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Grayscale Research | Matthew Beck, CFA | June 2019

Hedging Global
Liquidity Risk
with Bitcoin

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June 20191

Hedging Global
Liquidity Risk
02 | 20

with Bitcoin
“Bitcoin is the beginning of something great: a currency without a
government, something necessary and imperative.” – Nassim Taleb, Author
of ‘The Black Swan: The Impact of the Highly Improbable’

Crises Are Becoming More Common and Global

Financial crises are becoming more common and global. The following chart
from Goldman Sachs identifies a long list of large drawdowns across US,
European, and Asian equity markets over the last sixty years, showing just
how devastating their effects can be. For example, during the Global
Financial Crisis (GFC) between October 2007 and March 2009, the S&P 500
and several of its global equity counterparts lost more than half of their value,
erasing decades of wealth creation and challenging our understanding of
market efficiency and systemic risk.

Unfortunately, these broad-based drawdowns in asset prices happen with


greater frequency than most investors realize. Now, more than ten years into
©2019 Grayscale Investments, LLC

a bull market for risk assets2, it is crucial for investors to understand the
dynamics of liquidity risk and the tools available to hedge before the next
crisis materializes.

In this paper, we'll explore Bitcoin's potential role as a hedge against liquidity
risk through the lens of five macroeconomic developments, including the
recent escalation of US and China trade tensions.

1. Originally published December 2016. Updated as of June 11, 2019.


2. We define “risk assets” as those with uncertain cash flows and high sensitivities to credit and business cycles (e.g., equities,
corporate bonds, industrial commodities, and commercial real estate). We define “wealth preservation” assets as those with
hedged exposures to these forces (e.g., certain forms of cash, currency-hedged government bonds, gold, and in our view, Bitcoin).

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FIGURE 1: LARGE EQUITY DRAWDOWNS ARE FREQUENT AND GLOBAL3

0
-10
-20
-30
-40
US stagflation
-50 Iraq Euro
Cuban Russian Default
1987 crash War crisis
-60 Missile Vietnam / LTCM
Crisis (Black Monday)
War GFC
-70 Oil Tech bubble burst
UK stagflation crisis
-80
03 | 20
1956
1957
1961
1963
1966
1968
1969
1971
1972
1973
1975
1976
1978
1979
1980
1981
1986
1987
1989
1990
1991
1992
1993
1996
1997
1998
2000
2006
2007
2010
2011
2015
S&P 500 Dax FTSE All Share TOPIX

What is Liquidity Risk?

Liquidity risk is the risk of a real4 decline in wealth resulting from (1) an
imbalance in the amount of money and credit relative to debt in a given
economy and (2) how exposed an investor’s portfolio is to that imbalance.
Generally, this imbalance can take one of two forms: deflation or inflation.
When there is not enough liquidity to service debts or stimulate economic
growth, the result is deflation, while too much can spur excessive inflation.

In the modern macroeconomic order, liquidity is primarily controlled via


fiscal and monetary policies enacted by federal governments and central
banks. How liquidity is transmitted and the mechanisms through which
it will be managed (or mismanaged) has important implications for the
performance of markets and asset classes, and consequently the optimal
construction of investor portfolios. The truth is, most traditional portfolios lack
adequate diversification to protect against liquidity risk because they are
heavily concentrated in equities, which typically respond negatively to both
deflationary and inflationary pressures (e.g., the Global 60/40).

When building a portfolio, it’s important to keep in mind that all investment
decisions are relative. For example, an equity portfolio manager may choose
to allocate capital to various countries, sectors, and investment styles (e.g.,
value, growth, momentum) while a strategic asset allocator may choose to
deploy capital across various asset classes (e.g., equities, bonds,
©2019 Grayscale Investments, LLC

commodities, real estate). These are typical allocation decisions that


managers make in normal economic cycles as they seek to diversify their
portfolios and generate returns that match or exceed a given benchmark.

However, in a liquidity crisis, capital allocation decisions change. Investors


make choices between holding risk assets with uncertain cash flows and high

3. Source: Datastream, Bloomberg, Goldman Sachs Global Investment Research.


4. Real prices are adjusted for general price level changes over time, i.e., inflation or deflation. Nominal prices, sometimes called
current-dollar prices, measure the dollar value of a product at the time it was produced. Source: Federal Reserve Bank of St. Louis.

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sensitivities to credit and business cycles (e.g., equities, corporate bonds,


industrial commodities, and commercial real estate) versus wealth
preservation assets with hedged exposures to these forces, including the
currency devaluations that often follow (e.g., certain forms of cash, currency-
hedged government bonds, gold, and in our view, Bitcoin).5 Time and again,
we’ve witnessed risk asset correlations converge, reducing diversification
benefits when investors need them most.

A key component of liquidity risk is that it scales non-linearly with the amount
of leverage in the financial system. This is particularly important within the
04 | 20 context of our current economic environment, since global debt is at an all-
time high of roughly $250 trillion and debt-to-GDP is over 300%.6 Despite
muted volatility across global markets in recent years, the looming risk of a
liquidity crisis is also high.

FIGURE 2: THE WORLD’S $250 TRILLION DEBT7

Debt as a percentage of GDP

320%

310%

300%

290%

280%

270%
2008 2018

Nominal debt

$250T

$200T

$150T

$100T
©2019 Grayscale Investments, LLC

$50T

$0T
2008 2018

5. Source: Bridgewater Associates: The All Weather Strategy: Transitioning to the Safe Portfolio in a Depressionary Environment.
http://sdcera.granicus.com/MetaViewer.php?view_id=4&clip_id=75&meta_id=9141.
6. Source: Bloomberg. Global Debt of $244 Trillion Nears Record Despite Faster Growth. January 15, 2019. Chibuike Oguh and Al-
exandre Tanzi. https://www.bloomberg.com/news/articles/2019-01-15/global-debt-of-244-trillion-nears-record-despite-faster-growth.
7. Source: Bloomberg. The World’s $250 Trillion In Debt: the World’s Post-Lehman Legacy. September 13, 2018. Brian Chappatta.
https://www.bloomberg.com/graphics/2018-lehman-debt/.

