Written by: Matias Andrade Cabieses

Compiled by: Shenchao TechFlow

A major development in the world of digital asset investing is the upcoming launch of spot exchange-traded funds (ETFs). The arrival of spot ETFs could significantly simplify investing in digital assets and expand the range of investment products, especially for U.S. investors. Currently, investment options are mainly based on futures. These instruments have fixed maturities and established term structures, which can result in unexpected costs for investors. Alternatively, investments can be managed through a trust, like Grayscale’s offering.

In this article, we take a deeper look at how Grayscale’s digital asset trust works and compare it to a potential spot ETF.

Trust products without trusting assets

In the digital asset space, investor demand for exchange-traded products has been steadily growing for a variety of reasons. One of the key reasons is the difference between tax-advantaged accounts and self-custody of assets. The process of self-custody, while providing full control over assets, involves significant complexity and requires extensive technical knowledge to ensure a safe and successful implementation. In addition, investments made in this manner will be subject to considerable tax obligations, proportional to capital gains tax and income tax.

Currently, the major tax-advantaged accounts available to most investors in the U.S., including individual retirement accounts (IRAs), 401(k) plans, and health savings accounts (HSAs), do not allow for direct investments in digital assets, although there are some notable exceptions, including Fidelity, publicly traded mining companies, and Microstrategy. This restriction hinders the ability to defer or offset taxes associated with digital asset investments, which is a considerable disadvantage for investors. Even for investors who choose self-custody, these accounts are still very important, as even a slight reduction in capital gains tax payments can significantly affect the overall performance of an investment (especially when short-term capital gains tax rates apply, as shown below).

(Note from Shenchao: The blue line is the short-term after-tax return rate, the gray line is the long-term after-tax return rate, and the yellow line is the net return rate of BTC itself)

We can further reflect that for most people, self-custody is simply not a viable option, whether due to a lack of technical knowledge or because regulatory or legal restrictions interfere with such ownership, especially for corporate entities. Given these obstacles, exchange products are not only a convenient alternative, but also an important part of the digital asset investment landscape. They play a similar role in other asset classes where self-custody may be possible, but not practical, like precious metals.

However, it is important to understand that not all exchange-traded products are created equal. Each product has unique characteristics that may impact an investor’s portfolio differently. In this context, we turn our attention to Grayscale’s product suite. Our goal is to dive into the specific features of their products to better understand their nuances. In doing so, we can gain a clearer understanding of why the potential introduction of a spot ETF is causing so much excitement in the market.

Grayscale Trust Products

Grayscale offers a range of investment products that can give investors exposure to individual digital assets (such as BTC, ETH, etc.) or various indices that track a portfolio of multiple assets. All of Grayscale's products have one thing in common, they are all structured as trusts, which means that the value of the shares can fluctuate with the value of the underlying portfolio of assets. Throughout its history, Grayscale's Bitcoin Trust (GBTC) has seen shares value exceed the value of the underlying Bitcoin during the peak of the 2020-2021 bull market. At other times, shares may trade at a discount to the value of the underlying Bitcoin, even as low as 50% of its value. These movements are often referred to as premiums and discounts.

The value dynamics of these trust products are important for two main reasons. First, as an investor, you can purchase shares at the current market price. This means that you may gain exposure to Bitcoin at a discount or premium, depending on the market conditions at the time, which may change your investment risk profile, especially compared to spot investments without annual management fees. The second reason it is worth noting is that savvy investors can profit from mispriced assets through carry trading strategies. Therefore, when GBTC is trading at a premium to Bitcoin, it is possible to enter a risk-free trade by simultaneously selling or shorting GBTC in the spot or futures market and buying Bitcoin. Investors can profit from the price convergence of these two positions, achieving theoretical risk minimization.

(Note from Shenchao: An overview of the changes in the net asset value (NAV) of Grayscale’s different digital asset trusts. The vertical axis represents the premium/discount ratio)

If we look at the chart above, we can see that the various trusts set up for different assets have developed very differently. While ETH is trading at a discount of around 50%, BTC, BCH, LTC, and ETC are trending closer to parity, while LINK is actually exceeding parity, trading at a 270% premium. This trend is likely due to investors realizing that, following recent news that BlackRock has applied to create a spot Bitcoin ETF, the price would match parity if Grayscale also receives approval to convert these funds into ETFs. While we may think this sounds far-fetched (since it would mean people are paying nearly three times the spot price), this is common for particularly illiquid investment vehicles, especially when speculative flows dominate. We can see the same behavior for other trusts offered by Grayscale below.

Filecoin (FIL) and Stellar (XLM) are trading at 8x and 4x the spot price respectively. These price dislocations are significant, indicating that these funds are very illiquid and with limited access to these assets within the United States, arbitrageurs can easily drive down premiums and profit. However, it also shows that some are willing to acquire these assets at a huge premium, which is an interesting observation.

in conclusion

In summary, the evolution of the digital asset investment landscape, especially the expected launch of spot ETFs, promises to bring revolutionary changes. Currently, options such as futures and trust investments offered by Grayscale come with a unique set of challenges. However, the introduction of spot ETFs has the potential to simplify these complexities and provide investors with a more efficient and direct way to acquire digital assets. As we continue to explore this fascinating digital investment space, investors' ability to adapt and innovate, as well as regulatory advances, will undoubtedly play a key role in shaping the future of digital asset investment.