Grayscale Crypto Products: The Benefits
Grayscale Trusts are a popular way to gain exposure to digital currencies through traditional equities. Grayscale Bitcoin Trust (GBTC), which is actually the largest publicly traded Bitcoin trust, has an AUM of $24.6 million (at the time this writing).
Grayscale also offers financial products that track crypto assets such as GBTC and Litecoin. You can see the complete list on Vested.
These Grayscale products are preferred by institutional and retail investors over direct ownership of the digital assets.
These are easier to invest in (no risk and complexities associated with holding custody of your digital assets). Clearer tax regulations. Grayscale shares can be tax-efficient because they are traditional securities. This may be true for investors from India. Crypto assets have been subject to a 30% tax since April 1, 2022. This cannot be used for losses due to other crypto transactions. Additionally, a 1% TDS (tax deduction at source), which is a form tax prepayment, will be in effect after July 1, 2022.
Grayscale Crypto Products: The Problem
There is, however, a ts. Grayscale products all have a common problem. They have not been able to achieve their stated investment goals of tracking the prices of the underlying digital assets.
Two problems are involved in this problem:
The management fee ranges between 2 and 2.5%. Grayscale funds frequently sell or distribute digital assets in order to cover ongoing expenses. Grayscale products are notorious for making large tracking errors. Grayscale products can be described as Trusts, which are for practical purposes similar to closed-end fund. They cannot issue or withdraw shares from the open markets to adjust capital inflow/outflow. The Trusts’ share prices can differ from their net asset value.
What does this all mean? Below is the percentage return for various cryptos relative to their Grayscale counterparts over 1.5 years. The underlying crypto asset is represented by the solid blue line. Grayscale is represented by the light blue line. You can see that tracking is poor and Grayscale products generally outperform their crypto counterparts.
Figure 1: Comparison of the percentage returns of various crypto assets and their Grayscale counterparts. The performance of the underlying crypto asset is represented by the dark blue lines. Grayscale equivalents are represented by the light blue lines. Yahoo Finance provides data.
You would expect persistent tracking errors to lead to deviations in both the positive and the negative direction. However, Figure 1 shows that this is not the case. Let’s look deeper at these tracking mistakes.
Grayscale products are often sold at a substantial premium or discounted for long periods of time
Let’s first look at GBTC vs. BTC track errors. Tracking errors can be caused by the imbalance between supply and demand in GBTC shares. The deviation for GBTC over the past three year is shown in Figure 2. It appears that the direction of the deviation is consistent with time.
Figure 2: Three years of GBTCvs. BTC returns and deviations from the native asset values (NAV). Positive deviation is when the GBTC per share price trades at a premium compared to the equivalent BTC amount. Negative deviation is when the GBTC per-share value trades at a discount compared to the equivalent BTC amount. Source
When the deviation of GBTC is positive, it trades at a premium compared with the spot price for BTC. If the deviation of GBTC is negative, GBTC trades in a discount compared to BTC’s spot price.
GBTC was once traded at a premium. However, this deviation has changed to a discount in February 2021. The discount is currently around 21% in comparison to the BTC NAV as of the time this article was written. You get $1.00 worth of GBTC shares if you purchase $0.79 worth.
Two reasons may explain the February 2021 transition to a negative premium: (1) Grayscale might have over-issued shares in the past. (2) Two Canadian BTC ETFs were launched at the same time, providing additional opportunities for institutional investors to gain BTC exposure.
Grayscale’s ETHE (Etherium) vs. EETH (Etherium) can show a similar phenomenon. Refer to Figure 3.
Figure 3: A year of ETHE deviation (NAV) from the native asset valuation Source
Grayscale products, despite their poor NAV tracking, can still be of value to investors.
Grayscale Products and Underlying Crypto Assets have a positive correlation in daily price changes
Our analysis should be focused on those periods when the price fluctuations of Grayscale’s products were less volatile. This means that we should focus our attention on the last 6 months.
Let’s examine the relationship between the percentage change in crypto’s daily value and Grayscale’s product. The relationship between the percentage daily change of crypto and Grayscale products will be perfect (Figure 4).
Figure 4: When correlation is one
In reality, correlation does not exist. Grayscale’s share prices and the underlying cryptocurrency have a wide spread. Figure 5 shows that correlations are positive, and tend to be less than one. The blue dotted line is more steep than the red dotted. This represents perfect correlation.
Figure 5: Daily percent change in crypto vs. its Grayscale counterpart
How does this get fixed?
Grayscale will be able to solve the supply-demand issue if it is successful in its application for a Trust to become an ETF. The discount will disappear if that happens. However, this is a big IF.
The SEC has approved BTC Futures (for instance, BITO – we did a deep dive there) but not BTC spot ETF. The digital currency would directly back spot ETFs, instead of futures contracts. Many people have failed to create the first BTC spot exchange traded fund (Fidelity Ark VanEck among others). There are a few unknowns that can cause this.
Where will the BTC be purchased? Unlike BITO (where the ETF is for futures contract backed by Chicago Mercantile Exchange, CME), which is an extension to current regulatory structure), where will the spot BTC ETF obtain its BTC? Which exchange will the BTC be purchased? The SEC does not regulate many of the biggest crypto exchanges around the globe. Who will own the BTC? The SEC has yet to publish a framework for digital asset custody. However, the agency has requested public comments.
Grayscale is not stopping Grayscale from trying. The FT reported last week that Grayscale had submitted a new bid to the SEC. If their latest bid is successful, we will find out in July.
Disclaimer: “This guest post has been authored by the Vested team (https://vested.co.in/). Vested Finance Inc. and its affiliates own all intellectual property. ZebPay has not approved the content of this guest post. It was published to our blog for information and convenience only. ZebPay has no control over the guest post’s content. ZebPay is not responsible for Vested’s website or its content.
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