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Monday, April 15, 2024

Bitcoin Investors Are Plotting a Major Coup

A group of activist shareholders in the world’s largest bitcoin investment trust, GBTC, is plotting a coup. The unlikely patchwork of hedge funds, asset managers, and amateur investors is trying to unseat Grayscale Investments, the steward of the trust, whose management they claim has cost them billions of dollars.

Since 2015, GBTC has been marketed as a simple way for regular people to invest in bitcoin without having to deal with an exchange, send crypto between wallets, or figure out how to store it safely. The value of GBTC shares is linked to the price of bitcoin: For every new share created, a fraction of a bitcoin is added to a pot, anchoring its value.

In a series of adverts targeting the general public, some of which aired on major US TV networks, Grayscale described bitcoin as “the future” and the ideal investment for retirees and other investors that “deserve the best.” Now, GBTC shares are owned by hundreds of thousands of amateur investors. 

At the start of 2021, the shares, which had consistently traded at a higher price (sometimes even double) than the underlying bitcoin for years, slumped to 52 percent of the value of bitcoin in mid-December, meaning that for every $1 in bitcoin that shareholders own through the trust, they can only claim back $0.52 by selling their GBTC shares on the market. In aggregate, the discount created a multibillion-dollar hole in investors’ pockets.

“Investors are in limbo,” says Christian Galíndez Beltrán, a shareholder who claims to hold around $200,000 in bitcoin via the trust. “I’m really worried about not being able to redeem the totality of my money.”

Another investor, who asked not to be named for fear of repercussions from the brokerage at which he works, says he purchased roughly $30,000 in bitcoin through GBTC with the goal of hedging against inflation as he prepares for retirement. Although his financial situation has not been too badly damaged, he says the performance of the trust has “ill-affected” his marriage; his wife, who “fears the loss is permanent,” has taken to calling him a “bitcoin bozo.”

Thousands of GBTC shareholders like these have registered their support for the activist campaign, according to David Bailey, founder of BTC Inc and hedge fund UTXO Management, and leader of one strand of the movement.

“That’s what makes this a unique situation,” says Bailey. “This product is sold on brokerage platforms in individual retirement accounts. This is your mom and dad thinking they are diversifying their portfolio.”

WIRED spoke to six GBTC shareholders, all of whom told similar stories. One person said they have the entirety of their savings tied up in GBTC, while another has taken on additional work to ensure he is able to sustain himself into retirement. 

Bailey claims that more than 50 institutions, some of which hold several hundred-million-dollar stakes in GBTC, are also involved in the rebellion to unseat Grayscale, representing a total of at least 20 percent of GBTC shares. He claims to be unable to provide proof, citing investor privacy and legal considerations, but supplied WIRED with web traffic and form submission data that suggests at least 2,000 investors have joined the campaign.

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Michael Sonnenshein, Grayscale CEO, says his firm is going nowhere. “We have absolutely no intention of stepping down from our role,” says Sonnenshein. “Our trust agreement explicitly states that we would have to voluntarily step down—and our work is not done.”

But the activists are unperturbed. “Our expectation is that, through the pure groundswell of people that want to get out of this thing, pressure is going to be put on,” says Steven McClurg, chief investment officer at asset management firm Valkyrie, another ringleader of the campaign to overthrow Grayscale. “There are a lot of ways to affect change.” He refused to elaborate on what he meant. McClurg describes this information as “secret sauce.”

Crossed Wires

The group spearheaded by Bailey, called RedeemGBTC, wants Grayscale to reduce its 2 percent management fee, which it describes as “predatory,” because it’s calculated against the trust’s bitcoin reserves, not the price of the severely discounted shares. The group also wants Grayscale to allow investors to exchange their shares directly for the underlying bitcoin—in a process known as redemption—as soon as possible.

The nature of the trust’s fee structure, lawyers representing Bailey’s hedge fund have claimed, creates a “perverse incentive” for Grayscale to maximize the number of shares in the trust and restrict redemptions: They argue that the greater the number of shares in the trust, the larger the pot of bitcoin, which swells the revenue generated by management fees. 

McClurg describes this arrangement as a “hostage” situation: Investors cannot exit without absorbing a large markdown on the price of bitcoin.

However, the demands mapped out by Bailey and RedeemGBTC are an unhelpful oversimplification of the situation, suggests Grayscale, which claims to be doing everything in its power to do right by its investors.

Namely, Grayscale has entered into a legal battle with the US Securities and Exchange Commission (SEC) over its campaign to convert the trust into an exchange-traded fund, or ETF, which would let investors cash in their shares for the bitcoin in the pot. 

On June 29, 2022, the SEC announced it would not grant permission to convert the trust, citing fraud and market manipulation concerns. Grayscale has sued the SEC over the decision, which it calls “arbitrary and capricious.” The two parties are scheduled to present their respective cases to a judge on March 7 and Grayscale expects a final decision to be reached by the autumn. The firm is bullish about the prospects of an ETF of this kind coming to market: “It’s a matter of when, not if,” says Sonnenshein. 

Although Grayscale could reduce its fees in the meantime, Sonnenshein argued in a recent interview with crypto journalist Laura Shin that the funds are best directed toward the ongoing legal battle with the SEC. Once the trust has been converted into an ETF, Grayscale promises to reduce its fees immediately.

There has also been a “meaningful misunderstanding,” Sonnenshein tells WIRED, among frustrated investors, who say that Grayscale could apply to the SEC for exemption from rules that prevent them from cashing out. The only way to apply for exemption, says Sonnenshein, is to pursue conversion to an ETF.

