Deconstructing the Grayscale Bitcoin Trust

Original Title: Deconstructing Grayscale Bitcoin Trust

Original Author: Ann Hsu | Chief Index Analyst at Chain Hill Capital

Grey Dubitcoin Trust is the largest encrypted digital asset trust product under Grayscale. Based on the irredeemable mechanism of the trust, the form of dual investment, and the clever separation of issuance and circulation across markets, the GBTC share in the US stock market exists The high premium provides space for cross-market arbitrage, and the participation of arbitrage funds has successfully realized the perfect closed loop of "transferring selling pressure to US stocks and bringing funds back to the currency circle". This makes Grayscale Bitcoin Trust a "only buy" in the market. Do not sell" bull power. This article will take Bitcoin Trust as an example to deconstruct the design principles of Grayscale Trust products for you.

Bitcoin Trust attracts 1.5 billion monthly gold

Greyscale’s products are divided into two types Types: single asset trusts and multi-asset portfolio funds. Among them, the single asset trust has a total of 9 products, including Bitcoin trust, Ethereum trust and so on. The multi-asset portfolio fund is a product called Grayscale Digital Large Cap Fund, which includes crypto assets with top market capitalization such as Bitcoin and Ethereum.

Figure 1: Grayscale product establishment timeline Source: "Grayscale Investor Deck October 2020"

The asset manager is siphoning outside money into the cryptocurrency market at an unprecedented rate. The inflow of funds in the third quarter of 2020 reached US$1.05 billion, of which the inflow of Bitcoin Trust in the third quarter was US$719 million, equivalent to an average monthly inflow of about 1.5 billion yuan. As of October 22, 2020, the asset management scale (AUM) of all Grayscale products was 7.257 billion US dollars, of which the AUM of Bitcoin Trust was 6.032 billion US dollars, accounting for 83% of the total product AUM, which is the scale of Grayscale biggest product.

Figure 2: Grayscale Asset Management Scale  Source: Grayscale Official Twitter

Currently, Grayscale Bitcoin Trust opens up private subscriptions in the primary market from time to time, mainly for qualified investments that comply with the US Securities Act , the minimum investment threshold is US$50,000. Judging from the financial report for the third quarter of 2020, the structure of investors investing in Grayscale’s products is mainly composed of institutional investors, qualified investors, family offices, retirement account funds, etc., of which institutional investors account for more than 80%. More than half of the investors (57%) came from countries and regions outside the United States.  

Figure 3: Grayscale investor structure by type Source: "Grayscale Digital Asset Investment Report Q3 2020"

Figure 4: Grayscale investor structure by region Source: "Grayscale Digital Asset Investment Report Q3 2020"

Among all investor groups, institutional investors are undoubtedly the largest. In the third quarter of 2020, the inflow of funds into all trust and fund products of Grayscale was US$1.05 billion, of which 81% (US$850 million) of funds came from institutional investors, and the total funds inflowing to Grayscale in the past 12 months were US$2.7 billion 80% of the funds come from institutional investors. According to the information disclosed by Grayscale, hedge funds account for the main part of the amount of funds flowing into Grayscale products from institutional investors. Although there is no specific disclosure of the specific capital data of hedge funds flowing into Grayscale products, considering that hedge funds account for the majority of Grayscale institutional investors, and institutional investors account for more than 80% of the capital inflows, hedge funds The contribution of grayscale products should not be small.

Figure 5: Overview of the capital inflow of Grayscale products Source: "Grayscale Digital Asset Investment Report Q3 2020"

"No maturity date + no redemption + currency-based fees" makes Grayscale a lot of money

Investment in Grayscale Bitcoin Trust In the terms, there are two very special pieces of information. One is about the regulations on the redemption mechanism of Bitcoin Trust. At present, Grayscale Bitcoin Trust does not support share redemption, that is, once an investor subscribes for a trust share, the share cannot be redeemed for Bitcoin. Investors can only trade in the secondary market of US stocks. Sell Bitcoin Trust share GBTC. The other is about the fee collection mechanism. Grayscale collects a 2% management fee from the Bitcoin Trust every year as its source of income. The management fee is deducted from the amount of Bitcoin held in the position, that is, the management fee is charged in a currency-based manner. .

