. The Pro Shares Bitcoin Strategy ETF is a leading Bitcoin futures ETF. That fund does a good job of trading right next to the ups and downs of Bitcoin itself, while Grayscale’s non-ETF offering struggles to do the same:

Bitcoin price data from YCharts

My investment thesis started with Bitcoin’s long-term value prospects. I believe that secure, decentralized, computerized transaction ledgers will disrupt the very concepts of banking and financial transactions in the long run, and that Bitcoin should remain a leading cryptocurrency for the long term. Therefore, I wanted to add some more Bitcoin exposure to my portfolio.

But I also expect Grayscale Bitcoin Trust to become a true ETF one of these days. I don’t see how the SEC can continue to deny ETF applications from Grayscale and its peers while allowing futures-based Bitcoin ETFs to exist. I am not a lawyer and I could be wrong about this, which is why I recognize that this investment carries additional risks. But today’s robust 40% discount looks downright excessive, especially as industry peers join supporting amicus curae filings on Grayscale’s side of the SEC argument.

The final briefs in the SEC lawsuit are due by February 3, 2023. You have at least that long to think about your own position on the trust’s huge risk-based discount — unless they settle the case early, of course.

Limited risk versus (probably) large rewards

So that’s why I’m the proud owner of some Grayscale Investment Trust shares as of last Tuesday. I see Bitcoin as a solid buy right now, and Grayscale Bitcoin Trust gives me a higher potential profit and I’m willing to accept a small risk that the fund will never become an ETF. Also, Grayscale’s funds may well erase the discount and perhaps even report premium prices again, even without the (admittedly useful) ETF-specific price management tools.

The potential upside is well worth the fairly small risk, as I understand it.