GDLC - Grayscale Digital Large Cap Fund: Achievement Unlocked

2023-12-01 09:00:00 ET

Summary

• While still high at 22%, Grayscale Digital Large Cap has seen its discount close over the last few months.
• The fund has outperformed both Grayscale sister funds GBTC and ETHE during much of 2023.
• The discount adjustment that I've been using to value GDLC since June is now showing a fund that is priced more in line with what might be fair value.
• I'm still personally long, but I've now taken some profit in GDLC after what has been a terrific trade.

It has been three months since my previous coverage of Grayscale Digital Large Cap Fund ( GDLC ). This is a fund I've covered three times in the past.

• Grayscale Digital Large Cap: Plenty of Meat Still On The Bone
• Grayscale Digital Large Cap: A Potential Arbitrage Opportunity
• GDLC: Where's The Diversification?

Quickly recapping my general thoughts on GDLC; as a diversified crypto asset fund, Grayscale has missed the mark with this product. I think the Bitwise 10 Crypto Index Fund ( BITW ) is a better alternative to GDLC if you want exposure to a variety of coins in one ticker. However, because GDLC has been so bad as a diversified crypto investment vehicle, it's actually been more interesting as an arbitrage trade just because of the 96% allocation to Bitcoin ( BTC-USD ) and Ethereum ( ETH-USD ).

Over the last eleven months, we've seen the NAV discounts close in the Grayscale Bitcoin Trust ( GBTC ) and the Grayscale Ethereum Trust ( ETHE ). Those arbitrage trades have performed marvelously on top of the asset appreciation from the underlying:

Despite the significant NAV discount closures in GBTC and ETHE this year, GDLC still trades at a 22% discount to net asset value. What I've done in each of my last two GDLC articles is provide a NAV discount adjustment that projects where GDLC shares should be if the crypto held in that fund was valued the same way the crypto held in Grayscale's other funds was valued.

Critiquing The Process

Just because I might believe Grayscale's BTC and ETH should be valued the same between their funds, that doesn't necessarily mean the market will agree. In the last article, there was a good discussion about why the discount in GDLC should theoretically lag ETHE and GBTC. Quoting a commenter :

Bitcoin alone and Ethereum alone have applications on the table ready to be approved to become spot ETFs...not only GBTC and ETHE, but also at several other companies like Blackrock, Fidelity, and 21shares/Ark. So, I think that those are very likely to happen. WILL a spot ETF be approved to convert GDLC which holds also SOL, ADA, and MATIC (Solana, Cardano, and Polygon), I don't know! And that scares me. I don't think it will nearly as easily get approved to be a spot ETF which would exactly mirror the price of all 5 things in it.

Frankly, this is a terrific point and the commenter continued that Solana ( SOL-USD ), Cardano ( ADA-USD ), and Polygon ( MATIC-USD ) have all been deemed to be unregistered securities by the SEC. Thus, any closed-end fund that holds them is unlikely to be converted to a spot ETF. I happen to agree with that.

However, if GDLC's NAV rate were to still trade at deeply depressed levels even as other Grayscale funds have been successfully converted to spot ETFs, there are things Grayscale could do to counteract that. The company could buy shares on the open market to help close the window. Or it could simply close the fund and distribute the proceeds from asset liquidations - in this instance, holders of GDLC would capture the premium. And since related parties hold about 8% of the fund's shares, there would theoretically be a motivation to do this.

Given the amount of trading volume each of these currencies has during a typical day, I view it as unlikely that liquidating the 6,200 BTC and 38k ETH in the fund would dramatically impact the value of the fund's assets. But each of these situations is probably unlikely because I don't think they're necessary. In fact, my thesis has already worked.

Updating The Discount Adjustment

GDLC has had a terrific run over the last several weeks. So much so, that it justifies reassessing where we currently are with this valuation model that I described above. If we do the same thing we've done in the past and zero out the SOL, ADA, and MATIC and focus exclusively on the ETH and BTC in GDLC, a revaluation in line with ETHE and GBTC would discount the Ethereum by 13% and the BTC by 8%. Here's how that adjusted discount would value GDLC shares currently:

Source: Grayscale, Author's calculations

Given GDLC's closing price of $16.00 on November 29th, we can now reasonably say the fund is trading at fair value, adjusting for the other fund discounts. If, like me, you've been playing this trade purely as an arbitrage, this could be a decent time to start locking in the gain in GDLC.

GDLC has outperformed both ETHE and GBTC over the last week, month, 6 months, and year to date. It has been a marvelous trade. In my last GDLC article, I said there was still meat on the bone. Even just a few weeks ago , I felt there was still quite a bit of upside in GDLC. However, after a 20% rip in the last two weeks, there is now much less meat. That doesn't mean one has to sell out of GDLC. There's nothing wrong with holding it from here. But purely from a NAV discount play, I think the achievement has been unlocked.

Additional Considerations

Even though it looks increasingly like we will get spot ETFs for Bitcoin soon at minimum, cryptocurrencies continue to be among the riskiest of the risk assets. The value of the collateral backing GDLC shares could decline, and in that case, the price of GDLC shares will almost certainly decline as well. There continues to be related party risk as Grayscale's parent company and sister companies own 8% of the fund, while there are still ongoing financial issues with Grayscale's parent company Digital Currency Group.

Investor Takeaways

In my view, Bitcoin and Ethereum will be higher a year from now. In that scenario, GDLC shares will likely move higher as well. We've experienced quite a bit of excitement for spot ETFs over the last few months. But the fact of the matter is, despite all that excitement, we still don't actually have an approval yet. And as a long-term investment that is designed for asset diversification, GDLC's methodology still leaves quite a bit to be desired.

That said, if you like BTC, ETH, and SOL, GDLC may not be a bad option. I wouldn't touch the Grayscale Solana Trust ( GSOL ) even after a 50% selloff. But GDLC could certainly see its NAV window continue to close if ETHE and GBTC get to low-single-digit discounts. I don't see much of a need to wait around for that though with a big size. I'm personally still long GDLC shares. But I have locked in some profit after what has been both a sizeable move up this year and also a discount window that is now more in line with where I believe it should be.

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