Grayscale’s Win: A Turning Point for Digital Asset Regulation

By Edward Carroll 

Head of Global Markets and Corporate Finance

MHC Digital Group

 

The digital asset regulatory shake-out is gaining momentum.

The recent ruling in the US courts to overturn the SEC’s decision relating to a spot bitcoin Exchange Traded Fund (“ETF”) from Grayscale is momentous for the future of digital asset regulation and adoption.

 

Background

 

Grayscale operates a number of trusts holding digital assets. Ownership of units in the trusts provides investors access to price movements of the assets held by the trust. The most notable of these, the Grayscale Bitcoin Trust, currently holds ~3.4% of the global supply of bitcoin (worth approximately US $15 billion).

To date, Grayscale units have been only available to accredited investors (“wholesale investors” in Australia), and are not traded on an exchange. That is, they are not “Exchange Traded Products” (“ETP”), and as such are subject to substantially less regulation and available to only wealthy investors. The structure of the product means that the underlying assets cannot be bought or sold when investors buy and sell the Trust units. Due to the illiquidity created by this construct, Grayscale units trade at a discount to the value of the underlying assets in the trust (in this case, bitcoin). This discount has been as large as ~49%.

In October 2021 Grayscale applied – and were rejected for – a conversion of the trust to an ETF with the SEC. A conversion would be hugely significant as it would a) give access to the product to retail investors; and b) likely close the valuation gap between the discounted value the units have traded at for the past 12 months and the value of their underlying assets.

Following the rejection, Grayscale sued the SEC, resulting in the current proceedings which were resolved on Tuesday.

Our funds at MHC Digital Group have been holders of Grayscale Bitcoin Trust units since December 2022. The ownership of Grayscale products is one of the largest concentrations in our portfolio and accounts for a material portion of our outperformance vs benchmarks since the beginning of the year.

The thesis was twofold:

1) buying Grayscale units gave exposure to bitcoin at an attractive discounted entry point; and

2) a conversion to an ETF would help close the discount and realise outsized returns. This is consistent with our value-orientated approach to long-term allocation.

 

What happened?

 

On Tuesday, they won their appeal. The requirement that the proposal was not “designed to prevent fraudulent and manipulative acts and practices” under the significant markets test has long been used by the SEC to deny a spot ETF. This was overturned. This ruling means that a significant barrier to future ETF spot crypto listing and adoption in the United States has been overcome.

The discount on Grayscale bitcoin units narrowed 20% overnight following the ruling. The market now anticipates spot bitcoin (and other crypto) ETFs to be approved in time. A good result for our funds, and, in our view, retail investors.

In effect, it was found that the SEC was acting arbitrarily in its treatment of Grayscale compared to similar products. Given our experience building a digital asset business, it was unfortunately not a surprise to see a regulator acting this way. There has been a consistent effort globally by regulators, led by the SEC, to thwart the establishment of crypto as a viable asset class. This is particularly true when looking at the treatment of “crypto native” companies and their products, much like the parent company of Grayscale.

We’ve seen the same thing with the treatment of another prominent digital asset firm, Coinbase, by the SEC. Their stock and debt notes have suffered as a result. After an extensive analysis of their credit and the longer-term risks surrounding their business, we began to acquire Coinbase debt between December 2022 and February 2023. This investment has similarly shown strong returns as the regulatory shake-out gains momentum.

 

Why is this significant?

 

Put simply, this opens up digital asset financial products to everyday investors. We expect that, following the launch of the first bitcoin spot ETF, other crypto ETFs will follow. Some of the most notable traditional financial institutions in the world (e.g. Blackrock, VanEck, Fidelity) have all filed applications for bitcoin ETFs recently. This greatly increases the likelihood that they will eventually be approved.

At a macro level, we hope that the ruling accelerates a push for encouraging appropriate, considered regulation globally. This will allow more people access to an asset class with incredible prospects when approached prudently.

 

What is next?

 

If there is one thing – above all else – that this case has demonstrated, it is that the time is now for regulators to get their act together and come up with a framework for this sector. The ship has sailed on shutting down crypto – it is here to stay.

And once the regulation comes, it’s game on.

 

Register your interest in MHC Digital Asset Fund, MHC Market Neutral Fund or in any other of MHC Digital Group’s products by contacting our team at [email protected]

 

Disclaimer

 

This document has been prepared by MHC Digital Finance Pty Ltd (“MHC Digital Finance”). The information contained herein should be considered as preliminary and indicative and does not purport to contain all the information that any recipient may desire. In all cases, recipients should conduct their own investigations and analysis. No liability whatsoever is accepted and neither MHC Digital Finance nor any members of the MHC Digital Finance nor any of their respective directors, partners, officers, affiliates, employees, contractors, representatives or other agents (“Agents”) is or will be making any warranty, representation or undertaking (expressed or implied) concerning the accuracy or truthfulness of, any of the information, forecasts, projections or of any of the opinions contained in this document or any other written or oral statement provided or for any errors, omissions or misstatements contained herein. Nothing contained in this document is, or should be relied upon as (i) the giving of financial product or any other advice by MHC Digital Finance nor as constituting an offer or invitation to enter into any transaction or investment, or (ii) a promise or representation as to any matter whether as to the past or the future. No representation, warranty, undertaking or other assurance is hereby given by MHC Digital Finance, any member of the MHC Digital Finance or any of their Agents that any of the forecasts or projections contained herein will be realised. Recipients of this document in jurisdictions outside Australia should inform themselves about and observe any applicable legal requirements in their jurisdictions. In particular, the distribution of this document may in certain jurisdictions be restricted by law. Accordingly, recipients represent that they are able to receive this document without contravention of any applicable legal or regulatory restrictions in the jurisdiction in which they reside or conduct business. No part of this document may be shown or distributed to third parties or reproduced, stored or transmitted in any form or by any means, elections, mechanical, photocopying, recording or otherwise without the prior written permission of MHC Digital Finance.