Grayscale Bitcoin Trust (GBTC): ETF Conversion Could Happen Sooner Than Many Expected

I’ve been in a measured Bitcoin (BTC-USD) accumulation mode since October 2022. I’ve been especially interested in the Grayscale line of products like the Grayscale Bitcoin Trust (OTC:GBTC). I intend to hold this until Grayscale converts it into an ETF (and thus closes the discount to NAV on this closed-end fund). GBTC is currently trading at a 36.87% discount. I think that’s still a very wide discount (very few closed-end funds trade at such a discount) that’s not warranted to begin with but especially not because Grayscale sued the SEC because it doesn’t allow it to convert GBTC into an ETF.

This lawsuit signals that the company wants to convert the closed-end fund into an ETF/ETN. There are also clear business incentives because converting GBTC into an open-ended product would create the largest such U.S.-based product. The largest ETF/ETN within a category tends to attract quite a lot of the flows. It is also a much easier vehicle to hold or trade for many investors.

Unfortunately, the FTX blowup set the crypto world back a bit. It certainly doesn’t help Grayscale with its case against the SEC. A month ago, I didn’t think there was a real rush to scoop this up but thought it could look like a great buy in a few years’ time.

Two important things have changed:

1) Grayscale’s oral arguments in the Grayscale vs SEC case went down very well.

2) The tensions around deposit safety are again casting Bitcoin in a favorable light.

The recent banking turmoil with today’s acquisition of Credit Suisse (CS) by rival UBS (UBS) won’t have escaped anyone’s attention. Bitcoin’s popularism was likely a product of the Great Financial Crisis and the widespread unhappiness about banking. That sentiment is becoming more salient as banks are blowing up once more. I think this is reflected in the recent Bitcoin price action. It took off around March 10 when Silicon Valley Bank failed:

In part, it is also a duration trade. Bitcoin also seems somewhat correlated to the 30-year treasury and the Nasdaq.

With rates dropping hard through the banking turmoil, this is a tailwind as well. But in my opinion, that only explains part of the outsized move.

Bitcoin is surging above its 200-day moving average, and the longer it stays ahead, the more and more quantitative traders (momentum/trend following) start buying into that trade.

The move in GBTC has been even more pronounced and that’s because of the oral arguments hearing on March 7 that went really favorably for GBTC. GBTC also broke through the 200-day moving average and is likely getting picked up by quantitative strategies (these were previously likely short).

The way I understand the Grayscale vs SEC lawsuit is like this: Grayscale alleges it doesn’t add up if the SEC 1) allows a Bitcoin futures ETF but not a 2) Bitcoin spot ETF.

I understand Grayscale’s argument as follows(remember, I’m not a lawyer, you can read the unofficial transcript here):

• Futures derive their prices from spot and are approved by the SEC
• Because the SEC has accepted the situation of the futures ETF where; futures and off-exchange manipulation will be spotted by CME (Futures exchange) a Bitcoin spot ETF (while fraud monitoring futures) should be allowed as well

The SEC’s position is contradictory in arguing that the manipulation of the off-exchange Bitcoin spot would be spotted in Futures because the price action would show up there as well.

The SEC is also arguing that the manipulation of off-exchange Bitcoin spot to defraud investors in a potential spot ETF wouldn’t necessarily show up in the futures and wouldn’t necessarily be spotted.

Greyscale then argues the spot ETF could rely on the same fraud monitoring system the futures ETF uses.

The SEC’s defense to this appears to be that Grayscale first needs to establish whether futures or spot Bitcoin can be considered as leading the other.

This in turn seems to be a peculiar argument because 1) the futures market didn’t exist before they were allowed to trade. 2) I’d argue this isn’t how liquid markets operate. Futures and spot markets are much more likely to be part of a dialogue of price. A dialogue that’s kept in check by moderators (i.e. arbitrageurs). At times one will lead, and at other times another market will lead. It can’t be true one market consistently leads, or arbs would start front-running other markets until the lead disappeared.

It comes very much across to me as if the SEC is invoking questionable grounds to stall the inception of a spot ETF. Another sign that its case may be quite weak was its attempt to invoke the Chevron deference doctrine. The doctrine makes it harder to second-guess the agency:

The scope of the Chevron deference doctrine is that when a legislative delegation to an administrative agency on a particular issue or question is not explicit but rather implicit, a court may not substitute its own interpretation of the statute for a reasonable interpretation made by the administrative agency. Rather, as Justice Stevens wrote in Chevron, when the statute is silent or ambiguous with respect to the specific issue, the question for the court is whether the agency’s action was based on a permissible construction of the statute.

The judges also appeared interested in the $4 billion of value that would be unlocked if GBTC were allowed to be converted into an ETF (because of the disappearing discount). A practical effect that would greatly benefit investors.

The timeline of the case looks like this:

A decision could follow as soon as Q2 of 2023. That doesn’t necessarily mean the discount will close. It would likely narrow given the recent response. However, the SEC doesn’t have to approve the conversion. If the SEC is found to be in the wrong here, it could choose to get rid of futures ETFs to equalize the treatment of the two classes. That seems an unlikely response but it is theoretically possible.

Finally, one last thing I believe is essential to understand is that a true U.S. Bitcoin ETF would likely have an impact on Bitcoin itself. It makes the asset even more widely accessible and embeds it into the existing investment universe. When a gold ETF was launched it seems to have permanently impacted the valuation of the metal.

On November 18, 2004, State Street launched the SPDR Gold Shares ETF (GLD), it surpassed $1 billion in assets within its first three trading days. My impression has always been it had a marked impact on the price of gold because it became much easier to include as part of an asset allocation plan:

I’m not sure if the recent banking panic-induced Bitcoin spike has legs but several other potentially more enduring tailwinds could start driving Bitcoin back toward previous highs. I still think it is quite likely the Grayscale Bitcoin Trust (OTC:GBTC) will look like a solid buy in a few years from now.

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