Grayscale’s once-mighty fund is bleeding bitcoin

GBTC, as the trust is known for its ticker symbol, remains the world’s largest bitcoin fund thanks to the recent surge in crypto prices. But its assets have shrunk by more than half from their peak in November 2021, in large part because the trust charges a 1.5% fee while bitcoin funds offered by BlackRock, Fidelity Investments and others charge next to nothing.

Investors have yanked a net $16 billion from GBTC since Jan. 11, when it converted from a trust into an ETF following U.S. approval of sales of bitcoin funds. Over the same period, the nine competing ETFs launched by mostly large asset managers have taken in nearly $29 billion.

Yet Grayscale has resisted a significant fee cut, insisting that rising bitcoin prices will continue to buoy its fortunes. Given bitcoin’s 43% advance this year and the currency’s long history of boom-bust cycles, it isn’t a bet that everyone is comfortable with.

“If this pace of outflows continues without a material jump in the price of bitcoin even for another couple of months, they are in a tough spot," Steven Lubka, head of private client services at investment firm Swan Bitcoin, said of GBTC.

Michael Sonnenshein, the chief executive of Grayscale Investments, said he isn’t worried about the investor exodus. He has previously defended GBTC’s higher fee as warranted given what he said were its advantages relative to competitors, such as easier trading.

“Over time, I do believe that as the market matures, GBTC’s fee will come down," he said.

Behind the erosion of GBTC’s bitcoin stash is a stark reversal of fortune. Before the mass launch in January of ETFs that hold bitcoin directly—instead of via futures contracts, as previous products did—Grayscale had a stranglehold on those who wanted to convert currencies such as the U.S. and Canadian dollar to bitcoin and vice versa in their brokerage accounts.

This privileged position at times led to unusual trading in the trust that rippled through markets. Largely because of trading by those seeking to move between “fiat" and cryptocurrencies, the Grayscale trust often traded at a premium to the market price of its bitcoin holdings—a practice that, despite the fund’s large fees, attracted waves of speculative investors betting that it would continue.

But in 2021, the trust’s typical premium to bitcoin flipped to a discount in part because of the substantial rise in the supply of GBTC shares on the market. The turnabout helped bring the demise of hedge fund Three Arrows Capital, which was incurring huge losses on one of its largest trades.

Grayscale has proposed a lower-fee version of GBTC that it would swap for a yet-to-be-determined percentage of every GBTC investor’s current holdings. But regulators have eight months to approve the plan, and previous bitcoin applications have often gone down to the wire.

If investors continue to redeem bitcoin from GBTC at the current pace of about 24,000 a week, Grayscale could run out of tokens long before any approval—in about 13 weeks, according to blockchain analytics firm Arkham Intelligence. GBTC has shed assets every trading day since it converted into an ETF, while BlackRock’s bitcoin ETF, the biggest of its competitors, has taken in cash for 66 straight sessions.

Sonnenshein, who is 37 years old, became Grayscale’s chief executive in early 2021 after founder Barry Silbert stepped back. Silbert recruited him in 2013 to help raise assets for his bitcoin fund, which had only $60 million in assets at the time. Back then, the duo would go on roadshows to pitch the fund to traditional finance professionals only to have the meetings canceled at the last minute after negative headlines about bitcoin came out, Sonnenshein recalled.

GBTC backers expect outflows to stabilize because they estimate more than half the fund’s remaining assets are stuck in taxable accounts. They contend investors are unlikely to sell and incur large tax bills unless they want to exit their bitcoin investments entirely.

“No one is going to buy another bitcoin ETF and concurrently take a 30% tax hit on capital gains just to save 1% a year" in fees, said Ryan Selkis, a former executive at Digital Currency Group, Grayscale’s parent company, and chief executive of crypto-research firm Messari.

Investors in Grayscale’s lower-fee bitcoin fund wouldn’t be forced to pay capital-gains taxes to transfer their assets, assuming it gains approval.

Another factor potentially working in Grayscale’s favor: The bankruptcy estates of FTX and DCG’s lending unit Genesis as well as crypto exchange Gemini Trust, which collectively held 89.4 million GBTC shares, mostly sold out of their holdings in the first quarter.

“The biggest parties that needed to exit GBTC have just about exited," said David Bailey, who led an activist shareholder campaign against Grayscale. “I think the outflows are going to slow down a lot."

Write to Vicky Ge Huang at vicky.huang@wsj.com