Six Questions, Six Answers What does GBTC’s Conversion to a Spot ETF Actually Mean?

Unpacking GBTC's Transformation into a Spot ETF Six Questions, Six Answers

Source: Grayscale

Compiled by: LianGuaiBitpushNews Mary Liu

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At Grayscale, we believe that the approval of a Bitcoin spot ETF by US regulatory agencies is a question of “when” and not “whether”.

We are still focused on listing GBTC as a Bitcoin spot ETF on NYSE Arca. While the timeline is inherently uncertain, looking ahead, we spoke with Grayscale’s Chief Legal Officer Craig Salm and Chief Financial Officer Edward McGee to address common questions from investors and other market participants regarding the process and impact of listing products like GBTC on securities exchanges, including the process of listing GBTC on NYSE Arca and what it means for investors trading GBTC as an ETF.

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Q: First of all, can you give us an overview of how ETFs generally work?

A: ETFs are investment products that are traded on national securities exchanges (such as NYSE Arca, Nasdaq, or CBOE). ETFs can facilitate both share creations and redemptions, aiming to allow ETF shares to trade in line with the value of their underlying assets or holdings (often referred to as Net Asset Value or NAV).

Market participants known as Authorized Participants (APs) (typically broker-dealers, such as banks or trading firms holding certain registrations) are incentivized to create ETF shares when the trading price of the shares is higher than the NAV of the ETF, or redeem ETF shares when the trading price is lower than the NAV of the ETF.

APs are usually the only market participants who can engage in such transactions with the ETF. These creation and redemption transactions provide APs with the opportunity to profit through this arbitrage mechanism, which serves as an incentive to ensure that the ETF tracks the value of its underlying assets. ETFs that closely track their NAV can also incentivize non-AP broker-dealers and investors to trade the shares on the public market without the need to create or redeem shares. The higher the liquidity of ETF shares, or the greater the availability and volume of trading, the less dependence there is on creation and redemption transactions.

Q: How does GBTC currently operate?

Answer: GBTC is an investment trust company that owns over 3% of the current circulation of Bitcoin. As of November 29, 2023, each share of GBTC is backed by 0.0008968 BTC. GBTC does not own anything other than Bitcoin and does not use leverage or derivatives such as Bitcoin futures contracts. The underlying Bitcoin tokens are stored in secure offline storage. Grayscale is responsible for overseeing the day-to-day management of GBTC, including managing custodial relationships, communicating with regulatory agencies, tax reporting, financial statements, and other requirements for publicly traded investment vehicles.

GBTC shares have always been issued through a private placement process, which according to the Securities Act of 1933 does not require registration. Therefore, these shares were initially only open to qualified investors and subject to holding periods under Rule 144, and GBTC shares cannot be redeemed. In order to provide liquidity, GBTC obtained a public quotation on the OTCQX market in mid-2015. Since then, any investor who can access the public market can buy and sell freely tradable GBTC shares, thereby increasing their exposure to Bitcoin in their investment accounts.

However, due to Rule 144, newly created shares must go through a holding period, and if the trading price of GBTC shares on the OTCQX is higher than the net asset value (NAV) of GBTC, Authorized Participants (AP) cannot create more shares to immediately add to the market and adjust the price according to the NAV of GBTC. On the other hand, since GBTC does not offer a redemption program, if the trading price of GBTC shares is lower than the NAV of GBTC, AP cannot redeem shares to remove them from the market and adjust the price according to the NAV of GBTC. Therefore, GBTC cannot rely on the arbitrage mechanism inherent in ETFs described earlier. GBTC shares can and have been traded at a premium or discount to their NAV.

The innovation of the ETF product structure lies in its arbitrage mechanism, which allows for the continuous creation or redemption of shares to address premiums and discounts.

Importantly, in the ETF model, GBTC shares are expected to closely track the price of Bitcoin, meaning that any premiums or discounts on GBTC shares are expected to disappear. As of November 29, 2023, GBTC has a total of $23.4 billion assets under management and a trading discount of 8.09%, which is approximately $1.89 billion. This means that assuming the current discount disappears, when GBTC lists on NYSE Arca and becomes an ETF, it would unlock approximately $1.89 billion of value for investors through the arbitrage mechanism.

Question: What would happen to GBTC if the SEC gives regulatory approval for spot Bitcoin ETFs to enter the US market?

Answer: The creation of GBTC shares would be registered with the SEC through a registration statement on Form S-3 under the Securities Act of 1933. The redemption of GBTC shares is expected to be conducted under an exemption provided by Rule M previously granted by the SEC for products with similar characteristics. This would provide GBTC with the necessary approvals for simultaneous creation and redemption, allowing for arbitrage opportunities when there are premiums or discounts between the trading price of GBTC shares and the NAV of GBTC, thus enabling GBTC to closely track the value of its underlying asset, Bitcoin. Once the SEC approves NYSE Arca’s 19b-4 rule application, GBTC will also upgrade from OTCQX to NYSE Arca.

GBTC has long been prepared to operate as an ETF. After obtaining the appropriate regulatory approval, Grayscale will immediately work with our partners to list GBTC on NYSE Arca.

Q: What do GBTC investors need to do if the SEC approves a Bitcoin ETF and allows GBTC to list on NYSE Arca?

A: GBTC investors do not need to take any action. When investors view their holdings of GBTC stock after it is listed on NYSE Arca, they will only see these stocks listed on NYSE Arca, not quoted on OTCQX. GBTC will retain the same stock ticker (GBTC) and the same CUSIP, and investors will continue to be able to buy and sell GBTC stock at market prices.

Q: What tax implications should I be aware of when GBTC upgrades to NYSE Arca?

A: None. The listing of GBTC on NYSE Arca will not constitute a taxable event.

Q: Is there a timeline for when GBTC will be approved to list on NYSE Arca?

A: Unfortunately, there is not. Despite the favorable ruling by the DC Circuit Court in August 2023 regarding Grayscale’s lawsuit against the SEC, which overturned the SEC’s decision to deny NYSE’s 19b-4 application to list GBTC on NYSE Arca. This is an unprecedented situation, and the timeline is essentially uncertain. The Grayscale team is committed to working constructively with the SEC to list GBTC on NYSE Arca and will continue to share updates in a timely manner when more information becomes available.

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