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.
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.
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 firstname.lastname@example.org
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