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NLW explores the debate surrounding the GBTC unlock’s bearish or bullish nature on this episode of “The Breakdown,” including:

Historical impacts of market structure on prices
GBTC’s influence on markets as its premium attracted investors
Analysis of the GBTC unlock bearish vs. bullish debate
Grayscale Bitcoin Trust (GBTC) is an investment vehicle that allows institutional and public market investors to invest in bitcoin without purchasing the cryptocurrency directly.

While many GBTC investors were simply looking for public market exposure to bitcoin, many firms also took a more strategic approach to capture the neutral arbitrage trade of GBTC shares trading at a premium to the native asset value (NAV) of bitcoin. The demand for public market vehicles coupled with a lack of other alternatives placed GBTC at a desirable premium.

The GBTC NAV trade was a significant source of buying pressure through the back half of 2020 and the beginning of 2021, but when the premium turned to a discount (thanks to a variety of factors, including competition from other bitcoin proxies in the public markets), that source of buying pressure dried up.

When an investor buys into GBTC, their shares are locked up for six months. More than 100,000 bitcoin worth of shares are expected to be released throughout July. The looming flood of shares into secondary markets has sparked a debate on whether the unlock will be bearish or bullish for the spot price of bitcoin.
Grayscale is owned by Digital Currency Group, which is CoinDesk’s parent company.

Image credit: Francis Specker/Bloomberg/Getty Images, modified by CoinDesk

Transcript

What’s going on guys? It is Thursday July 8 and today we are talking about the latest, greatest debate on Bitcoin Twitter. Are the Grayscale Bitcoin Trust unwinds bullish or bearish for Bitcoin? Now, as you will well know I talk a lot on this show about the big picture, global macro, large patterns of history, where Bitcoin fits as a disruptive force, how that disruption is connected to other larger global trends. I mean, hell, I actually used 15th century Genoese merchant networks as a reference point yesterday, and frankly, it took all my resolve not to go more in depth about how Italian merchants use social capital and social networks as the grounding for some of the earliest modern economic instruments and, you get the point. I love some good historical context and I love big patterns.

However, hopefully, you’ve also heard me explain why because I’m so inclined towards macro patternistic explanations of things. I’m always trying to check that impulse with data, and with other explanations that don’t necessarily involve some grand narrative or great pattern of history. In particular, when it comes to bitcoin and the crypto markets as a whole, I try to spend a little more time on market structure. To better understand what I mean, let’s take an example of one of the market crashes earlier this year, when after some combination ofElon backing off BTC and China announcing some ban, bitcoin spent the weekend dumping from around $42,000, all the way back down under $30,000. The narrative explanations of this were plentiful. Elon not only triggered the ESG folks with his new line of environmental inquiry, he also scared off the institutional and Treasury investors who had previously been using Tesla as a model. China was setting pace for how governments were going to start banning Bitcoin, and so on and so forth.

Here’s the thing. It’s not that these narratives were wrong, it’s that they didn’t explain the drama of the move down we saw. Remember when I had Travis Kling on the show a few months ago, his main thesis, the thing that was frustrating him then, was the disingenuous nature of a new set of critics. These critics all effectively shared one thing in common, they pointed to one area of FUD or risk and said, because of this concern, bitcoin is worth nothing, you should be far, far away. Travis’s point was that as a capital allocator, your job is to price risk, not to throw the baby out with the bathwater. So to put what happened that week before such a massive rapid drop in those terms, the larger risk that these events represented was real. But the price of that risk was absolutely not a 30% drop in a couple of hours. Now, for that, there had to be some other explanation.

There was. For some time now, crypto markets had been led by derivatives, not spot trading and a big part of crypto trading is trading with leverage. When prices move quickly down like they did that day, many accounts got margin called and ultimately, liquidated. In other words, because of the terms of the exchanges they were trading with, their collateral got liquidated to cover their losses. This happened automatically, and as such, ruthlessly and without feeling. Most importantly, without regard for the price at which the sale happened. One impact of that was that the liquidations were cascading, that automated for selling had to move to lower and lower prices to complete their trades, and as that happened, still others got liquidated, and so on and so forth all the way down. To listen to someone like Sam Trabucco from Alameda Research discuss this particular event on Luke Martin’s podcast: “What the market wanted to do that day was go from $42,000 or so to around $40,000 or so, but that $39,000 or $40,000 level had been a key level of a lot of people entering the market on the way up, meaning that it was a key trigger point for liquidations on the way down. The rest of that $40,000 to $30,000 drop wasn’t panic selling, it was forced selling.”

