Summary Today's apparently favorable legal discussions could ultimately collapse Grayscale Bitcoin Trust's discount to NAV, creating a positive outcome for investors. A decision could come around May 2023. You are exposed to Bitcoin price risks regardless that could change the return profile. In the upside case, you could see an almost 60% return, though there is downside risk too. Grayscale Bitcoin Trust (GBTC) may win a court case to enable it to convert to an ETF later this year. That would enable it to potentially close its discount to NAV creating a +59% return for investors. Currently the market appear to imply that the chances of legal victory is quite low (about 1 in 4 on my estimates), but assessment of today's hearing suggest otherwise. You are of course exposed to Bitcoin (BTC-USD) volatility in the interim, which could cause the trade to lose money even on conversion, and GBTC's high fees will erode value too. Also, even if the case is won by GBTC maybe they chose not to create an ETF or maybe some other ruling or action blocks spot Bitcoin. Still, if you're constructive on Bitcoin this is an interesting setup. Legal Arguments In today's legal arguments in the D.C. Circuit Court of Appeals, basically GBTC argue that the SEC is using inconsistent "arbitrary and capricious decision making" in blocking a spot Bitcoin ETF when many Bitcoin futures exist, for example see ProShares Bitcoin Strategy ETF (BITO). That's a Bitcoin ETF that trades today based on Bitcoin futures pricing. Media coverage of the arguments has been positive to GBTC. Greyscale Bitcoin Trust's Discount To NAV Some brief history. Greyscale Bitcoin Trust was one of the first ways to easily trade Bitcoin. Now it's a comparatively high fee structure to own the cryptocurrency as investors have other options. That's led to a discount to NAV. That is to say that the value of the trust is less than the value of the Bitcoin that it holds. To some extent that makes sense, if Bitcoin were flat over time, you'd receive 90% of your cash back after 5 years due to the 2% annual fee. However, the discount to NAV is currently extreme. Below you can see the price of GBTC and its NAV. The discount has closed somewhat on today's news but the discount is still large. Also note that at times prior to 2021 GBTC traded at a premium to NAV. Data by YCharts Scenarios Let's assume that Bitcoin does not change in price and the NAV remains at $20.33/share. At the time of writing, the price is $12.78/share. Here are some scenarios: Premium/Discount to NAV GBTC Price ($) Simple Return +10% 22.36 75% 0% 20.33 59% -10% 18.27 43% -20% 16.26 27% -30% 14.23 11% -40% 12.20 -5% -50% 10.17 -20% Source: Author's calculations To be clear, I don't think GBTC will return to a premium to NAV, but ETFs typically trade in a very tight spread around NAV, so that would imply a 59% return from current levels if GBTC became an ETF. Of course, if GBTC remains in its current high-fee trust format, the discount could widen again and maybe you lose 20% or more from current levels. GBTC's Incentives You might think that GBTC wants to keep their high cost structure and keep charging 2% fees. However, the discount to NAV is today so large that they could well be more profitable trading at NAV with a lower fee. Also the history of the ETF market has shown first-mover advantage, so if GBTC can become the first ETF to market at scale, then they may continue to enjoy a large asset basis over time. What The Current Price Might Imply Scenario Approx. value GTBC becomes an ETF $20.33 GTBC remains a trust with a 2% fee forever (50% NAV discount) $10.17 Source: Author's calculations With the share price at $12.80 we can infer (simplistically) that the market believes there's a 26% chance the court case is successful and GBTC converts to an ETF. Of course, this is pretty basic analysis and carries limitations. Risks Of course, there are risks here, specifically: The U.S. system is becoming increasingly anti-Bitcoin, maybe the currency is banned or ownership is heavily regulated or taxed in some other way. In that case the discount to NAV may not matter if the price of Bitcoin fell materially or became harder and more costly to own. Just because GBTC might win the court case doesn't mean they are obligated to create a Bitcoin ETF, maybe they will win and choose not to. Bitcoin is volatile. If the price of Bitcoin fell ~38% from here, the discount to NAV would close in a much less favorable way for investors. So you could lose money even with a favorable legal outcome. The timing of the legal decision is hard to estimate. Looking at similar cases in the D.C. court a May 2023 decision is possible, but equally legal cases can drag on for much longer. You'd be left paying 2% fees while you wait and as mentioned above Bitcoin is volatile. Maybe GBTC will win the legal case, but the SEC will find another way to block a Bitcoin ETF using some other process or language, or another law or regulatory agency blocks it. For example, the SEC could decide to block Bitcoin futures ETFs and achieve regulatory consistency here. I'm not a lawyer so I may be misunderstanding the legal nuances here. Conclusion The market may be underpricing the chance of GBTC winning the case. This is not a certain outcome, and if the SEC continues to want to block spot Bitcoin ETFs, they may find another route. However, given Bitcoin futures do trade in an ETF structure today, it appears GBTC has a case and this issue could be resolved within months for an attractive return.
