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I don’t throw the word bubble too lightly. For example, what’s been happening lately with software-as-a-service stocks is certainly exuberant and probably not justified by fundamentals, but I wouldn’t put the word bubble on it yet. If you want to see limitless animal spirits, however, the cryptocurrency world is currently serving it in spades.
In all honesty, there are reasonable bullish arguments for Bitcoin; I’m not convinced that all cryptocurrencies will be zeroing anytime soon. It could, but it could also turn into a decent asset class over time. There is reasonable debate there.
However, what is happening in altcoins, and in particular, some of the derivatives traded of them, is truly amazing. If there’s ever been a time to use the word “bubble,” it’s by looking at something like the Bitcoin Cash Trust in grayscale (OTCQX: BCHG).
Bitcoin Cash, for those unfamiliar with it, is a fork of the original Bitcoin. Bitcoin Cash split in 2017, as a group of holders were dissatisfied with the development of Bitcoin and wanted to take the cryptocurrency in a different direction that would make it easier to use the coin for commercial transactions. There has been a lot of controversy and Bitcoin Cash itself has forked again.
Source: Cointelegraph
As a result of all this, Bitcoin Cash has lost a lot of value, both compared to Bitcoin and fiat. Bitcoin Cash’s value has dropped from 0.2 bitcoin at its peak to just 10% of its current value. Meanwhile, the dollar price has plummeted from a peak of over $ 3,000 for Bitcoin Cash to just $ 325 at the time of this writing.
However, despite this dramatic underperformance, Bitcoin Cash has maintained a following and makes good trading volume. Hence, it was a reasonable target for a new Grayscale-listed product.
Enter the Bitcoin Cash Trust, under the ticker BCHG, which was established this summer to allow speculators the ability to hold Bitcoin Cash via an exchange-traded product. As the SEC was slow to accept crypto ETFs, grayscale products had to stay over-the-counter, reducing access to trading. However, they are finding an audience despite the lack of a major exchange list.
The Bitcoin Cash Trust started trading around $ 12, which was already a big premium for the fund’s roughly $ 3 worth of underlying assets per share. In early October, the Bitcoin Cash Trust price had plummeted and was approaching the NAV. It appeared that the market would be reasonably efficient. But then, things got weird …
source
Since the beginning of October, the Bitcoin Cash Trust share price has risen nearly tenfold. The underlying price of the Bitcoin Cash cryptocurrency, on the other hand, only rose about 40% in the same stretch. A share of BCHG simply represents ownership of 0.00933862 units of Bitcoin Cash, so the value of BCHG is expected to move in an almost 1: 1 correlation with the price of Bitcoin Cash. Instead, the Bitcoin Cash Trust has gone on an exponential moon even though the underlying assets it holds haven’t done much.
It’s not all. Grayscale also launched a Litecoin Trust (OTCPK: LTCN). This is even more ridiculous, traded for a 5,000% premium on the NAV:
source
That’s right – if you buy a share of LTCN now, you can pay $ 500 to get $ 8.37 worth of Litecoin cryptocurrency. Litecoin would have to rise 50x the current price simply to break even if the Trust ever started trading at the NAV. On November 24 alone, as the chart shows, the market price of LTCN rose by 47%, while the actual value of the underlying Litecoin assets only increased by 3.7%.
And squeezing back to the NAV could happen in the future. My understanding, based on the verbiage below, is that grayscale is capable of issuing more shares to accredited investors:
Source: grayscale
Therefore, for accredited investors with the ability to somehow short or hedge these altcoins elsewhere, this seems like an incredible arbitrage opportunity by investing directly in the product offered at the NAV and exposing crypto exposure elsewhere.
While rewards are unlikely to disappear entirely anytime soon, given the restrictions on the sale of newly issued shares, the odds of Bitcoin Cash Trust remaining at 1,000% premium over NAV and Litecoin Trust at 5,000% seem pretty low. In any case, retail speculators should be exceptionally careful before trading these products.
People arguing against a crypto bubble might say these products are not representative of the wider space as they are fairly unknown funds that are traded over the counter. This is a reasonable point, particularly on the Litecoin Trust, where the trading volume is still minimal. On the Bitcoin Cash Trust, however, the average trading volume is over 50,000 shares per day and is now surpassing 100,000 shares per day as the price has risen:
BCHG trading data. Source: Yahoo Finance
On November 24, for example, the fund traded 305,200 shares in a single day, for a volume of approximately $ 10 million. So, make no mistake, these products are starting to attract some real streams now, even at these jaw-dropping NAV rewards.
You may be wondering, why not short BCHG then? For one thing, what’s stopping it from reaching a 2,000% or 5,000% premium on its NAV, like its sister Litecoin Trust? You should use a very small position size on any potential short trade. Furthermore, the loan is expensive and difficult to locate.
For another example of the current crypto-mania, consider MicroStrategy (MSTR). The enterprise software company decided to pivot in September. He converted his cash into Bitcoin, with the CEO rightly concluding that the market would value that money more if it were held in Bitcoin. Specifically, MicroStrategy bought 38,250 Bitcoins at a price of just over $ 11,000 each for a grand total of $ 425 million.
It hasn’t arrived yet, but for the sake of argument, let’s assume Bitcoin gets to $ 22,000 so that MicroStrategy earns double their investment. This would add $ 425 million to their market value, all things being equal. So, what is the value traders have applied to MicroStrategy’s share price in exchange for its roughly $ 350 million in Bitcoin earnings so far:
YCharts dataThat’s right, MicroStrategy added a whopping $ 1 billion to its market cap for its roughly $ 350 million in cryptocurrency earnings. Bitcoin is expected to reach nearly $ 40,000 per unit to justify the current market capitalization of MicroStrategy, assuming the software core business is worth the same value as in September.
It goes without saying that speculation is much more difficult if you need to double the price or more simply to match your bets. In the case of the Grayscale Trusts, it is much worse than that. Paying $ 37 per share for $ 3.19 in Bitcoin Cash’s NAV is a questionable idea. And paying $ 500 for Litecoin’s $ 8.37 is almost indefensible.
My most read article of all time on Looking for Alpha was back in November 2017 when I suggested that The Big Short Moment was close for Bitcoin. Bitcoin’s price peaked within two months and subsequently plummeted. Sentiment is starting to get just as frothy now as it was in late 2017, particularly in altcoins. Be careful out there.
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Disclosure: We have no positions in any of the stocks mentioned and have no plans to initiate any positions within the next 72 hours. I wrote this article myself and express my views. I don’t get any compensation for this (other than Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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