Spotlight Interview: Michael Sonnenshein of Grayscale Investments
Thank you for joining us for this edition of the NovaBlock newsletter. Here, we explore the intersection of technology, finance, politics, and of course, the crypto asset space.
Founded by digital currency magnate Barry Silbert in 2013, Grayscale offers a family of private funds providing passive exposure to digital assets for institutional and accredited investors, four of which are publicly trade funds. Grayscale is also the largest asset manager in the space with over $1 billion invested in Grayscale’s family of products since inception and over $600 million invested in 2019 alone. In my interview with Managing Director Michael Sonnenshein, we discuss Grayscale’s products and offerings, how institutional investors are using its products, its path to making Grayscale Bitcoin Trust an SEC reporting company and what the asset manager has in store for the future. - Leeor Shimron
Leeor: Tell us a bit about yourself and Grayscale.
Michael Sonnenshein: I’m the Managing Director at Grayscale Investments, a New York-based digital currency asset management business that has approximately $3.2 billion in assets under management. Grayscale is the world’s largest digital currency asset management business. We have ten investment products, nine of which facilitate exposure to a single digital currency. For example, there’s a passively managed Bitcoin product and a passively managed Ethereum product. Another managed fund, the Grayscale Digital Large Cap, offers exposure to a rules-based methodology to the upper 70% of the digital currency market and holds its constituents on a market cap weighted basis.
We are generally soliciting and taking in subscriptions into all ten products through a 506(c) private placement where an accredited investor can purchase shares in any one of these products at their respective daily net asset values. We’ve done something innovative in that we’ve been able to get some of our product family to become publicly quoted. Four of our ten products now have public quotations. While we certainly are serving the accredited investor audience through those private placements, there is also no shortage of both retail and institutional investors that are trading in and investing in the Grayscale products that are publicly quoted every day, where investors do not necessarily need to be accredited, and there are no holding period requirements in order to participate in those products.
And those products represent the only publicly traded digital currency investment products available on the U.S. market. My role at Grayscale, having been with the firm, now starting my seventh year, is to oversee the daily operations and running of the Grayscale business. I oversee our sales and marketing teams, operations and legal teams, and I’m really focused on also continuing to maintain a lot of our key client relationships as well as drive overall strategy for the firm.
Leeor: You announced that last year was your best year, with inflows of more than $600 million across all your products. What contributed to the rise?
Sonnenshein: I think we are seeing meaningful inflows from institutional investors. Last year, 71% of our inflow came from institutions and primarily hedge funds, but also high net worth individuals, family offices, and other institutional investors like endowments and more traditional institutional investors.
I think we are seeing across that community a real belief in the staying power of the digital currency asset class and a need for many of those investors to begin getting exposure to it. They realize it’s not going away. They’re starting to see how it currently or in the future will affect some of the other investments they have, and they are excited to be investing in an asset class that can offer them a diversified return stream, which may offer them higher risk adjusted returns.
Leeor: Which Grayscale products are you seeing gain the most traction?
Sonnenshein: We’re seeing inflows across the board. For most of our investors, typically their first Grayscale investment is into our Bitcoin product or our Digital Large Cap Fund, either because Bitcoin is where they’re most comfortable or where they’ve done the most research and/or the Digital Large Cap Fund, because it provides them with a broad based exposure to the asset class through a singular investment.
As of the end of last year, about 35% of our investor base has now invested in more than one Grayscale product. We’re starting to see meaningful data that suggests that investors are not only excited by the opportunity of diversifying their portfolios by including digital currency exposure, but also realizing additional diversification benefits through exposure to more than one digital currency in their portfolio.
Leeor: In recent weeks, we’ve seen increased interest in ethereum classic (ETC), especially as it’s undergone its recent upgrade that aims to increase compatibility with Ethereum. What’s your view on this?
Sonnenshein: I think that ethereum classic, emerging when it did after the DAO fork, has some really interest- ing attributes that we’ve seen other digital currency protocols introduce and stick to causing it to be investible and well received by the investment community, and have been really strong catalysts for ethereum classic. For example, the fact that ethereum classic has a hard cap on its overall supply, not to mention there is no confusion around whether or not ethereum classic will move from proof of work to proof of stake.
