Grayscale, the world’s largest crypto fund manager, has been caught in a likely financial crisis amidst the FTX collapse, and the suspension of loan originations and redemptions by Genesis Trading, Grayscale’s sister firm. Grayscale and Genesis trading are both subsidiaries of Digital Currency Group (DCG).
Grayscale launched its Bitcoin (BTC) investment fund called the Grayscale Bitcoin Trust (GBTC), in 2013. GBTC is the first U.S. Bitcoin investment fund and one of the first securities solely invested in, and deriving value from, the price of BTC. Grayscale holds roughly 3.5% of the current Bitcoin circulating supply – estimated to be around 630,000 BTC, making it one of the biggest Bitcoin whales. Investors buy GBTC shares directly from Grayscale; the shares represent a certain amount of Bitcoin.
Discounted GBTC Shares and Refusal to Publish Proof-of-Reserves, Is Grayscale on the Brink of Insolvency?
Many speculate that Grayscale might be teetering on the brink of collapse as GBTC shares which once traded at a premium are now traded at a discount, since March this year. GBTC shares are currently trading at over 40% discount to net asset value (NAV). The huge price disparity between BTC and GBTC shares has continued to raise eyebrows. There are also concerns that Grayscale’s parent company DCG has had difficulty in raising the $1.1 billion it owes Genesis Trading. It is strongly believed that the financial woes faced by Grayscale’s parent company DCG would have a ripple effect on its subsidiaries This has led to calls by the crypto community for Grayscale to publish its claimed crypto asset holdings via a proof-of-reserves protocol.
Grayscale released an announcement via a Twitter thread in which it acknowledged that investors are understandably inquiring deeper into their crypto investment as a result of recent events. Grayscale reassured its investors and the crypto community that the laws, regulations, and documents that define its digital asset products prohibit the digital asset underlying the products from being lent, borrowed, or otherwise encumbered. Grayscale says Coinbase is the custodian of all digital assets that underlie its digital asset products.
No Released Proof-of-Assets For Coinbase Custody
As a result of recent events in the crypto space, investors, users, and the cryptocurrency community at large are finding it difficult to take just the word of crypto firms for it, without further scrutiny. The benefit of the doubt once given to firms in the crypto space has been largely affected and withdrawn, Despite Grayscale’s Twitter thread and reassuring statements, the crypto community has widely called out Grayscale for its refusal to publish its assets base via a proof-of-reserves audit.
Grayscale says Coinbase, its digital assets custodian, performs frequent on-chain validation. However, due to security concerns, it does not and would not publish such on-chain wallet and confirmation information through a proof-of-reserve or other cryptographic accounting procedure. Following FTX CEO Sam Bankman-Fried’s initial reassurances of safe assets and funds at the start of the FTX fiasco and then a subsequent revelation of deep-rooted financial woes, the statement released by Grayscale was not well accepted by the crypto community. The crypto community has accused Grayscale of trying to cover up its tracks because it refuses to release an independent audit of the digital assets it claims to possess.
For the time being, Coinbase Custody has confirmed in a recent communication with Grayscale itself the amount of each asset it holds as of late September. While no wallet address were made public, this document should hopefully abate lingering fears surrounding the financial position of Grayscale.
Grayscale’s ETF Bid is Likely Tainted
Grayscale has tried to get a Bitcoin spot exchange-traded fund (ETF) approval from the U.S. Securities and Exchange Commission (SEC); the SEC has, on several occasions, rejected Grayscale’s ETF bid. The creation of GBTC shares is not continuous and the redemption of the shares can only take place on secondary markets. A Bitcoin ETF would allow continuous share creation and redemption, hence an arbitrage mechanism will exist to ensure that the market price per ETF share is close to the market price of the underlying asset per share. The structure of the GBTC investment fund has no arbitrage mechanism, hence the huge disparity between the price per share and the price of the underlying asset. Converting GBTC to an ETF will allow Grayscale to create and redeem shares.
Grayscale first applied for a Bitcoin ETF with the SEC in 2016. Grayscale said it withdrew its Bitcoin ETF application at that time because it believed that the regulatory environment for digital assets had not advanced to the point where such a product could be brought into the market.
In October last year, the SEC allowed Bitcoin Futures ETFs that offer derivative contracts that speculate on the future price of Bitcoin. However, the Bitcoin spot ETF, which would be tied to the market price of Bitcoin, remain blocked by the SEC.
In June, the SEC rejected Grayscale’s fresh application for a Bitcoin ETF. The SEC said it rejected the ETF bid because Grayscale did not do enough to protect investors from fraudulent and manipulative acts and practices. The decision prompted Grayscale to file a lawsuit against the SEC. Grayscale said the SEC is failing to apply consistent treatment to similar investment vehicles and is therefore acting arbitrarily and capriciously in violation of the Administrative Procedure Act and Securities Exchange Act of 1934.
With the current turmoil in the crypto space and DCG’s exposure to FTX, the SEC will most likely be emboldened in its resolve to block Grayscale’s spot Bitcoin ETF bid.