In an August opinion, D.C. Circuit Judge Neomi Rao reopened the door for the approval of a Bitcoin spot ETF when she ruled that the SEC’s prior rejection of Grayscale Bitcoin Trust’s (GBTC) application was “capricious.”
After declining to appeal the order, the SEC conducted a closed-door meeting in early November to discuss, among other things, “Resolution of litigation claims,” per the meeting announcement.
This has prompted rampant speculation that a spot Bitcoin ETF (among other cryptocurrencies, most notably Ether) may be imminent. Partially fueled by this speculation, Bitcoin has risen more than 38% in the last month alone.
Now, the judge’s decision does not compel the SEC to grant the application, but it does force them to reconsider the application on the merits, and the possibility of a spot ETF approval could open up an arbitrage trade in Bitcoin. (An arbitrage trade is an investment that relies on a pricing mismatch, like shares of a company that is being acquired trading for less than the acquisition value due to the time anticipated to complete the merger or risk of regulatory intervention.)
In handing down the order, the court failed to see a distinction between exchange-traded funds that rely on Bitcoin futures trading (like the ProShares Bitcoin Strategy ETF (BITO), or the Valkyrie Bitcoin and Ether Strategy ETF (BTF), which have SEC approval) and an investment like GBTC (which holds Bitcoin directly), all of which offer investors exposure to the price performance of Bitcoin.
Should the SEC ultimately approve the application (more on that later), there’s potential for an arbitrage trade in Bitcoin based solely on GBTC’s historical discount to net asset value (NAV), which is the difference between the market price of the Trust and the market value of the underlying Bitcoin holdings.
As you can see in the chart from Grayscale below, for the last few years, GBTC has traded with a 10-20% discount to NAV, although that figure reached as high as 40% over the summer. As of November 13, the fund was trading at an 11.9% discount to NAV.
Should the SEC ultimately approve the ETF application, or signal that it is likely, GBTC could close some or most of that gap, even if Bitcoin itself does not rally on the news.
Flat (or rising) Bitcoin prices would still allow for double-digit appreciation in the fund on what is ultimately a binary event.
For context, let’s look at the Sprott Physical Gold Trust (PHYS). Both funds invest solely in the underlying asset and hold it in custody for unit holders. Each underlying asset also presents challenges for investors. In the case of gold, buying or selling large quantities of physical gold is difficult and time-consuming, as is keeping it secure. Bitcoin, on the other hand, presents similar security challenges and added technical risks, but is far easier to trade in and out of.
PHYS trades at a 1% discount to NAV as of this writing, compared to GBTC’s 11.9% discount.
Conversion to a spot ETF could allow large market participants to take actual delivery of the underlying Bitcoin, or, from a risk management standpoint, to consider shares of the fund as actual Bitcoin holdings to trade or hedge against.
This could rapidly close the gap between the NAV and the market price of the fund to a range more consistent with PHYS, which would represent around a 10% premium to where shares are trading now.
Additionally, Bitcoin itself is likely to rally on promising news, if only in the near term, which offers added upside in addition to the NAV discount.
The SEC Remains a Risk
As mentioned above, the court order only compels the SEC to revisit the application, not to approve it.
Should the SEC deny the application on other grounds with surer legal footing, not only would GBTC retreat closer to the NAV discount it was trading with throughout the summer, but the price of Bitcoin would also likely fall on the news.
One of the key speculative elements of Bitcoin is the prospect of mass adoption, wherein large institutions and retail investors will make a mad dash to invest in the “digital gold” should they be granted a green light by regulators.
The major risk there is that … they simply don’t. Cryptocurrency investors pinning their hopes on widespread adoption have driven the price of Bitcoin up 127% year to date, based on some combination of historical prices, the abhorrent relative performance over the past two years, and the prospect that institutional investors are just around the corner.
Approval of an ETF without the expected buying pressure could easily let some air out of this year’s Bitcoin rally and lead to stagnating or declining prices.
That said, if you are a Bitcoin bull, the NAV discount of GBTC offers additional upside beyond the price performance of the token itself.
