Bitcoin is breaking out above its critical $25,000 level, which has been acting as stubborn upside resistance for the last nine months. Briefly trading above $27,000 on Friday morning, Bitcoin looks like it's trying to mount another bull trend.

Like gold, Bitcoin is a proxy for skepticism of fractional reserve banking and fiat currency. With two large US banks failing this week as the government steps in to bail them out, it's no surprise that Bitcoin is rallying.

And the Grayscale Bitcoin Trust (OTCMKTS: GBTC) is the most efficient way to play the Bitcoin rally. The trust trades at a whopping 42% discount to Bitcoin in the fund, which means you're buying Bitcoin for 58 cents on the dollar, and you can do it through your brokerage account.

There are also some exciting catalysts on the cusp for the fund, as Grayscale, the fund's manager, is in a court battle with the SEC to convert the trust into an ETF.

What is the Grayscale Bitcoin Trust?

The Grayscale Bitcoin Trust (OTCMKTS: GBTC) is a publicly-traded fund that holds Bitcoin. The entire idea of the fund is to provide investors with a way to invest in Bitcoin without the compliance and custodianship concerns that come with buying and storing the actual crypto tokens.

GBTC operates as a closed-end fund, similar to an ETF. Still, for some technical reasons, which we'll get into later, it can trade at substantial premiums or discounts to its net asset value (NAV), unlike an ETF. Throughout the fund's history, it has traded at a significant premium to its NAV due to its convenience and compliance.

Why Is It Trading at a Discount?

As a closed-end, GBTC lacks the built-in arbitrage mechanism that allows market makers to create and destroy shares at will to bring the fund's price in line with its net asset value. Between 2017 and 2021, this fact, combined with GBTC being the only avenue for institutional investors to access Bitcoin, led the fund to trade at a sustained premium.

Historically, GBTC at an average premium of about 20%.

Hedge funds capitalized on this premium by executing a straightforward arbitrage trade. They bought GBTC directly from Grayscale in a private placement, allowing them to purchase at NAV. However, there was a catch: they had to wait 6 months before selling the shares. As long as the premium persisted, the trade yielded considerable profits.

But investors won't pay a premium forever. Eventually, GBTC's premium to its Bitcoin holdings began to decline, creating losses for hedge funds, who, in many cases, borrowed lots of money to make the arbitrage trade.

The resulting margin calls led to a widespread liquidation of GBTC for over a year. However, the current deep discount offers a significant margin of safety, and two catalysts in play could close the discount.

Three Catalysts to Close the Discount

The SEC Lawsuit: Vying for a Bitcoin ETF

Grayscale has been trying to turn GBTC into an ETF for a long time, but the SEC continually turns them down. The fund manager is now suing the regulator after it rejected its application to convert GBTC into a Bitcoin ETF.

Grayscale CEO Michael Sonnenshein said the company was "really encouraged" after giving the DC Circuit Court of Appeals oral arguments.

GBTC converting to a spot Bitcoin ETF would mean the fund would almost immediately start trading at its net asset value.

Shareholders Suing Grayscale

A number of shareholders have been suing Grayscale to get the company to take action to close the fund's deep discount to its net asset value (NAV). Fir Tree Partners, a hedge fund, is in a legal battle with Grayscale.

The hedge fund claims that Grayscale prohibits redemptions of its fund for its gains and recommends that Grayscale initiate a tender offer to buy shares at net asset value.

Suppose activist investors like Fir Tree can apply enough pressure on Grayscale. In that case, they might have to start acting to redeem some shareholder value.

A Bitcoin Bull Market

Bitcoin has been on an aggressive rally to start the year. This month, it was given additional tailwinds with the spat of bank failures and government intervention in the financial system. Despite the bullish price action, the classic conditions of a Bitcoin hype train aren't in place yet, meaning the discount on Grayscale hasn't yet closed.

If Bitcoin continues to rally and the hype train returns, the GBTC discount will likely narrow.