Grayscale Bitcoin Trust and its ties to cryptocurrency crashes

The Grayscale Bitcoin Trust (GBTC) is an over-the-counter (OTC) traded fund intended to track the price of bitcoin. Grayscale Investments is owned by Barry Silbert’s cryptocurrency giant Digital Currency Group (DCG), which also owns beleaguered cryptocurrency trading and lending firm Genesis.

Here’s how it works: When Grayscale chooses to open its private placements, accredited investors are able to deposit bitcoin to receive shares of the trust (or deposit cash and have Grayscale help facilitate the purchase of bitcoin).

Private placement buyers cannot sell their shares for six months, due to specific regulations governing GBTC. Subsequently, they are able to sell the shares to other people.

Once those shares are available for sale, people can buy them from their broker, and so on gain indirect exposure to bitcoin.

Grayscale charges 2% of assets under management (AUM) as fees for GBTC.

How is GBTC different from an ETF?

An exchange traded fund (ETF) is able to issue and redeem shares for the underlying index. So an investor approaching a spot bitcoin ETF with bitcoin can convert their bitcoins into shares of the ETF, and investors with shares of the ETF can convert them into bitcoin. Exchange-traded funds are also traded on national stock exchanges, while GBTC is traded OTC.

This redemption capability would help eliminate GBTC’s tendency to trade at a premium or discount to its net asset value (NAV).

Grayscale is famously in the midst of a Securities and Exchange Commission (SEC) subpoena for denying your request convert the trust into an ETF.

GBTC has not offered redemptions since 2014. It settled with the SEC (along with subsidiary SecondMarket) in 2016, over alleged violations of Rules 101 and 102 of Regulation M. Since then, Grayscale has not offered redemptions.

Regulation M prevents Grayscale from offering refunds within the limited six-month period following an issue. However, Regulation M appears to allow Grayscale to offer redemptions outside of that limited period. In this case, it can only redeem and not issue at the same time.

David Hennes, a partner at law firm Ropes and Gray, explained in his public comment to the SEC that “Regulation M, however, does not prohibit GBTC from redeeming shares so long as GBTC does not concurrently distribute shares.”

Since 2014, investors have been able to contribute to the fund, helping it grow, but no one has been able to redeem. If Grayscale were to open redemptions, that would be reversed: shareholders would be able to redeem but no new investors would be able to issue shares.

Opening redemptions would reduce the amount Grayscale would earn in commissions by reducing total AUM.

How did he help destroy Three Arrows Capital?

For a long time, GBTC has traded at a significant premium to its NAV, with shares trading at up to double the value of the corresponding bitcoin. While this premium persisted, institutional investors were incentivized to lock up bitcoin and receive GBTC stock, which they hoped to sell once the six-month period had passed.

However, this trade has become popular with a variety of companies, including BlockFi and Three Arrows Capital (3AC). As shares began to unfreeze, GBTC eventually began trading at a discount to the NAV. This has become especially challenging for BlockFi, which it had lent 3AC money against GBTC collateral.

Eventually, 3AC was liquidated by BlockFi, which meant more GBTC sales in the market, further increasing the discount. Currently, GBTC is trading at around 45% discount to the NAV.

Where are the bitcoins?

Coinbase case. Grayscale and Coinbase Custody will not disclose addresses citing “Security Concerns.”

An earlier version of this article cited the original custody agreement that prevented the disclosure of public and private keys. Coinbase responded to a request for comment from Protos and pointed us towards the new custody arrangement, which only prevents disclosure of private keys. We apologize for any confusion

It’s unclear what security issues could prevent these addresses from being disclosed, and other Bitcoin Trusts like the one run by Osprey, which also has custody of Coinbase have disclosed their address.

There is no way to verify ownership of bitcoins from GBTC on-chain without disclosure of such addresses.

Will Genesis affect it?

DCG, the parent company of Genesis Trading and Grayscale, is reportedly raising money to help support the Genesis books.

If Grayscale Investments withdraws as sponsor for GBTC, the remaining shareholders have 90 days to find a new sponsor or the trust will terminate. If the trust is forced to liquidate, the bitcoin will be sold “as quickly as possible at the best possible fair value.” The cash proceeds will be distributed pro rata to the shareholders.

GBTC currently has 644,000 bitcoins. Those who bought at a significant discount could potentially make money, but that depends on what this bitcoin sale would look like influence the market price of bitcoin.

Grayscale is one of the most profitable parts of the DCG empire and would likely be looking to avoid liquidation, as it generates around $200 million in fees. The shares also allow for the distribution of bitcoins to shareholders, instead of cash proceeds. However, this appears to require a voluntary resolution and an affirmative vote of 75% of shareholders.

If Grayscale decides to open refunds, DCG would be able to redeem the hundreds of millions of dollars of GBTC purchased at a discount.

For more informed news, follow us on Chirping And Google News or listen to our investigative podcast Innovation: Blockchain City.

Update 2022-22-23 22:00 UTC: Added language clarifying the nature of the custody agreement with Coinbase and removed language from the expired custody agreement.

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