Grayscale Bitcoin Trust

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 5/5

A digital asset investment vehicle that aims to track the price of Bitcoin, providing a means for investors to gain exposure to Bitcoin without directly holding the cryptocurrency.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

### Business Overview

Grayscale Bitcoin Trust (BTC), a publicly traded investment vehicle, operates solely as a passive investment vehicle. Unlike a traditional business, it does not manufacture products or offer services. Instead, the Trust’s primary objective is to provide investors with exposure to the price movements of Bitcoin without the complexities of directly holding and managing the digital asset.

Revenue Distribution: GBTC does not generate revenue through operations. The revenues it receives are from a small fee it charges to investors based on the amount of Bitcoin they invest through the trust. They do not earn money from their underlying Bitcoin holdings or activities on the Bitcoin Network. Their fees are their primary source of revenue.
Industry Trends: The broader cryptocurrency industry has experienced immense volatility and hype. Investment interest in Bitcoin has surged at certain points as investors seek new ways to diversify and potentially benefit from the cryptocurrency market. However, with the increase in interest, the industry faces regulatory scrutiny and has seen periods of rapid expansion and contraction.

As of October 2023, the overall crypto market continues to fluctuate and remains very uncertain. Regulatory hurdles and uncertainty about future financial and economic trends are causing a lot of market turbulence. Bitcoin spot ETFs were recently approved.
Competitive Landscape:
The competitive landscape is evolving rapidly, primarily with the recent approval of Bitcoin Spot ETFs. Several firms, like BlackRock and Fidelity, now offer their own Bitcoin spot ETFs, which are also publicly traded and offer a lower management fee than Grayscale’s GBTC.

This increased competition and lower fees are likely to affect Grayscale’s profits and AUM, and could cause investors to abandon GBTC for other options.
There are many exchanges and platforms offering Bitcoin exposure without requiring clients to hold the actual digital asset, but Grayscale aims at institutions that desire a regulated investment vehicle in the form of a publicly traded security.
What makes GBTC different?: GBTC is a publicly traded and regulated investment vehicle that owns Bitcoins. It has pioneered exposure for institutional clients into the Bitcoin market and is one of the largest Bitcoin funds by assets under management. However, it has had its management fees and shares fluctuate with volatility and uncertainty in the crypto market.

Recent Concerns and Controversies:
One of the largest issues facing GBTC is its higher management fees relative to its peers, especially now with spot ETFs being approved. Many firms, such as BlackRock, are offering fees far lower than GBTC.
For long, the investors of GBTC could not easily redeem their shares, and often the stock price traded at premium and later at significant discount to the value of the underlying Bitcoin. However, this issue is being addressed with a new ETF filing by the Trust, which would allow for shares to be redeemed at market value of the underlying BTC.

### Financials

GBTC financials are somewhat unusual compared to other companies as the trust simply purchases and holds bitcoins and the fee it charges is the only thing that it counts as revenue. Also, it’s financial statements do not present the overall financial state of the company. Since the company’s function is to hold Bitcoin on behalf of others, its statements of assets and liabilities essentially constitute Bitcoin held and it’s equity is equal to the net assets held.

Assets: As of the latest financials, nearly all of GBTC’s assets are held in Bitcoin and it’s current value is approximately at $26B, down from $40B in 2021. The value of the Bitcoin is based on its market value at the end of the fiscal period. The bitcoin holdings are approximately at 620,000 units. The trust also holds a small portion of its assets as US Treasuries.

As the price of bitcoin is highly volatile, the assets can fluctuate significantly on a quarterly or even daily basis depending on price action in the crypto markets.
Liabilities: GBTC’s liabilities are negligible, mainly due to fees that it owes to its service providers.
Revenue and Expenses: As a result of its ETF filing, its revenues should only be comprised of management fees and expenses from keeping the bitcoin in a secure manner. These fees come from management, and authorized participation, etc. Previously, it has had some other minor expenses related to its marketing or share offerings, which have been discontinued.

The level of revenue and expenses should stay the same for any similar bitcoin fund, which is related only to its management fee and the costs of storing assets.
Profitability: The profitability of the fund is strongly correlated to Bitcoin’s price, as higher prices lead to more revenues from management fees. However, the expenses are relatively constant, leading to profitability to closely track the price action of Bitcoin. Since Bitcoin crashed dramatically in late 2022, the profits have decreased significantly.