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A New Way to Hedge


What makes Bitcoin such an exciting financial technology and investment
opportunity is that it has a distinct set of properties unlike any other asset.
Through this unique mix of properties, Bitcoin has the potential to perform well
over the course of normal economic cycles as well as liquidity crises, especially
those involving currency devaluations. These properties are as follows:

• Store-of-value characteristics similar to real assets like gold, with hard-


money attributes like immutable scarcity. (For more, see our previous
paper, Bitcoin & the Rise of Digital Gold). (Positive in Liquidity Crisis)
05 | 20
• Spending characteristics similar to cash. Today, you can spend bitcoin with
over 100,000 merchants worldwide including Whole Foods, AT&T,
Microsoft, Overstock.com, Expedia, PayPal, and Dell to name a few. Bitcoin
also has trading pairs with every major fiat currency, making it a ubiqitous
medium-of-exchange. (Positive in Liquidity Crisis)
• Growth characteristics of a new technology as real applications for
blockchain technology and decentralized digital assets continue to emerge
and create value, stimulating further demand. (Positive in Normal Economic
Cycles)

With continued adoption, Bitcoin represents a transparent, immutable, and


global form of liquidity that can provide both wealth preservation and growth
opportunities. As a result, we believe it deserves a steady strategic position within
many long-term investment portfolios. While Bitcoin may not be appropriate for all
investors based on their investment mandate or market microstructure limitations,
some may see the benefit of adding an allocation to their portfolios.

Thriving in Crisis
To better understand Bitcoin’s potential role as a hedge against liquidity
risk, we’ll look at Bitcoin market action in the wake of five macroeconomic
developments:

1. Grexit and the 3-week Greek bank shutdown amid sovereign debt
restructuring, sparking a physical liquidity crisis. (April – July 2015)

2. Economic concerns in China resulting in a surprise shift in monetary policy


©2019 Grayscale Investments, LLC

by the People’s Bank of China (PBoC) and structural devaluation of the


renminbi (RMB). (August 2015 – December 2016)

3. Brexit followed by a knee-jerk selloff and a steady decline in the pound


sterling (GBP) and euro (EUR). (June – December 2016)

4. Rising geopolitical risk and tighter financial conditions in the US


leading to global growth concerns and weakness in the currencies of
major US trading partners. (September – December 2016)

5. Escalation of US and China trade tensions posing systemic risks to


global economic growth and placing further pressure on the RMB.
(May 2019 – Present)

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Grexit
(April – July 2015)

On January 27, 2015, Alexis Tsipras, leader of the Syriza party, announced
the formation of a new government, igniting speculation of a Greek exit from
the European Monetary Union. In the months that followed, a default on
Greek debt seemed inevitable as political and financial experts around the
world questioned the new government’s ability and willingness to negotiate
emergency funding ahead of impending obligations.

Perhaps the most interesting development of this period was the decision
06 | 20 announced by the Greek government on June 28, 2015, to close state banks and
impose strict capital controls on transactions. These restrictions remained in place
for three weeks, while bailout terms were negotiated with international creditors.

The unprecedented move sparked serious concerns about the unilateral


power that governments can exhibit over holders of centralized assets in
times of crisis. During the liquidity freeze, Bitcoin emerged as one of the only
means by which to transfer value in or out of Greece, reinforcing this new
asset’s ability to return the power of control to the individual who holds it.

On July 13, 2015, an agreement was finally reached, avoiding Grexit and
bringing an end to a three-month risk asset rout. In the time leading up to the
agreement, Bitcoin was a top performer, producing a return of 28% versus an
average of just -1.7% for the twenty other markets and currencies below.

FIGURE 3: GREXIT DRAWDOWN8


APRIL 20, 2015 – JULY 10, 2015

Bitcoin 28.0%
British Pound (GBP) 4.1%
Euro (EUR) 3.9%
Swiss Franc (CHF) 1.8%
DJCME Spot FX Index 1.6%
Nasdaq Composite 0.1%
Chinese Renminbi (RMB) -0.2%
Singapore Dollar (SGD) -0.2%
Short-term liquidity
S&P 500 Index -1.1%
shock drives physical
Bloomberg Commodity Index -1.8% Eurozone currency
MSCI World Price Index -2.0% demand beyond
MSCI EAFE Price Index -2.4% longer-term
Barclays Capital Bond Index -2.4% devaluation concerns.
©2019 Grayscale Investments, LLC

COMEX Gold Index -2.7%


Argentine Peso (ARS) -2.9%
Japenese Yen (JPY) -2.9%
Canadian Dollar (CAD) -3.4%
Brazilian Real (BRL) -4.0%
EM equities
hit hard
Thai Baht (THB) -4.5%
Russian Ruble (RUB) -5.3%
MSCI Emerging Markets Price Index -9.8%

8. Source: Bloomberg. Performance of Bitcoin is based on the daily values of the Bloomberg Bitcoin Price Index (USD). Drawdown
periods are defined based on a proprietary indicator measuring peak-to-trough declines of global risk assets.

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Economic Concerns in China


(August 2015 – December 2016)

On August 10, 2015, the PBoC announced a significant change to its monetary
policy amid local stock market turbulence and concerns over the health of
the world’s second largest single-country economy.9 In an effort to stimulate
export driven growth, Chinese policymakers lowered the RMB-USD reference
rate by 1.9% and signaled the transition to a more “market-driven” pricing
regime. Following the RMB’s largest single day drop in over twenty years,
investors repriced risk through a five-month selloff of global risk assets in favor
07 | 20 of wealth preservation assets.

