GBTC negative premium is gradually narrowing, what are the reasons and impacts?

The nearly $14 billion Grayscale Bitcoin Trust ( GBTC ) is the focal point of the crypto investment universe, and for more than two years the fund has traded at an increasing premium to the value of its bitcoin holdings, but that has taken a major turn in recent weeks, boosting investor confidence.

“When the negative premium narrows, it’s a sign that investors are becoming more confident in the trust or that demand for the shares is increasing,” Martin Leinweber, digital asset product strategist at MarketVector Index, told CoinDesk. “If the discount narrows significantly or disappears altogether, investor returns could be significant . ”

So why is there a negative premium, why does it matter, and why is it shrinking?

In answering these questions, it is important to understand the structure of the trust. GBTC is a closed-end fund (CEF), which is different from the exchange-traded funds (ETFs) that have quickly become popular in recent years. Both are actually vaults that hold large amounts of assets, whether stocks or, in the case of the Grayscale trust , billions of dollars worth of Bitcoin.

But ETFs have a feature that ensures that professional trading firms, called authorized participants, help keep their value closely aligned with the value of the assets they hold. If an ETF has $10 billion worth of shares but a market cap of $12 billion, these traders can create new shares of that ETF. Doing so allows them to make money through premiums while also driving the price of the ETF down to the value of the ETF’s holdings; the intermediary fund companies are rewarded for making the ETF more efficient.

Conversely, if the ETF’s price drops to a negative premium — say its market cap drops to $8 billion and its assets are $10 billion — these traders can redeem their shares, again profiting from the difference and pushing the price and assets back to parity.

Grayscale wanted to turn GBTC into an ETF, but the U.S. Securities and Exchange Commission ( SEC ) rejected the proposal. Grayscale has filed a lawsuit to overturn the decision. At the same time, as a closed-end fund CEF, it lacks the arbitrage mechanism that ETFs use to prevent prices from getting out of control.

GBTC has been trading at a discount to its Bitcoin holdings since February 2021. The situation deteriorated sharply after the FTX explosion last year. In November, Genesis ’s lending arm stopped customer withdrawals and GBTC’s negative premium increased to 43%. It is unclear why Genesis’s woes hurt GBTC, although the theory is that many trading firms are Genesis customers, some of which may have bet on the negative premium to narrow, and losing funds could hinder these trading strategies.

GBTC’s negative premium deepened to a record 50% in December after the SEC reiterated its reasons for rejecting Grayscale’s application to convert the trust into an ETF.

Why has the negative premium narrowed significantly in recent weeks to its smallest level since early 2022?

The hottest topic in the crypto space right now is whether U.S. regulators will eventually approve a spot Bitcoin ETF, which currently allows ETFs that hold Bitcoin futures contracts. Traditional financial giant BlackRock recently invested heavily in promoting this move, which has sparked great optimism that a spot Bitcoin ETF may not be far away given its influence in Washington, D.C. as the world's largest asset manager. Other companies, such as Fidelity, a large mutual fund manager, have also applied for a Bitcoin ETF.

Analysts said the possibility of the U.S. SEC approving the conversion of GBTC into an ETF was one reason for the narrowing discount. Grayscale said in April that it expected to learn by the end of the third quarter whether it would be allowed to convert GBTC into an ETF.

Leinbewer said: “The catalyst for the current narrowing of the GBTC discount may be the ongoing legal discussions surrounding the possibility of GBTC converting to an ETF. The market seems to be reacting to these discussions, and the anticipation of a potential legal victory for GBTC may drive increased demand for the stock. Think of the discount to [net asset value] as the implied probability of conversion to an ETF. The lower the discount, the higher the probability of a higher market price.”

James Seyffart, ETF analyst at Bloomberg Intelligence, said of Grayscale’s lawsuit against the SEC that he expects the decision could be in Grayscale’s favor. “But it will just send the GBTC ETF conversion request back to the SEC to approve the GBTC conversion or deny it for different reasons. The hope of this conversion may be the reason for the narrowing of the negative premium.”

Seyffart added: “We don’t know how long it will take for the SEC to approve these products. That could happen with this wave of applications (we think Grayscale has a 50/50 chance of approval right now, but if it’s rejected again, it could take years). We also don’t know how long it would take for Grayscale to convert GBTC once it’s approved.”

What would happen if GBTC converted into an ETF?

Seyffart said that the recent surge in applications from large U.S. institutions for approval of Bitcoin spot ETFs has given rise to high hopes for Grayscale’s potential to convert GBTC into an ETF.

He said it was only a matter of time before GBTC converted to an ETF. “Once converted to an ETF, GBTC will no longer trade at a significant discount or premium due to the flexibility of the ETF structure,” Seyffart said.