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Although it seems like ages ago, only two months have passed since Genesis announced the need for a $1 billion liquidity injection following the FTX and Alameda incidents. As the week dragged on without resolution, the details of the story became more public, building on the fraud allegations against Digital Currency Group (DCG) announced by Gemini co-founder and president, Cameron Winklevoss. Gemini is still trying to recover $900 million in assets from Genesis that were used to generate revenue for Earn customers.
If it is not solved and only gets bigger, the problem of DCG and Genesis weighs heavily on the bitcoin market because there are many answers that are needed and various results that are not yet possible.
The biggest question is what will happen to Grayscale Bitcoin Trust (GBTC) and how the issue could affect the price of bitcoin. GBTC has been the preferred vehicle for many to gain exposure to regulated bitcoin and has also been a breeding ground for speculative arbitrage strategies during the previous shift from premium to discount to net asset value (NAV). An approved bitcoin spot ETF in the United States is supposed to solve this problem, but we are still a long way from that happening.
It’s easiest to start with GBTC shares on DCG’s balance sheet which is roughly there. 9.67% of all supplies. If DCG needs to raise cash or file for Chapter 11 bankruptcy, selling the stock could be an option. Selling into an already illiquid market puts further pressure on GBTC’s historically low discount. DCG holds approximately 67 million shares in a market that trades less than 4 million shares per day. However, the more important factor is that under the law, DCG can sell no more than 1% of outstanding shares every quarter. It took about 2.5 years of continuous selling to sell all the stock.
Another path – the most likely – is that GBTC, along with other Grayscale trusts, find their way into the hands of new sponsors and managers. Valkyrie has proposed to do this:
- Give the option to investors to exchange shares at NAV through a request to file Regulation M (although it is not clear that the request Regulation M will be approved by the SEC).
- Fees are down from 200 basis points to 75.
- Attempting to offer investors redemption in cash and bitcoin.
The option for a new manager gives investors the opportunity to exit their investment at NAV.
The GBTC product is still a cash cow for Grayscale and DCG, with a 2% management fee – forever. Across all major trust products, Grayscale collected more than $300 million this year from management fees alone. Instead of liquidating all trusts in the worst case scenario, there will be many buyers willing to take on the management of the vehicle without US point bitcoin ETF available in the market.
However, liquidation is not a non-zero probability. In the event of Grayscale’s insolvency or bankruptcy, voluntary liquidation is possible unless 50% of the Shares choose to transfer to a new sponsor. There is an upside to DCG liquidating the trust because there is money to be made from the stock closing NAV, but that could lead to selling bitcoins on the open market. No one wants to see 632,000 bitcoins – about 3.3% of the current supply – put into selling pressure in the market. In the unlikely scenario where a complete liquidation of the trust takes place with USD cash returned to shareholders, one might assume that the bulk of the sale will be absorbed through OTC deals with interested investors. At this point, this is purely hypothetical.
New information will be discovered that has the potential to change the superstructure of the dynamics between Grayscale and the shareholders of Grayscale products. We will continue to write about developments in the coming weeks.
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