The governance structure, being decentralized, has no central authority or individual controlling the network, or making decisions about how the network upgrades. But instead you see a diversity of teams and developers working on the protocol. I think there is a really strong appreciation within the investing community for some of those attributes having been solidified within the ethereum classic protocol and I think ultimately there is ever growing interest and confidence in the interoperability of applications being developed for both ether and ethereum classic. I think that folks want to ensure that they have exposure oftentimes to both assets, given that, any application that can be developed for ether can just as easily be deployed on ethereum classic, or vice versa. We are continuing to monitor those types of developments in the community. But it certainly is demonstrating a lot of staying power by sticking to those attributes.
Leeor: That makes a lot of sense, as you’ve highlighted, how it shares some of the characteristics of bitcoin in terms of not trying to make this transition from proof of work to proof of stake. And it’s more decentralized in terms of its decision-making process. Maybe that’s what’s creating staying power and further interest in the protocol.
Shifting gears here a little bit, it’s fairly well known that GBTC often trades at a premium to the spot price. Why is this the case? And would you expect this to change moving forward with the emergence of similar competing products in the future?
Sonnenshein: GBTC trades on the secondary market. The public quotation shares of Grayscale Bitcoin Trust have been publicly traded now since May 2015. Consistently, GBTC is amongst the most liquid securities on the OTCQX market, trading alongside other world class companies like Roche and Adidas, which are also quoted in that marketplace.
I think that GBTC’s public quotation price is based on the liquidity, and the fact we are seeing more than two dozen active market makers in the security every day is strong evidence that there is ever growing demand to access the product and access bitcoin.
Investors have certainly seen over the past few years no shortage of new and easier ways for them to gain exposure to bitcoin. Which is certainly fantastic for the asset class, but nonetheless, for investors to have the optionality to gain exposure to bitcoin in their investment account, or even in their past advantage account, be it an IRA or 401(k), they have that bitcoin exposure sit right alongside stocks, bonds and other investments they may make.
It certainly makes the ability or their proclivity to gain exposure to bitcoin far easier. Owning that exposure through the security affords them the protections of it being audited and producing financial and tax statements. It really makes having that exposure feel much, much more familiar. We’re seeing ever growing demand for the product and are really excited to see how much of the demand continues to be there. Ultimately the price at which GBTC trades on the public market is, of course, dictated by market forces, as we are not involved in trading GBTC on a daily basis.
Leeor: So, you don’t have any influence on the secondary market—you have to rely on these market makers and third parties that are providing liquidity. Obviously, you don’t have any control over that as it’s a freely traded product on an exchange?
Sonnenshein: Correct. We do not.
Leeor: We’re seeing hedge funds depositing bitcoin and arbitraging the premium. Do you view this as a substantial portion of the products’ inflows? Are you seeing this as a trade or a substantial source of demand for the product?
Sonnenshein: We do accept in-kind contributions for our various products, whereby investors who may already own digital assets, instead of subscribing to the Grayscale product with cash, can instead subscribe with digital currency they already own. In some instances that has caused the investor to be able to achieve a higher rate of return on their investment, because of the liquidity mechanism where they deposit the digital asset in exchange for shares of the private placement, and are then able to sell those shares, after the mandatory holding period, out onto the public market at a premium to the product’s net asset value.
So sometimes that’s allowing the investor to achieve a higher rate of return over owning the digital asset outright. But I would by no means say it is a guarantee the investor will be able to capture any sort of premium. The premiums at the moment exist and they can continue to exist, but obviously they may go up or down in value. And the products could even trade at a discount. We are seeing investors being able to potentially capture that premium, sometimes participating in the products through that means.
Leeor: The thing I’m trying to get at is, although this trade may exist, it seems as if most investors are utilizing the product just to gain exposure, perhaps long-term exposure, to bitcoin and other cryptocurrencies. Would you say that’s the case?
Sonnenshein: Yes. We certainly have investors we can point to who invested in the Grayscale Bitcoin Trust in 2013 that have still never sold their shares. Because this is an allocation they want in their portfolios. And they have a long- term view on where these digital currencies are heading.
Leeor: A recent Bitwise survey indicated that 6% of financial advisors allocated to crypto assets in 2019, which is expected to double this year. How is Grayscale engaging with the financial advisor community? Is that a particular area of focus for you?
Sonnenshein: We commissioned a study last year that looked at investor preferences and proclivities around digital currencies. We found there is quite a bit of interest among American investors to gain exposure to digital assets, and that the key component that’s missing from those investors’ ability to action an investment is purely education.
