The 4 stage product life cycle of crypto funds
- Investment Vehicles like GBTC and ETHE are struggling to become ETFs.
- In the absence of acceptance as an ETF, Grayscale offers a unique 4 Stage Product Life Cycle for Crypto Funds, that increases accessibility at every stage.
Despite Bitcoin’s popularity, crypto funds like Grayscale’s $20 billion GBTC are still waiting for recognition as an ETF. To date, the SEC has not approved a crypto ETF based on spot pricing.
Since this widely-accessible investment vehicle is currently unavailable, fund providers need to offer “the next best thing,” according to Craig Salm, Grayscale’s Chief Legal Officer. Speaking at Tearsheet’s inaugural Bankchain Conference last week, Salm outlined Grayscale’s “4 Stage Product Life Cycle”, a blueprint for how digital assets can be turned into robust investment vehicles despite regulatory unclarity:
1) First, Grayscale raises a private placement in a trust to invest in digital assets, which is only available to accredited investors, with a lock up period of at least one year. According to Salm, this is done through an exemption from SEC registration under Rule 506(c). It’s the easiest type of fund to get off the ground but also the most restrictive.
2) In the next stage, the investment firm obtains a public listing for the trust for investors that bought shares in private placement – now investors can choose to either sell their shares or hold them. This step increases the accessibility of the fund, making it available to retail investors, as well as accredited ones.
3) The third step involves turning the asset into a reporting company. At this stage in the lifecycle, Grayscale seeks an SEC recording status, through a document called the Form 10 Registration Statement, which registers the securities under the Securities and Exchange Act. This makes their products more like publicly traded funds which must file 10-Ks, 10-Qs, and other audited financial statements with the SEC. Once the company starts reporting, the initial holding period of 1 year is reduced to 6 months.
4) The final stage involves conversion to ETFs. According to Salm, this would do a couple of things: It allows the product to better track its underlying net asset value, because of the arbitrage mechanism. This allows for both creations and redemptions when you have things like premiums and discounts, which publicly traded products historically have had. ETFs are also just really easy to buy and sell.
Investment vehicles like Grayscale Bitcoin Trust (GBTC) allow those investors that don't want to deal with the hassle of managing cryptocurrency themselves or those who want a piece of the pie but in a more traditional setting, to gain exposure to the asset class. GBTC and Grayscale Ethereum Trust (ETHE) became SEC reporting companies on Jan 21st and October 12th of last year, respectively. The picture below shows where the firm’s other products are in this Lifecycle. GBTC and ETHE can only move ahead to the final stage of the Product Cycle if regulatory winds shift in their favor.
The Fight to become an ETF
Since its launch in 2013, GBTC has grown to become the largest publicly traded fund for Bitcoin, now at $20 billion, with a little over 850,000 investors, according to Salm. GBTC is more like a closed end fund, because the shares that are publicly trading now are the same shares that were originally created in the private placement, and are now freely tradable.
Grayscale has been working to turn GBTC into an ETF for some time. Salm told Tearsheet that their efforts started as early as 2017, when the first wave of issuers sought to obtain approval from the SEC for a Bitcoin ETF” At the time, two main types of ETFs were being pursued: spot-based and futures-based ETFs. However, when the SEC cited concerns over fraud and manipulation of the underlying Bitcoin markets, Grayscale voluntarily withdrew its application. Salm explained that since the SEC was concerned with the underlying market’s mechanisms, it made sense that they had halted proceedings on both types of ETFs. But things changed last year when the SEC issued “positive statements” on the matter, but those only concerned futures-based ETFs.
According to Salm, this raises more questions about why the SEC would favor one type of ETF over another, since on the one hand “it is great to see more comfort from regulators around this asset class. But on the other hand, it's sort of confusing in that how can you be okay with a futures-based ETF but not a spot-based ETF again, because they're both priced based on the same underlying markets?”
In October 2021, the first futures-based ETF started trading, prompting Grayscale to reapply for turning GBTC into an ETF. Soon after their application though, another spot-based ETF was denied ETF status, raising even more questions about what the SEC has in mind for digital assets. These uneven decisions urged Grayscale to send two letters to the SEC stating that the “SEC is potentially acting arbitrarily and capriciously in violation of something called the Administrative Procedure Act.” While Grayscale’s application is being processed, a common letter period is being observed with the SEC, where the public is invited to write to the SEC about their views on the subject. According to Salm, the SEC website now has more than 6500 letters, and more can be easily submitted through https://grayscale.com/comment/.
Salm reports that after canvassing the letters, three themes emerge:
a) Investors Asking for Protection: “Grayscale has over 1000 investors in GBTC, except those investors are in a product that is not able to track the underlying bitcoin price as efficiently as an ETF would. So today, GBTC is trading at a discount. Based on a $20 billion fund, it is trading at a 20% discount.
That is billions of dollars of value that is being kept from investors. What these comments submitters are saying is, ‘I'm in this investment vehicle. It is not tracking Bitcoin the way it would if it was an ETF. How are you protecting the investor?’ So just a very straightforward investment protection argument.”
b) American Competitiveness: Since the White House issued positive statements around cryptocurrencies and digital assets, a lot of investors are demanding to know how the government plans to stay ahead of the game. “What better way to do that, than by starting bringing things like Bitcoin further into the regulatory perimeter through products like a spot Bitcoin ETF?” he asked.
c) The Natural Next Step: Some investors echo the sentiments of people at Grayscale and think that after future-based ETFs, spot-based are the natural next step.
America’s Unique Regulation Landscape
Salm also pointed out that unlike other countries, America does not have one overarching regulatory body that overlooks these matters. In fact, the task is distributed amongst many heads with the SEC covering securities, the CFTC covering commodities, FinCEN focusing on money usage of digital assets, the Office of the Comptroller of the Currency, which looks over banks, whilethe IRS decides how to tax digital assets.
In this environment he thinks “that it's really important to have a top-down comment from the White House saying, ‘all of you federal agencies, I know you've been reviewing your purview over digital assets and coming out with guidance to date, but we need to have coordination.’ With White House’s recent announcement of an Executive Order on “Ensuring Responsible Development of Digital Assets”, things seem to be moving in the right direction because they reaffirm crypto’s position.“It really was a crystallizing moment that Bitcoin and crypto is here to stay,” Salm said.
With the fight raging since 2017, Grayscale may finally have some answers on July 6th when the SEC ruling is supposed to arrive on GBTC’s fate. However, after that point, many options remain on the table, including a lawsuit. Some think that by approving the futures based ETF Teucrium, the SEC has weakened its argument against accepting ETFs like GBTC. Either way, Grayscale’s resolve and the grassroots mobilization by investors on the matter emphasizes what Salm echoed: Bitcoin is here to stay, and might I add, Bitcoin is here to change.