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When Crypto Met Deep Value

You may have noticed Bitcoin recently broke $70,000. How did this happen?


The story begins with Grayscale Bitcoin Trust (GBTC) — a publicly traded trust that was created for the sole purpose of giving investors exposure to Bitcoin through the stock market.


GBTC is a passive vehicle that owns billions of dollars worth of Bitcoin. From its 2015 listing, GBTC had always traded at a premium to the underlying value of its Bitcoin holdings. Retail and institutional investors alike poured money into GBTC because it was one of the only ways they could effectively own Bitcoin without buying it directly.


At the beginning of 2022, things changed abruptly. The markets were hit with the inflation shock. Powell pivoted and began jacking up interest rates. Bitcoin and growth stocks—especially the most speculative tech stocks that got bid up during Covid—entered what would become a severe sell-off over the rest of the year.

SBF in Federal Court

By November 2022, FTX, the fraudulent crypto platform of Sam Bankman-Fried, had declared bankruptcy. Investors across the entire crypto industry were panicking.


GBTC was getting dumped. Investors were even concerned its custodian Coinbase (COIN) might fail—leaving them with an uncertain claim to the trust’s assets.


At year-end 2022, GBTC was trading at close to a 50% discount to its Net Asset Value (the current market value of all the Bitcoin it owned). And Bitcoin itself was down about 75% from its 2021 peak.

Sometimes I call it crypto “crappo.” Sometimes I call it “crypto-****". It’s just ridiculous that anybody would buy this stuff… It’s totally absolutely crazy, stupid gambling. - Charlie Munger, 2/16/2023

Value investors, like the late Charlie Munger, don’t often think highly of cryptocurrency. They like cash generation. They like businesses they can understand. They dislike speculative nonsense. They are allergic to financial bubbles.


But the essence of value investing is buying a dollar for fifty cents. Buying something for much less than it’s really worth (or its intrinsic value). This discount is what Ben Graham called a “margin of safety.”


The value mindset is arguably the complete opposite of the crypto mindset, which probably helps explain how the NAV discount on GBTC became so severe. Normally, value investors step in to take advantage of the arbitrage between market value and underlying value. Free money sitting on the sidewalk usually doesn’t last that long.


Where were the value investors?


A typical value investor at the time might have taken note of the discount but run the other way because he didn’t want anything to do with Bitcoin. This would have been a huge mistake.


Just as everyone was dumping GBTC, or refusing to buy it, legal efforts were underway by the industry to allow trusts like GBTC to convert into ETFs. Their case was strong, and if successful, it meant the discount to the underlying value of Bitcoin holdings would disappear instantaneously.


But the potential collapse in the discount was only half the appeal. Bitcoin itself would become more valuable if it could eventually be purchased through ETFs, a structure that provides daily liquidity.


Money would pour into Bitcoin ETFs, once they finally got approved. And the price of Bitcoin itself would surge because these ETFs would take all that fresh capital and buy more Bitcoin.


Double discount  


In late 2022, GBTC was offering one of the most coveted of all scenarios in the eyes of a value investor: the legendary “double discount.” The underlying assets were undervalued, with an enormous catalyst ahead, and the entity that held the assets was also undervalued.


On December 29, 2022, you could have purchased a share of GBTC for less than $8. Less than 15 months later, on March 13, 2024, GBTC closed at over $65. That is 8-times higher.


To read the full story on the recent surge in GBTC and Bitcoin —in addition to a stock pick idea aligned with the electrification theme, and much more—get immediate online access to Issue #2 of the 76report by starting your subscription right now

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