So, to sum this all up, there was a narrative element to that big weekend crash, a repricing of the risk based on ESG and China concerns around Bitcoin from about $42,000 to $40,000. But the 25% drop that happened after that was all market structure and leveraged liquidations. So, with that setup, let’s discuss the market structure question that has most been on people’s minds this week. And that is the question of Grayscale Bitcoin Trust, GBTC, unlocks. Let’s actually return one more time to that Travis Kling interview and then let’s play his epic list of all of the risks that exist around Bitcoin.

One in that list that maybe flew a little under the radar then, because this was February 6, was this idea of a GBTC NAV trade unwind. So, what, pray tell, was the GBTC NAV trade, what is its unwind and what might it mean for markets? Well, before we talk about the NAV trade, we should talk about what the Grayscale Bitcoin Trust is.

However, I suppose before that, a couple of disclosures are in order. The first, that Grayscale is owned by the digital currency group, the same company that owns CoinDesk. The second is that I’ll use this as a chance to remind listeners that while CoinDesk is an unbelievable production, distribution and sales partner of the show, “The Breakdown” is 100% entirely editorially controlled by me. I own the IP, I make the decisions about the topics, and that was built in from day one into the terms of our partnership. Part of what I appreciate so much about these guys is that they respected that independence right from the get-go. So, the point of that is that when I talk about Grayscale, it’s because it’s relevant, not because there’s some larger overlapping interest.

Alright, with that out of the way back to what the Bitcoin Trust actually is, the Grayscale Bitcoin Trust is one, the biggest bitcoin fund in the world; and two, the historical leader in letting public market investors get exposure to BTC via a public market vehicle. The way it works is that accredited investors are able to buy shares of the fund directly in daily private placements, and then sell them on secondary markets after a six month lockup. The way that the share buying works is that people buy bitcoin and contribute it to the trust and get the equivalent amount of shares in return. The secondary market shares have the ticker GBTC. And, historically, GBTC has tended to trade at a premium to the spot Bitcoin price, aka the net asset value, NAV, of the underlying.

Why? Well, it’s simple. Right now, you can’t invest in Bitcoin with your 401k, at least not without some instrument like GBTC. What’s more, buying and selling Bitcoin directly has implications for custody, there are some institutional investors who want to be able to buy big chunks of Bitcoin, without slippage due to crypto exchange illiquidity. There’s also tax clarity, which goes back to the 401k argument. The point of all of this is that there are many investors for many reasons who prefer to use public market vehicles for at least some part of their Bitcoin exposure. GBTC facilitates that and historically, that demand, and the lack of other alternatives has produced a premium. And this is especially true when markets are rising, which brings us to last year. After the COVID crash, markets were rising, effectively all year. I spent plenty of time on the narrative dimension of this. To be honest, how many of you guys can now recite the first paragraph of Paul Tudor Jones’ “Great Monetary Inflation Thesis?”

Correspondingly, there was something going on that fit more cleanly in this market structure bucket and that had to do with the GBTC NAV trade. The NAV trade was basically a process by which firms took their Bitcoin and made it instantly more valuable by exchanging it for GBTC shares, which are then worth a premium to the value of the BTC that was exchanged for them. The trade off, of course, is that those shares were locked up for six months, but on paper, those trades were lucrative right out of the gates.

There was a lot of this trade happening for a lot of last year. Some were general bitcoin and crypto bulls who were just taking advantage of this particular arbitrage opportunity, but according to others, there are more than a few opportunities as well. On Luke Martin’s show “Profit Maximalist,” Twitter-famous loomdart said that he saw a pretty meaningful number of firms and funds last year use the paper gains of the GBTC NAV trade as a way to blunt other failures and losses. The example he uses is that if a fund bought $100 million when the premium was 20%, that they could immediately book $20 million in profit on paper, even though there was that six month lockup. This could, as you might imagine, cover all manner of sins. And that premium was available. There were record high premiums towards the end of last year, getting all the way to 40% on December 17. And, whatever the combination of reasons that companies were buying GBTC shares, it feels clear in retrospect that the run-up in bitcoin’s price was correlated with GBTC buying.

Lyn Alden shared a chart that showed this dramatically. What’s more, she showed that as the premium turned to a discount, Grayscale stopped buying and that within a couple months, bitcoin had started to fall again. On June 28, she tweeted, “Bears focusing on Tether’s impact on bitcoin over the past year would have probably done better to focus on the Grayscale neutral arbitrage trade instead. When new competition resulted in the market taking away GBTC’s premium to NAV, the biggest bitcoin buyer stopped buying.” In other words, part of the run-up in the second half of 2020 was due to the Grayscale neutral arbitrage trades sucking in a ton of bitcoin. When ETFs and other new ways to access Bitcoin made GBTC less unique, the premium went away, so the neutral ARB trade went away. Then, of course, after the biggest buyer vanished, add retail investors pouring into alt-coins to euphoric levels, Elon’s ESG backtracking, leveraged traders getting liquidated on the correction, momentum traders stepping away, etc. She goes on, “The biggest BTC buyer in Q2 2020 was Grayscale. When GBTC’s premium over NAV turned into a discount in late February 2021, the neutral arbitrage trade dried up and Grayscale stopped buying. It now gradually sells BTC to fund expenses. Thus, the biggest buyer vanished and a lot of that was the neutral arbitrage trade.” So, as you can see, Lyn’s focus here is how the end of that particular trade ended a particular buyer pressure that had been key in driving prices up.

