Unpacking misconceptions about Grayscale's investment trusts

Launched on Sept. 25, 2013, Grayscale’s Bitcoin Investment Trust is one of the oldest Bitcoin investment products in the industry. Yet, despite its nearly seven years of operations it is still not widely understood. This misunderstanding has not only caused absurd mispricings of its trusts, but has also caused flawed analysis of its significance as a purchaser of cryptocurrencies. In short, Grayscale trust buyers are paying ridiculous premiums for cryptocurrency exposure, and Grayscale purchases much less cryptocurrencies than many would believe.

How do Grayscale trusts work?

Simply put, Grayscale investment trusts are investment vehicles that provide exposure to cryptocurrencies. What makes them popular is that they’re accessible through traditional brokerage and retirement accounts. The trusts are structurally similar to large commodity ETFs like the SPDR Gold Trust, however they’re not traded on exchanges (they’re instead available OTC) and initial shares are only available to accredited investors. In order to provide access to its trusts on secondary markets, Grayscale relies on a “Rule 144 exemption” that allows Grayscale and its investors to resell investment trust shares to the public after an initial restricted “Reg D” accredited-only offering and a 12 month holding period (now 6-month for GBTC). This is how investors in the private placements access liquidity because the trust does not currently operate a redemption mechanism.

Potential issues with Grayscale trusts

While Grayscale’s contribution to the industry is unquestioned, their fund structures can create numerous issues. The peculiar structure of the product has likely created a significant information asymmetry between institutional and retail investors. Data suggests many retail investors do not understand how much they’re really paying for their cryptocurrency exposure.

When there are a lot of buyers and few sellers, investors in the secondary markets can push the price of the shares well above the value of the underlying cryptocurrencies. This is because no new shares are being created, which means no new cryptocurrency is going in the trust despite increased inflows into the shares of the trust. This creates a premium to the underlying cryptocurrency, which is referred to as the premium to net asset value (NAV).

This premium to NAV not only creates significant arbitrage opportunities for the limited set of accredited investors who can create new shares, but it also causes heightened volatility relative to the trust’s underlying cryptocurrency.