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May 31, 2017

S3 Research: GBTC Bitcoin ETF Trading at Premium Due to Limited Stock Borrow Availability

Grayscale Investments’ Bitcoin Investment Trust (GBTC US) is trading at a large premium to its underlying Bitcoin holdings as investors are eager to get long Bitcoin exposure but are wary of owning the actual asset. While the XBT\USD cross rate is up 72% for the month of May, the GBTC ETF is up 248%. With the actual Bitcoin rate at 2,322.74 and the implied GBTC Bitcoin rate at 4,790.00 – there is a 106% premium when acquiring Bitcoin long exposure via the GBTC ETF. This large premium has been an ongoing issue with the GBTC ETF but was muted in 2017 with an average premium of only 10% prior to this recent spike. The premium was a much larger issue for traders in 2016 as it averaged over 44% for the year.

One of the main reasons for the pricing premium of the ETF versus the actual currency is simple supply and demand economics – the amount of shares outstanding in the GBTC ETF has remained around 1.7 million shares since its inception in 2015 and Bitcoin demand has grown exponentially. As demand for ETF ownership ebbed and flowed over the last 2 years, so did the price premium.

Even though there has only been minimal additional ETF creations since its inception, the fluctuation in premium would have been subdued if there were sufficient shares to borrow to support active short selling activity in the GBTC ETF. With very little institutional ownership in GBTC there is very little stock in lending programs and total short interest has never been over 20,000 shares or $2 million until this month when short interest increased to 32,000 shares or $15 million. With virtually no downward sell pressure on the ETF when premiums begin to expand, long shareholders were able to bid up the stock to a 90% premium in June/July 2016 and over 100% this month.

Long shareholders now not only have to deal with Bitcoin currency risk but also Bitcoin ETF demand risk. Even if the Bitcoin currency rate continues to rally, a reduction in ETF demand will begin to collapse the 106% premium and ETF long shareholders will have been conceptually correct in their Bitcoin currency rate play but will lose on the ETF’s premium contraction. From July to November 2016 the Bitcoin currency rates appreciated by 15% and the GBTC ETF was down 18%, but from November 2016 to the present, Bitcoin currency rates appreciated by 300% and the GBTC ETF rose 387%.

An active short selling market would temper GBTC’s premium rollercoaster ride and allow long shareholders to focus solely on Bitcoin’s currency rate for GBTC’s price movement and not its buy side demand. When GBTC’s premium begins to expand, short sellers would pounce on the price inefficiency and push GBTC’s premium down to “normal” levels. Or if more GBTC ETF shares were created, buying demand would be satiated and the price premium would disappear altogether. But with the operational risk of buying and holding actual Bitcoins to support ETF creation very high, and difficult and expensive to insure, it is unlikely that GBTC’s outstanding share amount will climb above 1.7 million anytime soon.   

With borrow inventory so small, the cost to borrow GBTC stock is very expensive. Stock borrow rates on GBTC existing positions are around 25% fee while new borrows are going at 40% to 60% fee. With daily stock loan volumes only a few thousand shares and total short interest only 32,000 shares short sellers have not had much of an effect on GBTC’s stock price. GBTC’s stock price premium is at historically high levels and there are a substantial amount of potential profits to be made as the premium eventually erodes – unfortunately, today there is no way to get into this trade in size.  

Want deeper insight into the above analysis? Contact: 
Head of Research, S3 Partners
The information herein (some of which has been obtained from third party sources without verification) is believed by S3 Partners, LLC ('S3 Partners') to be reliable and accurate. Neither S3 Partners nor any of its affiliates makes any representation as to the accuracy or completeness of the information herein or accepts liability arising from its use. Prior to making any decisions based on the information herein, you should determine, without reliance upon S3 Partners, the economic risks and merits, as well as the legal, tax, accounting and investment consequences, of such decision.

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