The main takeaway from all this is that GBTC’s financials are mainly a reflection of the price of bitcoin and there is little analysis that can be done on the financials, they also aren’t a great predictor of its future. The only thing that matters is their management fee rate, which is significantly higher than its competitors.

### Moat Analysis

Moat Rating: 2 / 5

GBTC’s moat is limited by the rise of newer Bitcoin spot ETFs, which are cheaper and more easily tradable for investors. The ease of redemption of GBTC shares that was previously a unique proposition for the trust is now not an advantage.
Intangible Assets: GBTC has established brand name recognition as a way to easily gain exposure to Bitcoin, especially in the institutional sector. However, with the launch of many ETF competitors, this is likely to diminish. In addition, though the Grayscale’s Bitcoin Trust has a first-mover advantage, there isn’t much to benefit from this, because the underlying asset is Bitcoin, and it is open to anyone and has no monopoly. The trust also has some form of regulatory authorization, but it also does not provide an edge since the Trust is subject to numerous regulatory changes.

All those factors above make its “brand” intangible asset very weak, especially going forward, where it doesn’t provide the edge that the firm needs to gain dominance in a competitive market.
Switching Costs: There are some switching costs for investors to leave GBTC, because they might have to undergo capital gains taxes depending on how the asset was held. Other things such as tax implications might make investors reluctant to change.

However, with newer ETFs that also do not have any transaction charges when buying and selling shares (unlike trading GBTC at a discount or a premium), and with the potential for the shares to now also be redeemed, even the switching costs can be limited, since similar benefits can be achieved elsewhere.
Network effect The network effect is not present. Since bitcoin isn’t owned by the trust, the amount of investors doesn’t contribute to a competitive advantage. They benefit similarly from bitcoin’s increase in price regardless of how they hold it.
Cost Advantage: GBTC does not have lower costs compared to its peers. In fact, its management fee is among the highest in the space.

### Risks to the Moat and Business

Regulatory Risks: Regulatory uncertainty around Bitcoin and digital assets continues to pose a significant risk to GBTC. New rulings or enforcement actions by regulatory bodies like the SEC could change investor sentiment and hurt GBTC. Specifically, the ongoing battle between Grayscale and the SEC over converting GBTC to a Spot ETF is a significant and ongoing risk.

It seems likely that the SEC and Grayscale have recently reached an agreement for this issue, but ongoing regulations from the SEC and changes in current regulations could affect GBTC’s standing in the future.
Competition Risks: The approval of spot bitcoin ETFs in the market may drastically hurt GBTC’s assets under management and revenues, as there are many similar funds with cheaper management fees.
Price Volatility: Bitcoin’s price is subject to high volatility. Since GBTC holdings are completely in Bitcoin, it’s value is susceptible to these drastic price changes.
Technological Changes: Any changes in the bitcoin network like forks, hacking, etc. can severely impact its value and perception.
Operational Risks: There may be problems relating to the custody and security of Bitcoins that can harm GBTC’s value. However, as Grayscale works with Coinbase as its custodian and they have a proven track record for safeguarding their client’s assets, it’s not very relevant.
Macroeconomic risks: Overall economic trends, such as recession, inflation, or a stock market crash can adversely impact the Bitcoin market.

### Understandability Understandability: 3 / 5

GBTC is not very complex in its operations and purpose: it just holds bitcoins and charges a fee to investors. However, most of the financial instruments and operations involved, like trading derivatives, options or warrants can be complex to understand, which can make the financials seem very opaque. In addition, it’s also hard to see the real value of the business because it’s completely dependent on the price of Bitcoin, which is mostly unpredictable, and it’s not related to management, its financial strength, or the other factors that determine other companies. Therefore, it is not as simple to understand as many other businesses.

### Balance Sheet Health Balance Sheet Health: 5 / 5

The trust has minimal liabilities, consisting mainly of operational fees that are paid to service providers. The trust is not really in any danger of insolvency and does not have any significant short-term or long-term debt.
Its assets are held in Bitcoin and US Treasuries, both relatively liquid.
GBTC is mostly unimpacted from the macroeconomic environment and market shifts, because its holdings are primarily in Bitcoin.

### Summary

While GBTC remains a well-established player in Bitcoin investment, recent changes in the crypto space pose a challenge to its moat and business model. The approval of spot Bitcoin ETFs have added a more liquid alternative with cheaper fees, which are likely to erode GBTC’s AUM and profits. Despite having a strong balance sheet, the future of this entity remains uncertain and dependent on its adaptability and the evolution of its underlying asset.