← The Bitcoin Treasuries Podcast with Tim Kotzman
The Bitcoin Treasuries Podcast with Tim Kotzman
The $10 Billion Bitcoin "Put Wall" Nobody Is Ready For | Michael Mescher
00:38:38
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- [00:00]
A
Welcome back to the Bitcoin Treasuries podcast. I'm Tim Kotsman. I'm here in the studio with Michael Mescher, CEO at Gammon Capital. Michael, thanks for joining us today.
- [00:09]
B
Thanks for having me and I appreciate it.
- [00:11]
A
Let me set this first question up properly. In August 2020, the Financial Times, writing about the fund you were running at the time, said, quote, a 600% gain, ranking it as one of the world's best performers. You've since taken that skill set to the corporate side and Gammon today advises companies, not investors. Can you tell us a little bit about your background there and what you were doing in that crash that everyone else wasn't? And why now point that to Bitcoin treasury companies?
- [00:48]
B
Sure. I appreciate that. So to understand that question, you kind of need to understand the career arc. And I had started my career on the floor of the options Exchange in Chicago learning about derivatives and volatility. And as I progressed through my career, started working at Lehman Brothers, saw that blow up nine months after I had joined the firm, ended up running special situations at Barclays and then also working for prop firms where I have spent probably the last 20 years operating in levered tail risk. And when you start to learn how volatility surfaces work, how options work, how distributions work in these types of scenarios, you recognize that Bitcoin is a great proxy for the same instruments that I used to trade. It's just now on a bigger stage because you're dealing with corporates instead of individuals. Ultimately, we structured the protection to carry positive and we owned it before the cataclysmic event. And when I take a look at the DT space, I see all of the Treasuries on the other side of that trade.
- [01:46]
A
You've said you spend your days reading loan documents that Bitcoin treasury companies file with the sec. What do you see in the filings that maybe the market doesn't see?
- [01:58]
B
Sure. A lot of what we look at that we think is very interesting are the covenants surrounding a lot of these loans. So if you go into the loan docs, it's usually hidden in about Exhibit 4.1 where they talk about these covenants. And these covenants can be something like who is the calculation agent that's determining the value of the underlying collateral? What are rehypothecation rights look like? Where do they have the ability to close you out? What is your cure period? The obvious horror story here is imagine it's Friday, it's about 11pm You've just gone to bed and you never fully went through your loan docs or maybe didn't negotiate your loan docs and you have a 6 or a 12 hour cure period. If the market caps. Okay, well on Fridays you have limited liquidity as we saw back on October 10. If the market gaps down, your counterparty, your lender can basically say we decided to mark the bitcoin here in an illiquid market, that's your threshold for blowing out. We have delevered you and sold all of your bitcoin and the big concern there is you're left with no bitcoin. That's existential left hand tail risk. And this is something that we see across the treasury space and this is one of the things that we help work with the treasuries on is both how to fortify against an extinction event such as that, but also how to negotiate the right docs with your counterparts parties to make sure that you're properly protected.
- [03:18]
A
Can you explain a 50% collateral haircut? What does it actually do to a company that borrowed against its bitcoin?
- [03:27]
B
Sure. So this is one of the typical loan structures that we see in the market right now is you see dats taking out loans and collateralizing with this with bitcoin and they over collateralize. It can be anywhere from usually 150 to 200% over collateralization. Now if the market continues to rally and you've posted let's say 200 bitcoin to borrow enough money to go buy 100 bitcoin and you're now long 300 bitcoin. If the market rallies, that's great, you're going to make a ton of money. But when you hit these stress scenarios, what happens is as you draw down, you're drawing down at a quicker rate than you otherwise would. Now as that loan amount changes and as those collateral levels change, you can start to face a serious extinction event in the left hand tail. Meaning that if the market gaps down because you're running with leverage, you might end up blowing up a public company that has your name on it. We don't think that that is a great business idea. So we spend a lot of time trying to work with the DATs to make sure that that left hand tail is properly hedged and they're fortified against market volatility. Ultimately in these over collateralized loans you're getting half the balance sheet and all of the debt.
- [04:39]
A
As you mentioned, six 12 hour cure windows, some of these credit facilities have those sort of tight cure windows and liquidation triggers. You touched on it but walk me through what a 3am Saturday gap down actually looks like for a treasurer of a bitcoin treasury company.
