Discounts on GBTC and ETHE remain elevated after prospects of a quick dissolution/resolution have slowed over the last few weeks.
The main problem is the trusts’ 2% performance fee; there remains strong incentive to keep it closed as long as Digital Currency Group remains healthy.
Our view: negative market sentiment accounts for an outsized share of the effective discount calculation here, which creates potential opportunities on a value basis, but no resolution is likely any time soon.
May you live in interesting times.
Resolution on the Grayscale trust situation has been slower than expected or desired over the last few months, and action since the start of 2023 has emphasised those issues. The filing for bankruptcy by lender and fellow DCG portco Genesis looked to be something of a ray of hope for holders, but it has not been so; while the discount has not deepened since early December’s -50% low, it has not substantially rallied either, staying stubbornly below -30% and sitting at -42% at the time of writing.
The overriding problem here is that the general expectation is, for redemptions to ever happen, Digital Currency Group as a whole would have to be existentially threatened. The structure of GBTC, and in particular the dual pillars of no redemption and a 2% management fee, heavily incentivise the company to maintain the trust indefinitely, no matter how bad the premium gets; the net effect that any of the bad publicity around the trust creates for the market at large (thus reducing the principal) is for the most part outweighed by the management fees collected.
Activist efforts around the fund have hence centred on those two points, and in particular the point of redemption. In practical terms, redemption would mean total dissolution of the fund, since it is hard to see almost any current holders retaining holding in the fund or funds; GBTC and ETHE in particular are relics of a time when market access was much poorer for would-be participants in the US than it currently is, even after the collapse of FTX and several CeFi platforms. Valkyrie, an asset manager principally involved in the issuance of crypto-correlated funds such as its strategy and mining ETFs, has lead the charge on this, proposing to take over the trust and allow redemptions (as well as reducing fees).
However, these efforts have gained little traction overall, and stakeholders received some bad news earlier this week when it came to light that Genesis were selling off some quantity of their held GBTC and ETHE shares at the current discount. This is hard to take as anything other than an indicator that the trust is definitely not considering an unforced dissolution – something that was generally presumed, but where the one route towards them doing so would have been around paying down Genesis’ debtors. The door remains open on a forced dissolution, but at the very least, it seems that any winding down may be painfully slow, which was the opposite of what was hoped for when relative prices rallied in late December.
For GBTC, ETHE, and other Grayscale trusts, this leaves things in a somewhat odd state. The first thing to say is that the potential for a broader market impact through any activity taken on the trusts is usually overstated in both directions; while dissolution would have cash settlement as a default, it would be suicidal for all involved to not look to steer towards in–kind instead, and liquidations following on from that would probably be a smaller portion of assets than is generally judged.
On the trusts themselves, and the current discount: especially given that it has gotten more expensive and more difficult (especially for regulated participants) to partially or fully hedge, the discount as it exists is possibly more of a reflection of sentiment on cryptocurrency as a whole than anything else, as opposed to when it was in the -5% to -20% range and could be understood as pricing of a broad guess at time towards a possible exit.
The trusts in that regard become somewhat interesting when the underlying assets are trading at close to a market low; after all, looking from the perspective of Grayscale themselves, and assuming that the discount will never shift back into an outright premium again, dissolution would make most sense when the underlying assets are at cycle highs in a year or two. The problem, of course, is that there is still ultimately no guarantee whatsoever that redemption is necessarily ever possible, and current prices to current cycle lows alone would represent a -30% drop in the base asset valuation.
Hence, while the trusts are interesting in terms of potential buys for the long-term (especially in jurisdictions where capital gains regimes etc. are more favourable towards OTC trusts than base assets), any arbitrage-based interaction with them at this time is risky at best.