GDLC - GDLC: Where's The Diversification?

Summary

• Grayscale's Digital Large Cap fund is the company's only tradeable fund that has exposure to multiple cryptocurrency assets.
• Despite that, GDLC has exposure to just five coins and is more allocated to Bitcoin and Ethereum than an industry peer.
• GDLC's asset inclusion methodology is a big reason why the fund isn't putting more coins into the fund.

With the continued failure of spot Bitcoin ( BTC-USD ) ETF applications, investor demand for Bitcoin exposure has been limited to a handful of options. The most notable of which, is probably the Grayscale investment trusts. Two of which have direct exposure to Bitcoin; pure play Grayscale Bitcoin Investment Trust (OTC:GBTC) and the Grayscale Digital Large Cap ( OTCQX:GDLC ) fund. The latter of which has exposure to more than one cryptocurrency asset. While GDLC has typically housed somewhere between eight and ten assets, fund shares currently only offer exposure to just five crypto assets:

Sources: Grayscale, CoinMarketCap

At a 63% fund allocation to Bitcoin, GDLC is tracking Bitcoin's dominance against proof of work coins as opposed to Bitcoin's dominance in the broad cryptocurrency market.

Bitcoin's actual dominance against the entire crypto market is actually closer to 40%. Ethereum's is a little under 19%. While there are thousands of crypto tokens, many of which are zeroes long term, exposure to all of them would not be advisable or even feasible. But, there are many tokens that have a strong chance of making it in the long run. Judging from the proliferation of single asset funds that are available from the company, it would seem that Grayscale agrees with that assessment. Given that, it's perplexing that Grayscale's diversified fund has just a 5% allocation to alternative coins.

Comparison to Peers

While Grayscale is probably the most widely recognized digital asset investment company, Bitwise Investments also offers a diversified crypto asset fund. The Bitwise 10 Crypto Index Fund ( BITW ) has a slightly smaller exposure to Bitcoin and Ethereum and has ten assets under management rather than five; including Polkadot ( DOT-USD ), Polygon ( MATIC-USD ), Litecoin ( LTC-USD ), ChainLink ( LINK-USD ), and Uniswap ( UNI-USD ).

Sources: Grayscale, Bitwise

While GDLC's exposure levels to Solana, Cardano, and Avalanche are almost identical to BITW's, the Grayscale fund has the same management fee and roughly half the AUM of Bitwise's fund. For a fund that aims for diversification, GDLC's actual exposure to that strategy is lacking in my view.

Discount vs. Pure Play Funds

In the last year and a half, investors have seen almost all of these crypto investment funds move from premiums to NAV to discounts to NAV. The NAV, or net asset value, of these fund shares is the valuation of the underlying assets in the fund based on how much of that asset is represented by each share:

Sources: Grayscale, Bitwise

The Bitwise fund has a much larger discount to NAV - possibly explainable by the different tax treatment BITW has compared to GDLC. You can read more about that difference here . But compared to just Grayscale funds, GDLC has a slightly larger discount than GBTC and a considerably larger discount than Grayscale's Ethereum fund ( OTCQX:ETHE ). If you're only looking to play Grayscale's price arbs, there's a case to made for going long GDLC rather than GBTC or ETHE.

While July saw a NAV discount in GDLC that actually eclipsed 40%, GDLC is still highly undervalued compared to the fund's historical trend.

Methodology Flaw?

From where I sit, the biggest question surrounding this fund is what is the reason for such a small footprint of broad market crypto assets in what is marketed as a diversified fund. Grayscale's methodology sheet , which still falsely cites Bitcoin Cash ( BCH-USD ), Litecoin, and Chainlink exposure, gives insight into how assets are designated for inclusion into the fund. Here's two of the key metrics for inclusion:

For inclusions, each new asset to be included in the Fund’s portfolio must have a market capitalization at least 1.25 times that of the smallest Fund Component at the time of measurement, on a trailing 90-day average market capitalization, and on a trailing 90-day median market capitalization. In addition, each new asset must demonstrate an average 30-day trade volume of at least 30% of its current market capitalization .

I think the second point is likely why the fund isn't getting more inclusions. 30% volume to market cap is a difficult metric to achieve. For instance, most of the large cap assets fail to achieve that mark.

I've compared the daily volume to market cap percentage over the last 90 days for Bitcoin, Ethereum, Avalanche, and Polygon. None of them actually achieve 30% volume to market cap averages over any 30 day period in the last 90 days. Bitcoin's average over the last 90 days is just 7%. And at a 13% daily volume to market cap average, MATIC is the closest of the four sampled to accomplishing a 30% metric and it's the only one that isn't actually in GDLC. The point is, I think the methodology for asset inclusion may need tweaking.

Summary

I don't see much justification for holding GDLC shares at this point in time. As investors, I think the time to be overweight Bitcoin and Ethereum is before the market selloff has intensified, not after. Because GDLC's fund is so concentrated to the top 2 crypto assets by market cap, whenever the market sentiment turns bullish again, GDLC is likely to lag the crypto market broadly speaking because outperformance will come from exposure to alt coins. Currently, there just isn't enough exposure to the alts in GDLC after such a sizeable selloff in the broad crypto market. For a fund that charges a 2.5% management fee, shareholders should be getting more active management than what they're getting.

For crypto investors who want altcoin recommendations, BlockChain Reaction subscribers get access to my live crypto portfolio. Currently, I have a 37% allocation to Bitcoin. Each month, I provide two Top Token Ideas that I believe will perform well against the broad cryptocurrency market. As of submission, an equal weighting of exposure to those ideas is outperforming Bitcoin by roughly 1,600 basis points.

For further details see: