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Dec 6, 2017

S3 Analytics: Shorting Bitcoin Using the GBTC ETF

Grayscale Investment’s Bitcoin Investment Trust (GBTC) is the only active ETF whose performance is directly tied to Bitcoin’s market price and is presently trading at a 53% premium to its total assets. One of the main reasons for this premium is that GBTC’s shares outstanding and unrestricted tradable shares have not increased appreciably even though demand for the security continues to grow along with its stock price. GBTC’s stock price has increased by 1228% this year while shares outstanding only increased by 2.1% (to 1,868,700 shares) and unrestricted tradable shares by 28.6% (to 1,686,822 shares).

Unlike traditional commodity and currency ETFs there is no “physical” Bitcoin that is a tangible asset that can be seen or held once purchased. Bitcoins are essentially a set of encrypted 0’s and 1’s residing in a virtual blockchain general ledger. Since they can’t be physically stored and secured there is an existential fear of loss due to its abstract nature. GBTC’s Bitcoins are custodied at Xapo Inc., a Hong Kong based Bitcoin wallet, ”cold storage” vault and Bitcoin debit card issuer. Xapo was insured by Merdian Insurance, but in GBTC’s June 2017 quarterly report they stated that their “Custodian did not renew its insurance coverage.” GBTC’s Bitcoins are segregated between Xapo’s offline and segregated “deep cold storage” and more accessible, but self-insured, “hot wallet.”

Because a physical gold ETF, like the Spider Gold Shares Fund (GLD), can buy physical ounces of gold to support ETF creations, and that gold can be put in a vault under the vigilant eyes of a custodian, there is a manifest sense of safety and permanence in the underlying ETF asset. This not only instills confidence in the ETF, but also allows for relatively inexpensive and easy insurability of the underlying assets to make the ETF even more stable. Additionally, the ease of creating new shares to meet increased buy-side demand also mitigates the chances of ballooning asset versus market cap premiums (GLD’s premium is currently 0.025%).

Bitcoin ETF competition has been stymied by the SEC as both the Winklevoss brothers and SolidX Partners derivative based ETF launch filings were rejected by the SEC due to a lack of investor protection and unfavorable investment profile, but both may re-apply once Bitcoin futures contracts begin trading. Investment management firm VanEck recently withdrew its futures based ETF filing until Bitcoin futures become available as well. ETF company ProShares recently submitted filings to the SEC for both a long and short futures based Bitcoin ETFs. With CBOE’s Bitcoin futures contracts set to roll out on December 10th, the competition for Bitcoin ETF investment dollars will soon expand dramatically.

Once new Bitcoin ETFs enter the market, demand for the GBTC ETF will decrease as investment dollars diversify into their competitor’s products. This reduction in buy-side demand will naturally shrink GBTC’s asset versus market cap premium and the ETF will most likely underperform Bitcoin performance in the short term. Couple the lack of insurance of its Bitcoin custodian Xapo with the strong possibility of its premium bubble bursting, GBTC short interest should begin to climb prior to CBOE’s Bitcoin futures go-live date.

But as Tesla Inc. (TSLA) short sellers can attest, a value/fundamental short theorem in a hyper-momentum stock can be a losing proposition. It is not enough for a trade’s fundamental rationale to be correct, the market has to agree that your rationale is correct. Tesla’s short interest topped $11 billion in September as the stock hit its year-to-date high and shorts were down $5.2 billion in year-to-date mark-to-market losses.  The iron willed short sellers that weathered the year-long rally were finally rewarded with a 21% stock price correction and recouped $2.2 billion of their losses in less than three months.

GBTC short interest has averaged $21 million for the year, and hit its year-to-date high of $71 million on December 5th. Shorts are down $45.9 million in year-to-date mark-to-market losses, or down 217%. $39.1 million of which occurred since the late October Bitcoin rally started. The cost to short GBTC has not been cheap, stock borrow costs have averaged 10.2% fee for the year and borrow rates are getting more expensive as borrow supply diminishes. With GBTC being more of a retail owned stock rather that an institutionally owned stock new shorts are being charged 18.5% fee because there is a relatively small borrow float available in the name. Shares shorted have been slightly below the 50,000 share level for most of the last month, with less than 40,000 shares left to borrow. If short interest continues to climb, we should see new borrow rates hit the 50% fee level quickly.

While some analysts see Bitcoin as an over-hyped and over-bought asset ripe for a pullback once the CBOE futures contracts go live on December 10th, the cost to short the GBTC ETF will probably be over 50% fee and possibly near 100% fee by the time the first futures contract trades. While the futures contract will allow easier and safer Bitcoin short selling, it will also allow for easier and safer Bitcoin long buying. Long GBTC holders may feel the pain of its 53% asset premium shrinking, while short sellers will probably be incurring a 50%+ stock borrow fee – both sides will be paying a premium in order to ride the Bitcoin rollercoaster once the CBOE futures start trading. 

Want deeper insight into the above analysis? Contact:
Ihor Dusaniwsky
Managing Director Predictive Analytics, S3 Partners, LLC
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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