As the Grayscale Bitcoin Trust (GBTC) discount – the value of the shares versus the underlying asset – continues to trade in the double digits, the Securities and Exchange Commission (SEC) has rejected the company’s application to convert it into an exchange-traded fund (ETF).
(Grayscale is a subsidiary of Digital Currency Group, which owns CoinDesk.)
Should GBTC be converted into an ETF, it would be a massive loss in fee revenue for Grayscale because the firm takes a 2% fee on the underlying assets regardless of the discount.
“A ‘winning’ case and ultimate ETF conversion would eviscerate Grayscale's revenue by more than 50%. An ETF would mean an open redemption window, and a likely reduction in fees in order to retain AUM (assets under management). We’re talking about $200 million+ per year in profit reduction for DCG,” Selkis wrote.
So the question is whether Grayscale is pushing for the ETF in good faith, or is it one big pantomime ordered from the shadowy lair of Barry Silbert?
Selkis doesn’t think converting the trust to an ETF is likely to happen, at least during Gary Gensler’s tenure. Part of this has to do with premium harvesting trades that took place when GBTC traded at a premium and not a discount, which Three Arrows Capital used with extreme leverage.
“What's interesting is that there's a non-zero chance that the SEC blocks Grayscale purely out of spite, and because they don't want to reward what they view as historically bad behavior,” Selkis wrote. “The bad Grayscale Trade was 3AC’s first step toward insolvency. 3AC owned a huge chunk of GBTC with leverage – up to 6% of the trust at one point.”
Selkis thinks that the most prudent and realistic path to "fixing" GBTC comes via something called a Regulation M exemption.
Regulation M revolves around redemptions of trusts and funds. This is the series of rules which prevents Grayscale from offering a redemption program as it is prohibited from repurchasing shares at the same time it is offering shares through private placements. In 2016, a legal scuffle between Grayscale and the SEC over these rules caused Grayscale to close the redemption mechanism.
But Selkis doesn’t think Grayscale will initiate this as it will mean giving up hundreds of millions in fees. Why would it? Instead, GBTC shareholders will need to sue for it in order to force DCG's hand away from maintaining the status quo. DCG might not want this, but there is a pathway for them to be forced. The SEC would be receptive to the suit as it would keep a GBTC ETF off the market while its shareholders are made whole from redemptions at a market rate – what Selkis calls an appropriate punishment for a fund that “just helped fuel a shadow banking [and] crypto lending contagion.”
“Assets would absolutely gush from the trusts until the GBTC discount closed in full versus [net asset value]. Grayscale Trusts could theoretically unwind to zero,” Selkis wrote.
In the end, this is still a long shot, Selkis believes, but “for the past 18 months, Grayscale and Gensler have won, while investors have lost. Reg M relief could be the move that reverses the toxic trade. Potentially, for good.”
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