The Grayscale Effect: Deciphering The bitcoin Lore That Stood The Test of Time

Here's an update on how Grayscale's Bitcoin Trust (GBTC) will impact prices in the coming months...

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Dust off your toolboxes.

Now is the time to double-check everything is in a place so you can instinctively grab it without hesitation.

Fumbling around to decide how a tool works or where it’s located can result in a massive opportunity.

I say this because the next two months might become the most exciting time for crypto to date.

This feeling stems from something I decided to finally unveil about five months ago. Many of you are aware of the Grayscale Effect. For those that are unfamiliar with the concept, it tends to run counter-intuitive to what the market believes.

If we distill it down to its core components we are left with this premise:

Bitcoin’s price rises soon after fresh GBTC are minted and become tradable.

If you are thinking that sounds backward, please take the time to read the Grayscale Effect. I understand this goes against the grain… How can the dilution of GBTC result in higher bitcoin prices?

In the essay I break it down by analyzing each major unlocking event, what happened afterwards, how the Trust operates, and what investors tend to do upon an unlocking event.

Once caught up, come back here to read this update. It’s not going anywhere.

Time to Step Up

The clock is nearing the 11th hour on The Effect in terms of it still being in play.

If it’s late May and we’re witnessing outsized GBTC discounts and / or lower prices for bitcoin, then it’s liver over for GBTC. But if price starts to rip in the coming weeks, saddle up.

Now, before getting into the timing of everything I want to address the negative P.R. Grayscale is receiving. It stems from the discount it’s realizing. Meaning GBTC shares are trading at a discount to bitcoin’s spot price.

This can happen for the mere fact Grayscale charges a yearly fee on the assets under management of 2.5%.

Now if you decide to hold BTC for several years, this fee begins to approach major chunks of your holding. And because most bitcoin investors (55% as of right now) hold their tokens for greater than one year. - we know this thanks to HODL waves created from on-chain analysis - the true equilibrium for where the Trust’s premium/discount should sit is somewhere between -2.5% to -7.5%.

OK, now as to why the premium vanished earlier this year and finally became a discount?

The answer is share dilution…

I know what you’re thinking… You just said the dilution of GBTC results in higher bitcoin prices?

You would be correct. But this dilution doesn’t impact price until the unlockings have run their course. Here’s what I mean…

From the end of October to the end of December the amount of new shares outstanding were much bigger than what is deemed normal.

The reason is because six months prior there were record inflows of capital to GBTC.

It was tranche 8 in the report. Remember, new shares can be traded in the market six months after the inflow and accountants take note of the new capital.

Near the end of 2020 price ripped higher as more than $500 million of GBTC were unlocked, and investors likely repurchased their BTC on spot. This repurchasing rocketed price higher while generating retail FOMO.

The FOMO got so extreme that the premium rose from single digits to over 40% in that stretch.

This is what I mean when I say price rose while the market got diluted. If you’re curious how diluted it was getting every week and you don’t have access to a Bloomberg Terminal, check out the 8-K SEC filings during this time span by going to the SEC website here.

It’s insane.

Dilution was in full force, but once the historic unlocking waned and investors no longer needed to rebuy BTC on spot markets to replenish their coffers - reducing demand for BTC… The new onslaught of supply crushed the premium.

From late December to most recently, the Premium went from 40% to -15%.

Now most Espresso readers are wondering if the Grayscale Effect is dead and if the Trust will ever recover.

I say yes. And that’s what we are going to cover for the rest of today’s issue.

The Case

Here’s the Grayscale Effect chart I regularly update. The purple vertical lines are major unlocking events. Major in the sense that a quick eyeball test says it’s a big uptick.

The numbers are self labeled tranches I refer to in the original report.

The investors who took part in tranche 8 are about to come full circle. During tranche 8 the incentive to reinvest in the Trust was present due to a large premium in the Trust.

Also, here’s what the inflows looked like as those unlockings took place late last year. Over $3 billion dollars. Most of this was likely from investors selling GBTC, buying BTC, and then transferring it over to the Trust.

It was a lot of rinse and repeat.

In terms of bitcoin, here’s a chart from Bybt.com showing the inflows in that time period. Nearly 160k BTC.

