Understanding the Relationship between GBTC and Grayscale in One Article

Communication and Sharing.

DCG has been frequently trending lately, with the continuous occurrence of a negative premium on GBTC becoming a market focal point. Concerns have arisen regarding whether Grayscale will be adversely affected by GBTC. The purpose of this article is to introduce the design principles of GBTC and explore potential risks associated with the negative premium.

What is GBTC?

Grayscale, a subsidiary of DCG, operates the Grayscale Bitcoin Trust, commonly known as GBTC. In essence, GBTC is a financial trust product introduced by Grayscale, distinct from the family trusts we typically discuss. It operates as a fund.

The initial design of GBTC aimed to meet the investment demand for Bitcoin from ordinary investors. The fund operates based on the evolving value of Bitcoin contained in the trust, essentially representing a certain quantity of Bitcoin for each GBTC. The introduction of GBTC can be seen as a risky financial innovation and, to some extent, the first compliant Bitcoin cash fund.

How does GBTC Subscription Work?

Firstly, there is the mechanism of physical creation, where investors can directly exchange Bitcoin for a specific quantity of GBTC. Secondly, there is cash creation, where investors provide cash to Grayscale, which then purchases Bitcoin with the funds and allocates the corresponding quantity of GBTC to the investors.

From this mechanism, the risk of GBTC seems relatively low, as it gives the impression of being backed by tangible value. However, the premise is that "GBTC can be converted back to Bitcoin."

Cancellation of Reverse Redemption

Initially, GBTC allowed redemptions, but on October 28, 2014, the U.S. Securities and Exchange Commission suspended the "GBTC redemption mechanism" due to alleged manipulation of GBTC redemption prices. This decision led to the suspension of the GBTC redemption mechanism.

It's noteworthy that Genesis, also a subsidiary of DCG, is equally popular. As Genesis plays a crucial role in the key transactions and redemption process of GBTC, controlling the buyback and cancellation operations, investors' transactions and redemption requests are mainly controlled by Genesis. Given this situation, the U.S. SEC suspended the redemption mechanism for GBTC. Grayscale also accepted the ruling in 2016, relinquishing profits obtained through redemption fees.

Therefore, the current operation mechanism of GBTC involves a 6-month lock-up period once subscribed. After unlocking, GBTC cannot be redeemed through Grayscale but can only be traded on the secondary market. This change will further diminish the liquidity of GBTC in the secondary market.

Risks of GBTC Product

With the cancellation of the reverse redemption function, GBTC is essentially decoupled from BTC. Its price depends on the trading activity in the secondary market.

During market prosperity, GBTC generates a higher premium, indicating that the total market value of GBTC has surpassed the value of BTC in the trust. In times of market panic, GBTC experiences a negative premium, signifying that the total value of GBTC is lower than the value of BTC in the trust. As a financial product targeting the mass market, its volatility is higher than expected, carrying significant fluctuation risks.

Additionally, GBTC holders are required to pay an annual management fee of 2% to the trust custodian. This management fee may not be significant during a bull market, but in the current bear market, investors need to bear more losses, potentially leading to increased sell-offs of GBTC. This reminds me of the oil negative pricing in early 2020, where oil had to be stored even if it couldn't be sold, incurring storage fees.

Difference between GBTC and Other Tokens

In reality, the design of GBTC essentially involves pledging BTC and then exchanging it for GBTC. However, this process is unidirectional, and the market value of GBTC does not directly anchor or reflect the locked BTC market value.

Moreover, concerning the lock-up mechanism, the value of GBTC is closely tied to the credibility of the trust institution. In other words, users choosing to invest in GBTC rely more on the protection of genuine justice in traditional finance than strictly adhering to the "code rules" of the crypto world.

Compared to the Stake mechanism in the crypto world, the greatest risk faced by GBTC comes from real-world "hacks." If the BTC assets pledged by GBTC are misappropriated, the value of GBTC will suffer a severe blow, resulting in significant losses. This highlights a unique risk faced by GBTC compared to other mechanisms in the crypto world.