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Bailey’s lawyers have also argued that Grayscale could allow investors to cash out without dealing with the SEC at all. But it’s not that simple either, says Sonnenshein, because of a cease and desist letter issued by the SEC in 2016 that prevented the trust from issuing new shares and allowing shareholders to cash out simultaneously.

The complexity of the securities laws that apply to trusts like GBTC creates opportunity for disagreements of this kind. “It’s a spider’s web,” says Andrew Parish, a veteran crypto founder with close relationships to parties across the industry. “It’s a mess that can hardly be understood by anyone other than accountants and lawyers.”

Pretenders to the Throne

Contenders to take over from Grayscale have emerged from the ranks of the rebellion, including McClurg’s Valkyrie. Bailey also has skin in the game: Not only does his hedge fund hold $2.5 million in GBTC shares, but his companies also have a combined $113,000 stake in Valkyrie. If Valkyrie were to succeed in its bid to take on the management of GBTC, it would absorb hundreds of millions of dollars in annual management fees, and Bailey would profit indirectly.

But Bailey also says he holds a stake in DCG, Grayscale’s parent company, that’s greater in value than his Valkyrie position, so he also stands to lose if Grayscale is forced out. “This started because we were frustrated our fund had lost some money on its [GBTC] investment,” says Bailey, “But once we started to receive comments from people about how they had been affected, it became something else. [We realized that] people need immediate relief.”  

While Sonnenshein says Grayscale is always willing to hear investors out, he has reservations about the credibility of the RedeemGBTC campaign, which is run almost exclusively through Bailey’s personal Twitter account and a simple website.

“We always appreciate the opportunity to engage with any and all of our investors,” says Sonnenshein. “[But] it’s tough to take seriously a Twitter account as a standalone, as compared to the nearly 1 million investor accounts we have across the US … Anyone could go to the website and say they have one share or 10 million shares—and there’s no verifying it.”

But RedeemGBTC is not the only group Grayscale has to contend with. In December, investment firm Fir Tree filed a lawsuit against Grayscale in an effort to force the firm to hand over information that might assist in an investigation into potential mismanagement and conflicts of interest. The lawsuit asserts that Grayscale’s “shareholder-unfriendly actions” have harmed Fir Tree customers that hold GBTC shares, many of which are pension funds.

This was followed in late January by a lawsuit filed by asset management firm Osprey Funds claiming Grayscale made “false and misleading statements in its advertising and promotion” that gave investors the impression that GBTC’s conversion into an ETF was a “foregone conclusion.” Osprey also claims Grayscale’s approach to advertising has made it impossible for competitors, including itself, to accrue meaningful market share.

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Like Valkyrie, Osprey has called on Grayscale to step down as sponsor and put itself forward as a replacement. In an open letter, Osprey CEO Greg King promised to cut the management fee by 75 percent, seek immediately to implement a redemption program, and collaborate with regulators instead of pursuing litigation.

The Fir Tree and Osprey lawsuits were described by Jennifer Rosenthal, vice president of communications at Grayscale, as “baseless” and “frivolous,” respectively. “We remain steadfast in our belief that the conversion of GBTC to an ETF is the best long-term product structure for investors, and are 100 percent committed to that endeavor,” she says.

As it stands, the various parties are locked in a stalemate; Grayscale says it’s not going anywhere and remains confident in the strength of its case against the SEC, while the activists are scratching their heads over how to remove the firm.

In the meantime, the situation threatens to devolve into a mud-slinging contest, says Parish, as Grayscale tries to ride out this difficult period.

It is not necessarily in Grayscale’s interest for the conversion to an ETF to take place too quickly, he says, because the recent negative press around DCG and its subsidiaries (the lending unit of one subsidiary, Genesis, filed for bankruptcy in January) would likely cause investors to run for the exit at the earliest opportunity, taking millions of dollars in management fees with them.

“The entirety of Grayscale’s strategy here is to limit redemptions and then PR, PR, PR. And to fight legal battles on whatever field they have to fight,” claims Parish.

Sonnenshein contests the idea that activating redemptions would trigger a customer exodus, arguing that the “regulated, battle-tested” ETF structure will attract an even larger audience and an even greater amount of capital into bitcoin. He also says that converting the trust into an ETF has been the plan from the outset. “This is something that investors want and deserve,” he says.

If the courts were to rule against Grayscale and the company exhausts all remaining legal avenues of appeal, Sonnenshein says it would pursue a tender offer whereby a portion of shareholders are bought out of their shares at a price established with “investor fairness” in mind.

But RedeemGBTC and Fir Tree do not share Grayscale’s conviction in the strength of its case against the SEC, which is described by the pair as “doomed” and “wasteful,” respectively, and point to the need for an urgent resolution to the situation.

“If we thought Grayscale was going to be successful [in converting GBTC to an ETF], we wouldn’t try to stop it. We just don’t think it’s going to happen—so something has to be done,” says Bailey. 

Three other shareholders say they believe it is unlikely for an ETF to be approved while Gary Gensler, sitting chairperson of the SEC, remains in charge. (Gensler’s term is due to end in 2026.) The SEC declined to comment.

“They [Grayscale] are going to dig their heels in and fight to the very end, but it’s not going to bode well for them,” says McClurg. “Financial services is a confidence game; when your clients lose faith, you’ll never get them back. In the long run, I think they’re done.”

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