Summary: Steadily declining premium-to-NAV for Grayscale’s GBTC and ETCG instruments show the premium dissipating fully by the end of this month. The shrinking premium cannot be explained by recent price declines or decrease in adoption rates of cryptocurrency in general. Nor is it well explained by an increase in existing securitized cryptocurrency vehicles. We think the most viable explanation is that a widely available cryptocurrency ETF will be approved in the foreseeable future.
For the past several months, the premium to net asset value of two cryptocurrency trusts – GBTC and ETCG – has been declining. This past week, the premium reached the lowest levels ever in their history.
The Grayscale Bitcoin Investment Trust and Grayscale Ethereum Classic Trust are two (the only two) pure-play publicly available securitized cryptocurrency investments. The trusts hold actual bitcoin or ethereum classic, and each has a discrete number of shares issued. Each GBTC share holds 0.00099395 bitcoin. Each ETCG share holds 0.95776552 ethereum classic.
Investors purchase shares of the trust through Grayscale Investments. There is a two-year lock-up period, after which shares of the trust may be traded over the counter. Grayscale operates several such trusts, but only bitcoin and ethereum classic have publicly available shares.
Investors have been willing to pay premium for these shares, in part because they originally offered the convenience of cryptocurrency access through a traditional securities brokerage account.
That premium has been declining through 2018. ETCG now trades at a discount to net asset value. As of October 12, 2018, that discount was 24%, meaning you could but $1 worth of ETC for just 76 cents!
What is behind this drop in premium?
The first suspected cause is the overall decline in price in cryptocurrency in 2017. As the price falls, fewer investors are interested in cryptocurrency, and so the demand for these trust investments should also decline.
We see that there is a relationship between the premium of GBTC and the 9-month trailing return of bitcoin. This is consistent with a momentum strategy and individual investor behavior, both of which use historical return as a predominant criterion for investment. As performance wanes, the “performance chasers” leave. This effect is also found in ETCG, but with a 4-month trailing return.
While there is definitely a relationship, the R2 statistic tell us that even if this hypothesis were true, past performance only accounts for 10% of the change in GBTC premium and 17% of the change in ETCG premium. What about the remaining 80-90%?
Also, demand for bitcoin and ethereum classic has not been declining over this time, it has been increasing. Network value is an estimate of a cryptocurrency’s equilibrium value. It is calculated using number of active users and transaction counts.
In the case of ETC and BTC, both have increased user counts and transaction counts. So what else could responsible for the decline in premium for GBTC and ETCG?
Increasing Investment Alternatives
2018 has seen an increase in the number of securitized alternatives to Grayscale’s products. An aggressive marketing campaign by BitcoinIRA, Inc. has likely drawn some prospective investors away from these trusts. Bitcoin IRA has charged an up-front fee of 15%, 3% of which is kicked back to investment advisors that implement the BitcoinIRA platform for their clients. When Grayscale’s premiums were high, this might have seemed a cheaper investment option. But with Grayscale trust premiums declining or negative, it does not seem so compelling.
In August, U.S. investors could purchase a Swedish exchange-traded note (ETN) OTC, Bitcoin Tracker One (BITCOIN-XBT.ST). While this investment has the potential to better track the underlying bitcoin price, ETN’s are notoriously illiquid.
This does not explain the decline in ETCG premium, except that the market may be anticipating similar investment vehicles for ETC and other coins.
Finally, a True Cryptocurrency ETF
This brings us to the final possibility, that widely available, pure-play securitized cryptocurrency instruments will be approved soon. We looked at the average premium for GBTC and ETCG since May 2018. This decline has been steady through this period. Interestingly, the average premium for both securities is expected to reach zero in the last week of October.
Why is this important? The SEC has opened the floor to comments either in support or opposition of cryptocurrency ETF products through Oct. 26. Many that the SEC could make an announcement regarding ETF approval shortly thereafter.
Regardless of the specific comments the SEC will make or has made, it is clear that the market is demanding, and fully expecting, cryptocurrency ETFs to be made publicly available in the foreseeable future.