The essence of Strategy is arbitrage business

Author: Dio Casares

Compiler: Deep Tide TechFlow

Over the past five years, Strategy has spent $40.8 billion, equivalent to Iceland's GDP, on more than 580,000 bitcoins. This accounts for 2.9% of the Bitcoin supply or almost 10% of the active Bitcoin (1).

Strategy's ticker symbol $MSTR has risen by 1,600% over the past three years, while Bitcoin has risen by only about 420% over the same period. This significant growth has resulted in Strategy's valuation exceeding $100 billion and its inclusion in the Nasdaq-100 index.

This tremendous growth also raises questions. Some claim that $MSTR will become a trillion-dollar company, while others have sounded the alarm as people question whether Strategy will be forced to sell its bitcoin, triggering a huge panic that could drive down the price of bitcoin for years.

However, while these concerns are not entirely unfounded, most people lack a basic understanding of how Strategy works. This article will explore in detail how Strategy works and whether it is a significant risk or a revolutionary model for Bitcoin acquisitions.

How did Strategy buy so much Bitcoin?

Note: Data may differ from when it was written, for example, due to new financing.

Broadly speaking, Strategy obtains funds to buy Bitcoin in three main ways: income from its operating operations, sale of stocks/equity, and debt. Of the three approaches, debt is undoubtedly the most concerned. People tend to be very concerned about debt, but in reality, the vast majority of the money that Strategy uses to buy Bitcoin comes from issuance, which is the sale of shares to the public and the use of the proceeds to buy Bitcoin.

This may seem counter-intuitive, why would people buy Strategy's stock instead of buying Bitcoin outright? Actually, the reason is simple, back to the favorite type of business in the cryptocurrency space: arbitrage.

Why people choose to buy $MSTR instead of buying $BTC directly

Many institutions, funds, and regulated entities are subject to "mandates." These authorizations specify the assets that a company can and cannot buy. For example, a credit fund can only buy credit instruments, a stock fund can only buy stocks, and a long-only fund can never go short, and so on.

These mandates give investors confidence that, for example, a fund that invests only in equities will not buy sovereign debt and vice versa. It forces fund managers and regulated entities, such as banks and insurance companies, to be more responsible and only take on specific types of risks, rather than being free to take on any type of risk. After all, the risk of buying Nvidia stock is completely different from the risk of buying U.S. Treasuries or putting money into the currency market.

Due to the highly conservative nature of these mandates, much of the capital that stays in funds and entities is "locked in" to access emerging industries or areas of opportunity, including cryptocurrencies, and in particular, direct exposure to Bitcoin, even if the managers and associated personnel of these funds wish to gain exposure to Bitcoin in some way.

Michael Saylor (@saylor), founder and executive chairman of Strategy, saw the difference between what these entities wanted to gain exposure to and what they could actually afford to take and took advantage of it. Before the advent of Bitcoin ETFs, $MSTR was one of the few reliable ways for these stock-only entities to gain exposure to Bitcoin. This means that Strategy's stock often trades at a premium because the demand for $MSTR exceeds the supply of its shares. Strategy is constantly taking advantage of this premium, which is the difference between the value of $MSTR stock and the value of the bitcoin it holds per share, to buy more bitcoin while increasing the amount of bitcoin it holds per share.

Over the past two years, if you hold $MSTR, you've achieved a 134% "gain" on Bitcoin-denominated investments, which is the highest return on Bitcoin investment at scale on the market. Strategy's products directly address the needs of entities that would not normally have access to Bitcoin.

This is a typical case of "Mandate Arbitrage". Prior to the launch of Bitcoin ETFs, as mentioned earlier, many market participants were unable to purchase stocks or securities that were not exchange-traded. However, as an exchange-listed company, Strategy is allowed to hold and buy Bitcoin ($BTC). Even with the recent launch of Bitcoin ETFs, it would be a complete mistake to think that this strategy is no longer effective, as many funds are still prohibited from investing in ETFs, including most mutual funds with $25 trillion in assets under management.

A typical case study is Capital Group's Capital International Investors Fund (CII). The fund manages $509 billion in assets, but its investment scope is limited to equities and cannot directly hold commodities or ETFs (Bitcoin is mostly considered a commodity in the United States). Because of these limitations, Strategy became one of the few tools used by CIIs to gain exposure to Bitcoin's price fluctuations. In fact, CII's confidence in Strategy is so high that it owns about 12% of Strategy stock, making CII one of the largest non-internal shareholders.

Debt Terms: Binding on other companies, but helping Strategy

In addition to a positive supply situation, Strategy also has a certain advantage in terms of the debt it has taken on. Not all debts are created equal. Credit card debt, mortgages, margin loans, these are all very different types of debt.

Credit card debt is personal debt that depends on your salary and ability to pay off the debt, not asset-backed, and often has an annual interest rate of up to 20% or more. A margin loan is usually a loan made against the assets you already have (usually stocks) as collateral, and if the total value of your assets is close to the amount you owe, your broker or bank may confiscate all of your funds. A mortgage, on the other hand, is seen as the "holy grail" of debt, as it allows you to use the loan to buy an asset (such as a house) that would normally appreciate in value, while only paying monthly interest on the loan (i.e. mortgage repayment).

While this is not completely risk-free, especially in the current interest rate environment, where interest can accumulate to unsustainable levels, it is still the most flexible compared to other types of loans because interest rates are lower and assets are not forfeited as long as monthly payments are made on time.

Typically, mortgages are limited to housing. However, a business loan can sometimes operate similarly to a mortgage loan, where interest is paid over a set period of time, while the loan principal (i.e., the initial amount of the loan) only needs to be repaid at the end of that term. Although loan terms can vary greatly, generally the debt holder does not have the right to sell the company's assets as long as the interest is paid on time.

Chart source: @glxyresearch

This flexibility makes it easier for corporate borrowers like Strategy to deal with market volatility, which also makes $MSTR a way to "harvest" the volatility of the crypto market. However, this does not mean that the risk is completely eliminated.

conclusion

Strategy is not in the leveraged business, but in the arbitrage business.

While it does hold some debt at the moment, it would take the price of Bitcoin to fall to around $15,000 per coin within five years before it poses a serious risk to Strategy. This will be the focus of another topic as "vault companies" (referring to companies that copy Strategy's Bitcoin accumulation strategy) expand, including MetaPlanet, @DavidFBailey's Nakamoto, and many others.

However, if these vault companies stop charging premiums in order to compete with each other and start taking on excessive debt, the whole situation will change and there could be serious consequences.