BlockFi has stopped accepting shares of Grayscale Bitcoin Trust (GBTC) as collateral for loans, concluding its relationship with one of the most profitable arbitrages in modern history.
GBTC only owns one asset: bitcoin. Nevertheless, GBTC currently trades at a -31% discount to the bitcoin it possesses. Because investors cannot redeem GBTC shares for bitcoin — Grayscale’s trust is “closed end” — GBTC has decoupled from the price of bitcoin and shares simply trade on the whims of the market.
Years ago, investors were optimistic that the SEC would approve Grayscale’s application to convert the trust to an ETF.
Indeed, in 2017 they were so optimistic about ETF approval and the future prospects of bitcoin that they bid up GBTC to a +130% premium to its net asset value. At this point, it was virtually risk-free for accredited investors who wanted exposure to bitcoin to arbitrage GBTC’s premium, and, predictably, BlockFi made tons of money.
What’s more, if the investor was willing to wait for six to 12 months (and many were, including BlockFi), they simply purchased bitcoin, gave it to Grayscale, bided their time, and then received shares of GBTC at its actual net asset value.
Assuming the premium persisted upon vesting, the investor had captured an arbitrage: vesting GBTC shares at net asset value and selling those shares for the market’s irrational premium.
BlockFi was one of the major participants in this arbitrage.
Fast forward to today, and the SEC has repeatedly denied Grayscale‘s numerous applications to convert GBTC into an ETF. Incredibly, Grayscale is suing the SEC and litigation proceedings could take over a year to resolve.
Needless to say, investor fatigue has set in. GBTC has shed its premium as investors have sold off to today’s -31% discount.
The end of BlockFi’s GBTC arb trade
BlockFi’s departure from GBTC marks the end of an era when nose bleedingly-high interest rates were commonplace for crypto depositors. Powered by arbitrage yields and other risky trades by BlockFi’s fund manager (and fellow Digital Currency Group member) Genesis, BlockFi once advertised 6% interest for bitcoin depositors. Nowadays, it’s slashed that rate to just 2%.
Today, BlockFi states that it no longer invests in GBTC as a corporation at all. The company is merely working on settling some loans that used GBTC as collateral.
In a statement, BlockFi cited concerns about collateral haircut ratios. For context, there are statutory and other accounting rules about the mix of assets that can collateralize an institutional loan portfolio. Haircuts are based on risk factors like liquidity and volatility.
Still dealing with the 3AC fallout
BlockFi has not ruled out the possibility of reopening GBTC as collateral — when it’s recovered from the ripple effects of the collapse of once-$18 billion crypto hedge fund Three Arrows Capital (3AC).
Three Arrows once owned as much as 5% of GBTC and BlockFi had several financial ties to the defunct hedge fund.
A New York judge recently froze 3AC’s remaining assets due to concerns that the founders — who remain in hiding — siphon them off. Creditors reported that 3AC’s Singapore offices are empty besides a few computer screens.
Co-founder Su Zhu accused creditors of “baiting.” In addition, he alleged that his family had received threats of violence. Conveniently, he claims that he has made good-faith efforts to cooperate with his creditors.
Zhu also referenced an investigation by the Monetary Authority of Singapore (MAS), saying that he and co-founder Kyle Davies have had to “field inquiries” from the regulator. He’s not provided a spreadsheet referenced in emails between Zhu and an attorney that Zhu made public in a tweet.
BlockFi reportedly lost $80 million due to 3AC’s bankruptcy. CEO Zac Prince said that the company can absorb the loss and is working on making it a part of 3AC’s bankruptcy proceedings.
However, investors do not expect a quick resolution. Bankruptcy proceedings can take years in a complex case like this.
Unlike Celsius Network, Vauld, CoinFlex, and Voyager Digital, BlockFi has not yet suspended operations or withdrawals. Due to emergency credit extended by Sam Bankman-Fried (SBF) that lowered the company’s valuation from $4.8 billion to as low as $240 million, Prince has reassured customers that he’ll honor all valid withdrawal requests.
Indeed, BlockFi recently signed a deal with SBF’s FTX US for a $400 million revolving line of credit and a possible $240 million acquisition. It also laid off 20% of its staff in mid-June 2022, citing market volatility and recent losses due to 3AC’s collapse as significant reasons for the FTX deal and layoffs.
Grayscale has not yet issued a statement on BlockFi’s removal of GBTC as an option for collateral.