Canadian BTC ETFs Bring Significant BTC Inflows - CrossTower

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March 17, 2021

Cryptocurrency Research                                                        Martin Gaspar, Research Analyst
                                                                                 martin.gaspar@crosstower.com
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Canadian BTC ETFs Bring Significant BTC Inflows
BTCC Acquires More BTC Than Grayscale in February
We expect Bitcoin ETFs to replace GBTC as major driver of BTC price.

Last month brought the previously unthinkable – a sustained GBTC discount, with GBTC
trading below NAV for 13 out of 15 trading days since closing at a discount on February
23, 2021, according to data from Glassnode. As the GBTC premium waned in January from
its historical range of 10-40%, flows into GBTC thinned in February. Grayscale purchased
approximately $349 million of BTC in February, down from roughly $1.5 billion in January.
In our view, the lower inflows may have been a catalyst for BTC price weakness in the back
half of February. We believe investors should be concerned about lower Grayscale flows
into BTC, as the flows were crucial market support, especially over the last year. Offsetting
these flows, however, are three Canadian BTC ETFs which were recently approved and
launched. Purpose Bitcoin ETF (BTCC) has seen the most inflows thus far, acquiring
approximately $730 million of BTC through March 15, 2021, nearly a month since
launching. In our view, BTCC’s early success suggests pent-up retail and institutional
demand for such a product and should continue to attract investor interest. As institutional
investors shun GBTC, we expect ETFs like BTCC to be a key barometer of investor demand
and support for relatively high BTC prices.

Highlights
▪   Grayscale premium evaporates. After briefly turning negative several times in               Contents                         Page
    January, the GBTC premium remained in the low single digits throughout much of
                                                                                                Highlights ............................. 1
    February, before closing at a discount at the end of the month. The Grayscale trade
    has long been a favorite of institutional investors and with the premium at risk, we        GBTC ................................... 2
    anticipate demand for GBTC at private placement to be pressured, leading to a lack of
                                                                                                Canadian BTC ETFs ........... 3
    what has historically been strong inflows for BTC. In fact, Grayscale has since closed
    the private placement.                                                                      Corporate Buying ............... 4

▪   Purpose Bitcoin ETF (BTCC) sees strong demand. From its launch on February 18,              Institutional Interest ............ 5
    2021, BTCC has dominated the Canadian Bitcoin ETF space and has seen robust
                                                                                                Disclosures .......................... 6
    demand, adding over $0.5 billion of BTC in just a week since its debut. The Evolve
    Bitcoin ETF (EBIT), another Canadian Bitcoin ETF that launched in February, held
    approximately $51 million of BTC as of March 15, 2021.
▪   ETFs likely to replace Grayscale as key driver of crypto market. For much of 2020,
    Grayscale inflows were key in Bitcoin’s price appreciation, but will likely dwindle with
    the premium at risk. We expect ETFs to fill the inflow gap as awareness grows and as
    investors prefer the liquidity of an ETF to trusts such as those offered by Grayscale.
▪   Corporate and institutional appetite for crypto remains high. Bitcoin bellwethers
    MicroStrategy and Square continued to purchase BTC in February, while more
    financial companies, such as Goldman Sachs and JPMorgan announced plans to offer
    crypto-related products.
Grayscale Inflows Taper Off as GBTC Premium Turns Into Discount
The Grayscale Bitcoin Trust (GBTC) saw inflows slow down significantly in February as the
premium (OTC price vs. NAV) thinned and traded negative. Since closing at a slight
discount on February 23, 2021, GBTC has traded at a discount to NAV for 13 of the               Grayscale purchases of BTC
following 15 trading days, according to data from Glassnode. The sustained discount was         plunged in February 2021 as
just a matter of time, in our view, as awareness of the Grayscale trade increased among         investors grew concerned
institutional investors. Consequently, shares of GBTC increased substantially over the last     about the durability of the
                                                                                                GBTC premium.
year, leading to a glut of shares on the market. In fact, outstanding GBTC shares as of
February 23, 2021 totaled approximately 692 million, more than double the 304 million
shares from a year ago (February 27, 2020) and nearly 55% more than the approximately
445 million shares from 6 months ago (September 1, 2020). Since the lockup for GBTC
shares became 6 months in 2020, the 6-month growth in shares is particularly telling of
how crowded of a trade it has become. Since February 23, 2021, GBTC has mostly traded
at a discount, according to data from Glassnode, partly on outflows from the ARK ETF, a
large holder of GBTC.

We believe the recent discount is due to a couple factors, namely 1) A supply glut of
unrestricted shares and 2) Broad market weakness across risk assets that made investors
reconsider their positions at near all time-highs.

