Where Has the Bitcoin Arbitrage Trade Gone?

  • Grayscale Bitcoin Trust’s premium over the underlying asset it tracks was whittled away and momentarily negative as the price of Bitcoin fell last week 
  • Increasing number of alternatives and knowledge of the “Grayscale Premium” for Bitcoin indicative of a maturing market 
In Vang Vieng, a picturesque town on the banks of the Nam Xong river and nestled between rice padis and some of the most gorgeous scenery in Southeast Asia, the price of a can of Pepsi can be almost the price of a joint.
Because even though marijuana is easily available in this remote region of Laos, Pepsi is not.
Much of it has to do with logistics.
Roads in Laos have improved over the years, but many remain unpaved and impassable during the monsoon seasons.
Which has presented plucky entrepreneurs with a good arbitrage trade, buying cans of Pepsi from distributors on the cheap in cities and on boats plying the river and selling them for a handsome premium in some of the most remote villages and towns across landlocked Laos.
Tourists seldom bat an eyelid when paying these handsome premiums for their favorite soft drinks and the local arbitrageurs clean up.
And for the longest time, that was the name of a simple but highly profitable trade when dealing with Grayscale Bitcoin Trust.
For years, as the only institutional-grade gateway into the Bitcoin world, Grayscale Bitcoin Trust commanded a hefty premium over the underlying asset it was meant to track, providing a juicy arbitrage trade that hedge funds swooped in to take advantage of.
Hedge funds would borrow Bitcoin to deposit them with Grayscale Bitcoin Trust, in exchange for shares that were more valuable than the cryptocurrency they bought, and then profit by selling the marked-up shares after a compulsory six-month lock-up period expired.
Even if the price of Bitcoin fell, the premiums were often so substantial that they more than covered the fall of the underlying cryptocurrency versus the fall in the shares of Grayscale Bitcoin Trust.
The trade became so popular, assets in Grayscale Bitcoin Trust, including the rise in the value of Bitcoin, have swelled to over US$35 billion from just US$1.5 billion only a year earlier.
But that arbitrage trade is fast vanishing, thanks to more volatility in Bitcoin’s price as well as the rise of a stable of competing products.
Making matters worse, investors can’t actually redeem their shares in Grayscale Bitcoin Trust, they can only on-sell them to a fresh set of investors, which sounds sort of like another type of investment scheme made famous by a man named Ponzi.
And with the rally in Bitcoin becoming less certain, the Grayscale Bitcoin Trust premium has been rapidly falling, especially since there’s now more supply of the shares than there necessarily is demand.
Investors are choosing instead to buy Bitcoin and custody it themselves directly and last week Grayscale Bitcoin Trust shares fell as much as 11.6% below their net asset value, the biggest ever discount.
And while Bitcoin has gained almost a quarter this past month, Grayscale Bitcoin Trust is only up 14% for the same period.
Nonetheless, Grayscale Bitcoin Trust still remains an attractive offering for investors reluctant to sign up for their own cryptocurrency exchange account, or fumble with their own digital wallets.
And for institutional investors whose fund mandates prevent them from buying Bitcoin directly, Grayscale Bitcoin Trust remains one of the few access points for the cryptocurrency.
As with all arbitrage trades, the opportunities eventually get, well, arbitraged away, as more investors get wind of the opportunity.
And that’s a good thing, because it shows that the market is maturing by way of more competing products that offer the same, if not better access to Bitcoin, as well as more institutional investors potentially altering their mandates to avail themselves of more sophisticated custody options. 

Novum Digital Asset Alpha is a digital asset quantitative trading firm.

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The information and thoughts laid out in this analysis are strictly for information purposes only and should not be regarded as an offer to sell or a solicitation of an offer to buy any security in any jurisdiction where such an offer or solicitation would be in violation of any local laws.

It does not constitute a recommendation or take into account the particular allocation objectives, financial conditions, or needs of specific individuals.

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