Bitcoin Reserve Holdings Ponzi Scheme: A Financial House of Cards Bound to Collapse

Original Article Title: "Opinion: Funding Bitcoin Purchase with Listed Companies is 'Toxic' Leverage"

Original Article Author: lowstrife, Crypto KOL

Original Article Translation: Felix, PANews

Lately, Bitcoin reserve companies such as MSTR, Metaplanet, Twenty One, and Nakamoto have been in the limelight. However, I personally believe that their "reserve" is a destructive leverage, one of the worst things Bitcoin and what it represents have encountered. Here is an analysis of how this model would collapse under certain conditions.

The feedback loop these companies employ is to use corporate funds to purchase Bitcoin, record it on the balance sheet, and then leverage that balance sheet through various corporate mechanisms to raise more funds. This model has been hailed as the greatest invention of all time.

The funds raised through methods like issuing new shares (ATM), bonds, preferred shares, loans, etc., are immediately used to buy Bitcoin to drive this flywheel. An important distinction here is the use of appreciation leverage: companies like Tesla simply hold the asset in Bitcoin (something I have no objection to).

However, the key to this flywheel is that common stockholders are the ultimate holders of these financial assets. All these funding mechanisms ultimately lead to dilution of common shares, selling shares into the market to fund this flywheel. The primary method MSTR employs is issuing new shares (ATM) to achieve dilution. This method works well if the mNAV (PANews note: representing the current stock price versus the value of its Bitcoin holdings) is greater than 1.0. However, the issue arises when this leverage relies on issuing new shares to meet its cash flow needs. If MSTR's stock price is below 1.0 times mNAV (like in 2022), problems emerge.

Another tool is using leverage to boost the yield of its products, such as convertible bonds and perpetual preferred stock. As there is an expected buy-in in the future, this accelerates the expected value of equity and initially magnifies the equity premium. Issuing more common shares and diluting existing shareholders' equity, this leverage will eventually come due. Yet, they allow this dilution to happen down the road, swapping today's dollars for tomorrow's cash flow/dilution, deferring this payment and "cost" to a distant future. How "smart." The issue here is twofold: the first is that if the underlying stock does not meet performance targets, these products cannot be the fulcrum of all leverage. For convertible bonds, MSTR must refinance or sell BTC to raise cash.

The second issue is preferred stock. They require the payment of a perpetual, non-appreciating dividend (i.e., interest) to these debt holders. MSTR plans to issue trillions of dollars of such securities, where the payment funds come from diluting MSTR's equity holders. Specifically, Strategy's STRF (PANews note: a fixed income product packaged as a preferred stock issuance to easily and continuously raise funds to buy Bitcoin) has no maturity date, serves as a perpetual debt, and carries a 10% annual interest rate. MSTR will perpetually rely on non-appreciating ATM, diluting shareholder equity for every dollar of funding raised. Today's purchase comes at the expense of tomorrow's shareholder interests. What does this sound like?

The issue with using ATM to provide the necessary cash flow is that it relies on mNAV, which is not derived from its own assets. It entirely depends on market sentiment: what people believe the value of its treasury is. This is an insult to the essence of Bitcoin. While there are provisions for dividend suspension, it would lead to more issues. STRK must pay all outstanding dividends plus penalties to convert (mature). Not to mention, dividend suspension will significantly reduce the demand for the product.

If the point of income-generating assets is to mitigate risk, the last thing you want to see is to destroy the very purpose of holding that security. These risks are not addressed by MSTR's proponents. The dividend suspension would be a warning of solvency. Supporters argue that the issuance of these preferred stocks is for the immediate purchase of Bitcoin, and the dividend payments are justified. They believe that if it has been "modeled," then fundraising is worthwhile.

You must look at the transaction holistically, not in isolation of each part. If they are financing with preferred stock, you must consider the valuation/premium at which they are financing. Then, you can simulate using ATM to pay dividends and forecast the future based on your own predictions of Bitcoin and stock performance to determine how much stock needs to be issued and when conversion would be most value-accretive. Once you do so, you will realize how valuable these preferred stock issuances are.

Currently, there are around $1.8 billion of such securities in circulation, making the payments still feasible. However, Saylor proposes to issue $30 trillion of such securities, requiring the dilution of $3 trillion of equity annually, which is clearly unsustainable.

So how will this all unravel? It all starts with mNAV, mNAV is critical. It is life, it is vitality. If mNAV falters, the company's ability to raise funds will disappear, and debt conversion will impair mNAV, rendering the company unable to fulfill its debt obligations.

GBTC is another closed-end fund that skyrocketed in popularity during the 2021 bull market. People used it to invest in BTC when their existing accounts did not allow it. Today, the reasons for MicroStrategy's purchase are largely similar. The issue is that there are increasingly more avenues to acquire Bitcoin. GBTC is a closed-end fund with a premium or discount to its underlying asset. Once the demand for this investment channel diminishes, the need for the fund to purchase new assets also decreases.

Once the mNAV is shattered, the demand disappears as well.

Once the mNAV falls below 1.0, MicroStrategy's ability to raise funds will be in jeopardy, a situation similar to the loss of willingness and capability to purchase GBTC. It is worth noting that mNAV is entirely based on market sentiment. There is no mechanism or reason requiring it to trade based on asset value.

As the mNAV declines, the future ability to raise funds (and purchase Bitcoin) weakens, and the expected value of the stock decreases. If forced to issue debt dividends under unfavorable conditions, this situation may exacerbate. Convertible bonds make the situation even more complex. Currently, MicroStrategy holds $8.2 billion in convertible bonds, maturing between 2028 and 2032. The risk with these bonds is not about price; regardless of Bitcoin's price fluctuations (within a reasonable range), the bonds will not be "liquidated" or margin called.

The issue with convertible bonds lies in their name. They need to convert. MicroStrategy's stock must appreciate to a predetermined price level for the bonds to convert into new stock issuance. Remember: this trigger point is MicroStrategy's stock price, which is based on mNAV fluctuation, and mNAV is based on market sentiment. If for some reason, the price fails to rise, then the issue becomes a matter of time, not price. Regardless of Bitcoin's underlying price, the bonds may mature. MicroStrategy must refinance or repay the debt by selling BTC for cash.

Ultimately, the flywheel mechanism will reverse, eventually causing the entire plan to fail. Repurchase stocks below mNAV 1.0 and sell underlying assets to raise funds. Some believe this is a fiduciary duty, with Bailey publicly stating that he would do so as well.

This is not a financial revolution. It is the frenzied pursuit of a Ponzi scheme enthusiast chasing leverage. Individuals have held Bitcoin for a long time, seeing Bitcoin OGs cheering for Saylor, who is, however, replaying the same financial engineering from 2008 using Bitcoin, which is truly heartbreaking. It is important to note that it was this very maneuver that led to the birth of Bitcoin.

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