- [05:01]
B
Sure. So when we think about October 10th and what the market looked like, I think this was right about at the close. And if I remember correctly, it was. Tariffs on China sent the market into a tailspin. And one of the things that's a little deceptive when you take a look at bitcoin is people always talk about the liquidity in the market, whether it's for Bitcoin or Ethereum or any of these altcoins. And typically the liquidity is centered around the last traded price, meaning that there's very deep liquidity, maybe up 1 or 2% in either direction. But if you start to see the market gap beyond that, market makers tend to pull their quotes, the AMMs stop working and there's no real liquidity. And this is the catastrophic scenario that people should be most concerned about because then you have wide marks. So for example, let's say that bitcoin is trading at 100,000, the market gaps down 15 or 20% and now it's around 80,000. Well, depending on which venue you reconcile against, you might see marks of 78,000 at 82,000 because nobody's providing liquidity on the bid or the ask. That means that your lender or your counterparty, if they have calc agent rights, gets to effectively tell you what your bitcoin is worth. Is it worth 78,000? Is it worth 80? Is it worth 82? Is it worth less than 78? Because there isn't really much liquidity on the bid side. And this creates a huge problem. You're now at the mercy of the lender. Now weave that into the fact where maybe it's a weekend or maybe it's super late at night and you're fast asleep, or you can't move money quick enough to be able to go and cover your collateral call. Your lender is going to blow out your position, you're going to be left with huge losses and again, everyone's going to come to you and say, why wasn't this managed? So when you think about these cure windows, it's less of a 12 hour cure window and more of a countdown clock.
- [06:55]
A
Two quick terms. Can you define AMM and calc agent rights for the audience?
- [06:59]
B
Sure. So calc agent rights are calculation agent rights. Basically, when it comes time to value your collateral, who gets to determine that it doesn't necessarily go off? The last price that bitcoin traded at, it might go on the bid side, because that's where you would be able to get out of your position. Or let's say that there's not much on the bid. They might even discount it a little bit further because they would say for you to move this much collateral, we need this much liquidity in the market. And there actually isn't sufficient liquidity at 78. So we're going to say it's even lower. So calc agent rights and dispute rights, if you disagree with those calculation, are incredibly important. And these are the type of terms that you negotiate in the ISDAs. One of the things that we've seen in these ISDA docs is quite frequently a lot of people will just take whatever the lender gives them, not understanding that there's usually a negotiation that goes along with this. So, for example, there was one fund that I'm working with. They needed to tighten up their operational infrastructure. And, and to do that, we had to install the ISDAs. It took us about nine months to negotiate our first ISDA with one of the main dealers because the dealer was pushing back on a lot of terms. But these terms represented existential risk to the firm, so we had to push back on them as well. So when you think about calc agents and how that works, you need to be very aware of who's calculating your collateral. How do liquidations work? Who has the ability to force the liquidation? What do you need to do to be able to make sure that that liquidation doesn't happen? Do you have the operational infrastructure to make sure that you're able to fulfill all of those requirements? With the amm, that's the automated market making. So you will see firms come in and they'll post bid and offers on both sides of the market. So for example, let's say Bitcoin's 100,000. They might be 99,950 bid at 100,050, meaning they'll buy slightly below 100 grand or they'll sell slightly above 100 grand. Those guys typically provide deep liquidity because on the average, the market doesn't move that much and they want to be able to constantly collect that bid and ask the problem. And this exists with bitcoin market makers that are streaming quotes. This works in liquidity pools, is once you break through those bands where the heftiest liquidity lies, you start to realize there's a vacuum for bids and offers. Basically everyone says, I don't want to make markets in this market anymore. It's too volatile for me. I'm taking My money and I'm getting out. And if you're in a situation where you're obligated to transact because you weren't properly risk managed going into that equation, you face serious, serious risks because you need the liquidity most when it isn't there. And those are always the people who pay the highest price.
- [09:48]
A
You told me about a filing where selling Bitcoin to cure a margin call triggers a second cash obligation. How does a company end up in a structure like that?
- [10:00]
B
Okay, so this goes back to the ISDAs and the covenants and not necessarily negotiating all of your covenants aggressively. So for example, if you have warrants, or let's say that you have some debt outstanding, there might be some sort of covenant that says you need to hold X amount of bitcoin in a side pocket to collateralize this instrument. Okay, well, if you have this existential left hand tail risk, meaning if the market gaps down and let's say that you're over levered on loans and you haven't controlled the volatility to the downside, you don't have a lot of options at that point. Typically your best option is going to be to sell bitcoin. But if you have covenants that prevent you from doing that, you're in a situation where it's almost like standing in quicksand where you pull one leg out and the other leg sinks deeper. So in those scenarios, the only real avenue that you have to be able to meet your requirements is your hedge. And if you don't have a hedge walking into that position, you don't have any good options. And if you start breaking your covenants, the lawsuits are coming shortly thereafter.
