Skyrocketing Bitcoin (BTCUSD) prices coupled with greater institutional interest in cryptocurrencies powered crypto investment firm Grayscale to its best year ever in 2020. The New York-based firm witnessed “unprecedented investor demand,” and its assets under management (AUM) rose by more than 10 times to $20.2 billion last year, according to a recent digital asset investment report. The last quarter of 2020 was especially pivotal to Grayscale’s operations, accounting for approximately $3.3 billion in inflows. That figure is equal to roughly 58% of the year’s total investments and nearly half of the $7 billion lifetime flow of investments into Grayscale’s products.

Last year, investors poured money into the Grayscale Bitcoin Trust (GBTC), an open-ended trust that provides indirect exposure to Bitcoin and trades on over-the-counter (OTC) markets. GBTC’s AUM jumped to $17.5 billion from $1.8 billion at the start of 2020. According to the digital asset investment report, investors plowed an average of $217.1 million on a weekly basis into the trust.

Besides GBTC, Grayscale has seven other trust holdings of cryptocurrencies, including ones for Ethereum (ETHUSD) and Litecoin (LTCUSD), and a digital large-cap fund. The Grayscale Ethereum Trust pulled in an average of $26.3 million per week last year, while other single-asset focused products had weekly average inflows of $33.6 million. The sum total of investments flowing into these products totaled $1 billion for the entire year.

Key Takeaways Crypto investment firm Grayscale has reported record assets under management for 2020 as the pandemic shutdown increased macroeconomic instability.

The increase in trading of GBTC shares parallels Bitcoin’s price trajectory last year.

The increase in Grayscale’s AUM is a function of its attractive share premiums and critical place in the fledgling crypto economy.

Institutional investors accounted for 93% of all investments flowing into Grayscale’s funds. “There’s no longer a professional risk of investing in the digital currency asset class,” Michael Sonnenshein, CEO of Grayscale, told CNBC. “There’s probably more career risk in not paying attention to it.” According to Sonnenshein, the surge of inflows into Grayscale was primarily a result of investors rotating out of gold, the traditional safe haven from market mayhem, and into Bitcoin, which is positioning itself as digital gold.

“The kind of inflows that we are reporting should be evidence that investors are not waiting for an ETF to begin participating in this asset class,” he said, referring to the prospect of a Bitcoin exchange-traded fund (ETF) that might provide investors a cheaper way to access Bitcoin.

The increase in the Grayscale Bitcoin Trust’s AUM last year paralleled Bitcoin’s Brobdingnagian price trajectory. After a multi-year slump, Bitcoin price shot up from around $7,000 in January 2020 to surpass $40,000 by mid-December on the back of macroeconomic instability due to rising government debt from the pandemic shutdown and greater interest from institutional investors. Other cryptocurrencies also came along for the ride, and the market cap for crypto markets blew past the $1 trillion mark.

As of this writing, Bitcoin is trading at $36,247.73, roughly unchanged in the past 24 hours. The overall market cap for cryptocurrency markets stands at $1 trillion, with Bitcoin’s valuation accounting for 66.3% of that figure.

Grayscale and Cryptocurrency Markets

The figures for AUM for GBTC have increased even during serious drawdowns in Bitcoin price. For example, Grayscale reported an AUM of $359.5 million, or nearly three times the figure recorded during the 2017 digital asset bull market, in 2018. By 2019, that figure had advanced to $607.7 million. Bitcoin price crashed and subsequently moved sideways for most of those two years. The latest surge in AUM is simply a continuation of previous year trends, although it differs in scale and extent.

In its digital asset investment report, Grayscale wrote that the latest figures for GBTC inflows are “further evidence of institutions looking to Bitcoin as a reserve asset.” But that is a misleading statement. Investment into GBTC does not provide direct ownership of Bitcoin. Rather, it is a method to generate short-term profits off the cryptocurrency’s wild price swings without the associated ownership fees and custody costs.

The increase in GBTC’s AUM is a function of the fund’s structure and its critical position in the crypto economy. The fund creates shares in private placements, and redemption is only available to investors through public markets. They cannot redeem their shares for actual Bitcoin and are subject to a mandatory share lockup period of six months. This practice increases liquidity for GBTC shares in secondary markets and creates price volatility.

Based on SEC filings, Grayscale issued almost 3.5 billion shares in GBTC alone in 2020. The number of Bitcoin per GBTC share available to investors has declined over the years. It was 0.09242821 in 2017 and is 0.00094950 in January 2021.

According to Capital IQ, the top three holders of the fund’s shares are crypto lending firm BlockFi, Three Arrows Capital, and Horizon Kinetics. The last two are hedge funds based in Singapore and New York, respectively. BlockFi offers attractive interest rates in exchange to investors depositing Bitcoin and other cryptocurrencies on its platform. On the backend, it lends the Bitcoin to other players in crypto markets, notably GBTC. The volatility in GBTC’s price provides the lending firm with a ready source of liquidity to meet its customer commitments.

In addition to cash, GBTC investors can use in-kind purchase mechanisms to purchase shares. This means they can purchase the fund’s shares by borrowing Bitcoin from a lending firm like BlockFi and contributing to GBTC’s overall Bitcoin holdings. After the lockup period, they sell the shares at a premium to another investor and purchase the Bitcoin back. To hedge their position, the investors also open short positions against Bitcoin at futures platforms like the CME.

The absence of regulatory clarity regarding Bitcoin custody for institutional and retail investors also meant that Grayscale cornered the market for those seeking to profit off their Bitcoin purchases. According to Bybt, a cryptocurrency derivatives data platform, GBTC’s Bitcoin holdings jumped by approximately 346,400 in the past year.

Not surprisingly, JPMorgan strategists wrote last month that Grayscale is key to Bitcoin price because inflows into its funds outpace investments into Bitcoin or its associated funds by momentum traders. But that dominance may not last long. Grayscale is facing new competition from the likes of Bitwise and Osprey, which promise similar services at lower costs.

Clarity around custody regulation and the prospect of a Bitcoin ETF approval may also eat into Grayscale’s business. In addition, not all investors may be able to stomach the price volatility and the rapidly fluctuating premium of GBTC shares over Bitcoin price.