Six Questions and Answers: What Does the Conversion of GBTC to a Spot ETF Really Mean?

Source: Grayscale

Compiled by: Mary Liu, BitpushNews

At Grayscale, we believe that the approval of a spot Bitcoin ETF by U.S. regulators is a question of "when," not "if."

We remain focused on listing GBTC as a spot Bitcoin ETF on NYSE Arca. While the timeline is inherently uncertain, looking ahead, we spoke with Grayscale's Chief Legal Officer Craig Salm and Chief Financial Officer Edward McGee to address some common questions from investors and other market participants regarding the process and implications of listing products like GBTC on exchanges, including the process for GBTC to be listed on NYSE Arca and what it means for investors to trade GBTC as an ETF.

Q: First, can you give us an overview of how ETFs generally operate?

A: An ETF is an investment product whose shares are traded on national securities exchanges (such as NYSE Arca, Nasdaq, or CBOE). ETFs can simultaneously create and redeem shares, designed to allow ETF shares to trade at or near the value of their underlying assets or holdings (commonly referred to as net asset value or NAV).

Market participants known as authorized participants (APs)—primarily broker-dealers, such as banks or trading firms with certain registration qualifications—are incentivized to create ETF shares when the trading price of the shares is above the ETF's NAV, or to redeem ETF shares when the trading price is below the ETF's NAV.

APs are typically the only market participants that can engage in such transactions with the ETF. These creation and redemption transactions provide APs with an opportunity to profit through this arbitrage mechanism, which serves as an incentive to ensure that the ETF tracks the value of its underlying assets. ETFs that closely track their NAV also incentivize non-AP brokers and investors to buy and sell shares in the open market without needing to create or redeem shares. The higher the liquidity of ETF shares, or the greater the ease of access and trading volume, the less reliance there is on creation and redemption transactions.

Q: How does GBTC operate today?

A: GBTC is an investment trust that holds over 3% of the total circulating Bitcoin. As of November 29, 2023, each share of GBTC is backed by 0.0008968 BTC. GBTC does not own anything other than Bitcoin, and it does not use leverage or derivatives like Bitcoin futures contracts; the underlying Bitcoin tokens are stored in secure offline storage. Grayscale is responsible for overseeing the daily management of GBTC, including managing custody relationships, communicating with regulators, tax reporting, financial statements, and other requirements for publicly traded investment vehicles.

GBTC shares have historically been issued through a private placement process that does not require registration under the Securities Act of 1933, meaning these shares were initially available only to accredited investors and subject to a holding period under Rule 144, and GBTC shares cannot be redeemed. To provide liquidity, GBTC obtained a public quotation on the OTCQX market in mid-2015. Since then, any investor able to access the public market can buy and sell freely tradable GBTC shares, allowing them to increase their investment in Bitcoin within their investment accounts.

However, due to Rule 144, newly created shares must go through a holding period, and if the trading price of GBTC shares on OTCQX is above GBTC's NAV, APs cannot create more shares to immediately add to the market and adjust the price according to GBTC's NAV. Conversely, since GBTC does not provide a redemption program, if the trading price of GBTC shares is below GBTC's NAV, APs cannot redeem shares to remove them from the market and adjust the price according to GBTC's NAV. Therefore, GBTC cannot rely on the inherent arbitrage mechanism described earlier. GBTC shares can and have traded at both premiums and discounts to their NAV.

The innovation of the ETF product structure lies in its arbitrage mechanism, which allows for the continuous creation or redemption of shares to address premiums and discounts.

Importantly, under the ETF model, GBTC shares are expected to track the price of Bitcoin more closely, meaning that any premiums or discounts in the price of GBTC shares are expected to disappear. As of November 29, 2023, GBTC's assets under management stand at $23.4 billion, with a trading discount of 8.09%, equating to $1.89 billion. This means that, assuming the current discount disappears, GBTC would release approximately $1.89 billion in value for investors through the arbitrage mechanism once it is listed on NYSE Arca and becomes an ETF.

Q: What would happen to GBTC if the SEC grants appropriate regulatory approval to allow a spot Bitcoin ETF to enter the U.S. market?

A: The creation of GBTC shares would be registered with the SEC through a registration statement on Form S-3 under the Securities Act of 1933. The redemption of GBTC shares is expected to be granted an exemption under SEC Rule M, previously awarded to products with similar characteristics. This would provide GBTC with the necessary approvals to create and redeem simultaneously, allowing for arbitrage opportunities when there are any premiums or discounts between the price of GBTC shares and GBTC's NAV, enabling GBTC to track the value of its underlying asset, Bitcoin, more closely. Once the SEC approves the NYSE Arca's 19b-4 rule application, GBTC will also upgrade from OTCQX to NYSE Arca.

GBTC has long been prepared to operate as an ETF. Upon receiving the appropriate regulatory approval, Grayscale will immediately work with our partners to list GBTC on NYSE Arca.

Q: If the SEC approves a spot Bitcoin ETF and allows GBTC to list on NYSE Arca, what must GBTC investors do?

A: GBTC investors do not need to take any action. When investors look at their holdings of GBTC shares after the listing on NYSE Arca, they will simply see those shares listed on NYSE Arca rather than quoted on OTCQX. GBTC will retain the same ticker symbol (GBTC) and the same CUSIP, and investors will continue to be able to buy and sell GBTC shares at market prices.

Q: What tax implications should I be aware of when GBTC upgrades to NYSE Arca?

A: None. The listing of GBTC on NYSE Arca will not constitute a taxable event.

Q: Is there a timeline for when GBTC will be approved to list on NYSE Arca?

A: Unfortunately, there is not. Although the D.C. Circuit Court made a favorable ruling for Grayscale in August 2023 regarding the SEC's lawsuit, which overturned the SEC's decision to deny the NYSE's 19b-4 application to list GBTC on NYSE Arca. This is an unprecedented situation, and the timeline is inherently uncertain. The Grayscale team is committed to constructive cooperation with the SEC to bring GBTC to NYSE Arca and will continue to share updates in a timely manner as more information becomes available.