Figure 6: Grayscale Bitcoin Trust Terms   Source: "Grayscale Investor Deck October 2020"

There is actually an ingenious design behind these two seemingly unrelated regulations. According to the announcement disclosed by Grayscale, the current regulation does not require trust shares to support redemption. Grayscale has chosen a mechanism where shares cannot be redeemed. Investors can only transfer trust shares in the US stock market if they want to make a profit. Grayscale chooses to collect management fees in a currency-based manner. After deducting operating expenses and external taxes and fees, the remaining bitcoins in the management fees collected from investors are Grayscale’s profit retention. Grayscale’s Bitcoin trust does not clearly stipulate the duration of the trust, which means that it is a trust with no expiration date (perpetual existence). By superimposing and interpreting the above information, we can get: Grayscale Bitcoin Trust’s irredeemable mechanism makes the holdings managed by it will become larger and larger. Proportional coin-standard form. This architectural design will eventually reduce the number of bitcoins corresponding to each share held by trust holders. In the long run, the bitcoins held by the trust will be slowly transferred to Grayscale, and Grayscale will become the largest in the market. One of the holders of Bitcoin, and in the long run, the value of Bitcoin will continue to appreciate, and Grayscale will make a lot of money.

 Figure 7: The number of bitcoins corresponding to each share is gradually decreasing Source: "Grayscale Investor Deck October 2020" 

「The Trust will not generate any income and regularly uses Bitcoin to pay for its ongoing expenses.Therefore, the amount of Bitcoin represented by each share will gradually decline over time.」  ;  —— "Grayscale Investor Deck October 2020"

"The trust does not generate any The number of bitcoins corresponding to the share will gradually decrease." - "Grayscale Investor Deck October 2020"

  Figure 8: Grayscale Bitcoin Trust Fees And taxes are collected on the currency basis and then sold into US dollars for payment Source: "Grayscale Bitcoin Trust BTC 2019 Tax Information Final"

Double capital contribution is left for the return of funds Imagination Space

Greyscale’s Bitcoin Trust accepts two forms of contribution, namely cash contribution and physical contribution (BTC).

Under the cash contribution model, investors submit subscription funds to Grayscale, and Grayscale hands over the subscription funds to an authorized broker, who is also a brother of Grayscale The company Genesis Global Trading, Inc. (hereinafter referred to as "Genesis"), Genesis buys BTC spot on the spot market and delivers it to Grayscale. Grayscale gets the spot and deposits it in the custodian agency Coinbase Custody for cold storage, and at the same time issues equivalent Bitcoin trust shares GBTC to investors.

Figure 9: Grayscale Bitcoin Trust Cash Contribution Model Source: Chain Hill Capital

Another way is to contribute in-kind in Bitcoin. Investors hand over bitcoins to Grayscale, and Grayscale deposits bitcoins into the custodian agency Coinbase Custody, and at the same time issues equivalent bitcoin trust shares GBTC to investors.

Figure 10: Grayscale Bitcoin Trust physical investment model Source: Chain Hill Capital 

Among the two investment modes, the cash investment mode is that investors use cash to buy Bitcoin when subscribing, which will have a certain impact on the price of the spot market (depending on the size of the fund). The physical investment model is to directly pay the bitcoins in the hands of investors to Grayscale in exchange for trust shares. Grayscale does not buy in the spot market, so the impact on spot prices cannot be predicted. However, if the bitcoins in the hands of investors are borrowed from the outside, wait until the trust shares issued by Grayscale to investors have passed the lock-up period (the lock-up period for Grayscale bitcoin trust shares has been reduced from 12 months to 6 months), investors are under pressure to return Bitcoin. Therefore, when there is a borrowing and capital contribution in the physical investment model, it leaves a huge room for imagination for the subsequent return of funds to the long market, and will also form a perfect closed loop of "transfer of selling pressure and return of funds".

