Cites Security Concerns for Not Publishing Proof-of-Reserves
Grayscale, the issuer of the world’s largest publicly traded crypto fund, is hoping to reassure investors that the digital assets backing its products are safe.
Grayscale is owned by Digital Currency Group, which is being scrutinized by investors after another subsidiary, Genesis Global Capital, reportedly sought an emergency loan of $1B last week in the wake of FTX’s collapse.
“The holdings of Grayscale’s digital asset products are safe and secure,” the company said on Nov. 18. Grayscale’s products function both as independent companies and publicly traded securities representing single digital assets.
At $10.5B in assets under management, GBTC is the company’s largest fund. The concern Grayscale is addressing is that the Bitcoin backing GBTC is liquid and isn’t being used for any other purpose.
Other major Grayscale products include ETHE, which has $3.7B in ETH under management, and the Ethereum Classic Trust, which holds $231M in ETC.
Coinbase holds the digital assets that underlie Grayscale’s funds. “We will never, directly or indirectly, lend, pledge, hypothecate or rehypothecate any of the digital assets underlying any Grayscale products,” reads a document published by Coinbase on Nov. 18.
Grayscale is taking heat on Twitter where it shared its security practices. “Coinbase frequently performs on-chain validation,” Grayscale said, adding that, due to safety concerns, it couldn’t publicly prove that Coinbase controls the assets.
Anthony Sassal, an Ethereum educator and investor, isn’t having it. “This reads like pure lawyer-speak from people who have no idea how blockchains work,” he tweeted in response. “Posting an address and signing a message proving ownership of that address is not a security concern.”
Grayscale and Coinbase’s reassurances come at a time when investors are nervous about any opacity with regards to who actually owns what. Numerous companies like BlockFi and the lending arm of Genesis have paused customer withdrawals.
The implication of paused withdrawals is that there aren’t enough liquid funds to cover customers’ requests for assets. As a company responsible for billions of dollars in crypto holdings, Grayscale is another company which could theoretically face the same issue. Concerns may have been exacerbated by a Wall Street Journal article which reported that Grayscale’s sister company Genesis unsuccessfully sought a $1B loan.
Another fact may have forced Grayscale to make its announcement — the discount for its flagship product, GBTC, has hit an all-time high of 42.7%, according to YCharts. This means that GBTC shares are worth 42.7% less than the actual underlying BTC.
The discount has presumably widened further because investors are selling GBTC with the concern that the underlying assets may not be available.
As GBTC is a trust, rather than an exchange-traded fund (ETF), there is no fund manager actively buying and selling the financial product’s underlying assets to match demand.
Instead, accredited investors buy GBTC at the actual amount of BTC, called net asset value (NAV), that it’s worth at the time. Grayscale then buys BTC with investors’ fiat currency. Those investors may sell the GBTC shares after a six-month lockup, a trade that was very profitable when the security traded at a premium to the underlying BTC.
When demand for GBTC is higher than the underlying BTC, the security trades at a premium to the underlying cryptocurrency. When demand for GBTC is lower than it is for the underlying BTC, it trades at a discount as it has since early 2021.
Interestingly, Coindesk, yet another company owned by DCG, produced an article which was instrumental in exposing the financial weaknesses of Alameda Research, the hedge fund intimately connected with FTX.
Since then, FTX has gone bankrupt and the fallout has forced DCG’s Genesis to halt withdrawals, and impelled Grayscale to reassure holders of its investment products.