The exchange-traded fund has made it easier for investors to buy and sell a multitude of illiquid assets. Sometimes, that’s a problem.
ETF investors are well-served by products like the
SPDR Gold Trust
(ticker: GLD) and
iShares Gold Trust
(IAU), which enable them to own the hard asset in an ETF, for instance. The crypto world, however, hasn’t proved to be nearly as sound.
Grayscale Ethereum Trust
(ETHE), launched on June 20. Its shares hit a peak of $526 on June 21, but in the two months since then have fallen 92%, to less than $40.
Etherium is not easy to explain, but let’s call it a programmable blockchain and a cryptocurrency. The Grayscale Ethereum Trust is also hard to explain—it’s not quite an exchange-traded, closed-end, or open-end mutual fund. It’s complicated enough that to purchase new shares, you need to be an accredited investor (with an income of more than $200,000 or a net worth or more than $1 million). New shares are created for accredited investors at essentially Ethereum’s value. But when those accredited investors want to sell, they must do so on the over-the-counter market, without the oversight of an exchange. Who’s buying? Retail investors. The problem? Those OTC shares can trade at a premium or discount to the trust’s Ethereum-based NAV.
So far, Grayscale Ethereum shares have traded at huge premiums, an absurd 1,825% on June 21, meaning that people were paying 18 times the value of the underlying cryptocurrency. As the price collapsed, the premium shrunk to a still-ridiculous 119%, as of Aug. 21, so the shares are now double the value of the underlying assets. During the same June-to-August span, Ethereum’s value as a cryptocurrency slid 39% because of overall securities markets’ volatility. For the currency to recover, it must gain 64%, while the trust’s shares must soar 1,232% to go back to $526.
There’s a similar, albeit less extreme, pattern with Grayscale’s older, more popular $2.4 billion
(GBTC). It had its highest premium of 142% in May 2015 near its initial public offering, its lowest premium of 0.1% on October 2015, and has averaged a 43% premium overall.
“There are probably quite a few things that affect the premium pricing in the market,” says Michael Sonnenshein, managing director at Grayscale Investments. “We ourselves do not trade the shares, and we’re not involved in the prices at which they end up being quoted each day. They’re purely subject to market forces and market interest. They are the first and only publicly quoted securities that provide exposure to digital currency. So, there are potentially not enough shares out there to satisfy the demand.”
True, but any retail investor can open a cryptocurrency account at a “digital currency wallet” such as Coinbase without paying such premiums to buy Bitcoin and Ethereum. If you link your regular bank account to a Coinbase wallet, it charges 1.5% of the value of each cryptocurrency transaction. That’s not cheap, but it beats paying a large premium. Also, bear in mind that Grayscale’s trusts have their own internal transaction costs and charge annual asset-based “sponsor” fees of 2% for the Bitcoin one and 2.5% for Ethereum.
The only winners here are the accredited investors who want to liquidate their position. Some did so at an 1,825% premium. Even though Ethereum itself has fallen 39% since then, accredited Grayscale investors can still avoid losses by selling at the current 100%-plus premium. The Ethereum and Bitcoin trusts have never traded at discounts.
“It’s a little unfortunate that accredited investors can buy at [NAV], and retail investors are forced to buy at a variable premium rate,” says Matt Hougan, global head of research at Bitwise Asset Management, a rival cryptocurrency money manager. “That’s not ideal.”
“Not ideal” is one term for it. Unfair is another. Bitwise also offers cryptocurrency investment funds for accredited investors, but doesn’t list them on the public markets, allowing its investors to redeem their shares at the NAV price directly through Bitwise—with no premiums or discounts. It also has filed with the Securities and Exchange Commission to launch a regular publicly traded Bitcoin ETF. “No retail investors should be buying a product trading at a 100%-plus premium,” Hougan says. “It’s just too risky.”
There are only two reasons that retail investors would pay such exorbitant prices. One is ignorance; the other is that they want cryptocurrency in their retirement accounts. Normal IRAs and 401(k)s don’t allow direct cryptocurrency purchases. (Self-directed IRAs, do, but they are complicated.)
Indeed, Grayscale promotes its Bitcoin Trust to retail investors on its Drop Gold blog as an easy way to access crypto in retirement accounts.
For some retail investors, the Bitcoin Trust trade has probably still worked despite being overpriced, as Bitcoin has soared in recent years. According to Morningstar, Bitcoin Trust shares have a whopping 96% five-year annualized return. Then again, in 2018, they fell 82%, more than the underlying NAV’s 75%. Add the premium phenomenon to an already volatile underlying investment and you have two ways of getting whipsawed.