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Why ‘Smart Money’ is Paying a ‘Dumb Premium’

Grayscale Investments, LLC, the biggest crypto investment fund, creates on-ramps for institutional investors to invest in cryptocurrencies. We have seen a huge influx of ‘smart money’ getting into the space and Grayscale has created financial instruments that these investors can understand. At the time of writing, they have $4.8 billion in assets under management.

Instruments like shares from actively managed funds like Grayscale Bitcoin Trust (GBTC) and Grayscale Ethereum Trust (ETHE) are offered to investors that are looking for traditional methods of investing. The annual management fee revolves around 2.5%–3% as shown in their fee and performance schedule (figure 1).

Figure 1

You can also notice that the performance of their funds have been horrific. Why is there such a misalignment with performance of the trust and the asset it represents? The answer is in their fine print:

The shares of each Product are intended to reflect the price of the digital asset(s) held by such Product (based on digital asset(s) per share), less such Product’s expenses and other liabilities. However, because none of the Products currently operates a redemption program, there can be no assurance that the value of the shares of such Product will approximate the value of the digital asset(s) held by such Product, less such Product’s expenses and other liabilities, and the shares of such Product may trade at a substantial premium over, or a substantial discount to, the value of the digital asset(s) held by such Product, less such Product’s expenses and other liabilities. Moreover, the prices of the underlying digital assets are derived from third-party indices and reference rates, and no assurance can be given as to the accuracy of these prices.

If you read carefully, you would have noticed that these investors do not own the actual thing they’re investing in. This makes it a derivative as opposed to a 1-to-1 instrument. You’re simply buying a piece of the operation, not a piece of actual crypto. So how much crypto is actually in the fund? Well take a look at figure 2.

Figure 2

Holdings Per Share represents, in USD, how much crypto the trust has. For ETHE, one single share represents a holding of .0936655 ETH ($29). If you purchase a share at $143 that makes the premium around 330% compared to the alternative which is holding actual ether (ETH). Just to throw another number in here, with a holding per share at $30 you’re buying ether at $1,400, which is around its all-time highs. Current ETH price is around $300. So now you pay a 2.5% annual fee, invest in a fraction of crypto and pay it at a premium… oh and there’s no way to redeem it for actual ether if you decide to do so. So why would any sophisticated investor do this?

Each trust is a post tax account that will grow tax free. This along with other legal and tax reasons are why the ‘smart money’ is pouring their capital into these funds. Investors that believe ETH will do well over the next 10 years, are willing to pay the large premium. If the SEC and government help push a crypto backed ETF, all this could be avoided. Unfortunately, there is no easy way that big money can enter the market without worrying about messing up their taxes or breaking anti-money-laundering laws.




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