- [11:07]
A
How can investors in dats understand and get comfortable with how these liquidations behave?
- [11:14]
B
Don't make the market guess your liquidation price. Make sure there isn't one.
- [11:19]
A
You've described a 2027 put wall. What is it, how big is it and why is nobody pricing it?
- [11:27]
B
Okay, this is one of the bigger things I think in the bitcoin space that I haven't heard people talking about quite yet is when people think about the various DATs out there and the converts that they've issued. The converts frequently have a put option in there, which basically means that the debt holder can give the bond back to the company and say, I want to be paid at par. Now, typically these debt holders will hold the debt and since it's a convert, they'll be long a call as well as part of this debt offering. With the market down here in the Trough a lot of these call options are so far out of the money that they don't really carry much value anymore. So someone who's holding the debt might start getting nervous and say, we're going to put this back to the company because we want to get paid right away. We don't think that this is necessarily coming back. So when people talk about liabilities over the next X number of years and we have enough assets to cover X years of liability, they're typically not taking into account the debt. And with this convert, a lot of this is able to be put back to the issuer starting about one year from now in mid-2027. In fact, through 2027 and 2028, there's about $10 billion in converts outstanding across the DATs that can be put back to the DATs. And the question is, where is the money coming from to be able to pay off $10 billion in debt? Obviously this is spread across different companies. Some people are a little bit more concentrated than others. But it still begs the question, you have certain obligations that you have to pay for already, and now with this huge put wall coming, you have to come up with a lot more cash. Do you have any options outside of selling your Bitcoin to be able to make good on that, or are we just kind of letting it ride?
- [13:17]
A
So these Bitcoin treasury Companies are paying 7.5%, sometimes 10% on Bitcoin backed loans. You've said the derivatives market prices the same exposure at roughly half that. So how is that possible? And why is nobody arbitraging their own balance sheet?
- [13:40]
B
I think the short answer is the dats have not paid anyone to show them how to do it more efficiently. If you go to a lender, the lender is going to sell you their product. And the loan rates that I've seen are 7 and a half, 8, 8.59, 10%, and sometimes there's even an advisory fee on top of that. So these loans get very expensive. But as soon as you start trafficking in the derivatives market, everything about the derivatives market is designed to be malleable and modular. So you can take different types of derivatives and put them together and create synthetic equivalents to the exposure that you currently want. So if you're taking a loan and you're doing that because you want leveraged upside in Bitcoin, you can do that in the derivatives market. And it currently runs at about half the price of what the DATs are paying right now. This is obviously massive. I mean, if you think about someone who's running 100, 200, $300 million loan books, 3, 400 bips on that every year, can quickly get into the tens of millions of dollars of leakage. And again, I think this is just a function of knowing what's available in the market and knowing how to express that that really prevents these guys from taking advantage of it because ultimately they're paying 7.5% for something the market will clear for half that price. So this is seven and a half percent. When the market clears at half that and no phone call attached, we see
- [15:07]
A
that a few of these companies already sell covered calls for yield. But you draw a hard line between derivatives as a yield tool versus derivatives as balance sheet armor. Can you explain the difference?
- [15:22]
B
For sure. I think this is one of the important evolutions that the market is about to make relatively soon, is a lot of the dats I see are looking for incremental yield largely to offset these very expensive loans that they're carrying. And one of the quick and easy answers is to go for the call overwrite that provides a little bit of yield. But one of the problems is that foregoes all of their convexity to the upside, which is the whole point of the debt, is that you want convexity to the upside. So if you're selling your upside right now, it makes it difficult to push the narrative that we're highly convex, meaning our gains pick up speed as the market rallies. So when we think about derivatives, we think about building a derivatives profile that is designed to protect the capital structure up and down. Converts behave very differently. If Bitcoin is at 10,000 versus 100,000 versus 300,000, the same holds true for prefs, the same holds true for ATMs, the same holds true for M Nav mechanics. And we think about all of these different components and how each of these components behaves across the price distribution in Bitcoin. And then we build a derivatives overlay on top of that so that the DATs are able to be protected in the drawdowns, maintain their convexity to the upside, meaning they continue to be able to take advantage of these massive gains when Bitcoin rallies and how we can manage the carry on these. So basically, yield earns on the coins, whereas armor protects you from losing the coins.
- [16:55]
A
So the whole Bitcoin treasury playbook, which is issue stock at a premium, buy Bitcoin, repeat. It only seems to work when the market's going up. What does the toolkit look like from your seat in what we are in now, which is like A sideways or down market?
