Summary Grayscale Bitcoin Trust has a fair chance of winning its legal case against the SEC, potentially closing the discount to NAV on its large Bitcoin fund though ETF conversion. The SEC has recently taken legal action against Coinbase, Binance and others - signaling an increasingly negative stance on crypto. The outcome of GBTC's case depends on the legal system rather than the SEC's activism, and investors could see upside from the verdict. I previously made the case that Grayscale Bitcoin Trust (GBTC) has a greater chance of winning its legal case than the market price might imply, creating potential upside. I briefly summarize that argument below, but here I want to focus on recent events and other angles to the trade as the SEC makes its position on crypto somewhat clearer. Ultimately, I still view GBTC as an attractive opportunity based on the potential for a win in court. That's because the decision is in the hands of the legal system, not the SEC, though the SEC's more stridently anti-crypto position may still impact Grayscale. Recap Here's my previous summary triangulating how Grayscale Bitcoin Trust may win its legal case against the SEC and therefore perhaps close the discount to NAV on its large Bitcoin fund by converting it to an Exchange Traded Fund (ETF). I estimated roughly a 44% chance of a legal victory for GBTC that could come over the next few months. Here's roughly how the numbers play out offering perhaps a +24% expected return at the time of writing, though it's also worth pointing out that the most likely outcome is that you lose money, and of course you are exposed to Bitcoin price volatility: Outcome Estimated probability Discount to NAV Return for GBTC investors Win legal case 44% 0% +72% Don't win legal case 56% 50% -14% Weighted expected return +24% The Actions Of The SEC However, since then, the SEC has been unusually active in bringing legal cases against both Coinbase and Binance that could potentially cause both to cease operating or be severely impaired. My favorite quote here is from the French philosopher Voltaire, "It is dangerous to be right when the government is wrong." It doesn't really matter what is correct here, but the SEC is powerful and may get its way. In the case of Coinbase, it appears that they tried to work with the SEC, but now the SEC have decided to turn against Coinbase, despite the business operating for 11 years. Of course, from the SEC's perspective there has been a lot of crypto frauds that have hurt investors and they feel the need to take action. As an aside, it is also worth remembering, that 90 years ago, in 1933 the government banned U.S. citizens from holding gold for investment purposes . That was a wartime measure, but it remained in force for over 30 years. So, arguably, things could get even worse for crypto in the U.S. There are hints in Gary Gensler's statements and interviews that he would just prefer to get rid of crypto entirely, perhaps because of the implicit threat it poses to the primacy of the U.S. dollar, though, of course, that isn't the SEC's mandate and regulation should not be entirely capricious. Still it is worth recognizing just how hostile to crypto the SEC currently appears. A Hardline SEC However, regardless of the preferences of the SEC, the legal case does largely hinge on the apparent inconsistency between the SEC allowing a Bitcoin futures ETF and blocking a spot Bitcoin ETF. Given the relatively draconian actions of the SEC in recent months, it does now seem possible that if the SEC lost the case, then they might chose to ban the previously approved Bitcoin futures ETFs and achieve consistency that way by 'burning all the ships'. This would maybe create a path to block spot Bitcoin ETFs, even if they lost the legal case. Previously that seemed extreme, now it's more consistent with the SEC's recent actions. Also the SEC appears committed to the idea that Bitcoin is a commodity. This makes it somewhat unique in the eyes of the SEC, and may mean that despite the aggressive approach the SEC is currently taking against crypto, Bitcoin may be spared to some degree as compared to other coins/tokens. Lastly, with everything else going on at the SEC in terms of a host of legal cases, spot Bitcoin ETFs may no longer be the primary focus. Given limited resources, if the SEC lost the case in the current environment, they may choose to not devote additional resources to this topic relative to other major legal battles that they perceive as more important. Other Paths Then if GBTC did lose the case and the SEC's ban on spot Bitcoin ETFs stands, what other paths are open to it? The challenge here is winning the legal case is one outcome that almost completely aligns Grayscale and its investors. With an ETF structure the discount is closed and Grayscale gets to likely retain the very significant assets under management of its Bitcoin fund and perhaps grow them further. Other scenarios are more adversarial, or problematic in other ways. In the case of closed-end funds sometimes mergers between funds can close NAV discounts, but these typically occur when a fund in sub-scale, that's not the case with GBTC with a $16B fund. Canada, and other exchanges, do permit spot Bitcoin ETFs today, but it's not clear that GBTC could migrate to a non-US exchange without losing significant assets in the process. GBTC could of course liquidate, that would be great for investors, but requires Grayscale to voluntarily walk away from hundreds of millions of dollars of annual revenue and a leading position in the crypto fund space more generally, which feels unlikely. It's also unclear what grounds investors could use to force a GBTC liquidation, many funds trade below NAV. Of course, given the high-powered lawyers Grayscale is working with in the first instance the most likely outcome is perhaps an appeal of the court's decision if Grayscale loses. Other Grayscale Funds It is also worth noting that Grayscale operates various other crypto-related funds and it is interesting to look at how they trade in relation to NAV. Here are some of the more notable ones. It is interesting that some of Grayscale's funds (for example those holding Solana and Filecoin) still trade at large NAV premiums, though these are relatively small and illiquid funds. It also makes clear that GBTC's current 42% discount is not a floor. In some ways this suggests there may be opportunity in ETHE if GBTC won its case, though it's not clear that the SEC would treat all crypto assets the same way, and Bitcoin's "commodity" status may offer an advantage. Fund NAV premium/discount GBTC (Bitcoin) -42% ETHE (Ethereum) -54% GSOL (Solana) +146% LTCN (Litecoin) -46% FILG (Filecoin) +250% source: Grayscale disclosures, author's analysis as of June 7, 2023 Risks Underlying Bitcoin is volatile, that could cause GBTC to decline in value even if they win the court case. Crypto investing carries significant risks given past frauds and/or the potential regulatory actions of the SEC hurting investment values. If GBTC lost the legal case then the discount to NAV would likely increase. GBTC is a high-cost fund so fees will erode your return while you wait for any legal outcome. Some brokers apparently only allow sell rather and not buy trades in GBTC and if this trend broadens it may further widen the NAV discount. GBTC could potentially lose custody of its Bitcoin assets due to a hack or other event which would cause large loses. It is also difficult to independently verify GBTC's asset holdings. Legal processes are often slow and any final verdict could be delayed by many factors. What's Next? Ultimately despite a more aggressive SEC, the decision on a spot Bitcoin ETF is currently in the hands of the legal system. Plus the idea that Bitcoin is a commodity may help the progression of a spot Bitcoin ETF relative to other regulatory actions that the SEC may want to focus on. As such there appears to still be a reasonable opportunity in GBTC though one that is increasingly complex as the SEC becomes more aggressively anti-crypto.
