10-K: Grayscale Ethereum Classic Trust (ETC) 2023 Annual Report: Navigating Volatility in the Digital Asset Market

Grayscale Ethereum Classic Trust's 2023 annual report highlights the challenges and risks associated with investing in the volatile digital asset market, particularly Ethereum Classic (ETC), while also detailing the Trusts financial performance and operational structure.

Summary

• The Grayscale Ethereum Classic Trust (ETC) is a Delaware Statutory Trust formed in 2017 with the goal of holding Ethereum Classic (ETC).
• The Trusts investment objective is for the value of its Shares to reflect the value of ETC held by the Trust, less expenses and liabilities, but this objective has not been met.
• The Shares are quoted on OTCQX under the ticker symbol ETCG.
• The Trust does not operate a redemption program, and Shares are not redeemable by the Trust.
• The Trust issues Shares in Baskets of 100 to Authorized Participants in exchange for ETC.
• As of December 31, 2023, the Trust held approximately 8.0% of the ETC in circulation.
• The Trusts assets consist solely of ETC, Incidental Rights, IR Virtual Currency, proceeds from the sale of ETC, Incidental Rights and IR Virtual Currency pending use of such cash for payment of Additional Trust Expenses or distribution to the shareholders and any rights of the Trust pursuant to any agreements, other than the Trust Agreement, to which the Trust is a party.
• The Sponsors Fee is 2.5% of the Trusts NAV Fee Basis Amount, accruing daily and payable monthly in ETC.
• The Trust may incur Additional Trust Expenses, which are paid by selling or delivering ETC, Incidental Rights and/or IR Virtual Currency.
• The Trust does not expect to take any Incidental Rights or IR Virtual Currency it may hold into account for purposes of determining the Trusts NAV, the NAV per Share, the Principal Market NAV and the Principal Market NAV per Share.
• The Trust uses the CoinDesk Ether Classic Price Index (ECX) to calculate its NAV, a Non-GAAP metric.
• As of December 31, 2023, the 24-hour trading volume of Ethereum Classic and Ethereum were approximately $121.7 million and $2,920.8 million, respectively.
• As of December 31, 2023, the aggregate market value of Ethereum Classic was $3.2 billion, as compared to the $274 billion aggregate value of Ethereum.
• Since the networks split, the market value of Ethereum Classic has been an average of 3.5% of Ethereums.
• Over the same period, the trading volume of Ethereum Classic has been an average of 12.4% of Ethereums.
• As of December 31, 2023, ETC was the 29th largest digital asset by market capitalization, as tracked by CoinMarketCap.com.
• As of December 31, 2023, each Share represented approximately 0.8253 ETC.

Sentiment

Score: 4

Explanation: The document is cautiously pessimistic due to the inherent risks and volatility of the digital asset market, the Trusts inability to meet its investment objective, and the lack of a redemption program. While the document provides a detailed overview of the Trust, it emphasizes the challenges and uncertainties associated with investing in ETC.

Positives

• The Shares offer investors a cost-effective and convenient way to gain investment exposure to ETC.
• The Shares are quoted on OTCQX, providing investors with an efficient means to implement various investment strategies.
• The Trusts ETC are held by the Custodian using offline storage mechanisms to secure the Trusts private key shards.
• The Custodian has agreed to allow the Trust and the Sponsor to take such steps as necessary to verify that satisfactory internal control systems and procedures are in place.

Negatives

• The Shares have historically traded at a substantial premium over, or a substantial discount to, the NAV per Share.
• The Trust does not operate a redemption program, which contributes to the price discrepancies.
• The value of the Shares is subject to the volatility of the digital asset market.
• The Trust relies on third-party service providers, and their failure could disrupt operations.
• The Trust may be required to disclose information, including information relating to investors, to regulators.
• The Sponsor may, in its sole discretion, dissolve the Trust for a number of reasons.
• Shareholders have limited voting rights and may not be able to bring a derivative action on behalf of the Trust.

