BITO - Unpacking Grayscale Digital Large Cap's 22% NAV Discount: Free Altcoins For Savvy Investors

2023-12-08 07:16:18 ET

Summary

• The Grayscale Digital Large Cap Fund (GDLC) is a closed-end fund that invests in five digital assets, primarily Bitcoin and Ethereum.
• GDLC currently trades at a 22% discount to its net asset value, creating potential arbitrage opportunities.
• Traders can go long GDLC while shorting the underlying assets or use it as a vehicle to get efficient access to Bitcoin, Ethereum, or its other underlying assets.

The Grayscale Digital Large Cap Fund ( GDLC ) is a closed-end fund that invests in five digital assets. The Fund's objective is to ensure that the value of its shares reflects the aggregate value of the digital assets it holds. When considering it keep in mind it charges a 2.5% fee and the index is periodically rebalanced. The rebalancing can have an impact on the weightings of the underlying. The fund currently trades at a 22% discount to net asset value or NAV. This is interesting for two primary reasons:

1) It opens up arbitrage opportunities where you can go long this fund and short derivatives of the underlying assets against it.

2) You can potentially get exposure to the underlying assets in a more efficient way.

Even if you're not interested in arbitrage or most altcoins, the fund is still interesting. I don't know much about most altcoins, but I don't have any objections when I can arguably get them for free.

What's interesting is that this fund mainly contains Bitcoin and Ethereum. Together, these two make up 95.77% of the fund's value. These are all of the assets and the weightings:

Meanwhile, Bitcoin can be shorted in the futures market at NAV or through different derivatives. The Grayscale Ethereum Trust ( ETHE ) trades at a 16% discount to its NAV. Ethereum ETFs or ETN's can be shorted in Canada and Europe at NAV. Wisdomtree has a physical Cardano ETP trading in Europe. These trades close to NAV. VanEck and 21Shares have products available on Matc trading in European markets. These trade at NAV.

Here is today's overview of the Grayscale single-asset products and their discount to NAVs:

When is this fund interesting?

There are various kinds of investors/traders for whom GDLC is currently interesting. I'll go into the reasons why:

1. Arbs with constrained crypto access

If you can't execute on any other arbs, I've been writing about here . It could be interesting to go long this fund and short the Bitcoin ETF ( BITO ), the Grayscale Ethereum Trust ((ETHE)) and Grayscale Solana Trust ( GSOL ) against it.

2. Bitcoin, Ethereum and Solana Holders

If you hold long-term single asset exposures to Bitcoin, Ethereum, Solana or a combination of these through various Grayscale funds, it could be better to restructure that exposure. A share of GLDC is currently $18.42.

As I write this pre-market on 7-12-2023, the fund contains the following crypto in USD values per unit:

• $16.89 Bitcoin
• $5.39 Ethereum
• $0.50 Solana
• $0.31 Cardano
• $0.153 Matic

These numbers are stale by now, but will still illustrate the idea here.

If you short a Bitcoin ETF against it, you almost get the other exposures for free.

If you short Bitcoin ETFs against one unit of GLDC worth $16.89 per unit, short $1.22 worth of the Grayscale Ethereum Trust per unit, and $0.18 of the Grayscale Solana Trust per unit; you get:

• $4.35 Ethereum
• $0.31 Cardano
• $0.153 Matic

Per unit as remaining long exposure per unit. Essentially, that's more or less free crypto exposure; theoretically, there is no market risk. In practice, keep in mind that these weird discounts can get even stranger and things may be marked against you in various ways.

3. If you hold Bitcoin and any combination of Ethereum/Cardano/Matic

If you hold long-term asset exposure to Bitcoin and any other cryptos in this fund, it could be considered to switch to this fund. The obvious caveat is that you're potentially locked into paying 2.5% fees for a long time.

Risks

I want to get into some high-level and practical risks that investors/traders could face when trying to exploit the discount this type of closed-end fund trades at. This isn't an exhaustive list, but it is a good start:

Conversion risk

Grayscale has a clear intent to convert the Bitcoin Trust into an ETF. The market appears to be buying into the idea that Grayscale wants to convert its Ethereum product.

I think that's a reasonable assumption. I'm not as sure the other funds, like this one, will be converted. It could depend on how the market develops. Will retaining locked-up assets under management be in the firm's best interest? Or if there is an opportunity to stake out the asset within a leading ETF wrapper?

This matters because the Grayscale Bitcoin Trust trades like it does (at only an 11% discount to NAV) because of the expected imminent conversion. The conversion also likely involves reduced fees on the assets under management. I mention this because I've written several articles about GBTC while trading at ~37% discount to its net asset value. A fund like this could easily trade at a more significant discount if the crypto market cools off again.

The GDLC fund (like most other Grayscale funds) charges a 2.5% fee. That's a lot of money; if you can't get out, you're stuck paying that. That's why closed-end funds usually trade at a discount. They can trade at a premium shortly after inception when running hot or the underlying asset is otherwise hard to access(point-in-case with these alternative crypto assets).

Borrow

Shorting incurs borrowing costs, and these are between reasonable and very high. I only call them reasonable in light of the incredible premia that some funds trade at. Check into these costs before setting up positions that require short positions because they can eat into the profit in a big way. For example, the annualized borrowing costs for the Grayscale Solana Trust are currently around ~60%.

Premium widening

The premia the Grayscale funds can trade at are so enormous that it is hard to say where they could go. An example is the Ethereum (ETH) trust having traded at a 3000%+ premium to NAV in the past. You could only combat this by waiting to engage in this trade when the premia starts falling. This is not a solution, but it could mitigate the risk.

Collateral mismatch

In theory, these are trades that have relatively little risk. You are holding similar assets on either side. In practice, it is possible your broker doesn't recognize this, and you get margin calls even though the position going against you is covered by a position moving in the right direction. My broker requires full collateral, and if the premium widens at first, it will quickly start eating into margin requirements. Positions need to be small and still require a lot of attention and active risk management. This is especially true if the long and short are held at different institutions.

Conclusion

The Grayscale Digital Large Cap Fun is a unique investment opportunity, particularly for those interested in the major cryptocurrencies like Bitcoin and Ethereum, which constitute over 95% of the fund's value. Trading at a 22% discount to its net asset value, GDLC also opens up potential arbitrage opportunities. Traders can profit from the discount by going long GDLC while shorting the underlying indirectly, or employing alternative strategies to capitalize on the current market dynamics. One compelling thing about this opportunity is that setting up attractive arbitrage trades only requires access to U.S. publicly traded assets.

The arbitrage trades are simple to understand, but they aren't easy to execute well. It's essential to consider the known risks and unexpected risks that may materialize. Some important risks are conversion risks, potential premium widening, borrowing costs, and collateral mismatches. In any closed-end fund arb it is essential to think through the risks well. It is especially true in the 24/7 fast-moving crypto markets.

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