- [17:14]
B
Sure. I think this largely comes down to the function of this being a relatively young market that is quickly maturing. And historically, there's only really been a need for strategies that work when the market is ferociously rallying. You see that with the ATMs, you see that with converts and the call options that are in demand. You see that with a PREF strategy where they say we need to return, we need Bitcoin to return at a rate greater than we're paying out on the prefs, which, as of the day, I'm sitting here with you, the market's demanding about a 14% return. So the entire playbook right now is the bull market playbook. And when we look around, we don't see a lot of bear market or sideways market playbooks that are being deployed by the DAX right now. This is one of the things that's great about derivatives, is since derivatives are modular, you can piece them together to create payouts no matter what the market does. You can have payouts that pay when the market goes sideways. You can pay out when the market goes down, you can pay out when the market goes up, or you can even get a little bit more advanced and you can set up structures that say if the market goes down, we don't lose anything, but if the market rallies for a little bit, we'll actually outperform Bitcoin. And that's when you start to get into some of the best tools that are available for DATs right now in these sideways and down markets. So ultimately, it comes back to what does your balance sheet look like, what does your capital stack look like, and how can we layer on these new tools that aren't necessarily being deployed by the market? Largely because I just don't think people are aware that they're available to them. How can we use these different tools? Pair them up with the balance sheet, fortify the company, protect the downside, and maintain that upside exposure that everyone is paying to be in the dats for. Volume pays in all three directions. So you need to learn to get paid in sideways markets.
- [19:05]
A
Okay, no conversation is complete without saying the words Michael Saylor. So let's give credit where it's due.
- [19:12]
B
Okay?
- [19:13]
A
Whatever you think of the leverage, Michael Saylor built something that no one else has from a securities engineering standpoint. What did he get right?
- [19:24]
B
I think there's two things he's gotten right that he probably doesn't get enough credit for. One is the evangelism. He has run a masterclass in distribution and getting the word out and bringing investors into the fold. There is no chance that the industry would be as far along as it is without him having put out that narrative. So I think that's incredibly important, and I think he deserves a lot of credit for that, because it doesn't matter what the podcast is, what the conference is, which television network you're on, he is on all of them consistently keeping the message out there. So credit where credit's due on that one for sure. Even more important than that is the financial engineering. If you're an institution, you don't buy conviction, you buy a mandate and a trade. Every different type of investor on the institutional level has their own lane. You have credit guys, you have equity guys, you have guys in converts, guys that want to deal with prefs. And he's built an instrument for all of them. And what makes this so great is one, it attracts institutional capital because he's building products for the people that want them outstanding. But each of these products has a different convexity profile, a different payoff profile. So on some products, maybe the losses pick up speed on the way down and the gains pick up speed on the way up. And then in other products, maybe the return is somewhat flatlined. And other products still, he may have a completely different convexity profile. Each of these create an opportunity to trade these products against each other. And for someone that really dives down into the guts of the products and understands the risk and understands that convexity profile, the arbitrage opportunities are amazing. I mean, if I were going to teach a junior guy right now how to do capital structure arbitrage, MSTR is the only, only name that you would do that in because he covers the entire capital stack. He has liquidity across the capital stack. And in doing this, he's created so many trading opportunities that it attracts institutional capital. And attracting institutional capital creates that flywheel where that attracts more institutional capital and builds more products. And I think the other DATs can't necessarily mimic him exactly the same way, because they're not sailor, and they don't have the same pile of Bitcoin that he has, but they still have the opportunity to create their own novel products and create these arbitrages across their products, which drive that institutional capital into the name. And I think that's an area where the DATs have the ability to really improve and attract new capital and be successful.
- [21:59]
A
Let's talk about the dats themselves. There are dozens or hundreds, depending on how you count them, of these treasury companies. Now, they all look like the Same trade to most investors, like, here's a pile of bitcoin with a ticker. So what in your mind separates these companies from each other, especially in the mid tier names?