Risks

• The extreme volatility of trading prices that many digital assets, including ETC, have experienced in recent periods and may continue to experience, could have a material adverse effect on the value of the Shares.
• The medium-to-long term value of the Shares is subject to a number of factors relating to the capabilities and development of blockchain technologies and to the fundamental investment characteristics of digital assets.
• The value of the Shares is dependent on the acceptance of Digital Assets, such as ETC, which represent a new and rapidly evolving industry.
• The unregulated nature and lack of transparency surrounding the operations of Digital Asset Trading Platforms may adversely affect the value of digital assets and, consequently, the value of the Shares.
• The value of the Shares relates directly to the value of Ethereum Classic held by the Trust, the value of which may be highly volatile and subject to fluctuations.
• Because of the holding period under Rule 144, the lack of an ongoing redemption program, and the Trusts ability to halt creations from time to time, there is no arbitrage mechanism to keep the value of the Shares closely linked to the Index Price and the Shares have historically traded at a substantial premium over, or a substantial discount to, the NAV per Share.
• The Shares may trade at a price that is at, above or below the Trusts NAV per Share as a result of the non-current trading hours between OTCQX and the Digital Asset Trading Platform Market.
• A determination that ETC or any other digital asset is a security may adversely affect the value of ETC and the value of the Shares, and result in potentially extraordinary, nonrecurring expenses to, or termination of, the Trust.
• Regulatory changes or actions by the U.S. Congress or any U.S. federal or state agencies may affect the value of the Shares or restrict the use of ETC, mining activity or the operation of the Ethereum Classic Network or the Digital Asset Markets in a manner that adversely affects the value of the Shares.
• Changes in the policies of the U.S. Securities and Exchange Commission (the SEC) could adversely impact the value of the Shares.
• Regulatory changes or other events in foreign jurisdictions may affect the value of the Shares or restrict the use of one or more digital assets, mining activity or the operation of their networks or the Digital Asset Trading Platform Market in a manner that adversely affects the value of the Shares.
• An Authorized Participant, the Trust or the Sponsor could be subject to regulation as a money service business or money transmitter, which could result in extraordinary expenses to the Authorized Participant, the Trust or the Sponsor and also result in decreased liquidity for the Shares.
• Regulatory changes or interpretations could obligate the Trust or the Sponsor to register and comply with new regulations, resulting in potentially extraordinary, nonrecurring expenses to the Trust.
• The Trust may be required to disclose information, including information relating to investors, to regulators.
• Conflicts of interest may arise among the Sponsor or its affiliates and the Trust.
• The Sponsors services may be discontinued, which could be detrimental to the Trust.
• If the Custodian resigns or is removed by the Sponsor, or otherwise, without replacement, it could trigger early termination of the Trust.
• The Trust relies on third-party service providers to perform certain functions essential to the affairs of the Trust and the replacement of such service providers could pose a challenge to the safekeeping of the Trusts ETC and to the operations of the Trust.

Future Outlook

The Trust may in the future operate a redemption program, subject to regulatory approval from the SEC and approval from the Sponsor in its sole discretion. However, the Trust currently has no intention of seeking regulatory approval to operate an ongoing redemption program.

Management Comments

• The Sponsor believes the Index Providers selection process for Constituent Trading Platforms as well as the methodology of the Index Prices algorithm provides a more accurate picture of ETC price movements than a simple average of Digital Asset Trading Platform spot prices.
• The Sponsor believes that the weighting of ETC prices on the Constituent Trading Platforms limits the inclusion of data that is influenced by temporary price dislocations that may result from technical problems, limited liquidity or fraudulent activity elsewhere in the ETC spot market.

Industry Context

The report highlights the broader challenges and volatility within the digital asset market, including the recent failures of major platforms and increased regulatory scrutiny. The Trust is positioned as a way to gain exposure to ETC, but it is subject to the same market forces and risks as the broader digital asset industry.

Comparison to Industry Standards

• The report notes that while ETC was one of the first digital assets with a network that served as a smart contracts platform, a number of newer digital assets also function as smart contracts platforms, including Solana, Avalanche and Cardano.
• The report also notes that the aggregate value of outstanding ETC is smaller than that of Bitcoin and ETH and may be eclipsed by the more rapid development of other digital assets.
• The report notes that the Ethereum Classic Network facilitated daily transaction values between approximately $73.7 million and approximately $505.8 million in the month ended December 31, 2023, while the Bitcoin network facilitated daily transaction values between approximately $3.7 billion and $14.6 billion over the same period.