Between the day of the announcement and the trough of the drawdown
(January 20, 2016), Bitcoin largely outperformed the following major markets
and currencies, producing a cumulative return of 53.6% versus an average
return of -10.1% across the rest.

FIGURE 4: CHINA DRAWDOWN10


AUGUST 10, 2015 – JANUARY 20, 2016

Bitcoin Bitcoin 53.6% 53.6%


JapeneseJapenese
Yen (JPY)Yen (JPY) 6.6% 6.6%
Barclays Barclays Capital
Capital Bond Bond Index
Index 1.7% 1.7%
COMEX
COMEX Gold Gold Index
Index -0.3% -0.3%
Euro (EUR)
Euro (EUR) -1.2% -1.2%
Swiss
Swiss Franc Franc (CHF)
(CHF) -2.0% -2.0% Traditional wealth
DJCME
DJCME Spot Spot FX Index
FX Index -2.2% -2.2% preservation assets
Thai BahtThai Baht (THB)
(THB) -3.3% -3.3%
Singapore
Singapore Dollar (SGD)
Dollar (SGD) -3.9% -3.9%
Chinese Renminbi
Chinese Renminbi (RMB) (RMB) -5.7% -5.7%
British
British Pound Pound (GBP)
(GBP) -9.0% -9.0%
CanadianCanadian Dollar (CAD)
Dollar (CAD) -10.3% -10.3%
S&P 500S&P 500 Index
Index -11.6% -11.6% RMB
devaluation
Nasdaq Composite
Nasdaq Composite -12.4% -12.4%
MSCI
MSCI World World
Price Price Index
Index -15.6% -15.6%
Brazilian Brazilian
Real (BRL)Real (BRL) -16.1% -16.1% EM equities
hit hard
MSCI
MSCI EAFE EAFE
Price Price Index
Index -19.4% -19.4%
Bloomberg
Bloomberg Commo
Commodity Indexdity Index -21.3% -21.3%
MSCI Emerging
MSCI Emerging Markets
Markets Price Price Index
Index -22.0% -22.0%
Russian
Russian Ruble Ruble (RUB)
(RUB) -22.6% -22.6%
ArgentineArgentine Peso (ARS)
Peso (ARS) -31.3% -31.3%
©2019 Grayscale Investments, LLC

Through December 2016, the RMB continued its decline, falling by roughly
11% versus the US dollar. Given the strong inverse relationship between the
performance of Bitcoin and the RMB since the policy change, global investors
might consider looking at Bitcoin to hedge against China-driven liquidity risk,
while local investors look to protect their wealth from structural currency
devaluation.

9. Source: “World Economic Outlook Database”. International Monetary Fund. October 2016.
10. Source: Bloomberg. Performance of Bitcoin is based on the daily values of the Bloomberg Bitcoin Price Index (USD). Drawdown
periods are defined based on a proprietary indicator measuring peak-to-trough declines of global risk assets.

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FIGURE 5: RMB VS. BITCOIN SPOT RATE (USD)11


AUGUST 10, 2015 – DECEMBER 31, 2016

$0.1600 $1,000
RMB/USD Appreciation
Bitcoin
$0.1575 $900

$800

Bitcoin/USD Cross Rate


$0.1550

RMB/USD Cross Rate


$700
$0.1525
$600
$0.1500
$500
08 | 20
$0.1475
$400

$0.1450 $300
Depreciation
$0.1425 $200

25-Jan-16

07-Mar-16
10-Aug-15

11-Jul-16
31-Aug-15

01-Aug-16
21-Sep-15
12-Oct-15

22-Aug-16

05-Dec-16
18-Apr-16

24-Oct-16
02-Nov-15
23-Nov-15

12-Sep-16
09-May-16
14-Dec-15

20-Jun-16

14-Nov-16
15-Feb-16
04-Jan-16

28-Mar-16

03-Oct-16

26-Dec-16
30-May-16
RMB/USD Bitcoin

Brexit
(June – December 2016)

On June 24, 2016 the United Kingdom shocked the world as they announced
the result of a referendum vote in favor of separation from the European
Union (EU). On the day of the announcement, we witnessed a broad-based
selloff across both fiat currencies and risk assets as the market attempted to
digest whether Brexit would portend the disintegration of the European Union.

During the knee-jerk, one-day global selloff, Bitcoin was a top performing
asset, boasting a return of 7.1% on strong volume, versus an average of -2.1%
for the rest of the group. Once again, we watched Bitcoin outperform other
perceived safe-haven assets including gold, the Japanese yen (JPY), and
global bonds.
©2019 Grayscale Investments, LLC

11. Source: Bloomberg. Performance of Bitcoin is based on the daily values of the Bloomberg Bitcoin Price Index (USD).

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FIGURE 6: BREXIT DRAWDOWN12


JUNE 24, 2016

Bitcoin 7.1%
COMEX Gold Index 4.7%
Japenese Yen (JPY) 3.9%
Barclays Capital Bond Index 0.6%
Thai Baht (THB) -0.4%
Chinese Renminbi (RMB) -0.6%
Brazilian Real (BRL) -1.2%
Singapore Dollar (SGD) -1.3%
Traditional wealth
Swiss Franc (CHF) -1.6% preservation assets
09 | 20 Bloomberg Commodity Index -1.6%
Canadian Dollar (CAD) -1.8%
DJCME Spot FX Index -1.9%
Euro (EUR) -2.4%
Russian Ruble (RUB) -2.4%
MSCI Emerging Markets Price Index -3.5%
S&P 500 Index -3.6% DM equities hit
hard along with
Argentine Peso (ARS) -3.7% EUR and GBP
Nasdaq Composite -4.1%
MSCI World Price Index -4.9%
MSCI EAFE Price Index -7.1%
British Pound (GBP) -8.1%

In the aftermath of the Brexit referendum vote, weakness in both the GBP
and EUR continued through the end of 2016, as Eurozone policymakers and
investors grappled with an unprecedented economic challenge and the ways
it might unfold.

