Q&A: What does it mean to convert GBTC to a spot ETF?

Source: Grayscale

Compilation: BitpushNews Mary Liu

At Grayscale, we believe U.S. regulators approve spot BTC ETFs as a matter of “when,” not “if.”

We remain focused on listing GBTC as a spot BTC ETF on NYSE Arca. While the timeline is inherently uncertain, looking ahead, we sat down with Grayscale’s Chief Legal Officer Craig Salm and Chief Financial Officer Edward McGee to answer some common questions from investors and other market participants about the process and impact of listing products like GBTC on stock exchanges, including the process for GBTC’s listing on NYSE Arca, and what trading GBTC as an ETF means for investors.

Q: First of all, can you give us an overview of how ETFs work in general?**

A: An ETF is an investment product in which its shares are traded on a national stock exchange, such as NYSE Arca, NASDAQ, or CBOE. ETFs have the ability to add to and redeem shares at the same time, with the aim of having the ETF’s shares traded at the value of its underlying assets or holdings, often 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 registered credentials) are incentivized to create ETF shares when their shares are trading above the ETF’s NAV, or to redeem ETF shares when their shares are trading below the ETF’s NAV.

APs are typically the only market participants that can conduct such transactions with ETFs. These creation and redemption transactions give APs the opportunity to earn profits through this arbitrage mechanism, which is an incentive to ensure that ETFs track the value of their underlying assets. ETFs that closely track their net asset value can also incentivize non-AP brokers and investors to buy and sell shares on the open market without having to create or redeem shares. The higher the liquidity of ETF shares, or the higher the volume of free access and trading, the less reliance there is on creation and redemption transactions.

Q: How does GBTC work today?**

A: GBTC is an investment trust that owns more than 3% of the total BTC currently in circulation. As of November 29, 2023, GBTC per share was backed by 0.0008968 BTC. GBTC doesn’t own anything other than BTC, GBTC doesn’t use leverage or use derivatives like BTC futures contracts, and the underlying BTC tokens are kept in secure offline storage. Grayscale oversees the day-to-day management of GBTC, including managing custody relationships, communications with regulators, tax reporting, financial statements, and other requirements for publicly traded investment vehicles.

Historically, GBTC shares have been issued through a private placement process, which is not subject to registration under the Securities Act of 1933, so such shares are initially open only to accredited investors and are subject to the holding period set forth in Section 144, and GBTC shares are not redeemable. In order to provide liquidity, GBTC was publicly quoted on the OTCQX market in mid-2015. Since then, any investor with access to the open market can buy and sell freely tradable GBTC shares, allowing them to increase their investment in BTC in their investment accounts.

However, due to Rule 144, newly created shares must go through a holding period, and if GBTC shares trade above GBTC’s NAV on OTCQX, AP cannot create more shares to immediately add them to the market and readjust the price based on GBTC’s NAV. Conversely, since GBTC also does not offer a redemption plan, if the GBTC shares trade below the NAV of GBTC, AP cannot redeem the shares to remove them from the market and readjust the price based on the NAV of GBTC. As a result, GBTC cannot rely on the arbitrage mechanisms inherent in ETFs as described earlier. GBTC shares can and have been traded at a premium and discount to their net asset value.

The innovation of the ETF product structure is that it has an arbitrage mechanism, which can continuously add or redeem shares to solve the premium and discount.

Importantly, in the ETF model, GBTC’s stock is expected to track the price of the BTC more closely, which means that any premium or discount to the GBTC share price is expected to disappear. As of November 29, 2023, GBTC had $23.4 billion in assets under management, and its trading discount was 8.09%, or $1.89 billion. This means that, assuming the current discount disappears, GBTC will unlock approximately $1.89 billion in value for investors through an arbitrage mechanism once it is listed on NYSE Arca and becomes an ETF.

Q: What would happen to GBTC if the SEC gave the appropriate regulatory approvals to allow spot BTC ETFs to enter the U.S. market?

A: The creation of GBTC shares will be registered with the SEC pursuant to the Securities Act of 1933 through a registration statement on Form S-3. Redemptions of GBTC shares are expected to occur pursuant to a Regulation M exemption previously granted by the SEC for products with similar characteristics. This will provide GBTC with the necessary approvals for simultaneous creation and redemption to provide arbitrage opportunities in the event of any premium or discount between the GBTC share price and the net asset value of GBTC, allowing GBTC to more closely track the value of its underlying asset BTC. GBTC will also be upgraded from OTCQX to NYSE Arca once the SEC approves NYSE Arca’s Rule 19b-4 application.

GBTC is ready to operate as an ETF for a long time. Grayscale will work with our partners to list GBTC on NYSE Arca as soon as the appropriate regulatory approvals are obtained.

Q: What must GBTC investors do if the SEC approves a spot BTC ETF and allows GBTC to list on NYSE Arca?

A: GBTC investors do not have to take any action. When investors look at their holdings of GBTC shares after they have been listed on NYSE Arca, they will only see the shares listed on NYSE Arca and not quoted on the 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 open market prices.

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

A: No. GBTC’s listing on NYSE Arca will not constitute a taxable event.

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

A: Unfortunately, no. This is despite the DC Circuit’s ruling in favor of Grayscale in the August 2023 lawsuit against the SEC, thereby reversing the SEC’s decision to deny NYSE’s 19b-4 application to list GBTC to NYSE Arca. This is an unprecedented situation, and the timeline is inherently uncertain. The Grayscale team is committed to working constructively with the SEC to get GBTC live on NYSE Arca and will continue to share timely updates as more information becomes available.