The Worst Way to Buy Bitcoin – The Motley Idiot
The Worst Way to Buy Bitcoin
Investing in bitcoin isn’t effortless. It’s an online currency for the tech-savvy, difficult to buy and perhaps even stiffer to store securely. Thus, many investors and speculators have turned to an lighter way to own bitcoin, the Bitcoin Investment Trust (NASDAQOTH:GBTC) .
The Bitcoin Investment Trust was designed to make holding bitcoin as effortless as buying a stock or exchange-traded fund. Traded over the counter, the trust holds about 0.093 bitcoin for each share outstanding. Wielding a share is thus the equivalent to wielding about one-tenth of a bitcoin.
But like anything, shares of the Bitcoin Investment Trust are governed by the laws of supply and request, and impatient speculators are willing to pay more for each share than the trust’s bitcoins are worth. The fund recently traded for $531 per share, or 105% more than the underlying bitcoin is worth, according to my calculations.
Why this happens
It isn’t unusual for closed-end funds to trade at a price that differs from their net asset value. Some funds trade at premiums, while the majority trade at a discount. But what is unusual is the size of the premium — a 105% premium is a massive outlier to the rest of the closed-end fund world. Historically, closed-end funds have traded for a Four.5% discount to their net asset value, on average.
Bitcoin Investment Trust investors could lose money, even if bitcoin prices keep enlargening. Picture source: Getty Pics.
The sponsor of the trust, Grayscale Investments, recently filed to list the trust on the NYSE Arca exchange, where you’ll find most legitimate ETFs. At the same time, it suspended the creation of fresh trust units, which means that there won’t be any fresh shares created, at least not any time soon.
Even when it was actively issuing fresh units, creation wasn’t keeping up with request. Securities and Exchange Commission filings showcase it created only 31,400 shares in two thousand seventeen in the days leading up to its S-1 filing. With no fresh supply and an enlargening amount of request, the premium has widened quickly. Shares have traded at an average premium of 39% to underlying value of the bitcoin, according to my calculations.
Photo source: Author.
A big risk
Speculators who pay a premium to buy shares of the trust are taking a big risk by assuming that the supply and request imbalance is permanent. But things could switch, and quickly: Bitcoin could fall out of favor, or speculators could find lighter ways to buy and sell bitcoin quickly and in quantity. After all, as recently as April 13, shares traded at a mere 8% premium to NAV.
I find the premium difficult to justify. If anything, I’d argue shares should trade at a discount, given the trust’s 2% annual management fee that leisurely licks away at the bitcoin backing each share per year.
Closed-end fund investors often capitalize high management fees at ten times when valuing a fund. A fee of 2% per year capitalized at ten times means shares should theoretically trade at a 20% discount to the market value of the underlying bitcoin. The share price would have to fall by as much as 60% to get to a 20% discount to their net asset value, assuming no switch in the price of bitcoin.
I have no particular insight into where bitcoin will go from here, but I do know one thing: Fund premiums to net asset value have a tendency to revert to the mean. Investors who hold Bitcoin Investment Trust shares could thus stand to lose money even if bitcoin prices keep moving higher. Buyer beware.
Jordan Wathen has no position in any stocks mentioned. The Motley Idiot has no position in any of the stocks mentioned. The Motley Idiot has a disclosure policy.