Ingenious workmanship: the selling pressure is transferred to US stocks, and the funds are brought back to the currency circle

mentioned above The Bitcoin held by Grayscale Bitcoin Trust is not allowed to be redeemed. Investors need to sell the Bitcoin Trust shares (GBTC) issued by Grayscale in the U.S. stock market (OTCQX) in order to take profits. GBTC is currently one of the channels that can legally and compliantly participate in investing in Bitcoin. Due to the huge market demand, the price of GBTC in the secondary market often has a premium relative to the net value.

Figure 11: GBTC Discount and Premium Source: yCharts.com

Yes There are arbitrage opportunities at premiums. There are three common arbitrage models, cash loan arbitrage, physical loan arbitrage and share loan arbitrage.

In the cash lending arbitrage model, as long as the arbitrage profit in the market is higher than the cost of cash borrowing, there is theoretically room for arbitrage. Investors can borrow funds from companies such as Genesis or other lending platforms, and subscribe to Grayscale's bitcoin trust shares. After the 6-month lock-up period of trust shares expires, investors can sell GBTC on the U.S. stock market (OTCQX). If there is a positive premium space, the remaining part after returning the lender’s principal and interest is the profit of the arbitrageur.

The short-term price of GBTC is determined by investors in the U.S. stock market, but in the long run to track the price of Bitcoin, in order to restrain the loss of the downward price of Bitcoin, investors can Hedging arbitrage risks in the futures market.

Figure 12: GBTC Cash Lending Arbitrage Model Source: Chain Hill Capital

The principle of the physical lending arbitrage model is basically similar to the above-mentioned physical investment model, except that the bitcoins contributed by investors are borrowed from the outside. Investors use the borrowed bitcoins as capital contributions to subscribe to Grayscale’s GBTC trust shares. After 6 months expire, investors can sell GBTC shares in the US stock secondary market to get cash, and at the same time hold the cash in the bitcoin spot market Buy bitcoins and return them to lending institutions. If there is room for arbitrage, deduct the amount of bitcoins returned and the corresponding interest, and the remaining cash is the profit obtained by the arbitrageur.

Figure 13: GBTC cash physical arbitrage model Source: Chain Hill Capital

In the physical lending arbitrage model, the initial physical borrowing by investors may not be Bitcoin, but may also be other digital currencies. For example, Genesis, Grayscale’s brother company, can provide physical lending of Bitcoin and stable currency USDC lending. If an investor borrows stablecoins, they need to exchange them for BTC before subscribing for trust shares from Grayscale, which will eventually be returned to lenders as stablecoins.

The share lending arbitrage model is special compared to the previous two. Its principle is that investors first borrow GBTC from the GBTC securities lender (trust share lender) For trust shares, when the premium rate corresponding to the price of GBTC secondary market is higher than the borrowing cost, there is room for positive arbitrage.

After investors sell GBTC shares, there are two ways to participate in arbitrage. One is to buy bitcoin spot in the market with cash, and use bitcoin spot to subscribe for Grayscale’s trust shares. Investors obtain shares, and return the same amount of GBTC shares and agreed interest to the securities lender (trust share lender) after the lock-up period expires, and the remaining cash is the investor's arbitrage profit.  

Figure 14: GBTC share lending arbitrage model (contribution in kind) Source: Chain Hill Capital

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After borrowing GBTC shares and selling them, investors can also choose to subscribe for Grayscale’s Bitcoin Trust shares by way of cash contribution, and return the shares equal to the borrowed amount and the agreed interest after the lock-up period expires , the remaining cash is the investor's profit.