FIGURE 7: GBP VS. BITCOIN SPOT RATE (USD)13


AUGUST 10, 2015 – DECEMBER 31, 2016

$1.5000 $1,000
GBP/USD
Appreciation $950
Bitcoin
$1.4500
$900

Bitcoin/USD Cross Rate


GBP/USD Cross Rate

$1.4000 $850

$800
$1.3500
$750
©2019 Grayscale Investments, LLC

$1.3000 $700

$650
$1.2500
$600
Depreciation
$1.2000 $550
17-Nov-16
14-Jul-16

22-Sep-16
29-Sep-16
25-Aug-16
28-Jul-16

20-Oct-16

08-Dec-16
15-Dec-16
04-Aug-16

08-Sep-16
30-Jun-16
07-Jul-16

21-Jul-16

24-Nov-16
18-Aug-16

06-Oct-16
15-Sep-16

01-Dec-16
23-Jun-16

27-Oct-16
03-Nov-16
13-Oct-16

22-Dec-16
01-Sep-16

10-Nov-16

29-Dec-16
11-Aug-16

GBP/USD Bitcoin

12. Source: Bloomberg. Performance of Bitcoin is based on the daily values of the Bloomberg Bitcoin Price Index (USD). Drawdown
periods are defined based on a proprietary indicator measuring peak-to-trough declines of global risk assets.
13. Source: Bloomberg. Performance of Bitcoin is based on the daily values of the Bloomberg Bitcoin Price Index (USD).

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FIGURE 8: EUR VS. BITCOIN SPOT RATE (USD)14


AUGUST 10, 2015 – DECEMBER 31, 2016

$1.1400 $1,000

Appreciation
$950
$1.1200
$900

Bitcoin/USD Cross Rate


EUR/USD Cross Rate
$1.1000 $850

EUR/USD $800
$1.0800 Bitcoin
$750

$1.0600 $700
10 | 20
$650
$1.0400
$600
Depreciation
$1.0200 $550

17-Nov-16
14-Jul-16

22-Sep-16
29-Sep-16
25-Aug-16
28-Jul-16

20-Oct-16

08-Dec-16
15-Dec-16
04-Aug-16

08-Sep-16
30-Jun-16
07-Jul-16

21-Jul-16

18-Aug-16

06-Oct-16

24-Nov-16
15-Sep-16

01-Dec-16
23-Jun-16

27-Oct-16
03-Nov-16
13-Oct-16

22-Dec-16
01-Sep-16

10-Nov-16

29-Dec-16
11-Aug-16
EUR/USD Bitcoin

Now, three years later, Members of Parliament (MPs) are still negotiating the
withdrawal agreement detailing when, how, and under what conditions the
UK will leave the EU. After failing to gain approval three separate times in the
first quarter of 2019, the deadline for the withdrawal deal has been extended
to October 31, 2019. With so many details of the transition plan still unknown,
global investors might consider allocating a portion of their investable assets
to Bitcoin to help protect against contagion stemming from the Eurozone, the
world’s second largest economy.

Rising Geopolitical Risk & Tighter US Financial


Conditions
(September - December 2016)

Tighter financial conditions and rising geopolitical risk surrounding the 2016
US presidential election drove a multi-month selloff in risk assets. In the two
months leading up the election, interest rate expectations accelerated higher
on the prospects of monetary policy normalization by the Federal Reserve
and fiscal expansion under President-elect Trump. At the same time, talk of
protectionist trade policies (which have since materialized) and the
©2019 Grayscale Investments, LLC

continuation of easy monetary policies outside of the US were pushing the


dollar to multi-year highs.

From the beginning of the drawdown to the trough on November 10, 2016,
Bitcoin topped the performance charts, with a cumulative return of 17.2%,
versus an average of –3.5% for the other markets and currencies in Figure 9.

14. Source: Bloomberg. Performance of Bitcoin is based on the daily values of the Bloomberg Bitcoin Price Index (USD).

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FIGURE 9: TIGHTER US CONDITIONS DRAWDOWN15


SEPTEMBER 7, 2016 – NOVEMBER 10, 2016

Bitcoin Bitcoin 17.2% 17.2%


Bloomberg
Bloomberg Commodity IndexCommodity Index 0.5% 0.5%
Argentine Peso (ARS)
Argentine Peso (ARS) -0.2% -0.2%
S&P 500 Index S&P 500 Index -0.9% -0.9%
Nasdaq Composite
Nasdaq Composite -1.3% -1.3%
Russian Ruble (RUB)
Russian Ruble (RUB) -1.4% -1.4%
Swiss Franc (CHF)Swiss Franc (CHF) -1.7% -1.7%
Global currencies
Chinese RenminbiChinese
(RMB) Renminbi (RMB) -1.9% -1.9%
decline against
Thai Baht (THB) Thai Baht (THB) -2.0% -2.0%
11 | 20 strong dollar
MSCI World IndexMSCI World Index -2.6% -2.6%
Euro (EUR) Euro (EUR) -3.2% -3.2%
DJCME Spot FX Index
DJCME Spot FX Index -3.7% -3.7%
Bloomberg
Bloomberg Barclays Barclays
Global Bond IndexGlobal Bond Index -4.3% -4.3%
Japanese Yen (JPY)
Japanese Yen (JPY) -4.5% -4.5%
Singapore Dollar (SGD)
Singapore Dollar (SGD) -4.6% -4.6%
Canadian Dollar (CAD)
Canadian Dollar (CAD) -4.6% -4.6%
MSCI EAFE Index MSCI EAFE Index -4.8% -4.8%
MSCI Emerging
MSCI Emerging Markets Index Markets Index -5.2% -5.2%
Brazilian Real (BRL)
Brazilian Real (BRL) -5.6% -5.6%
British Pound (GBP)
British Pound (GBP) -6.6% -6.6% Global ex-US
COMEX Gold Index
COMEX Gold Index -6.7% -6.7% equities take a hit

Even after risk assets began to recover in mid-November, global currencies


continued to slide through the end of the year. As you can see from Figure 8, a
Bitcoin position may have helped insulate global portfolios from the risks of a
rising dollar and tighter financial conditions in the US.