What we should also make note of is BlockFi and Three Arrows Capital are both in this tranche. BlockFi will unlock their shares any day while Three Arrows is at the tail end of June. (You can go to that SEC link above if you want to see for yourself.)

Additionally, we know Digital Currency Group (DCG), the company behind Grayscale, is prepared to purchase GBTC shares off the open market.

So let’s take a step back real quick and explain what this means.

DCG, Three Arrows Capital, and BlockFi. These are the biggest entities in the space.

If we consider what their incentive is over the next few months, I think we can better understand what might unfold.

BlockFi and Three Arrows Capital will likely replenish their holding with BTC. We know BlockFi will likely do this since they operate in terms of BTC. And Three Arrows will likely based purely on their belief in cryptocurrency being the future - this is more of a ‘feeling’ based on Su Zhu commentary.

Assuming these two players who are responsible for nearly 10% of GBTC holding go back to the well via the spot market, this is significant buy side pressure.

Assuming even further… if this translates to higher prices, we will witness FOMO in the market. One of the side effects will be GBTC trading at less of a discount and perhaps a premium, again.

Pile on to this argument by glancing over at DCG who is sitting on the sidelines ready to act at any moment.

This is an entity that’s rolling out new Trusts. And they have a massive incentive to ensure their biggest backers and investors not only make it out of this lock up without a loss, but making sure these investors make out like bandits.

Because this tees Grayscale up for success in securing capital for itse Ethereum, Link, Decentraland, etc. Trusts… and soon more “Effects” similar to what we’ve seen play out with GBTC.

Grayscale/DCG wants AUM in its Trusts, and a player like Three Arrows Capital is a way to get it.

They don’t want to lose this as well as medium size investors that are coming due over the next few months.

These guys are all on the same team. Team “UpOnly”.

The 11th Hour

So here we are on the cusp of tranche 11. It’s massive. The Trust is trading at a discount, some of the market’s biggest players are involved, and the biggest crypto asset manager does not want to look like a fool.

Based on the history of the Grayscale Effect, I believe we will see higher prices unfold in the coming months.

And I think it starts now.

The first uptick in unlockings from tranche 8 was October 21st. Six months later puts us at today.

Bybt.com’s inaccurate chart puts it at April 25th… Inaccurate you ask? Because April 25th is a Sunday - a non trading day in the equities market.

Let’s call it April 26th then. I think that’s a safe bet.

Pulling up a chart… Seems we’ve been getting selloffs prior to a major run.

This looks to cleanse funding rates and create some bearish sentiments in the market - a perfect environment for price to build momentum in.

Whether this “flush out” is intentional or not, I don’t think so.

I’m not a “it was manipulation” type of analyst. To me that’s just an excuse and laziness. If you dig you’ll find a reason.

More importantly, I tend to think major movements tend to happen in synch with one another from time to time. Similar to how I wrote about the selloff from last weekend.

The cleanse in funding rate and April 26th unlocking means the effect for Tranch 11 is starting today.

Meaning we’re sitting here with major players who likely want prices and premiums higher for upcoming unlockings, a substantial dip creating a cleanse in the funding rate - bullish, bullish on-chain readings per my article from last week, BTC and ETH liquidity crises unfolding making supply scarce in the market, and of course that institutional chatter that’s always ongoing.

Are your spidey senses tingling yet?

The only piece standing in the way is the regulatory landscape throwing a curve ball, which I don’t see happening until June based upon prior recaps of the Weekly ChainPulse Reports… Funny enough, if that’s the timing for regulatory news it might prove impeccable as the market will be in full euphoria if what I described ends up taking place.

It’d be choreography at its finest.

Now, with all this uber bullishness, let’s throw in a few words of caution…

What I’m laying out here is some very bullish pieces all coming together at once. I encourage you to question me and force me to consider bearish alternatives. I’m in a unique situation in that Jarvis AI does my trading.

That means my style is not discretionary. My positions in the market change on a dime sometimes without my knowledge.

It’s a style that’s a result from finding effects in the market and letting AI technology do the trading once its modeled. This ultimately is how I remove my bias. It’s also why I have so much time to write!

Anyways, I feel like it’s important for you to understand that.

Why?

There’s always the possibility I have blinders on.

But assuming what I laid out unfolds, consider this your last reminder to get your toolboxes in order. Things might start getting crazy as early as next week.

Your Pulse on Crypto,

Ben Lilly

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