It seems that the weakness in the premium throughout 2021 indicates that the trade has
become more popular than the appetite for GBTC shares on the OTC market. We expect
this to continue unless a surge in BTC price or sentiment spurs higher demand for GBTC
shares. Consequently, we anticipate lower investor demand for the Grayscale trade, which
should lead to less BTC inflows from Grayscale. This was most evident in February 2021,
where the pace of inflows decreased significantly from recent months, with Grayscale
purchasing roughly $349 million of BTC, according to data from Glassnode. This is down
from approximately $1.5 billion in both January 2021 and December 2020. We believe this
is strong evidence that uncertainty about the Grayscale premium is leading to reduced
investor demand for the GBTC at the private placement. We note that Grayscale closed
GBTC to private placement following the discount in late February, which explains why
there were no March inflows to date.

This is a net negative for Bitcoin as Grayscale purchases of BTC were substantial drivers
of the BTC price in recent periods, in our view. With the GBTC premium gone and GBTC
private placement currently closed, other buying demand for BTC will need to step in to fill
the void from Grayscale, such as Canadian Bitcoin ETFs.

Digital Currency Group Steps in To Support GBTC
On March 10, 2021, Digital Currency Group (DCG), the parent company of Grayscale,
announced it would purchase of up to $250 million of GBTC shares on the open market.
We view this favorably, as these purchases could absorb some of the GBTC selling, but is
unlikely to be substantial enough to bring back GBTC closer to NAV or a premium. It is in
DCG’s best interests to step in and support GBTC on the open market, given that the
discount may be leading to losses at some of the firms its subsidiary Genesis lends to. A
discount is also unfavorable for DCG, given that Grayscale would not be increasing AUM
in terms of BTC. We are optimistic that this sort of intervention could help restore investor
confidence in the Grayscale trade, but note that it is more of a symbolic move, given
average daily volumes of GBTC of roughly $700 million in recent months. $250 million of

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purchases in this context seems unlikely to move the needle. We surmise DCG could
choose to increase purchases of GBTC to make a market impact if the discount persists.

Canadian BTC ETFs Set to Replace Grayscale for Key BTC Inflows
One area that has seen significant interest are the Canadian Bitcoin ETFs, the first of which
were approved and launched in February. Currently the Purpose Bitcoin ETF (BTCC),
Evolve Bitcoin ETF (EBIT), and CI Galaxy Bitcoin ETF (BTCX) are the Bitcoin ETFs that have
launched in Canada. Through March 15, 2021, BTCC saw approximately $730 million of
inflows since launching, bringing its total BTC holdings to roughly 13,565 BTC, according
to data from Glassnode. EBIT had approximately $51 million of BTC holdings as of March
15, 2021, or approximately 944 BTC, according to its website. BTCX began trading on
March 9, 2021 and held nearly $20 million of BTC as of March 15, 2021, according to its
website. Importantly, these three ETFs are required to hold physical BTC, so their inflows
have helped support the price amid recent market weakness.

Canadian Bitcoin ETF Timeline

February 12 – Purpose Bitcoin ETF (BTCC) cleared to launch by Canadian securities
regulators.

February 16 – Evolve Bitcoin ETF (EBIT) cleared to launch.

February 18 – BTCC starts trading.

February 19 – EBIT starts trading.

March 8 – CI Galaxy Bitcoin ETF (BTCX) final prospectus approved by securities Canadian
regulators.

March 9 – BTCX begins trading.

We expect these instruments to replace Grayscale as key drivers of the BTC price going
forward. While this trend may reverse in the future if GBTC returns to trading at a premium,
we believe a return to a sustained GBTC premium in the future is less likely given the
significant increase in supply of shares in recent months, barring continuous open market
purchases of GBTC by DCG. We also believe demand for products that have lower
management fees than GBTC’s 2%, such as these ETFs, will capture a portion of investor
demand that had previously went to GBTC.

Canadian ETFs Bring Unique Potential Risks
We want to draw attention to a unique potential tax risk that investors face when investing
in these Canadian Bitcoin ETFs – the determination of whether sales of BTC is recognized
on the income account or capital account, as is mentioned in the Purpose Bitcoin ETF
prospectus. The Canada Revenue Agency (CRA) has generally taken the position that sales
of commodities, as opposed to securities, are recorded on the income account and
therefore subject to Canadian income tax, rather than being treated as capital gains,

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although the treatment in each case is based on factual enquiry. Bitcoin is categorized as
a commodity in Canada for tax purposes, so it is our understanding that sales of BTC could
be subject to Canadian income tax, rather than treated as capital gains. The Purpose fund
generally intends to treat sales on the capital account (i.e. should give rise to capital gain
or loss), given it aims to be a long-term holder of BTC. If the CRA views sales of BTC to
actually be on the income account, the difference in the fund’s net income could be
deemed to have been distributed to investors, who could then be subject to withholding
tax. Given that the CRA is unlikely to pursue non-resident shareholders directly, it could
pursue the fund for unpaid withholding taxes. If the fund is unable to recover the unpaid
withholding taxes from non-residents whose shares are redeemed, the fund could need to
sell holdings to make the payment, reducing its NAV.