FIGURE 10: US DOLLAR INDEX VS. BITCOIN SPOT RATE (USD)16


AUGUST 10, 2015 – DECEMBER 31, 2016

104 $1,000
US Dollar Index
103 $950
Bitcoin
102
$900
US Dollar Index Price Level

Appreciation of Bitcoin helps

Bitcoin/USD Cross Rate


101
hedge US dollar strength $850
100
$800
99
$750
98
$700
©2019 Grayscale Investments, LLC

97
$650
96

95 $600

94 $550
26-Oct-16
07-Sep-16

28-Sep-16

21-Dec-16
09-Nov-16
02-Nov-16
05-Oct-16

12-Oct-16

19-Oct-16

16-Nov-16

28-Dec-16
23-Nov-16
21-Sep-16

14-Dec-16
30-Nov-16
14-Sep-16

07-Dec-16

US Dollar Index Bitcoin

15. Source: Bloomberg. Performance of Bitcoin is based on the daily values of the Bloomberg Bitcoin Price Index (USD). Drawdown
periods are defined based on a proprietary indicator measuring peak-to-trough declines of global risk assets.
16. Source: Bloomberg. Performance of Bitcoin is based on the daily values of the Bloomberg Bitcoin Price Index (USD).

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US-China Trade Tensions Escalate


(May 5, 2019 – ?)

Though trade tensions formally began between the US and China back in
2017, the dispute escalated in the second quarter of 2019.17 On May 5, 2019,
US President Donald Trump caught market participants by surprise as he
announced a tariff increase on $200 billion of annual Chinese imports, from
10% to 25%. In response, Beijing announced its own series of retaliatory
tariffs on US goods. Given that the US and China are currently the two largest
single-country economies in the world (representing more than $35 billion
12 | 20 in annual GDP or roughly 40% of the annual global economic output), further
escalation could pose significant contagion risks to the global economy and
financial markets.18 In fact, the IMF recently released a report evaluating the
impact of the high-stakes disagreement, stating “the latest [trade] escalation
could significantly dent business and financial market sentiment, disrupt global
supply chains, and jeopardize the projected recovery in global growth in
2019.” Moreover, they cite that “consumers in the US and China are unequiv-
ocally the losers from trade tensions.”19 This is an important detail considering
that consumption represented roughly 68% of GDP in the US and 76% in
China in 2018.20 Disruption to the core driver of aggregate demand in these
economies could significantly hamper global growth, potentially producing a
domino effect of negative consequences that result in a liquidity squeeze in
the future.

While the drawdown appears to be in its very early stages, Bitcoin is getting a
jump before these risks are fully reflected in other asset prices. Since Trump
first announced the tariff hike, Bitcoin has generated a cumulative return of
47% through May 31, 2019, versus an average of -2% for the others during the
same period.
©2019 Grayscale Investments, LLC

17. Source: BBC. US to review China intellectual property policies. August 19, 2017. https://www.bbc.com/news/business-40982032
18. Source: IMF. IMF DataMapper: GDP, current prices. April 2019. https://www.imf.org/external/datamapper/NGDPD@WEO/OEMDC/
ADVEC/WEO/JPN/FRA
19. Source: IMF. IMFBlog: The Impact of US-China Trade Tensions. May 23, 2019. Eugenio Cerutti, Gita Gopinath, Adil Mohommad.
https://blogs.imf.org/2019/05/23/the-impact-of-us-china-trade-tensions/
20. Source: Federal Reserve Bank of St. Louis. Shares of gross domestic product: personal consumption expenditures, Q1 2019.
https://fred.stlouisfed.org/series/DPCERE1Q156NBEA.
Source: CNBC. Final consumption accounted for 76.2 pct of China’s 2018 GDP growth, exports a drag. January 20, 2019. https://
www.cnbc.com/2019/01/20/reuters-america-final-consumption-accounted-for-76-point-2-pct-of-chinas-2018-gdp-growth-exports-a-
drag.html.

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FIGURE 11: US-CHINA TRADE TENSION DRAWDOWN21


MAY 5, 2019 – MAY 31, 2019

Bitcoin Bitcoin 47.0% 47.0%


Japanese YenJapanese
(JPY) Yen (JPY) 2.1% 2.1%
COMEX Gold COMEX
Index Gold Index 1.5% 1.5%
Swiss Franc (CHF)
Swiss Franc (CHF) 1.1% 1.1%
Bloomberg
Bloomberg Barclays Barclays
Global Global Bond Index
Bond Index 0.9% 0.9%
Thai Baht (THB)
Thai Baht (THB) 0.9% 0.9%
Euro (EUR) Euro (EUR) -0.4% -0.4%
Traditional wealth
DJCME Spot FXDJCME
IndexSpot FX Index -0.4% -0.4% preservation assets
13 | 20 Brazilian Real (BRL) Real (BRL)
Brazilian -0.4% -0.4%
Argentine
Argentine Peso (ARS) Peso (ARS) -0.4% -0.4%
Russian Ruble (RUB) Ruble (RUB)
Russian -0.5% -0.5%
Canadian
Canadian Dollar (CAD) Dollar (CAD) -0.9% -0.9%
Singapor
Singapore Dollar (SGD)e Dollar (SGD) -1.3% -1.3%
BloombergIndex
Bloomberg Commodity Commodity Index -2.0% -2.0%
Chinese Renminbi (RMB) -2.5%
RMB
Chinese Renminbi (RMB) -2.5%
depreciation
British Pound British
(GBP) Pound (GBP) -4.4% -4.4%
MSCI EAFE Index
MSCI EAFE Index -4.8% -4.8%
MSCI World Index
MSCI World Index -5.1% -5.1%
Global equities
S&P 500 IndexS&P 500 Index -6.4% -6.4% hit hard
MSCI Emerging Markets IndexMarkets Index
MSCI Emerging -8.1% -8.1%
Nasdaq Composite
Nasdaq Composite -8.7% -8.7%