Figure 15: GBTC share lending arbitrage model (cash contribution) Source: Chain Hill Capital

Because Grayscale cleverly designed the irredeemable mechanism and isolated the listing and circulation market of GBTC shares, the issuance of the primary market and the flow of the secondary market resulted in a cross-market separation, and the US stock market assumed the responsibility of the transfer of trust shares. functions, and the issuance market is in the currency circle. Therefore, investors cannot sell trust shares in the currency circle, but can only choose to sell them in the US stock secondary market, which is equivalent to transferring the trust's huge holdings to US stocks. At the same time, because GBTC has a premium arbitrage space all the year round, physical lending arbitrage and share lending arbitrage make investors have to bring funds back to the currency circle to buy bitcoin spot to return the lending institution after selling trust shares in the US stock market. The selling pressure is transferred to the US stocks, and the funds are brought back to the currency circle" perfect closed loop.

Potential arbitrage funds return, Bitcoin’s rally is expected to continue

Hayscale once disclosed The form of investment for investors to subscribe to trust shares. In the third quarter of 2019, 79% of the funds that flowed into all grayscale trust products were in the form of in-kind contributions. From Q3 in 2018 to Q3 in 2019, this ratio was also 71%, and Grayscale will no longer publish the corresponding data in the quarterly report.

Figure 16: 2019 Q3, 2018 Q3 to 2019 Q3 investment forms of Grayscale family products Source: "Grayscale Digital Asset Investment Report Q3 2019 October 2019》

Although Grayscale no longer announces the form of recent investor contributions, judging from the growth rate of the loan scale of its brother company Genesis, it is comparable to Grayscale Bitcoin The growth of trust holdings has a high tendency, especially since the second half of 2020, the growth of the two has accelerated significantly compared with the past. In addition, the main institutional investors mentioned above in this article come from hedge funds, and arbitrage is the most common way for hedge funds to make profits. We can roughly draw the conclusion that there should be many institutions in the market before.

Figure 17: After June 2020, the holdings of Grayscale Bitcoin Trust increased rapidly Source: Aicoin  

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Figure 18: Growth of the loan scale of Grayscale brother company Genesis Source: Genesis  

Investors enter the market to Arbitrage is carried out in the form of borrowing, and most of the investment methods may be to subscribe for trust shares in the form of in-kind contributions. Once the arbitrage funds return, there will be pressure to buy in kind and return them to the lending institution. According to the 2020 Q3 quarterly report disclosed by Grayscale, there have been two waves of subscription climaxes after April 2020. The first wave is from the end of April to the end of June, and the corresponding share unlocking period is from the end of October to the end of December. Another wave of subscription climax is from the end of July to the end of September. The corresponding share unlocking period is from January 2021 to March 2021. Now entering the fourth quarter of 2020, Grayscale’s bitcoin trust holdings have increased by 17,000 in October. In fact, the subscription climax has continued, so a large amount of trust shares will be unlocked before April next year. As the pattern of supply and demand continues to change, the stock of bitcoins in the market is gradually decreasing, coupled with the return of arbitrage funds, in view of this, we continue to be bullish on the market of bitcoin in the fourth quarter of this year and the whole year of next year.

Figure 19: The weekly inflow of Grayscale family products in the past year (dark green represents the inflow of Bitcoin trust funds) Source: Grayscale < /blockquote>

Conclusion

Based on the non-redeemable mechanism of Grayscale Bitcoin Trust and the form of double investment As well as cleverly separating issuance and circulation across markets, the high premium for GBTC shares in the US stock secondary market provides room for cross-market arbitrage, and the participation of arbitrage funds successfully realizes "transferring selling pressure to US stocks and bringing funds back to the currency circle" The perfect closed loop, which makes Grayscale Bitcoin Trust is becoming a bullish force that "only buys but not sells" in the market, and Bitcoin is expected to maintain a rising pattern in the future.

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