Legal Proceedings

• The Sponsor and an affiliate of the Trust, Grayscale Bitcoin Trust (BTC), are currently parties to certain legal proceedings.
• On December 6, 2022, Fir Tree filed a suit in Delaware Chancery Court against the Sponsor and Grayscale Bitcoin Trust alleging that the Sponsor and Grayscale Bitcoin Trust violated Fir Trees information rights and seeking to compel access to the requested books and records.
• On March 6, 2023, 210K Capital filed a suit in Delaware Chancery Court against the Sponsor and Grayscale Bitcoin Trust alleging that the Sponsor and Grayscale Bitcoin Trust violated 210K Capitals information rights and seeking to compel access to the requested books and records.
• On July 10, 2023, the Sponsor, Fir Tree, and 210K Capital entered into a Settlement Agreement which resolved the Demands.
• On January 30, 2023, Osprey Funds, LLC filed a suit in Connecticut Superior Court against the Sponsor alleging that statements the Sponsor made in its advertising and promotion of Grayscale Bitcoin Trust violated the Connecticut Unfair Trade Practices Act, and seeking statutory damages and injunctive relief.
• On March 6, 2023, Alameda Research, Ltd. filed a suit against the Sponsor, DCG, Michael Sonnenshein and Barry Silbert, the Chief Executive Officer of DCG, in the Court of Chancery of the State of Delaware alleging various breach of contract and fiduciary duty claims.
• On January 19, 2024, Alameda voluntarily dismissed the action without prejudice, thereby terminating the action.

Related Party Transactions

• The Sponsor has a conflict of interest in allocating its own limited resources among, when applicable, different clients and potential future business ventures, to each of which it owes fiduciary duties.
• The Sponsor and Grayscale Securities are affiliates of each other, and the Sponsor may engage other affiliated service providers in the future.
• The Sponsor and Genesis, which previously served as an Authorized Participant and distributor and marketer for the Shares, are affiliated parties that share a common parent company, DCG.
• DCG is a minority interest holder in both Coinbase, Inc. and Kraken, which operate two of the Digital Asset Trading Platforms included in the Index Price.
• DCG holds a minority interest in the parent company of the Custodian, which could lead DCG to cause the Sponsor to take actions that favor the Custodians interests over the Trusts interests.

Stakeholder Impact

• Shareholders may suffer a loss on their investment if the Shares trade above or below the Trusts NAV per Share.
• Shareholders may not receive the benefits of any forks or airdrops.
• Shareholders do not have the protections associated with ownership of shares in an investment company registered under the Investment Company Act or the protections afforded by the CEA.
• The restrictions on transfer and redemption may result in losses on the value of the Shares.
• Shareholders cannot be assured of the Sponsors continued services, the discontinuance of which may be detrimental to the Trust.
• Shareholders may be adversely affected by the lack of independent advisers representing investors in the Trust.

Next Steps

• The Sponsor intends to evaluate each fork, airdrop or similar occurrence on a case-by-case basis in consultation with the Trusts legal advisers, tax consultants, and Custodian, and may decide to abandon any Incidental Rights or IR Virtual Currency resulting from a hard fork, airdrop or similar occurrence should the Sponsor conclude, in its discretion, that such abandonment is in the best interests of the Trust.
• The Sponsor may, in its sole discretion, select a different index provider, select a different index price provided by the Index Provider, calculate the Index Price by using the cascading set of rules set forth under Overview of the ETC Industry and MarketETC ValueThe Index and the Index PriceDetermination of the Index Price When Index Price is Unavailable above, or change the cascading set of rules set forth above at any time.
• Subject to receipt of regulatory approval from the SEC and approval by the Sponsor in its sole discretion, the Trust may in the future operate a redemption program.

Key Dates

Keywords

Ethereum Classic, ETC, Grayscale Ethereum Classic Trust, Digital Assets, Cryptocurrency, Blockchain, Investment Trust, OTCQX, ETCG, Digital Asset Trading Platforms