FIGURE 12: RMB VS. BITCOIN SPOT RATE (USD)22


MAY 5, 2019 – MAY 31, 2019

$0.1480 $8,600
RMB/USD
Bitcoin
$0.1475
Appreciation
$8,100
RMB/USD Cross Rate

Bitcoin/USD Cross Rate


$0.1470

$7,600
$0.1465

$0.1460 $7,100

$0.1455
Depreciation $6,600
$0.1450

$6,100
$0.1445
©2019 Grayscale Investments, LLC

$0.1440 $5,600
22-May-19

26-May-19

29-May-19
25-May-19
17-May-19
07-May-19
08-May-19
05-May-19

18-May-19

24-May-19
12-May-19

16-May-19

19-May-19

21-May-19
15-May-19

23-May-19
06-May-19

09-May-19

20-May-19

27-May-19
10-May-19

13-May-19

31-May-19
11-May-19

28-May-19
14-May-19

30-May-19

RMB/USD Bitcoin

21. Source: Bloomberg. Performance of Bitcoin is based on the daily values of the Bloomberg Bitcoin Price Index (USD).
Drawdown priods are defined based on a proprietary indicator measuring peak-to-trough declines of global risk assets.
22. Source: Bloomberg. Performance of Bitcoin is based on the daily values of the Bloomberg Bitcoin Price Index (USD).

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There are significant shifts taking place in monetary, fiscal, and trade policies
around the world that will likely impact global markets well into the future.
While we don’t know when or at what levels the current drawdown will end,
it is clear that the challenges faced by politicians and policymakers will be
difficult to manage given the complexity of our global financial system. Bitcoin
could be a useful tool in helping investors insulate their portfolios from any
failure to manage these problems effectively.

Conclusion
14 | 20
While it is still very early in Bitcoin’s life cycle as an investable asset, we have
identified evidence supporting the notion that it can serve as a hedge in a
global liquidity crisis, particularly those that result in subsequent currency
devaluations. Our conceptual understanding of Bitcoin’s properties,
observations of its past responses to macroeconomic shocks, and increasing
support from some of the top thought leaders in the investment management
industry reinforce the idea that Bitcoin could play a pivotal role in the
construction of more efficient portfolios with continued adoption.

We certainly do not hope for the next crisis, but we understand that shocks are
an inevitable part of functioning financial markets and do our best to prepare
for them ahead of time. We will continue to analyze Bitcoin market action to
deliver investment insights as we learn more from our experience with this
exciting new asset.
©2019 Grayscale Investments, LLC

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About Grayscale Investments, LLC

Grayscale Investments is the world’s largest digital currency asset


manager. With a proven track record and unrivaled experience, we give
investors the tools to make informed investing decisions in a burgeoning
asset class. As part of Digital Currency Group, Grayscale accesses the
world’s biggest network of industry intelligence to build better
investment products. We have removed the barrier to entry so that
institutions and individual investors can benefit from exposure to digital
15 | 20 currencies. Now, forward-thinking investors can embrace a digital future
within an institutional grade investment.

Grayscale is headquartered in New York City. For more information on


Grayscale, please visit, www.grayscale.co or follow us on Twitter,
@GrayscaleInvest.
©2019 Grayscale Investments, LLC

PLEASE REVIEW IMPORTANT DISCLOSURES & OTHER INFORMATION AT THE END OF THIS PAPER.
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theses are available at:
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Important Disclosures & Other Information

©Grayscale Investments, LLC. All content is original and has been researched and produced by
Grayscale Investments, LLC (“Grayscale”) unless otherwise stated herein. No part of this content may
be reproduced in any form, or referred to in any other publication, without the express consent of
Grayscale.

This report is for informational purposes only and does not constitute an offer to sell or the solicitation
of an offer to sell or buy any security in any jurisdiction where such an offer or solicitation would be
illegal. There is not enough information contained in this report to make an investment decision and
any information contained herein should not be used as a basis for this purpose. This report does
not constitute a recommendation or take into account the particular investment objectives, financial
16 | 20 situations, or needs of investors. Investors are not to construe the contents of this report as legal, tax
or investment advice, and should consult their own advisors concerning an investment in digital assets.
The price and value of assets referred to in this research and the income from them may fluctuate. Past
performance is not indicative of the future performance of any assets referred to herein. Fluctuations
in exchange rates could have adverse effects on the value or price of, or income derived from, certain
investments.

Investors should be aware that Grayscale is the sponsor of Grayscale Bitcoin Trust (BTC), Grayscale
Bitcoin Cash Trust (BCH), Grayscale Ethereum Trust (ETH), Grayscale Ethereum Classic Trust (ETC),
Grayscale Litecoin Trust (LTC), Grayscale Horizen Trust (ZEN), Grayscale Stellar Lumens Trust (XLM),
Grayscale XRP Trust (XRP) and Grayscale Zcash Trust (ZEC) (each, a “Trust”) and the manager of
Grayscale Digital Large Cap Fund LLC (the “Fund”). The Trusts and the Fund are collectively referred
to herein as the “Products”. Any Product currently offering Share creations is referred to herein as an
“Offered Product”. Information provided about an Offered Product is not intended to be, nor should it
be construed or used as investment, tax or legal advice, and prospective investors should consult their
own advisors concerning an investment in such Offered Product. This report does not constitute an offer
to sell or the solicitation of an offer to buy interests in any of the Products. Any offer or solicitation of an
investment in a Product may be made only by delivery of such Product’s confidential offering documents
(the “Offering Documents”) to qualified accredited investors (as defined under Rule 501(a) of Regulation
D of the U.S. Securities Act of 1933, as amended), which contain material information not contained
herein and which supersede the information provided herein in its entirety.

