On Monday, I wrote about the weekend’s drop in Bitcoin and how its technical situation seemed to change nearly overnight. The 50-day moving average, which had been a bulwark of support during the cryptocurrency’s parabolic rise, instead became a source of resistance as it failed to contain last weekend’s fall. I attributed the bulk of the plunge to an ebbing of misguided enthusiasm ahead of last week’s Coinbase (COIN) listing, and I still believe that to be the case. But upon further research, I realized that I missed a possible warning sign in the valuation of the Grayscale Bitcoin Trust (GBTC). 

The trust has been trading at a discount to its net asset value (NAV) since February. This was a significant change since GBTC has traded at a premium throughout its existence. The fund was established in 2013, but I can only track its NAV from May 2015 when it became exchange-traded. Consider the following graphs, paying special attention to the right-hand side of the lower chart:

GBTC Price vs NAV Since May 2015

Source: Bloomberg

Here is a closer view of the same chart over the last 6 months, which makes the NAV discount easier to spot:

GBTC Price vs NAV Past 6 Months

Source: Bloomberg

For those investors who are used to ETFs that generally mirror the NAV of their holdings, GBTC’s wild swings around NAV may seem confusing. GBTC is an open-ended unit trust, akin to a closed-end fund, and a relatively uncommon structure that avoided the SEC’s reluctance to approve crypto-linked ETFs. A trust of this nature can allow the creation of units on a delayed basis or halt them outright, and there is no facility for redemptions. This is in contrast to an ETF, which typically allows creation and redemption on a daily basis. If an ETF trades far enough above or below its NAV, arbitrageurs are incentivized to capture that differential by selling or buying the components of the ETF and redeeming or creating units as necessary. In the case of GBTC, the delayed creation mechanism meant that potential creators would expose themselves to market risk even when the trust traded well above its NAV.  Essentially, there was a steady demand for the trust and the market was unable to keep up with it. That led to the persistent premium attributed to GBTC, and the premium tended to widen during periods when bitcoin was rising sharply. 

That dynamic changed dramatically in February, and GBTC began to trade at a discount.  It wasn’t because of a lack of demand for bitcoin, because the cryptocurrency continued to rise for most of the ensuing weeks. Instead, I attribute it to the listing of two bitcoin ETFs in Canada. Evolve Bitcoin ETF (EBIT) began trading on the TMX on February 19^th and the Purpose Bitcoin ETF (BTCC) followed on the 24^th. It is hardly a coincidence that the NAV premium evaporated around that time. GBTC’s premium was widely reported in the media, and it was quite rational for investors to shift their focus to products that are designed to track bitcoin more efficiently. 

I then questioned whether there was an arbitrage opportunity between GBTC and the CME listed bitcoin futures. With bitcoin trading around $54,500 today, the December futures had a last sale of $58,000. In theory, one could buy GBTC at a discount, sell the long-term futures at a premium and wait for the spread to collapse. The problem with that is that, as we noted, there is no explicit mechanism to induce GBTC to trade at NAV. And arbitrage is meant to be risk-free – this would simply be a relative value trade. Alternatively, one could buy sufficient bitcoin, submit them for creation to GBTC and hedge the time risk by selling those futures. Unfortunately, neither idea seems workable because the futures are too illiquid. The bid/ask on the December futures was 55,900 – 60,745, the volume was 3 and the open interest was 34 contracts. It would be unlikely, if not impossible, to sell enough longer-term futures at a reasonable price in order to properly hedge either trade.

Bitcoin may not be entering a downtrend yet. Most of its key moving averages are still rising. Even at a slower rate, that defines an uptrend. But we are starting to see warning signs for bitcoin, both in its price action and in the demand for related products like GBTC. It will be interesting to see whether the recent dip is simply profit taking, or whether there are more ominous warning signs on the horizon.