Grayscale Digital Large Cap: A Potential Arbitrage Opportunity

Summary GDLC has performed so badly that the setup may actually be good now. BTC and ETH make up over 97% of the fund's assets. If we adjust the GDLC share discount to match the discounts in GBTC and ETHE, GDLC shares should be closer to $11. When I last covered the Grayscale Digital Large Cap fund ( GDLC ) in August 2022, I was not impressed with the fund or the methodology used to determine asset inclusion for fund holdings. My thinking was a large-cap diversified fund should have exposure to more than just 5 assets and the weighting of those exposures shouldn't lean so heavily to Bitcoin ( BTC-USD ) and Ethereum ( ETH-USD ). Each of which has their own Grayscale funds and gets the lion's share of crypto investment fund flow. Since that article, very little has changed in that regard. GDLC is still a very poorly diversified crypto investment fund with just 5 assets under management. I still think the Bitwise 10 Crypto Index Fund ( BITW ) is probably a better option for investors who want exposure to multiple crypto assets in one ticker. However, I've actually flipped my stance on GDLC since that article. The performance of the fund has become so bad that it actually might be a good buy now, in my view. The Spot ETF Tailwind Grayscale Bitcoin Trust ( BTC )" target="_blank">GBTC ) is by far the most well-known fund that the company manages, and for good reason. It's the largest Grayscale fund by AUM, with $19 billion in BTC. GBTC is now notorious for serving as an arbitrage trade for investors who are comfortable with indirect exposure to Bitcoin as the fund has traded well below net asset value for over a year: Data by YCharts GBTC isn't alone in that regard. With the exception of the smaller illiquid funds, almost all of Grayscale's crypto investment funds trade at a sizeable discount to NAV. The Grayscale Ethereum Trust ( ETHE ) is now trading at a nearly 45% discount, even as the NAV discount in GBTC has closed to under 30%. To address this NAV discount problem, Grayscale has tried to convert GBTC to a spot ETF, though the US Securities and Exchange Commission has denied every spot BTC application to this point. A large driver of GBTC's NAV discount tightening over the last couple of weeks has been in response to BlackRock's ( BLK ) spot bitcoin ETF application. This is a positive catalyst that I pointed out shortly after BlackRock's application. Despite the June 30th news that the SEC believes the recent flood of spot bitcoin ETFs is "inadequate," there is actually some interesting language beyond the headlines. According to CoinDesk : At issue, the story continued, is that the filings didn't have enough detail with respect to the "surveillance-sharing agreements," including which spot bitcoin exchange would be used. The asset managers can update their applications and refile, and the CBOE indicated to the WSJ that it plans to do so. This would seem to suggest that the $1,500 intraday selloff in BTC following the SEC news could have been an overreaction. I suspect most or all of these spot BTC applications will be updated and refilled. And I maintain that the renewed interest in spot BTC ETFs is likely a very positive sign for GBTC. Arb of An Arb? This brings us to the arbitrage trade potential presently available in the GDLC shares. As I stated earlier, I believe Grayscale's large-cap fund has failed to deliver on providing traditional investors a diversified crypto asset fund. While the fund still has 5 assets under management, exposure to the bottom 3 altcoins has collapsed down to just 2.6% of the fund: GDLC Components (Grayscale) Bitcoin and Ethereum now make up over 97% of the assets in the fund, and the shares are trading at a 50% discount to NAV: GDLC (Grayscale/Author Chart) While 50% isn't the lowest the discount in GDLC shares has ever been, it does still potentially provide an interesting arbitrage opportunity since such a large amount of the fund is made up of BTC and ETH. The current fund shares have over 70% exposure to BTC and 27% to ETH. If we weigh those holdings to match the discount rates in GBTC and ETHE, the GDLC shares are dramatically underpriced at $8.55: GDLC Assets AUM Discount Adjustment Asset Value BTC $186,943,360 29.3% $132,168,955 ETH $72,978,401 44.8% $40,284,077 Adjusted Discount Market Cap $172,453,033 Adjusted share price $10.87 Source: Author Calculations based on Grayscale AUM and outstanding share data In the table above, I'm making an assumption of a $30,000 BTC price and a $1,850 ETH price. I'm also completely zeroing out the altcoins under management entirely, since they're such a small portion of the fund anyway. We still get a share price value off $10.87 when we discount the BTC by the same rate GBTC is discounted and the ETH by the same rate ETHE is discounted. I'll also point out that Grayscale has a single asset Solana fund ( SOL )" target="_blank">GSOL ) that actually trades at a sizeable premium because the fund is so illiquid. Given that, zeroing out the altcoins in GDLC could be argued to be overly conservative in building a revaluation estimate. Risks There is quite a bit of volatility with crypto and by extension the Grayscale funds. What adds to that volatility is the fact that the funds can often underperform and overperform the assets under management. Even if the discount closes, it doesn't necessarily mean the share price of the funds will appreciate. Furthermore, some of these Grayscale funds have high degrees of related party ownership. Those related parties include Digital Currency Group, Genesis, Grayscale, and CoinDesk. In recent filings, we've seen selling from those related parties and GDLC has been one of the funds that has been sold: Grayscale Trusts Last Reporting Period Current Reporting Period Change Related Party Ownership GBTC 36,065,470 36,066,527 0.0% 5.2% ETHE 11,811,797 8,728,797 -26.1% 2.8% Litecoin ( LTCN ) 1,296,956 1,126,498 -13.1% 6.6% Bitcoin Cash ( BCHG ) 1,786,273 1,443,441 -19.2% 4.2% GDLC 1,370,846 1,213,437 -11.5% 7.6% Source: Grayscale Furthermore, at 1.2 million shares still held by related parties and just under 15.9 million GDLC shares outstanding, there is a somewhat high concentration of related party ownership in GDLC compared to the other large Grayscale funds. And some of these related parties have been in the news in recent months for being financially distressed. Investor Takeaway This is a very simple thesis. GDLC has performed so badly as a diversified crypto fund that it's now arguably a good arbitrage trade, given how undervalued the shares are compared to other Grayscale fund shares that are holding the same assets. What could hinder this arbitrage trade would be the discounts of the other Grayscale funds moving back lower again, and that's certainly a possibility. Something else to consider would be the potential for Grayscale to adjust holding methodology to increase exposure to altcoins from the current 2.6% level. All that said, I like GDLC for a small speculative trade down here.