The Products are private investment vehicles. Shares of Grayscale Bitcoin Trust (BTC), which are
only offered on a periodic basis, are publicly quoted under the symbol: GBTC. The Products are not
subject to the same regulatory requirements as exchange traded funds or mutual funds, including the
requirement to provide certain periodic and standardized pricing and valuation information to investors.
The Products are not registered with the Securities and Exchange Commission (the “SEC”), any state
securities laws, or the U.S. Investment Company Act of 1940, as amended. There are substantial
risks in investing in one or more Products. Any interests in each Product described herein have not
been recommended by any U.S. federal or state, or non-U.S., securities commission or regulatory
authority, including the SEC. Furthermore, the foregoing authorities have not confirmed the accuracy or
determined the adequacy of this document. Any representation to the contrary is a criminal offense.

Certain of the statements contained herein may be statements of future expectations and other
forward-looking statements that are based on Grayscale’s views and assumptions and involve known
©2019 Grayscale Investments, LLC

and unknown risks and uncertainties that could cause actual results, performance or events to differ
materially from those expressed or implied in such statements. In addition to statements that are
forward-looking by reason of context, the words “may, will, should, could, can, expects, plans, intends,
anticipates, believes, estimates, predicts, potential, projected, or continue” and similar expressions
identify forward-looking statements. Grayscale assumes no obligation to update any forward-looking
statements contained herein and you should not place undue reliance on such statements, which speak
only as of the date hereof. Although Grayscale has taken reasonable care to ensure that the information
contained herein is accurate, no representation or warranty (including liability towards third parties),
expressed or implied, is made by Grayscale as to its accuracy, reliability or completeness. You should
not make any investment decisions based on these estimates and forward-looking statements.

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More Grayscale research
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Important Disclosures & Other Information

©Grayscale Investments, LLC. All content is original and has been researched and produced by
Grayscale Investments, LLC (“Grayscale”) unless otherwise stated herein. No part of this content
may be reproduced in any form, or referred to in any other publication, without the express con-
sent of Grayscale.

This paper is for informational purposes only and does not constitute an offer to sell or the solic-
itation of an offer to sell or buy any security in any jurisdiction where such an offer or solicitation
would be illegal. There is not enough information contained in this paper to make an investment
decision and any information contained herein should not be used as a basis for this purpose.
This paper does not constitute a recommendation or take into account the particular investment
17 | 20 objectives, financial situations, or needs of investors. Investors are not to construe the contents
of this paper as legal, tax or investment advice, and should consult their own advisors concerning
an investment in digital assets. The price and value of assets referred to in this research and the
income from them may fluctuate. Past performance is not indicative of the future performance of
any assets referred to herein. Fluctuations in exchange rates could have adverse effects on the
value or price of, or income derived from, certain investments.

Investors should be aware that Grayscale is the sponsor of Grayscale Bitcoin Trust (BTC), Gray-
scale Bitcoin Cash Trust (BCH), Grayscale Ethereum Trust (ETH), Grayscale Ethereum Classic Trust
(ETC), Grayscale Litecoin Trust (LTC), Grayscale Horizen Trust (ZEN), Grayscale Stellar Lumens
Trust (XLM), Grayscale XRP Trust (XRP) and Grayscale Zcash Trust (ZEC) (each, a “Trust”) and
the manager of Grayscale Digital Large Cap Fund LLC (the “Fund”). The Trusts and the Fund are
collectively referred to herein as the “Products”. Any Product currently offering Share creations
is referred to herein as an “Offered Product”. Information provided about an Offered Product is
not intended to be, nor should it be construed or used as investment, tax or legal advice, and
prospective investors should consult their own advisors concerning an investment in such Offered
Product. This paper does not constitute an offer to sell or the solicitation of an offer to buy inter-
ests in any of the Products. Any offer or solicitation of an investment in a Product may be made
only by delivery of such Product’s confidential offering documents (the “Offering Documents”) to
qualified accredited investors (as defined under Rule 501(a) of Regulation D of the U.S. Securities
Act of 1933, as amended), which contain material information not contained herein and which
supersede the information provided herein in its entirety.

The Products are private investment vehicles. Shares of Grayscale Bitcoin Trust (BTC), which
are only offered on a periodic basis, are publicly quoted under the symbol: GBTC. The Products
are not subject to the same regulatory requirements as exchange traded funds or mutual funds,
including the requirement to provide certain periodic and standardized pricing and valuation
information to investors. The Products are not registered with the Securities and Exchange
Commission (the “SEC”), any state securities laws, or the U.S. Investment Company Act of 1940, as
amended. There are substantial risks in investing in one or more Products. Any interests in each
Product described herein have not been recommended by any U.S. federal or state, or non-U.S.,
securities commission or regulatory authority, including the SEC. Furthermore, the foregoing
authorities have not confirmed the accuracy or determined the adequacy of this document. Any
representation to the contrary is a criminal offense.

