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Consider the Grayscale Bitcoin Trust (OTCQX: GBTC), which had a share price of $9.31 with $8.75 worth of Bitcoins per share on 2020-07-16:

Chart of GBTC price vs NAV

For a more extreme example, consider the Grayscale Ethereum Trust (OTCQX: ETHE), which had a share price of $74.90 with $21.93 worth of Ethereum per share on 2020-07-16:

Chart of ETHE price vs NAV

What explains the huge premiums to net asset value (NAV) of these cryptocurrency trusts? Like ETFs, these Grayscale trusts appear to have a creation mechanism, but unlike ETFs, these trusts have no redemption mechanism. The fine print on the website says:

  • For the Bitcoin Trust:

    * Grayscale Bitcoin Trust does not currently operate a redemption program and may halt creations from time to time. There can be no assurance that the value of the shares will approximate the value of the Bitcoin held by the Trust and the shares may trade at a substantial premium over or discount to the value of the Trust's Bitcoin. The Trust may, but will not be required to, seek regulatory approval to operate a redemption program.

  • For the Ethereum Trust:

    * Grayscale Ethereum Trust does not currently operate a redemption program and may halt creations from time to time. The Trust may, but will not be required to, seek regulatory approval to operate a redemption program.

Given that the creation mechanism exists, but not the redemption mechanism, I would expect these trusts to occasionally trade at a discount to NAV. However, in reality, these trusts appear to constantly trade at large premiums to NAV. What could explain the huge premiums to NAV of these cryptocurrency trusts?

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Normally, regardless of other supply and demand forces, arbitrageurs would exploit and thereby eliminate the premium, by buying BTC, exchanging it for ETF shares (the creation mechanism), then selling the ETF shares in the market. But the last step (selling -- or selling short, if you make it the first step) doesn't work for would-be arbitrageurs. One article explains:

GBTC can only create new shares through private placements to accredited investors, and they are not tradable until one year after they are created. This structure creates a high demand for a limited number of shares (182M) which drives the premium higher. ... because GBTC is not marginable with many brokers, it cannot be shorted.

Another article explains:

GBTC offers periodic private placement rounds that are available to accredited investors. In previous offerings, investors had a 1-year lockup period during which shares could not be sold since the products were not registered with the SEC. ... Grayscale's registration as a reporting company with the SEC would grant its products a reduced lockup period of 6 months. This could possibly result in increased liquidity and reduced premiums.

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  • In other words, accredited investors can exchange bitcoin for shares, but they have to wait 6 months before they can sell the shares. This delay means that the "creation mechanism" doesn't work well for keeping the supply of shares in line with the demand. Hence, when demand outstrips the current supply, the premium over NAV can persist for quite some time. Correct? – Flux Jul 17 '20 at 3:23
  • @Flux Yes, that's right. – nanoman Jul 17 '20 at 3:33
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So far the SEC has never approved an ETF for any cryptocurrency. Because of this, it is quite difficult to invest in Bitcoin through traditional means. Grayscale's fund is the closest thing there is to a traditional instrument backed by Bitcoin, so there is a lot of demand (especially institutional) for its shares. As institutional investors become more savvy (presumably they're working on mechanisms to invest in Bitcoin directly) or if a Bitcoin ETF is ever approved, it's possible that GBTC's premium will decrease.

I think of the premium as kind of like a convenience fee. If I'm willing to pay the premium for GBTC, I don't have to worry about storing my own Bitcoin with all the security and practical hassles that entails. Instead I can just hold my shares in my brokerage account along with all the other stocks, ETFs, mutual funds, etc. that I own.

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