Strategy’s Latest Bitcoin Buys Look Quite Puzzling – Here’s Why It’s a Worrisome Sign

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Strategy (MSTR), the world’s largest bitcoin treasury firm, scooped up 4,603 bitcoins in the last full week of August for a total price of $369.7 million. That’s an average cost of $80,318, which is right around the cryptocurrency’s recent peak.

Generally, Strategy uses arbitrage to make low-risk money when buying or selling bitcoins. If its common stock is trading for substantially more than the value of its bitcoin holdings, it can make financial sense for Strategy to issue common stock to buy more bitcoins.

Voila! – More bitcoins per common share, all at relatively low risk.

That’s what Strategy did with last week’s purchases, too. It sold 4.53 million shares of common stock, raising $602.8 million. It then spent nearly $370 million to buy those 4,603 bitcoins. It also spent $151.8 million on repurchasing its STRC preferred stock, saving it that security’s 12% coupon and following major repurchase activity in prior weeks.

What about the remaining $80 million or so from that cash raise?

A total of $50.7 million was used to pay out the dividend on the STRC preferred stock, while $30 million was stashed away in Strategy’s cash reserve for increased liquidity.

What’s puzzling is why Strategy acted at all, given the relatively low premium placed on its stock.

The stock was not trading at a substantial premium, particularly after an extended period of malaise in the bitcoin market. On Monday, Strategy marked its stock at 1.09 times its bitcoin holdings, so the stock was trading at just a 9% premium to its holdings. That figure dropped to just 1.05 times on Tuesday.

The 9% premium is quite small compared with what Strategy stock had fetched in bitcoin’s go-go years, but such a modest premium may be all that’s available to the company in this slow period.

But the thin arbitrage margin is worrisome in a fast-moving market like bitcoin. Strategy did not buy before the latest run, as bitcoin rose from $63,000 to $78,000 – up more than 20% – in a week or so. Instead, it bought more coins near the recent top around $80,000.

Now, with bitcoin a few thousand dollars off that purchase price, Strategy is quickly underwater on those buys. Such a thin premium on its stock gives the company much less room for error when trading the world’s largest cryptocurrency in the short term.

It shows the challenges Strategy faces in a slow bitcoin market, even as it has significantly altered how it manages its balance sheet and investments to meet them. With bitcoin down significantly from its all-time highs, Strategy’s executive chair Michael Saylor has been forced to rework how the firm can effectively raise funds to keep its bitcoin buying binge on track and protect its future.

Strategy Is Becoming the ‘Central Bank of Bitcoin’

At the center of these moves is what Strategy’s executive chair, Michael Saylor, is calling his digital credit plan. This plan reworks how Strategy manages its balance sheet, focusing its fundraising on the company’s STRC variable-rate preferred stock to increase the number of bitcoins per share of common stock.

Its digital credit plan turns Strategy into something like a “central bank of bitcoin,” meaning it manages its debt financing like how a central bank manages the money supply.

At the center of this fundraising process is the company’s preferred series STRC. It’s already the world’s largest preferred stock, according to Saylor, and by managing it carefully, Strategy can lower its financing costs.

“We expect to keep laser focus on it,” said Saylor in Strategy’s latest earnings call. “We’re going to do everything we can to make it the most appealing credit in the entire digital credit space.”

For example, Strategy can adjust STRC’s dividend payout, currently a 12% coupon, and the stock price by issuing or repurchasing shares when they’re priced favorably. If Strategy can develop a reputation as a solid counterparty, it may be able to lower that dividend over time.

This move is just one part of the company’s tool chest when it comes to managing its finances:

• Strategy can repurchase its preferred shares if the price falls too far, or it can issue them to raise funds if the price hits a favorable level, say its par value of $100 or above.

• Strategy can raise the yield on its preferred to raise the stock’s price, as it did recently, if it wants to raise cash or if it wants to boost its bitcoin holdings, for example.

• A larger issuance of STRC preferred stock creates more market liquidity, which may help reduce the preferred’s cost and make it seem like a more reliable investment.

In short, Strategy will adjust its actions in three asset markets – bitcoin, common stock, and preferred stock – so that it will raise its bitcoins per common share.

In the past few weeks, Strategy has been working to push up the price of its STRC preferreds, a move that should ultimately let Strategy issue them without suffering a discount. Its recent repurchase of nearly $152 million in STRC also keeps buying pressure up on that security, and it has nearly $365 million in repurchase authorization, giving it more dry powder.

Despite the strong bounce back in STRC, it’s not quite yet at its par value of $100 per share. The preferred stock bottomed around $71 per share and has since moved to around $97.

Saylor’s plan to keep the preferred near par may create unintended consequences, though. For example, if Strategy always keeps a floor under STRC, it may encourage investors to use the preferred as a source of cash, potentially draining the company’s coffers if it’s not careful.

Strategy’s new digital credit plan means it will need a longer-term approach to managing its assets and liabilities, which runs counter to short-term trading.

Do Bitcoin and Strategy Protect Against a Market Meltdown?

Bitcoin has bounced back over the past few weeks, moving from the low $60,000s to its recent peak above $80,000. One driver of this move is growing anxiety about massive U.S. debt and deficits, as well as the related issue of the dollar’s purchasing power.

While this “dollar debasement trade” may work as a short-term move for bitcoin traders, it’s apt to be a poor trade for those who think bitcoin will protect their money during tough times.

First, bitcoin and other cryptocurrencies trade like “risk” assets such as tech stocks or even more speculative, profit-less investments. So, it will trade largely in line with these riskier investments, though often with more exaggerated moves – that is, higher highs and lower lows.

These exaggerated movements make sense when you understand that bitcoin is backed only by traders’ sentiment and isn’t directly usable for goods and services (except the illegal kinds). Since it’s based solely on sentiment, bitcoin can fluctuate wildly as sentiment swings from fear to greed.

Second, because bitcoin is based on nothing but traders’ confidence or belief that they can sell it for more to the next trader, its price will evaporate if and when traders lose confidence in it. The market’s confidence is inherently unstable and can disappear at any moment for a variety of reasons, including if someone discovers a new way to hack the crypto.

Strategy combines this lack of intrinsic value with leverage in the form of its bonds and preferred stock, meaning its stock will be even more volatile than bitcoin itself. It’s taking steps to be able to control this inherently volatile situation more effectively so that it can keep buying bitcoins when prices are down and ensure the entire company doesn’t blow up in a downturn.

Another time may come when bitcoin is down so far from its peak that the market just capitulates, as it did in 2022. In that scenario, Strategy will need the capital to buy bitcoin after the plunge, but whether it ends up being the final death knell for the world’s biggest crypto, and therefore Strategy, will play out in time.

Regards

James Royal, PhD

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