So Grayscale is spending a considerable amount of time and energy creating content so that investors do have educational tools to not only understand digital currencies, but also how it might fit within their portfolios, as well as developing materials for advisors and other investment professionals that are responsible or carry a fiduciary responsibility for helping other investors to allocate their capital. Certainly, it’s a big priority of ours and something we’re continuing to be excited about engaging with the investment community.
Leeor: Your largest product, Grayscale Bitcoin Trust, is a gateway for investors to gain passive exposure to bitcoin. How do you think the trust will be challenged upon the arrival of an ETF or other exchange-traded products? Are you concerned that the approval of an ETF from a provider such as VanEck might affect interest in the trust?
Sonnenshein: Grayscale Bitcoin Trust has the longest track record, dating back to September 2013, and has been publicly traded since May 2015. It’s the world’s largest bitcoin investment vehicle, currently holding over 1.5% of all bitcoin in circulation and is growing. We recently achieved a very meaningful milestone, not just for this product, but for the Grayscale team, as well as the industry overall—which is that we were able to have the Grayscale Bitcoin Trust become an SEC reporting company, the first digital currency investment instrument to do so.
That essentially means the structure of the product will not change. Who can participate in it won’t necessarily change. But rather, what we’re really attempting and achieving here is to bring the investment community a higher level of disclosure and reporting that comes with being an SEC reporting company, as opposed to the trust’s current reporting obligations, which are already stringent under the Alternative Reporting standards.
This is the type of reporting and disclosure we see from other public companies. We want to hold ourselves accountable to that level of risk disclosure and audited financials, and file these reports, those 10-Ks and 10-Qs, because this is what investors are asking for and deserve. We hope it signals that there are pathways to providing exposure to digital currency despite the fact that it’s nascent within the existing regulatory framework and that our regulators are willing to engage on this asset class.
Leeor: The fact that you are proactive in terms of becoming an SEC reporting company speaks to what you’re trying to accomplish here. I think you also mentioned previously how by doing so can affect the holding period. Is that true?
Sonnenshein: Yes, accredited investors investing in the “private placement will have an early liquidity option, after six months, as opposed to the previous 12 months, once the Form 10 has been in effect for 90 days.
Leeor: Where do you see the future of Grayscale and its offerings? Are there any new products in your pipeline that you can discuss?
Sonnenshein: Grayscale has a list of 20-some-odd products that are sitting on the shelf that we continue to talk about and evaluate. I think that as a team, we are constantly toeing the line between identifying unique opportunities to bring to investors and matching that with what investors are telling us they’re interested in gaining exposure to.
I can’t necessarily think of any one product that is ready or imminent to launch. But I think the community can be certain that Grayscale will continue to bring new and innovative products to market and that we are always interested to hear from investors around certain areas they’d like to gain exposure to and see if we’re able to structure products that can satisfy that demand.
Leeor: Thank you.
Quick Bits
India’s Supreme Court lifts banking ban on crypto exchanges. The ruling strikes against a decision imposed by the country’s central bank nearly two years ago that stifled crypto trading in Asia’s third-largest economy. The central bank’s decision at the time forced Indian crypto exchanges to either close, relocate to other jurisdictions, or shift their business model to crypto-to-crypto and OTC trading. This is an extremely positive development that will enable exchanges to operate in India and provide Indian citizens easier access to crypto assets.
The SEC proposed raising Reg CF raise limits to $5 million and Reg A+ raise limits to $75 million, from $1 million and $50 million respectively. The proposals may dramatically impact platforms that facilitate online securities offerings and benefit smaller companies that seek to raise capital. Along with their proposed reforms to the investor accreditation rules, the SEC seems to be making an earnest effort to increase retail participation in private offerings. However, the reforms do not go far enough, and the investor accreditation rules still exacerbate income inequality and lock out retail investors from gaining access to the best deals.
The Greenidge Generation power plant in New York is reportedly mining ~$50,000 of bitcoin each day. Over the past few months, the 650,000-square-foot power plant has installed approximately 7,000 bitcoin mining machines and is now mining about 5.5 bitcoins every day. Bitcoin mining is becoming increasingly geographically distributed and less concentrated in China. Furthermore, a substantial amount of Bitcoin’s mining energy comes from otherwise wasted energy, through a process known as flaring natural gas.