Should Institutions Invest In GBTC?

I co-wrote this post with my good friend Anand Gomes.

The other day I wrote about Greyscale investment funds and the $250MM they have raised YTD. I believed many institutions were investing in GBTC (Greyscale’s Bitcoin fund) because of CYA. They wanted to outsource risk, so if the investment went awry, they had someone to blame. My friend Anand, founder of RiskEx, who previously traded rates and commodities and now is in the cryptocurrency space, offered an alternative view.He believed that there are several reasons why institutions invest don’t / won’t directly invest in Bitcoin / digital assets:

Regulatory risk: Traditional investment houses don’t want to deal with the optics of investing in an asset that still doesn’t have a clear regulatory framework and thereby invite the scrutiny of the regulators so in essence, this is another type of CYA but more external than internal.

Infrastructure: They lack the in-house expertise, support, (mainly traders, middle and back-office and in the case of digital assets a robust storage/custody solution) processes and the necessary integrations with their existing systems required to invest directly in the underlying digital asset. They cost of setting up all of the above must significantly outweigh the premium incurred when purchasing a GBTC.

Liquidity: An ETF / mutual fund type product offers potential liquidity benefits. Slippage is a considerable problem in the crypto markets, and when purchasing a large order of tokens, folks often incur a lot of slippage. By buying shares of GBTC, the risk of cost-effective execution is transferred to Grayscale and its authorized participants versus bearing that yourself. Further, eligible shares of GBTC are quoted on the OTC market which means you could sell these shares and possibly do better than if you had to liquidate a position directly in the asset on an exchange or in the OTC markets, but this may not always hold true.

Mandate Restrictions: Investment companies often have mandate restrictions i.e., their investment mandate prohibits from directly investing in asset classes not defined in their mandate (i.e., commodities et al.). A mutual fund / ETF type product allows them to skirt this rule because the ETF / fund is treated as an equity security/mandate approved instrument although the underlying asset is entirely different. GBTC shares are titled securities which are similar to stocks and bonds. Titled securities can be easily transferred under estate laws and also allowed to be held in IRA/Roth, and other types of tax-advantaged investor account making it accessible to a more significant number of investors.

This phenomenon is common in an ETF markets where investors will pay a premium not to have to buy the underlying asset/basket that the ETF represents due to the challenges mentioned above. Often, the demand for this type of product will cause it to diverge in value from the aggregate amount of the underlying it provides exposure to, leading to an arbitrage opportunity. Simply put, it is easier to invest in an equity type security that has a well-defined regulatory framework and is well integrated with existing investment infrastructure than an entirely new asset class — and for that, an investor should / would pay a premium!

Originally published at grasshopper.capital.

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