Certain of the statements contained herein may be statements of future expectations and other
forward-looking statements that are based on Grayscale’s views and assumptions and involve
©2019 Grayscale Investments, LLC

known and unknown risks and uncertainties that could cause actual results, performance or
events to differ materially from those expressed or implied in such statements. In addition to
statements that are forward-looking by reason of context, the words “may, will, should, could, can,
expects, plans, intends, anticipates, believes, estimates, predicts, potential, projected, or contin-
ue” and similar expressions identify forward-looking statements. Grayscale assumes no obligation
to update any forward-looking statements contained herein and you should not place undue reli-
ance on such statements, which speak only as of the date hereof. Although Grayscale has taken
reasonable care to ensure that the information contained herein is accurate, no representation or
warranty (including liability towards third parties), expressed or implied, is made by Grayscale as
to its accuracy, reliability or completeness. You should not make any investment decisions based
on these estimates and forward-looking statements.

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Certain Risk Factors

Each Product is a private, unregistered investment vehicle and not subject to the same regulatory
requirements as exchange traded funds or mutual funds, including the requirement to provide cer-
tain periodic and standardized pricing and valuation information to investors. There are substantial
risks in investing in a Product or in digital assets directly, including but not limited to:

• PRICE VOLATILITY
Digital assets have historically experienced significant intraday and long-term price
swings. In addition, none of the Products currently operates a redemption program and
may halt creations from time to time or, in the case of Grayscale Bitcoin Trust (BTC), peri-
odically. There can be no assurance that the value of the common units of fractional undi-
vided beneficial interest (“Shares”) of any Product will approximate the value of the digital
assets held by such Product and such Shares may trade at a substantial premium over or
18 | 20
discount to the value of the digital assets held by such Product. At this time, none of the
Products is operating a redemption program and therefore Shares are not redeemable
by any Product. Subject to receipt of regulatory approval from the SEC and approval by
Grayscale, in its sole discretion, any Product may in the future operate a redemption pro-
gram. Because none of the Products believes that the SEC would, at this time, entertain
an application for the waiver of rules needed in order to operate an ongoing redemption
program, none of the Products currently has any intention of seeking regulatory approval
from the SEC to operate an ongoing redemption program.

• MARKET ADOPTION
It is possible that digital assets generally or any digital asset in particular will never be
broadly adopted by either the retail or commercial marketplace, in which case, one or
more digital assets may lose most, if not all, of its value.

• GOVERNMENT REGULATION
The regulatory framework of digital assets remains unclear and application of existing reg-
ulations and/or future restrictions by federal and state authorities may have a significant
impact on the value of digital assets.

• SECURITY
While each Product has implemented security measures for the safe storage of its digital
assets, there have been significant incidents of digital asset theft and digital assets
remains a potential target for hackers. Digital assets that are lost or stolen cannot be
replaced, as transactions are irrevocable.

• TAX TREATMENT OF VIRTUAL CURRENCY


For U.S. federal income tax purposes, Digital Large Cap Fund will be a passive foreign
investment company (a “PFIC”) and, in certain circumstances, may be a controlled foreign
corporation (a “CFC”). Digital Large Cap Fund will make available a PFIC Annual Informa-
tion Statement that will include information required to permit each eligible shareholder to
make a “qualified electing fund” election (a “QEF Election”) with respect to Digital Large
Cap Fund. Each of the other Products intends to take the position that it is a grantor trust
for U.S. federal income tax purposes. Assuming that a Product is properly treated as a
grantor trust, Shareholders of that Product generally will be treated as if they directly
owned their respective pro rata shares of the underlying assets held in the Product,
directly received their respective pro rata shares of the Product’s income and directly
incurred their respective pro rata shares of the Product ’s expenses. Most state and local
©2019 Grayscale Investments, LLC

tax authorities follow U.S. income tax rules in this regard. Prospective investors should dis-
cuss the tax consequences of an investment in a Product with their tax advisors.

• NO SHAREHOLDER CONTROL
Grayscale, as sponsor of each Trust and the manager of the Fund, has total authority over
the Trusts and the Fund and shareholders’ rights are extremely limited.

• LACK OF LIQUIDITY AND TRANSFER RESTRICTIONS


An investment in a Product will be illiquid and there will be significant restrictions on trans-
ferring interests in such Product. The Products are not registered with the SEC, any state
securities laws, or the U.S. Investment Company Act of 1940, as amended, and the Shares
of each Product are being offered in a private placement pursuant to Rule 506(c) under
Regulation D of the Securities Act of 1933, as amended (the “Securities Act”). As a result,

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the Shares of each Product are restricted Shares and are subject to a one-year holding
period in accordance with Rule 144 under the Securities Act. In addition, none of the Prod-
ucts currently operates a redemption program. Because of the one-year holding period
and the lack of an ongoing redemption program, Shares should not be purchased by any
investor who is not willing and able to bear the risk of investment and lack of liquidity for
at least one year. No assurances are given that after the one year holding period, there
will be any market for the resale of Shares of any Product, or, if there is such a market, as
to the price at such Shares may be sold into such a market.

• POTENTIAL RELIANCE ON THIRD-PARTY MANAGEMENT; CONFLICTS OF INTEREST


The Products and their sponsors or managers and advisors may rely on the trading exper-
tise and experience of third-party sponsors, managers or advisors, the identity of which
may not be fully disclosed to investors. The Products and their sponsors or managers and
advisors and agents may be subject to various conflicts of interest.
19 | 20
• FEES AND EXPENSES
Each Product’s fees and expenses (which may be substantial regardless of any returns on
investment) will offset each Product’s trading profits.

Additional General Disclosures

Investors must have the financial ability, sophistication/experience and willingness to bear the
risks of an investment. This document is intended for those with an in-depth understanding of the
high risk nature of investments in digital assets and these investments may not be suitable for
you. This document may not be distributed in either excerpts or in its entirety beyond its intended
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The Products and Grayscale do not: make recommendations to purchase or sell specific secu-
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that this is impermissible under applicable securities laws.

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The above summary is not a complete list of the risks and other important disclosures involved
in investing in any Product or digital assets and is subject to the more complete disclosures con-
tained in each Product’s Offering Documents, which must be reviewed carefully.
©2019 Grayscale Investments, LLC

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