Summary Grayscale Bitcoin Trust's discount to NAV may narrow further after favorable legal ruling, though the risk/return is now more muted. Grayscale's Ethereum Trust may be a better investment as it trades at a wider NAV discount and is perhaps ultimately subject to similar legal and strategic trends. Both funds are subject to swings in underlying crypto asset values which introduce additional risk. The legal outcome may be delayed by an appeals process and paperwork associated with ETF implementation. Summary The Grayscale Bitcoin Trust (GBTC) today received a favorable legal ruling likely allowing conversion to an ETF. Of course the SEC may appeal and the mechanics of ETF conversion will take some time, but still the discount to NAV for GBTC (after narrowing today) may narrow further over the coming days and months. The market appears too pessimistic on the chance and timeline of ETF conversion now the legal ruling is in place, which removes the bulk of the risk. NAV Discounts Grayscale has a number of crypto funds that trade a discounts to Net Asset Value or NAV. This isn't unusual, as high fees and lack of ability to redeem at par make NAV discounts in investment funds quite common. Sometimes premiums exist too, and that's also the case for some of Grayscale's funds, especially for crypto assets that are less broadly adopted. Importantly, ETFs don't have material discounts or premiums to NAV. That's because if they do, market markets can issue or redeem ETF shares and exchange them for the underlying assets to remove any material difference between the share price and NAV. Hence Grayscale's desire to convert GBTC is important for investors. If it does it, then the current discount to NAV will very likely collapse to zero, or very near zero. That creates potential upside ; even after the ruling, the discount is 13%. That appears too wide. Context Grayscale runs a large fund, Grayscale Bitcoin Trust GBTC, that holds $22 billion of Bitcoin (BTC-USD) and charges a 2% fee. Grayscale has ambitions to remain a key player in the crypto space. If you've recently been to a U.S. airport, you may have seen its ads. Apparently, part of Grayscale's strategic plan is to convert its trust into an Exchange Traded Fund (ETF) to help cement its leadership position in the Bitcoin space. However, the SEC blocked Grayscale's spot Bitcoin ETF application, while allowing futures Bitcoin ETFs to launch. Grayscale argued that approach is inconsistent. Though regulators have relatively free reign, they are generally supposed to be consistent in their approach. The Legal Verdict The ruling was pretty damning for the SEC's case. The court specifically called the actions of the SEC "arbitrary and capricious" and noted that there was a 99.9% correlation between Bitcoin futures where the SEC has approved Exchange Traded Products, and spot Bitcoin, where the SEC has not approved Exchange Traded Products. The risk of course is that the SEC appeals, pushing out the timeline, but the legal verdict appears to offer the SEC scant grounds to build an appeals case. The one option they do have is to pull Bitcoin futures based ETFs, but that would be a little absurd and hurt their credibility given they already approved these products without incident. Running The Numbers With a favorable legal ruling in place, the question is, what hurdles remain to any ETF launch and the timeline? Certainly, even without any appeals process, an ETF launch may take time. An appeals process could add a year or more to the process. In the case of the Ripple (XRP-USD) verdict, it took the SEC around 3-4 weeks to decide to appeal. However, the ruling on GBTC does appear less ambiguous, even though it is perhaps embarrassing for the SEC to be rebuked by the courts in relatively strong legal terms. Here's the current discount at 12%. Asset value Current price Discount to NAV GBTC $23.41 $20.62 12% With the 10-year yield at 4%, and a 2% fee on GBTC currently, that implies a net 6% return if the GBTC conversion were to take a year. So we're now closer to merger arb type returns with this investment, rather than more speculative returns previously. Considering ETHE As the market understandably prices in optimism on GBTC after the ruling, I think the Grayscale Ethereum Trust (ETHE) might be more attractive. ETHE is Grayscale's Ethereum fund, similar in many respects, but with a different underlying crypto asset. The legal case is not directly about Ethereum, but if Grayscale gains permission to convert GBTC to an ETF, then it seems logical that ETHE may follow the trend of ETF conversion. Also, the recent Ripple decision may support Grayscale in that regard, because although the SEC may have some success in claiming that some smaller crypto assets are too risky for the public, they are on increasingly shaky legal ground when they make that statement about Bitcoin and now implicitly Ethereum, given the read-across from the Ripple ruling. This matters because ETHE is at a wider spread to NAV than GBTC, but ultimately they may both be subject to the same legal verdict and process. I would, of course, expect ETHE to trade at a slightly wider NAV discount than GBTC, as ETHE is less certain to convert, and maybe the SEC will decide to block it. However, the discount on ETHE is materially wider than GBTC, despite perhaps broadly similar dynamics in play. Fund Current NAV Discount GTBC 12% ETHE 25% Risks This article considers only NAV discounts when the swings in the underlying value of crypto assets such as Bitcoin and Ethereum will also drive investment returns. Crypto assets have no fundamental value so could theoretically fall to zero. The legal appeals process or ETF registration process could push out the timeline for a favorable actual outcome reducing returns. Grayscale may elect not to convert their funds to ETFs. These crypto funds generally carry high fees of around 2% a year or so based off NAV, so this can erode any potential return while you wait. Conclusion There may be some remaining upside on GBTC after the legal ruling as the SEC might be hard-pushed to find grounds to appeal. We should know the SEC's decision on that within a month if the Ripple process is any guide. However, at current trading levels, swings in the price of Bitcoin itself will perhaps drive the investment more so than the NAV discount. This suggests there may be some upside remaining in GBTC even though the NAV discount has compressed. However, the more attractive investment could be ETHE because the fund may see a similar ultimate outcome to GBTC, but with a materially wider NAV discount today. Bear in mind that if you invest in these funds, the swings in the prices of the underlying crypto assets, and the relatively high fees, may impact your returns as much, or more, than any changes in NAV discounts/premiums.
