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Grayscale and friends - Investing directly in crypto by buying a stock? Well...

byRoy M. FEB 12th, 2021

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It's 2021, we have a way to invest pretty much in anything without owning it directly. From precious metals, oil, stocks, real estate, to even corn and coffee. It is only suitable we would have such an option to invest in cryptocurrencies as well.

For example, by investing in one of the various silver ETFs, you actually indirectly own a piece of physical silver (well actually you are given a guarantee by some company that you own it). We can clearly see what are the advantages in that. You wouldn't want to store 100 barrels of oil in your back yard just to benefit a boost in the oil price. 

The same can be said about crypto. Instead of maintaining your own physical crypto wallet or signing up on some website, giving all of your personal details and creating an account, you could actually simply buy a stock that follows the price of your favorite crypto, like you would buy any other stock. Well, this is exactly what some companies like Grayscale seem to offer. But, there is much more than meets the eye, and if you don't know what you are getting yourself into you will be burned. We will go over everything you need to know.

Who is grayscale

The first thing you see on their site, Grayscale is a "A trusted authority on digital currency investing, Grayscale provides secure access and diversified exposure to the digital currency asset class". Established in 2013, Grayscale investments is a cryptocurrency asset manager. As of writing this, they have more than 20 billion dollars of AUM, which is "Assets under management", a common term in the investing world. This basically means they manage assets owned by investors, which in our case are cryptocurrencies, worth around 20 billion $.

Grayscale's CEO - Michael Sonnenshein

The different products

Out of the funds grayscale offers, the following are available to freely trade as stocks in the OTCQX exchange (US over the counter):

TickerDescriptionRelevant crypto currency
GBTCGrayscale Bitcoin Trust
Bitcoin
ETHEGrayscale Ethereum Trust
Ethereum
GDLCGrayscale Digital Large Cap Fund
Bitcoin, Ethereum, Bitcoin Cash, Litecoin
BCHGGrayscale Bitcoin Cash Trust
Bitcoin cash
ETCGGrayscale Ethereum Classic Trust
Ethereum classic
LTCGGrayscale Litecoin Trust
Litecoin

"ETF" Vs a "Trust" - what is grayscale offering?

The products grayscale offers are trusts. This basically means, that each share sold by grayscale is backed by a specified amount of crypto being stored. You cannot withdraw crypto to your wallet if you have a share, you must instead sell the share to someone else. This is your only way to liquify (=withdraw) your investment. This is very important to note. This model means that any crypto that inflows into grayscale's possession is locked.

Amount of bitcoin per GBTC share, taken from grayscale's website

As a trust, and not an ETF, the price of each share is not promised to follow the price of the underlying crypto.  As stated from their website for the bitcoin trust: "There can be no assurance that the value of the shares will approximate the value of the Bitcoin held by the Trust and the shares may trade at a substantial premium over or discount to the value of the Trust's Bitcoin."

With an ETF, you are investing in a fund that directly tracks the price of the underlying asset - in our case bitcoin. That means that the company issuing the ETF guarantees that, and that guarantee is also validated by regulators, such as the SEC.

Bitcoin ETFs are not legal in the USA as of writing this. But this may very soon change. The SEC has denied multiple applications by companies to set up such ETFs. The main reason for them denying it is that the price of bitcoin can be manipulated. As long as no such ETF exists, Grayscale remains pretty much the only other public option to invest directly in crypto. So, they definitely benefit from that. 

who actually holds the crypto

The crypto is held for grayscale by a custodian. A custodian is a financial institution (usually - some company) that holds the customer's assets for safekeeping, to prevent them from being stolen or lost. Basically - a custodian is the guard that keeps the assets. It will usually be a large enough company so that it could financially withstand theft of such valuable assets, which it guards.

In our case, the custodian is "Coinbase Custody Trust Company, LLC", which belongs to coinbase, the well known crypto exchange. Coinbase holds the actual crypto in "cold wallets" - hardware wallets whose private key is not held in any online database.

Coinbase - grayscale's custodian

The "premium"

As we have said, the price of each share is not guaranteed to follow the value of the crypto it is backed up with. Let's take a look at an extreme example. on 12.21.20, the price of a single share of the Ethereum trust was more than 3 times the value of the held Ether!:

ETHE share price and Ethereum holdings graph, taken from Grayscale's website.

As a counter example, 3 weeks later, even though Ethereum made a killer move to the upside, the share price has dropped quite a bit. This is an example of the trust going the other direction of the price of the underlying crypto:

ETHE share price and Ethereum holdings graph, taken from Grayscale's website.

When the price of the share is trading above the price of the crypto held against it, we say that it has a "premium". Shares of Grayscale trusts will almost always trade at a "premium". Though, technically they can also trade at a "discount" - which means they cost less than the backing crypto. A bigger premium means that there is much more demand for the trust shares than for the underlying crypto. We will discuss later several advantages of holding a share over holding the actual crypto. These reasons are what is propelling the premiums. You should always look at the current "premium" graph in Grayscale's site to determine if the premium is high. It is a bad idea to buy in when the premium is high.

The second main reason behind the premium spikes and drops, are "accredited investors". We discuss this in the next section.

Private Placement Offerings and "accredited investors"

There are two ways to purchase shares in Grayscale's trusts:

  1. At the public OTC exchange like any other stock
  2. Purchase them privately from grayscale as an "accredited investor"

If you fit the criteria of Grayscale of an accredited investor, you could buy shares directly from the company, during "private placement offerings", at a price that reflects exactly the amount of crypto the company holds. Since usually the price of the share at the public market is almost guaranteed to be higher than the "holding per share" price, it gives accredited investors a very big advantage over the small retail ones.

Once you but the share at the private placement, you have a time limit on when you could sell it. For example, in the latest private placement offering, private investors had to wait 6 months in order to be able to sell their shares in the public market. When these 6 months passed, a lost of these big accredited investors sold their shares, which is what led the sudden drop Shown in the graph image above at the beginning of january.

From the Grayscale site: "Accredited investors* may invest directly in Grayscale’s investment products at their respective daily “Holdings per Share” values (determined at 4 p.m. New York time based on the corresponding TradeBlock indices). Accredited investors interested in learning more about these private placement offerings should fill out the form on the right."

Who is an "accredited investor"

An accredited investor includes anyone who either earned income that exceeded $200,000 (or $300,000 together with a spouse) in each of the prior two years, and reasonably expects the same for the current year, OR, has a net worth over $1 million, either alone or together with a spouse (excluding the value of the person’s primary residence).

Accredited investors - Rich people have the advantage.

Advantages over buying actual crypto

So, why would investors buy shares in GBTC instead of just buying Bitcoin? There are a couple of reasons:

  1. You don't have to store it yourself (some rightfully see this as a disadvantage, and rather have complete control over their bitcoin).
  2. Complying with the tax law. Since the shares are like any other share, they are easily reported for tax, are eligible for tax returns etc.
  3. The trust is regulated and reports to the US SEC.
  4. Certain IRA, Roth IRA and other brokerages don't give tax breaks on investments of Bitcoin, but will give them for investments of these trusts.
  5. Allows you to short sell crypto - like any other stock.
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    Verdict

    In my opinion the advantages discussed are not strong enough to overshadow the main disadvantage - You invest in those trusts because you want to invest in crypto. Since these trusts do not exactly follow the prices of the underlying crypto (and in some cases are very far away from that) which they represent, one should ask himself if this is really the right investment tool for the job.

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    NOTE TO THE BELOVED READERS OF MARKET ALERTS: The views and opinions depicted in the article are for educational use, and do not constitute financial, investment, or other advice.

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