‘Slam Dunk’ Bitcoin Arbitrage Fizzles for Biggest Crypto Fund
(Bloomberg) -- One of the most popular arbitrage trades in cryptocurrencies is unraveling as the biggest Bitcoin fund’s once-hefty premium collapses.
The trade relies on the Grayscale Bitcoin Trust (ticker GBTC) trading at a premium to the value of the Bitcoin it holds -- a phenomenon caused in large part by investors paying up for access to the coin without having to buy it directly. When that happens, hedge funds swoop in to take advantage. They borrow Bitcoin, deposit the coins with GBTC in exchange for shares that are more valuable than the coins they bought, and they pocket that profit by selling the marked-up shares after a six-month lockup period expires. Thanks in part to the trade’s popularity, GBTC’s assets have swelled to over $35 billion from about $1.5 billion a year ago.
The fund has for much of its history traded at a premium to its underlying holdings, making the trade very profitable. However, as Bitcoin’s rally turns choppy and a stable of competing products attract attention, GBTC sank to a record discount relative to the value of the Bitcoin it holds. Exacerbating that situation is the fact that GBTC doesn’t allow redemptions -- meaning that shares can only be created, but not destroyed because the assets are held in a trust. That means that as new accredited investors plowed into the fund and boosted outstanding GBTC to a record high, those shares are now exiting the lock-up period at a time when demand for Bitcoin is fluctuating.
“It became just too popular and there’s only so much demand at the end of the day by retail investors who are using Schwab or using Fidelity or a traditional brokerage,” said Nic Carter, a partner at crypto-focused venture firm Castle Island Ventures. “Basically, too many funds plowed capital into this trade thinking it was a slam dunk, and then as that capital matured and the units in the trust became market-tradable, the demand that they expected to materialize wasn’t there from the market.”
GBTC’s price sank as much as 11.6% below its net-asset value last week, its largest-ever discount, according to data compiled by Bloomberg. That figure shrank to 3.22% on Tuesday as Bitcoin prices rebounded. While the world’s largest cryptocurrency has gained roughly 25% over the past month, GBTC is 14% higher in that period.
GBTC traded at a premium as high as 40% in late December as investors rushed to get exposure to anything in a crypto wrapper -- more than double its one-year average premium of 16.3%.
To be sure, the attractiveness of the arbitrage trade alone isn’t solely responsible for GBTC’s popularity over the past year. Ark Investment Management, helmed by longtime Bitcoin bull Cathie Wood, is the fourth-largest holder of the trust. And for those investors looking for Bitcoin exposure outside of signing up for a crypto exchange or setting up a digital wallet, GBTC -- which can be bought and sold on brokerage platforms -- provides an easy solution. Additionally, for institutional investors whose fund mandates might not allow them to purchase Bitcoin directly, GBTC provides an entry point.
Other big holders in GBTC include Three Arrows Capital Ltd., Horizon Kinetics LLC and Churchill Management Corp., Bloomberg data show.
But for those traders who did plow into the arbitrage trade, GBTC’s now-deep discount could prove painful, according to Multicoin Capital Management LLC’s Kyle Samani.
“There’s a lot of people who are in that trade who thought they were going to make money who are now going to lose money,” said Samani, co-founder of the Austin, Texas-based crypto hedge fund. “There may be some segments of traders who are over-exposed and could be really underwater.”
Amid all this, Digital Currency Group Inc., the parent company of Grayscale Investments, said on Wednesday it will be buying up to $250 million worth of GBTC shares. Grayscale declined a request for comment.
Of course, the premium could reemerge. GBTC’s discount could sink to the point where bargain-hunters begin buying the fund, according to Carter. Additionally, Bitcoin’s rally could reignite, resulting in the same red-hot demand for crypto exposure that ballooned the trust’s premium late last year.
But even still, given how ubiquitous the GBTC arbitrage has become, it probably won’t produce the same level of returns going forward, according to ProChain Capital’s David Tawil.
“The arbitrage trade has been exploited so much -- if you’re the first person that identifies it, certainly you’re going to be the person that makes the most money,” said Tawil, who is president of ProChain, a crypto hedge fund. “By whatever number -- the thousandth person who identifies the trade and tries to exploit it -- the arb goes further and further down. We’re not at those inefficient early days anymore.”
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