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World’s Largest Crypto Fund Caught by FTX Storm

The world’s largest cryptocurrency fund has found itself embroiled in the turmoil swirling around the struggling sector, yet another sign of waning enthusiasm for digital assets.

The share price of the $10.5 billion Grayscale Bitcoin Trust (GBTC), which holds 3.5% of global bitcoin, fell 39% against the value of its underlying assets as the Investors have been in an increasingly desperate race to get out.

The blowout means investors in the trust have suffered an 83% loss since bitcoin peaked in November 2021, outpacing the 74% drop in the value of bitcoin itself.

Confidence in digital assets has been shaken by the implosion of FTX crypto exchangethe fallout of which ripples through the industry by nearly $1 billion due to the complex and often opaque ties between key players.

Fears hit closer to home for Grayscale on Wednesday when crypto broker Genesis Trading, which issued more than $50 billion in loans last year, redemptions and originations suspended loans to its lending arm after suffering financial contagion from the bankruptcy of Three Arrows Capital, the Singaporean crypto hedge fund that filed for bankruptcy in July.

Grayscale and Genesis are both subsidiaries of Digital Currency Group, a venture capital firm based in Stamford, Connecticut.

Genesis acted as GBTC’s authorized participant, responsible for issuing new shares, until last month when Grayscale launched an in-house broker, Grayscale Securities.

Digital Currency Group is also GBTC’s largest shareholder, with a 4.1% stake, or 28.2 million shares, according to Refinitiv data.

The central problem with GBTC is that it has been superseded by the advent of better vehicles to hold bitcoin.

When launched as a private placement offering in 2013, it was one of the few of its kind, and as the crypto industry grew, it quickly increased its number of shares to absorb the incoming tide of liquidity.

Net assets peaked at $39.8 billion in October 2021, according to Morningstar data, and GBTC has continuously traded at a premium to net asset value.

However, it was mined by the emergence of the first bitcoin exchange-traded funds in Canada that year. The fees for these vehicles were generally less than half of the 2% per annum charged by GBTC. They also offered greater liquidity and new investors did not need to pay a premium.

Column chart of premium/discount (%) showing how high can it go?

As flows moved away from GBTC, demand and supply for its shares swung, pushing its stock price at a steep discount to net asset value.

The underlying problem is that, unlike ETFs, there is no arbitrage mechanism to rebalance supply and demand.

GBTC shares cannot be exchanged for bitcoin or cash and can only be sold to another buyer through the over-the-counter market. Grayscale would need regulatory approval to institute a stock buyback program.

Grayscale instead hopes to convert GBTC into a “spot” bitcoin ETF, holding the “physical” currency. Those plans have so far been blocked by the U.S. Securities and Exchange Commission, which has refused to follow the lead of regulators in Canada and elsewhere in approving spot bitcoin ETFs, citing concerns about fraud and corruption. potential manipulation on unregulated exchanges where transactions take place.

Grayscale is currently suing the SEC for the right to convert GBTC. However, the widening discount suggests that few market participants believe it is likely to succeed.

“If they were successful in winning the case, all of the investors would be cured. The discount would erode heavily because the [share] the process of creation and redemption can happen freely,” said Todd Rosenbluth, head of research at VettaFi.

Nate Geraci, President of The ETF Store, said: “GBTC’s structure is clearly sub-optimal, as shares cannot be redeemed.

“It is very disappointing that the SEC will continue to allow any retail investor access to this fund, but it will not approve a spot bitcoin ETF that would solve the rebate problem. This is yet another example of regulatory dysfunction. nonsense around the whole crypto ecosystem right now,” Geraci added.

Some investors kept the faith. Ark Investment Management, already GBTC’s third-largest shareholder with a nearly 1% stake, bought an additional $2.8 million worth of shares this week.

In October, Ark’s chief executive, Cathie Wood, said GBTC was trading at a “fire sale” price given the possibility of it being converted into an ETF at some point. Ark is also requesting permission to launch a spot ETF.

The second-largest shareholder, with 2.9%, is BlockFi, a crypto lending and trading platform that halted customer deposit withdrawals due to its “heavy exposure” to FTX.

Peter Tchir, head of macro strategy at Academy Securities, raised the possibility that Grayscale would seek approval to buy back a large amount of shares and then liquidate the fund, potentially making more than enough profit to offset its lost revenue. commissions and making outside investors whole in the process.

However, Geraci believed there was every chance the discount would widen further “especially if there is a new FTX contagion that weighs on the crypto space as a whole.”

Nonetheless, he suggested that GBTC “is clearly a better option than holding bitcoin on an exchange like FTX because investors can operate with confidence that the underlying bitcoin is actually there.”

Additionally, Geraci believes the FTX debacle has bolstered the case for regulatory oversight of crypto exchanges, “theoretically accelerating the approval timeline for spot bitcoin ETFs.”

However, Rosenbluth thought the SEC would see the fiasco as vindication of its position.

“The SEC views spot bitcoin as risky and is concerned about fraud and manipulation,” he said. “I’m not sure they will be surprised by these developments.”

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