But this week, that’s only been a part of the focus of the discussion, where Twitter has really been focused is on what happens as the shares that were bought six months ago actually unlock, will this be bearish or bullish? The opinions are extremely split. In JP Morgan’s latest analysis they consider it a bearish force. They wrote: “Despite some improvement, our signals remain overall bearish. Selling of GBTC shares exiting the six month lockup period during June and July has emerged as an additional headwind for bitcoin.” As CoinDesk puts it, quote, “After unlocking, investors have the option of liquidating their shareholdings in the secondary market. Analysts at JP Morgan foresee investors selling at least some of their shares, leading to downward pressure on GBTC prices and on bitcoin markets more generally.” On June 23, Meltem Demirors wrote: “One thing we haven’t discussed yet, the Grayscale GBTC unlocks schedule is looking really crusty. From mid April to mid June, 139,000 bitcoin worth of shares have been unlocked, there’s another 140,000 bitcoin worth of shares that will unlock through the end of July.” Ben Davenport pointed out on Lyn Alden’s thread that it wasn’t just the Grayscale had stopped buying bitcoin, he said: “Spot on, and it’s actually worse than that. The negative premium causes new marginal buyers of Bitcoin to be more attracted to buy GBTC than to buy spot, since discount will eventually close upon ETF conversion.” What he’s referring to is the fact that Grayscale has signaled their commitment to transform the trust into a bitcoin ETF and at that point, there will no longer be a discount or a premium, it will just mirror the price of Bitcoin, which means in effect, this discount is just a discount on the eventual price of BTC. Celsius’ Alex Mashinsky made a similar point saying, “one, GBTC discount will increase to as much as 25%; two, funds that will want to capture the arb will short BTC and buy GBTC at the high discount.”

But as I said, there is no consensus about this. Mark Davis wrote an entire thread with more than 3000 likes about just how wrong this perspective was. He tweets: “Later in July, starting from the 13th, Grayscale will begin the unlock of around 41,000 Bitcoin worth of GBTC shares. But WTF does this actually mean and should you be worried? One FUD master and chief JP Morgan is saying that it will dump Bitcoin to $25,000, I tend to never believe what these criminal financial terrorists say as a rule of thumb, the single biggest one day unlocking July will be 16,244 bitcoin worth of shares on the 18th. The Bitcoin for these shares were locked on January 18. You may notice they keep saying shares, this is because no spot Bitcoin is being released to market, instead it is GBTC Trust shares, Grayscale investors are forced into a six month lockup and the investors from January are now getting their shares. So will the share on locks cause a catastrophic price crash for Bitcoin? Let’s look at the numbers. No spot Bitcoin being released to market, I can’t emphasize this point enough. Here’s some curious points to consider. There are around 35,000 Bitcoin of shares unlocked June 20 to 23rd, during which Bitcoin also dropped 20%. It also coincided with the biggest China FUD news and miner sell-off. Want some more interesting numbers? December 19 to 21st saw 15,000 bitcoin shares release price dropped 10%, big releases in early February had no negative effects since Tesla and Musk forced the markets higher. March 22 and 24th saw 17,000 bitcoin worth of shares being released, bitcoin dropped 14%. Here’s the real big story: from April 14 at the top until May 20, one day post bottom, a total of 77,000 bitcoin worth of GBTC shares were released, the biggest single day release in that period May 20, one day after the bottom. Was someone shorting in advance of this release? This mega unlock period corresponds to a 50% drop in Bitcoin price. It is possible this is correlation and not causation, yes, but you must admit it is super suspiciously timed. Remember, no actual Bitcoin is being released to market and yet the correlation is incredible. Why are the markets dumping in unison with GBTC unlocks if no spot dumping is happening? It seems very clear that the institutions are shorting big time before major releases, it is likely they will short the coming unlock of 41,000 bitcoin worth of shares in late July. Final thoughts: in theory, a GBTC release should have no market impact on spot prices, but, this market like all markets, is massively manipulated and the gbtc product is too complex for most investors, so it allows manipulators to prey on you by spreading misinformation. The good news is that after July, there won’t be any more big GBTC unlocks anytime soon. So, August will likely be quite bullish as the effect of the institution’s shorting GBTC releases subsides. What am I doing? Same old, same old. Buying bitcoin on a regular basis and if the manipulators drop it in late July due to this malarkey, then I will buy more.”

