Michael Saylor, the founder at MicroStrategy, has been making headlines with Bitcoin purchases amid the onset of recent bull runs, sparking speculations on the legitimacy of it all.
The firm has been selling billions of dollars in convertible notes. These strategies have produced enormous returns during Bitcoin bull markets but also bring doubts about the bank’s long term sustainability, the nature of systemic risks, and the parameters of its financial model.
Why Is MicroStrategy Buying So Much Bitcoin?
In 2020, Saylor gave MicroStrategy a mission, to be Bitcoin’s primary reserve asset. Instead, this was presented as a hedge against inflation. However, the mechanics underlying this aren’t just about inflation, there’s something a bit more complex here.
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To back up its near zero-interest loans, MicroStrategy started issuing convertible notes. But these funds were used to buy Bitcoin and create a feedback loop as the price of Bitcoin went up this meant the company’s stock value rose. That, in turn, helped to facilitate note issuance and buy additional Bitcoin.
Flexibility is what convertible notes appeal to. The notes can be converted into equity at specified levels the company’s stock price hits. This has been a gold rush for MicroStrategy, an influx of capital at minimal cost during Bitcoin rallies.
This leverage however works two ways. The stock of the company is therefore likely to decline sharply if Bitcoin’s price falls. This also increases the possibility that noteholders will demand repayment in cash, which would place extreme strain on the company’s liquidity.
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MicroStrategy currently has around 300,000 Bitcoins, and they’re valued, on average, at $90,000, which is supported by roughly $3 billion of debt.
These holdings have ensured that the company is one of the major pro BitcoinCoin companies, but they have also tied the company’s fate to the cryptocurrency’s volatile market.
Are the Cashback Allegations True?
MicroStrategy’s model draws criticism partly for relying on the convertible notes it relies on. While they provide a cheap way to secure funds when markets are high, they put the company at risk from expensive repayments when markets are low.
According to some, this mechanism leads to such a situation when note holders may ask for their initial investment back. This is especially true if the company’s stock price falls below the conditions for conversion.
That would spawn a chain reaction. In the event that MicroStrategy doesn’t meet investor expectations, it will dismantle investor confidence and make a share value drop.
If noteholders claim repayments in cash, MicroStrategy will probably have to sell some of its Bitcoin holdings to meet them. This could lead the broader cryptocurrency market to panic.
To these worries, add Saylor’s strong public involvement in Bitcoin promotion. Some say he is appearing everywhere. This includes conferences, social media platforms, and the press to try to sustain optimism around Bitcoin’s prospects.
While detractors argue that this promotional effort is less a matter of conviction in Bitcoin’s use case, but rather down to signaling the health of a cheap stock alike (good for MicroStrategy, bad for their investors).
Could MicroStrategy Go Bankrupt?
It’s not farfetched at all that MicroStrategy would face bankruptcy, especially in the case of a worst-case scenario where Bitcoin’s price would crash.
The company’s financial structure relies on a delicate balance. Bitcoin prices need to remain high, so its stock remains above the conversion prices for the notes. Because if Bitcoin falters, it’s a domino effect from MicroStrategy’s stock involvement.
What would happen to the company was only one implication of such a collapse. However, MicroStrategy’s exposure is not limited to individual investors.
It is also held by institutions such as pension funds, mutual funds, and ETFs. Consequently, these will emanate systemic risks that have the potential to spread virtually throughout the financial market, disconnected from Bitcoin’s core ecosystem.
The forced liquidation of MicroStrategy’s Bitcoin holdings would be especially damaging. A fire sale could send market panic rumbling and the company controls around 1% of all Bitcoin in circulation.
However, if too many Bitcoins were copied into a wallet, it would not only erode Bitcoin’s value but also injure cryptocurrency in general. This is because the industry’s credibility in the domain of institutions would likely be shattered.
Reliable Genius or Careless Gamble?
Either it’s the playbook of a bold and visionary gambler, the SC Yogi, or it’s the act of a dangerously reckless gambler, say some. Saylor has used Bitcoin’s price movements to make MicroStrategy a high-risk, high-reward vehicle to get exposed to Bitcoin.
However, there is no clear exit plan for this strategy. It cannot afford to sell its Bitcoin holdings without killing the cryptocurrency and its stock price.
But it chains MicroStrategy deep within this self-imposed golden cage. This makes it extremely susceptible to market downswings and shocks.
However, legal analysts say MicroStrategy’s practices are technically on solid ground under the law. Direct allegations of fraud are shielded from the company by its duties of disclosure to the SEC and the company’s existing public transparency.
It, however, raises questions about the ethical dimensions of such financial engineering whereby short-term gains take precedence over long-term stability.
