I made an unusual investment last week, as I picked up a few shares of the Grayscale Bitcoin Trust (GBTC -3.90%). I'll show you what made this buy so different from my typical trades, and then I'll show you exactly why I couldn't help myself from tapping that buy button.
Long story short, I think Grayscale Bitcoin Trust is deeply undervalued these days. Read on to learn more about this unique moneymaking opportunity.
What's so strange about buying the Grayscale Bitcoin Trust?
There are a few qualities that set this particular transaction apart from anything I'd normally buy.
- I like to invest in stocks, exchange-traded funds (ETFs), and cryptocurrencies. This transaction didn't fall in any of those categories.
- This investment trust is a roundabout way to gain more exposure to Bitcoin, which I already own directly in a different account. What's up with the double-dipping approach?
- I'm willingly taking on extra risk beyond simply grabbing some more Bitcoin. In exchange for that, I get a deeply discounted share price. How can I be sure that the risk/reward equation is leaning in my favor?
There are other quirks making my involvement in Grayscale's Bitcoin fund less likely, such as a beefy annual management fee of 2% and the stock's over-the-counter trading platform. Those are only minor squabbles, though. The three points listed above deserve a closer look.
The Grayscale vehicle isn't even a mutual fund, which would be the next best thing to a convenient ETF format. Instead, it's an investment trust -- registered as a company for financial reporting purposes but lacking the share-swapping tools that are so crucial to operating an effective ETF.
Grayscale is trying hard to convert its Bitcoin Trust into a proper ETF. Doing so would unlock the ability to control the fund's market price. Grayscale's investment vehicle strives to keep the market value of each share as close as possible to the value of the Bitcoin tokens that are tied to each share. ETFs achieve this through sophisticated share-swapping actions with a special type of counterpart. Without that tool, Grayscale can only hope that the free market maintains a reasonable price in comparison to the related Bitcoin holdings.
That's been a losing battle so far. The trust used to trade at a premium to Bitcoin's price. However, that boosted price turned into a discount when the trust stopped taking on new capital investors in early 2021 (the Grayscale Bitcoin Trust shares you buy today are technically resold by your stock broker).
Data source: Grayscale Bitcoin Trust. Chart created by the author.
That discount explains the next two points. Investors are losing hope that this trust will ever become a properly regulated ETF, which would unlock the full value of the underlying Bitcoin assets. That event will nearly double the trust's share price overnight, as the current price levels work out to a 40% rebate.
The Securities and Exchange Commission (SEC) has rejected Grayscale's petition to restructure the Bitcoin Trust as an ETF. The fund manager is suing the SEC, arguing that the refusal was "arbitrary, capricious, and discriminatory." After all, the SEC has allowed fund managers to form ETFs based on Bitcoin futures instead of Bitcoin itself -- a more convoluted and arguably less stable method of ultimately achieving the same effect. The Pro Shares Bitcoin Strategy ETF is a leading Bitcoin futures ETF. That fund does a good job of trading right alongside the ups and downs of Bitcoin itself, while Grayscale's non-ETF offering struggles to do the same:
Bitcoin Price data by YCharts
My investment thesis started with Bitcoin's long-term value prospects. I believe that secure, decentralized, computerized transaction ledgers will disrupt the very concepts of banking and financial transactions in the long run, and that Bitcoin should remain a leading cryptocurrency for the long haul. Thus, I wanted to add some more Bitcoin exposure to my portfolio.
But I also expect the Grayscale Bitcoin Trust to become a true ETF one of these days. I don't see how the SEC can keep denying ETF applications from Grayscale and its peers while allowing futures-based Bitcoin ETFs to exist. I'm no lawyer and I could be wrong about this, which is why I acknowledge that this investment carries additional risk. But the robust 40% discount today simply looks overdone, especially since sector peers are teaming up with supportive amicus curae filings on Grayscale's side of the SEC argument.
The final briefs in the SEC lawsuit are due by Feb. 3, 2023. You have at least that long to think about your own attitude toward the trust's enormous risk-based discount -- unless they settle the case early, of course.
Limited risk vs. (probably) huge rewards
So that's why I'm the proud owner of some Grayscale Investment Trust shares as of last Tuesday. I see Bitcoin as a solid buy right now, and Grayscale Bitcoin Trust gives me a higher potential profit and I'm willing to accept a small risk that the fund never becomes an ETF. Moreover, Grayscale's fund could very well erase the discount and maybe even report premium prices again, even without the (admittedly helpful) ETF-specific price management tools.
The potential upside is well worth the fairly small risk, to the best of my understanding.
