With Bitcoin (BTC) at all-time highs over the weekend, spare a moment for investors in Osprey Bitcoin Trust (OBTC: Pink sheets. Closing price $21.00). While an investment in the underlying Bitcoin has been extremely profitable since the launch of the Osprey trust, each and every retail OBTC investor has lost money to date. Some investors are down 57% (OBTC buyers on February 17, when BTC was trading at $ 48,000).
There is no logical reason for this to be the case. OBTC is an investment trust launched in February of this year that holds only one asset, Bitcoin, and has very few other frictions (read: fees). Granted, Bitcoin has its own issues when it comes to safe custody and tax, to name two. But other crypto funds are no longer as out of touch with their fundamental value as Osprey is and, especially, has been since its launch.
This blog investigates why a bubble in Osprey, bearing no obvious relationship to it only asset (BTC), was so easily able to destroy investor wealth after its launch in February.
To be absolutely clear, I am astounded that, while every single buyer in history in BTC was in positive territory by this Sunday, every single retail who ever bought Osprey was down, mostly in double figures.
Worse still, OBTC still trades at a premium to its underlying assets, while all other trusts trade at a discount to their Net Asset Values (NAVs, see below).
What occurred? The answer will confound finance academics, practitioners and, indeed, any proponent of any version of the efficient market hypothesis, for some time.
The “law of one price” suggests that Osprey should trade somewhere close to its NAV. In illiquid markets in frothy times, that can be a premium, especially if other options are limited. Generally, however, trusts without redemption features trade as a discount (Lee et al 1990). The main reason is fees.
We should expect the trusts to track NAV in some way. But, since inception, the correlation between Osprey and its underlying asset is very close to zero (see left): Osprey’s price performance is completely unrelated to its underlying assets.
Why?
The only possible explanations are that (1) all OBTC investors are irrational and/or (2) OBTC was highly manipulated in an elaborate “pump and dump”.
This because these is no fundamental reason for a price premium in Osprey to exist. Like all Bitcoin trusts in the bull market, OBTC launched at a substantial price premium to the only underlying asset in the trust, Bitcoin. The justifications for a premium are/were many in earlier times. The trust, like others such as Greyscale Bitcoin Trust (GBTC – OTCQX), offered the most tax-efficient play on BTC. Better still, Osprey’s fees were one quarter of GBTC’s. Furthermore, when what are effectively closed end funds are the only entry into a hot market, premiums above the underlying assets are almost guaranteed. Greyscale popped on issuance to more than double its NAV, so why shouldn’t OBTC?
But this excuse still doesn’t wash. GBTC had no competition when it launched in the Bitcoin Iron Age, 2013. OBTC not only has direct competition, but also more efficient vehicles in Canada and, potentially, on the horizon in Osprey’s own playground, the US. The post-launch OBTC bubble is impossible to justify in these circumstances.
ETFs as GBTC/OBTC killers
Exchange-traded funds and mutual funds that allow redemptions of the units for the underlying assets are the solution, practically guaranteeing that the investment will track the underlying. However, the SEC has been reluctant to approve a Bitcoin ETF reserving the right to efficiently invest in Bitcoin funds to “accredited investors”, which to date has meant mostly large arbitrageurs.
While other explanations have been proffered, it seems the final straw for the trust premium was the launch of the first Bitcoin ETF, in this case in Canada (Purpose Bitcoin ETF). Why risk your investment failing to track BTC when an ETF’s relationship with the underlying is all but guaranteed?
Institutions win (again)
The egregious “BlockFi / Three Arrows” arbitrage based on the physical delivery of BTC in exchange for trust units at NAV disappeared almost in both GBTC and 3iQ earlier in the month. It should have: Closed end funds on reasonable liquid assets should and (eventually) usually do trade at a significant discount. How double-digit premia were sustained for so long will always be a mystery. Giving institutions arbitrage privileges was banned in mutual funds a few decades ago, as it was grossly unfair to retail investors.
In any event, with the loss of the GBTC premium, it was no longer profitable to deposit BTC into the trust in return for units that could be sold at a later date for a premium.
But the arb still has not disappeared in OBTC, though time will tell if the twelve-month lock in will prove profitable for institutional investors. To date, few institutional buyers are not suffering. They were able to exchange BTC for shares at NAV, and on a mark-to-market basis they are at worst down only slightly.
Finance and irrationality
What to make of the OBTC premium and price volatility? Well, it’s no secret that the buyers of the trust were (very) small retail. In financial theory, it’s though that the presence of ill-informed “noise traders” can skew prices away from efficiency. Though such irrational activities are often short-lived, long bull markets might reward and therefore encourage momentum strategies (see Tesla, for example). Such traders fail to do enough analysis to identify true bubble investments.
My personal theory is that OBTC investors were victims of ignorance, irrationality and manipulation. There is some logic to momentum strategies in any bull market, assuming you can identify one while it is occurring. Tesla and Bitcoin post March 2020 offer two such examples. There can even be some argument that GME is a steal at $300 plus. A bubble is extremely difficult to identify.
Yet OBTC was (and to some extent remains) obviously and by any measure irrationally over-priced. Its only asset was easily available in almost identical form at a much lower premium (in GBTC) or easily and directly available (but not tax-advantaged) at a much lower price, and these facts have been true for all of OBTC’s history. Disappointing OBTC investors further, the tax benefits of the trusts become a downside when losses accumulate, as such losses can’t be deducted from taxes owed.
On top of that, for the foreseeable future, Boomer financial capitalists are set to profit in fees, no matter what the performance of the trusts. There is no process by which the size of the trusts can be reduced.
Was the price action a “pump and dump”? We will never know, though it is very clear that institutional (momentum, HFT and arb) funds profit from many such short-term bubbles (e.g. the first spike in GME).
A warning
The sad story of OBTC’s collapse needs to become better known, if only as a warning to those who buy momentum stocks because they have gone up. Even in a bull makret, not all stocks go up. Mom and pop Boomers who were sold the trusts as an easy way to get into crypto end up paying directly into the pockets of the hedge funds and other financial capitalists. It’s ugly to watch.
The finance behind crypto remains important to understand the space. The key takeaways are:
Follow the money. If institutions are borrowing BTC and buying funds in private placement, there is generally free money (or a least the chance of low risk profits). The existence of an institutional arbitrage usually signifies a loss to someone else elsewhere (usually but not always retail investors).
Funds referencing reasonably liquid assets without effective redemption mechanisms should be avoided, even if taxed advantaged, when trading at a premium. They should and usually will trade at a discount eventually.
Watch the NAV. Buying a dollar for two dollars is generally a bad idea. (Note that this is happening in the SPAC bubble as well: CCIV post-announcement pricing was extremely difficult to justify based on fundamentals). If you buy something a twice fair value, it has to double just for the fund’s assets to bring you back to breakeven.
Any assumptions regarding rationality in finance can be easily shrugged off. Noise traders can remain solvent and irrational for a very long time. Bubbles can exist.
Crypto markets remain inefficient in many cases, much like capital markets were in the 1980s-early 1990s. If you do not know if you are being arbitraged – that is, if something seems to good to be true – you probably are.