So, as you can see, Lark has some theories around manipulation in the market but either way he’s not really worried, he sees this as, if anything, a transitory, temporary phenomenon. Willy Woo also had a thread on this, he wrote: “JP Morgan is bearish on the GBTC unlock coming up. Here I’ll go through the inner workings so you can make up your own mind. There are two impacts, one bullish and one bearish, the key is in how they interact. In my opinion, it’ll be immediately bullish. Grayscale is a unique product. It’s designed as a black hole that sucks in bitcoin, no bitcoin ever leaves the trust apart from Grayscale taking its 2% management fees from the holdings. This is the only way to reduce the GBTC inventory. How does GBTC increase its holdings? They allow accredited investors to add BTC into the trust holdings in return for receiving shares in the trust, which normally trades at a premium to BTC. This is the so-called “carry trade,” it’s historically been a lucrative trade, at times the premium is traded at over 100% to the underlying BTC and the trust. The only catch is you have to hold your shares for six months before you can sell them. The upcoming GBTC unlock we’re referring to are these shares unlocking and being available to be sold for cash. There are two impacts on the markets: one, derivatives playing the carry trade a.) buy Bitcoin spot, put it into Grayscale, b.) receive GBTC shares, c.) short BTC futures to hedge risk, d.) earn yield from shorting Bitcoin, e.) earn the GBTC premium unlocking, f.) sell GBTC shares for USD, g.) unhedged shorts. Option g.) is bullish.”

Effectively what Willie is saying here, is that part of this trade involved inherently shorting Bitcoin as a hedge, and when the trade itself unwind, so to do those shorts for his second market impact, he discusses the same sort of incentive that Ben Davenport was talking about before. He writes: “Two, spot markets. When GBTC shares unlock and get sold, the GBTC premium drops, share price drops relative to the bitcoin in the trust, investors now have more incentive to buy GBTC shares rather than BTC, it diverts some of the buying pressure on Bitcoin spot markets, this is bearish. One, the derivatives impact, is sudden and directly impactful while two, the spot market impact acts very slowly. The overall impact over the long term is neutral as it’s all arbitrage which balances out in time where we are analyzing the short term demand and supply imbalances which may impact price. There’s one more take on this that I want to add in and it comes from a post by QCP Capital. Effectively, their argument is that this is overblown and we’re only discussing it as much as we are because we have nothing else to discuss. They write, “the upcoming unlocks for institutional holders who subscribe directly to GBTC six months ago, and this batch consists of all the new Q1 2021 positions, largely, ARK’s last tranche. To state clearly, we don’t expect these unlocks on its own to have significant impact on the overall market outside of GBTC itself. Most of the large institutional positions who had subscribed in kind before have already been unlocked earlier, and they have held off selling at the current discounted price. Moreover, we know a large chunk of ARK stake is for a variety of their current ETFs like their next-generation internet ETF. The fact that the market is so focused on something like this just shows the lack of real catalysts of market-moving events right now.”

Let’s wrap this up and what to make of all of this? Well, for one, I genuinely have no idea what combination of bullish and bearish it is. And, I don’t think I’m alone, either. Altcoin Psycho asked a couple of days ago, “Is the GBTC unlock this month bullish or bearish?” Two days later and 140 comments later, there is no consensus. I will say that one perspective that probably also deserves some airtime is the efficient market hypothesis take, which is that GBTC unlocks are already priced in given that we’ve known about them for the entire duration of the trade. But, that would require a whole episode on the efficient markets hypothesis, so I think I’ll pass that for now. If I was really pushed, I think my argument would be that the unlock phenomenon is ultimately a pretty transitory phenomenon and one that, given that no one can really seem to decide what the outcome will be, is likely to net out to fairly neutral with only a little impact one direction or the other. What seems more significant to me is simply acknowledging how tied into the run-up the GBTC NAV trade was in the first place. In other words, the most bearish thing about Grayscale isn’t these set of unlocks, it was the shift from a premium to a discount and the consequent loss of perhaps the biggest buying pressure we had in the space. That helps stop the momentum going into the absolute barrage of FUD that characterized the last quarter. Ultimately, like I said at the beginning, I’m always interested to understand more about market structure and the forces shaping markets that aren’t just the narratives that makes so much intuitive sense to my brain. So, hopefully this journey has been helpful for you as well. If you still have questions, hit me up on Twitter @NLW and I’ll do my best to get them answered.
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