The World’s Largest Bitcoin Fund Is Troubled. Here’s Why.

With $37 billion in assets, the Grayscale trust is the world’s largest Bitcoin fund. It towers over every other fund on the market. Its next-closest rival, the

ProShares Bitcoin Strategy

(BITO) exchange-traded fund, has racked up $1.3 billion in assets since launching in October.

Investors have flooded into the Grayscale trust because it owns Bitcoin directly, while the ProShares ETF and others gain exposure through futures contracts. The Securities and Exchange Commission hasn’t approved a spot-based Bitcoin ETF, recently rejecting an application from VanEck.

“An ETF is the most efficient way to resolve any discrepancy between our products’ share price and the NAV,” a Grayscale spokesman says. “Investors want their Bitcoin exposure in the form of a Bitcoin Spot ETF, and, at Grayscale, it’s what we believe they deserve.”

Many institutional investors own Bitcoin through the Grayscale trust. Its largest holder is Ark Invest, the fund shop run by Cathie Wood, which has invested $375 million in the trust, including assets held in its

Ark Next Generation

ETF (ARKW). At least 47 mutual funds and separate accounts own stakes in the trust, according to Morningstar.

But many of those investors would have been better off owning Bitcoin directly, according to a Morningstar report issued Monday.

Shares of the trust, which trade over the counter, are up 42% this year versus a 95% gain for Bitcoin, through Oct. 29. Over the last year, the shares have gained 220% versus 340% for Bitcoin, according to Morningstar. The gap has widened over time. The Trust is up 648% and 4,048% for the respective three- and five-year periods, versus 876% and 8,427%, respectively, for Bitcoin.

Some of the performance gap comes down to the trust’s 2% annual expense ratio. That is well above the roughly 1% fee charged by ETFs and mutual funds that own Bitcoin through futures contracts.

The bigger problem is that the Grayscale Bitcoin Trust is structured like a closed-end fund with a fixed number of shares on the market. The shares may trade at a premium or discount to the fund’s underlying net asset value, or NAV, depending on market demand.

The shares currently trade at a 14% discount. That means investors who buy on the open market are effectively getting $1 of Bitcoin for 86 cents on the dollar.

That sounds like a great deal, but the discount to the NAV isn’t likely to narrow soon. And since the fund has traded at steep premiums, investors buying on the open market have overpaid for Bitcoin itself.

The fund traded at premiums to its NAV from Nov. 1, 2018, to March 1, 2021, when it flipped from a premium to a discount.

An investor who bought the fund on the market on Dec. 22, 2020, when the premium was at its peak, would have gained 64% through October, according to Morningstar. But Bitcoin itself rose 160% over that stretch.

“Investors that crowded into GBTC, buying at a premium, really got burned,” says Morningstar analyst Bobby Blue.

Accredited investors, with at least $1 million of net worth or annual income above $200,000, may have done better. Such investors are eligible to buy the shares directly from Grayscale at the NAV price. Grayscale filed for 35 private placements throughout 2020 and into early 2021, according to Morningstar.

When the trust traded at a premium, buying at the NAV could have paid off handsomely, since investors gained access to assets at a discount to their market price.

Grayscale collected $1.2 billion in assets from accredited or institutional investors in December, 2020, a period when the Trust traded at premiums of 19% to 40%, according to Morningstar.

“Those stuck buying on the open market had to do so at a significantly marked-up price,” says Blue. He notes that the premiums spiked from October 2020 to February 2021, as meme stocks surged and Bitcoin’s price soared.

Grayscale filed an application with the SEC in October to convert the Trust to an ETF. But the SEC’s recent rejection of a spot-Bitcoin ETF signals that regulators aren’t yet comfortable with the underlying spot market. SEC Chairman Gary Gensler has indicated that the regulatory path for Bitcoin ETFs goes through the futures market.

Grayscale parent company Digital Currency Group announced in October that it would buy back up to $1 billion of the trust on the market. DCG said it had already bought back $388 million worth of shares. But that hasn’t moved the needle on the discount, partly because it amounts to about 1% of the fund’s assets.

Another reason the discount hasn’t narrowed: more competition for Grayscale. Several Bitcoin futures ETFs are now trading the U.S., all of which have lower fees, along with some spot-based ETFs on the Canadian market.

Grayscale has incentives not to convert to an ETF, too. Its 2% expense ratio is generating $740 million in annualized fee income at recent asset levels. ETFs generally charge about half that expense ratio, and Grayscale earns its fee on the NAV, not the underlying share price, which may be lower.

Grayscale did not immediately reply to a request for comment.

Write to Daren Fonda at daren.fonda@barrons.com