Grayscale Bitcoin Trust is trading at a record 36.7% discount, but is it justified?

US investors have been waiting for a Bitcoin (BTC) exchange-traded fund (ETF) approval since May 2014, when the Winklevoss Bitcoin Trust submitted an amendment request to the United States Securities and Exchange Commission (SEC).

Over the years, the SEC has rejected all applicants, with the most recent rejection coming to WisdomTree’s application for a spot Bitcoin ETF on October 11. The SEC concluded that the offering did not have the ability “to obtain information necessary to detect, investigate, and deter fraud and market manipulation, as well as violations of exchange rules and applicable federal securities laws and regulations.”

Bitcoin mutual funds have been around since 2013, but they have been limited to accredited investors. Launching a spot-based BTC ETF will open up the market to retail investors and a wider range of mutual funds in the industry.

At the moment, US regulators are reluctant to release what many believe would be a fairer and more transparent product for Bitcoin. A contradictory reality is that while BTC spot ETFs continue to be rejected, the exact same product has long been available for bonds, global currencies, gold, Chinese stocks, real estate, oil and silver.

Grayscale Bitcoin Trust (GBTC), a $12.3 billion mutual fund, is currently trading at a record 36.7% discount to its Bitcoin holdings, but this may not be a “buy the dip” type of discount. The gap started after the Toronto Stock Exchange launched the Purpose Bitcoin ETF in February 2021, which is a spot investment product.

What is an exchange-traded fund?

An ETF is a type of security that has diversified underlying investments, including commodities, stocks or bonds. The ETF may resemble a mutual fund because it is pooled and managed by the issuer.

SPY, the ETF that tracks the S&P 500 index, is the most recognizable example of this instrument. The mutual fund is currently managed by State Street and has $328 billion in assets under management.

More exotic structures are also available, such as ProShares UltraShort Bloomberg Crude Oil (SCO). This fund uses derivatives and aims to offer twice the daily short leverage on oil prices, meaning that investors are effectively betting on a decline in oil prices.

Buying an ETF gives the investor direct ownership of its contents, creating different taxation events versus holding futures contracts and leveraged positions.

Trust funds such as GBTC do not offer redemption or conversion rights

Mutual funds sit outside the SEC’s authority and are actually regulated by the US Office of the Comptroller of the Currency.

Grayscale’s GBTC is the absolute leader in the cryptocurrency market, although it has been structured as a company — at least in regulatory form. The investment fund is considered a closed-end fund, which means that the number of available shares is limited.

Accordingly, GBTC shares are not freely created, nor do they offer a redemption program. This inefficiency creates significant price deviations relative to the fund’s underlying Bitcoin holdings. In contrast, an ETF allows the market maker to create and redeem shares, ensuring that the premium or discount is minimal at most times.

For example, the Purpose Bitcoin ETF (BTCC.U) had a net asset value of $3.59 per share on October 13, and shares closed at $3.60 on the Toronto Stock Exchange. Similarly, the underlying price for US derivatives ProShares Bitcoin Strategy ETF (BITO) was $11.94 on October 13, while shares were trading at $11.95.

Related: Grayscale fires first salvo in case against SEC over rejection of Bitcoin ETF

Shades of Gray is fighting the SEC, but the results could take years

In June 2022, asset manager Grayscale initiated a lawsuit against the SEC regarding the conversion of GBTC to a spot-based Bitcoin ETF. The firm has been waiting for a final decision from the regulator since the application was submitted in October 2021.

Grayscale’s senior legal strategist, Donald B. Verrilli, stated that the SEC rejection was “arbitrary” by “failing to apply consistent treatment to similar investment vehicles.” As a result, the asset manager pursued a legal challenge based on the SEC’s alleged violations of the Administrative Procedure Act and the Securities Exchange Act.

It should be noted that eight and a half years have passed since the first request for a Bitcoin spot ETF registry was submitted. Currently, GBTC charges a fixed annual management fee of 2%, so the 36.7% discount may be justified given that the SEC continues to reject appeals and requests from each fund manager.

Essentially, the mutual fund is far less optimal than an ETF, and so far Grayscale has done little to minimize the impact on GBTC holders.