Grayscale Puts Trust to the Test by Pursuing SEC Registration

On Nov. 19, Grayscale Investments, a subsidiary of Digital Currency Group and the world's largest digital asset manager, filed a voluntary registration statement on Form 10 with the United States Securities and Exchange Commission on behalf of its Grayscale Bitcoin Trust.

If successful, the move would result in the trust acquiring the status of an SEC reporting company, the first cryptocurrency investment instrument to do so. The trust’s shares would therefore be registered according to the requirements of the Securities Exchange Act of 1934.

Grayscale Investments expects the development to broaden the product’s investor base and provide those already holding the trust’s shares better transparency and liquidity. However, the digital asset management company also emphasized that it is seeking neither an exchange-traded fund status nor listing on a national securities exchange.

So, what would the regulator’s approval of the form mean for Grayscale Bitcoin Trust and the wider crypto industry?

How Bitcoin trusts work

An investment trust is a company that owns a fixed amount of a certain asset and issues contracts representing shares of its ownership. Investors who own the shares also pay fees to the company that manages the trust. Each share of Grayscale Bitcoin Trust currently represents a little less than 0.001 BTC, with an annual fee of 2%. The share of ownership by a contract slowly decreases over time. Overall, the trust holds some 175,000 Bitcoins.

Launched in September 2013 and trading since May 2015, Grayscale markets GBTC as a “traditional investment vehicle” whose structure is familiar to financial and tax advisors. Although the firm consistently emphasizes that the product is not an exchange-traded fund, GBTC is modelled similarly to many popular commodity-based ETFs. The shares are eligible to be traded through brokerages and can be held in tax-advantaged accounts, such as individual retirement accounts or 401(k)s.

Related: The SEC Does Not Want Crypto ETFs — What Will It Take to Get Approval?

Grayscale Bitcoin Trust shares are publicly traded on the over-the counter market OTCQX. In contrast with exchanges, such decentralized marketplaces normally host stocks of smaller companies and enforce less stringent reporting requirements.

GBTC is currently listed under the Alternative Reporting Standard, which does not require registration with the SEC. An investment in OTC securities is generally considered riskier than in those traded on exchanges.

While this solution facilitates Bitcoin exposure for accredited investors, the present reporting standard might be insufficient for many funds that are potentially interested in digital assets but wary of the lack of transparency. Others may simply have formal limitations on dealing with securities that do not have an SEC registration. Among other GBTC downsides that could be inhibiting investors’ enthusiasm are annual fee and a high premium.

Despite these limitations, the trust’s performance has been very solid this year. For one, in less than six months — between February and June — it recorded a spike of more than 300%, outperforming even Bitcoin itself, which had a 223% growth over the same period, due to increased premiums. In a recent interview with CNBC, Michael Sonnenshein, Grayscale’s managing director, touted the year-over-year tripling of last three-month GBTC trading volume.

Sonnenshein also noted that the Grayscale Investment’s Bitcoin product is seeing impressive demand from institutional investors seeking digital asset exposure, with 84% of inflows in the third quarter of 2019 coming from noncrypto hedge funds.

What does Form 10 do?

Also known as the General Form for Registration of Securities, SEC’s Form 10 is a filing designed to provide investors with all the relevant information they may need to make an investment decision.

The Exchange Act requires companies with more than $10 million in assets and 750 or more shareholders to file a registration statement on Form 10, while those below these thresholds can do it voluntarily. A Form 10 registration is one of the requirements for registering securities to be traded on U.S. exchanges. Another is the approval by Financial Industry Regulatory Authority.

A registration statement is deemed effective 60 days after filing, although the SEC might have additional questions or comments. Once it is in effect, the registration triggers a set of reporting requirements, including annual, quarterly and current reports; annual proxy statements; and beneficial ownership reporting for management and shareholders.

No pain, no gain

Grayscale Investments’ initiative is obviously directed at elevating its reporting standards, thus making GBTS appealing to a wider array of institutional investors. Apart from the potential distinction of becoming the first-ever SEC reporting digital asset-based security, it would also bring a tangible improvement improvement in liquidity.

While investors are currently required to hold their private placement shares for at least one year, this period would be reduced to six months if the trust’s SEC registration is approved. Michelle Gitlitz, Crowell & Moring’s global head for its Blockchain and Digital Assets practice, told Cointelegraph:

“If Grayscale reached reporting company status, it would increase transparency for investors and may encourage more people to invest in the fund. More investors means more liquidity for shareholders, which is a significant benefit. For certain, those investors who are currently restricted from investing in non-SEC regulated reporting companies, would be able to invest.”

The big question is: How much will Grayscale gain from a registration with the SEC? Alexander Blum, the chief operating officer of the fintech company Two Prime, thinks that it will facilitate gradual change rather than an instant explosion:

“If its Form 10 filing is approved and it becomes an SEC registered reporting company, Grayscale's Bitcoin Trust will continue its incremental maturation into a mainstream investment vehicle with the oversight and heightened reporting requirements that come with that. However, I wouldn't expect a massive influx of new funds or listing on new exchanges, but continued, steady growth.”

Dmitriy Berenzon, a research partner at blockchain capital firm Zenith Ventures, is hopeful that GBTC’s registration will spark an industry-wide trend toward increased transparency:

“My hope is that Grayscale's move will push more crypto companies to voluntarily disclose more comprehensive information on a more consistent basis. For example, while the Tezos Foundation publishes detailed biannual updates and the Ethereum Foundation publishes high-level quarterly updates, I'm looking forward to a time when we see detailed quarterly reports from all cryptoasset-related foundations.”

Not everyone is capable

Blum from Two Prime thinks that even though many other players in the digital asset space could be interested in following Grayscale’s example, it is a bar that only a few are able to clear:

“It's not a massive gamechanger. Other players might be interested in replicating it, but from a logistical standpoint — including quarterly reports to the SEC, auditing, accounting, and heavy legal and financial oversight — it's expensive and labor-intensive. It's a very high barrier for new entrants to achieve what Grayscale is doing.”

Speaking of the odds of GBTC obtaining its desired status, Blum said that the trust is an excellent candidate for approval, given its current regulatory status and assets under management. 

Unlike Bitcoin ETF applications, Grayscale is not seeking approval of a new, prospective product but is simply carrying on with an already operational and very successful product that has a track record.