In its prospectus, the fund says it anticipates only selling BTC for 1) Fund expenses and 2)
Redemptions. While the risk of a significant unpaid tax liability is relatively benign if there
are negligible redemptions, we note that large amounts of redemptions could lead to an
unfavorable scenario. However, there would likely need to be considerable selling pressure
of the fund’s shares or a lack of buying demand to spur investors to redeem their shares
rather than sell them on the market.

Corporate Buying Continues In Recent Weeks
In our previous report, we discussed our expectation of sustained institutional and
corporate purchases of BTC to support the price over $50,000. In our view, this has
materialized and has helped prop the BTC price despite recent market weakness.
Specifically, Square and MicroStrategy continued to snap up BTC.

Square announced in its Q4 2020 earnings press release on February 23, 2021, that it
purchased an additional 3,318 BTC at an aggregate purchase price of $170 million
(~$51,000/BTC). Combined with Square’s previous purchase of $50 million in BTC, it now
held approximately 5% of its total cash, cash equivalents and marketable securities as of
December 31, 2020 in BTC.

MicroStrategy announced it purchased $15 million and $10 million of BTC on March 1 and
March 5, 2021, continuing to add to its holdings shortly after its $1.05 billion debt financing
to purchase BTC in late February. As of March 5, 2021, the company held approximately
91,064 bitcoins that were acquired at an aggregate purchase price of $2.196 billion.
MicroStrategy is one of the largest known holders of BTC, according to data from the
website Bitcoin Treasuries. Speaking at an industry event in late February. MicroStrategy
CEO Michael Saylor indicated his firm was open to both equity and debt financings to
purchase BTC. The company has issued convertible notes twice so far (February 2021 and
December 2020) to fund BTC purchases but has yet to do an equity raise for the same
purpose.

Other notable institutional purchases of crypto included Meitu, a Chinese tech company,
which announced on March 7, 2021, that it purchased approximately $40 million of BTC
and ETH, allocating roughly $20 million to each. It said its cryptocurrency investment plan
allows it to purchase up to $100 million of crypto, suggesting we could see it return to the
market.

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On March 8, 2021, Aker, a Norwegian industrial company whose chairman is billionaire
Kjell Inge Rokke, announced it is launching Seetee, a unit that will focus on Bitcoin. It will
keep its treasury reserves in BTC and said its first purchase was 1,170 BTC (~$60 million
at recent prices).

We believe these announcements are just the tip of the iceberg for greater BTC adoption
from corporations. As yields continue to remain low, while inflation expectations rise on
potential stimulus and the prospect of economies reopening with COVID-19 vaccines
available, we anticipate more companies will consider BTC for their balance sheet.

Recent Headlines Suggest Institutional Interest Continues to Grow
Institutional interest in BTC remains strong, according to recent headlines, which included
Goldman Sachs relaunching its crypto trading desk after a three-year pause. The news
followed media reports in January that Goldman was exploring crypto custody. The move
signals rising institutional interest in crypto, which Matthew McDermott, Goldman’s Head
of Digital Assets, described as “huge” on a recent podcast. He also said that in a survey of
nearly 300 clients by the firm, 40% currently have exposure to crypto. 22% of the survey’s
participants expect BTC to trade above $100,000 within a year, an especially telling figure
of institutional interest in crypto, in our view.

Another development suggesting rising interest is PayPal’s acquisition of crypto custodian
Curv, announced on March 8, 2021, which CNBC reported was for less than $200 million.
The acquisition allows PayPal to further expand its services, and we could see PayPal roll
out more retail and even institutional products. This goes hand-in-hand with PayPal’s recent
plans for launching a dedicated crypto unit and its ambitions for expanding its crypto
product suite beyond basic investing services (buy/sell).

Retail demand is also high, leading firms to explore crypto offerings for this base. The Block
reported earlier in the month that Charles Schwab is considering launching a crypto
brokerage and could launch such a service by the end of the year. We believe this an
indication retail interest in crypto remains robust and view it positively for the space, as it
could help drive greater consumer adoption.

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