- [22:23]
B
So I think this is one of the areas that is going to be the best for the DAT space going forward is each of these companies has the ability to provide a different payoff profile. You can have one DAT that says if the market crashes, we're going to be perfectly fine or we'll make a ton of money. You could have another DAT that says if the market rallies, we're going to make 2, 3, 5, 10x what the market's doing. You could have another DAT that says as the market stays still and rallies in a controlled fashion, we're going to outperform everybody else. This is really the biggest opportunity set for the dats right now, because without going through all of the filings, without understanding the guts of all of these companies, without understanding their convexity profiles and where they lose money or make money or potentially blow up, every DAT has the ability to put together its own payoff profile and then articulate that to the market. And that's what will differentiate them from all the other DATs out there right now. Because right now, when we look at the space, I think one of the things that's holding back the space is for investors who haven't gone through and done these deep dives. They really can't tell you what the difference is between debt number 15, 20, 25 and 30. They all look like they're just hoarding Bitcoin. And ultimately, just keeping a pile of bitcoin on your balance sheet is a commodity trade. If you have a different convexity profile and a superior payoff, now you're starting to be a security. And I think that's what people are really paying for with the dats. There's just a disconnect between the way that's articulated to the investor base. And once that gets tightened up, I think that'll be the draw that starts to pull institutional money into the space. Because then institutional money can say, okay, this guy's safe, that guy's not. I want to put my money over here. And even more importantly, that starts to create trading opportunities where I can trade this debt against that debt, against that pref over there, against that convert over there. And it's ultimately cycling through these different instruments that really drives the institutional capital and brings a lot of the hedge fund flow into the stock, which we've seen Saylor be incredibly successful with. So bitcoin is ultimately the best collateral of the century being lent on pawn shop terms.
- [24:40]
A
Okay. Besides talking about Saylor, we've spent a lot of this episode talking about what's wrong with Bitcoin credit. If the loans are that mispriced the way that you've described them, why doesn't someone just build a better one in a free market?
- [24:57]
B
I think that's a great question and that's something that we're actively pursuing right now because we see this opportunity. When you're seeing these loans go up for 3, 4, 500bps over fair market pricing. I think a lot of this is simply a market education problem. And also there is education that goes into the mechanics of how this works, how it can be beneficial across the ecosystem. So it really comes down to volatility management and if we're going to be very specific, downside volatility management. So we're starting to see this. One of the issues I've seen, I was talking to some bankers who are starting to price out longer duration notes thinking like three years, four years, five years, is one of the problems they're having is calculating what those options are worth. What is the volatility component of this debt structure work? And the big problem there is if you don't know how to calculate that, if you don't have the models, if you don't understand the nuance behind this, someone is going to pay the wrong price on this and most likely it's going to be the issuer. The investor is not going to pay the wrong price because they're not going to give you money unless they know what they're doing. So one of the things that we're focusing on is how do we help construct these different profiles and structures such that it's priced fairly, it's the right duration, because a lot of the durations we see are typically one year, which doesn't necessarily line up with what a Treasury would want. And how can we go out and price that and where does that paper go? Who wants that type of paper? And how does this be beneficial for everyone that operates in their own lanes?
- [26:29]
A
One comment that I hear across conversations is liquidity volume retail versus institutional interest and volumes. Capital flow. What creates institutional interest and capital flow? Like, is there a top three or five things that are on a checklist that a bitcoin treasury company can say, well, here's our checklist and we need to get these five things done in order to graduate, if you will, up to like an institution actually having it on its radar sure.
- [27:13]
B
So I think the important takeaway on this question is put yourself in the shoes of the guy who has institutional capital. What one thing does he want more than anything, even more than returns? What does he want? He wants to keep his job. He doesn't want to blow up on you. This is part of the reason that large hedge funds can raise money so much easier than small hedge funds can. Even if the small hedge funds have an edge, nobody ever got fired for allocating to Bridgewater because they know you're not going to blow up with Bridgewater. This is an area where I think the dats have the ability to tighten up. Their game is if they can convince the institutional capital that their debt is not carrying existential risk, if the market gaps down, it makes it a lot easier to place capital in that vehicle. Furthermore, if the debt has the ability to articulate what its payoff profile looks like, what happens if Bitcoin's down 50%? Down 25%? Up 25%, up 50%. This is how our payout works. If you can do that while simultaneously convincing me that you're not going to blow up, then an institutional allocator can take a closer, more serious look at your name, because they know they're not going to blow up and they can see the edge that you have. And then to take it one step further, like we were just talking about, if you create these trading opportunities through your different instruments and your narrative to the capital markets, that also attracts the institutional capital, because they know you're not going to blow up, and you're also creating trading opportunities against different securities. Again, maybe it's other debts, maybe it's different financial instruments like debt or equity or pref, but you have more opportunities to trade across the capital structure and across the different asset classes.
- [28:54]
A
Can you break down your view on the Bitcoin reserve, the USD reserve, and access through multiple avenues in a lot of cases, to the capital markets? We have this whole conversation around 12 months, 18 months, 24 months of cash. What's your view on all these different takes? Strategy doesn't need any cash. They have access to the capital markets. What does that say when you have a USD reserve? What does that say to institutional capital? What does it say to credit rating agencies or other stakeholders, other institutions that are looking at it and giving it a grade? Sometimes literally, sometimes figuratively?
- [29:48]
B
Sure. So I think the important thing here is when you take a look at the reserves, you have to take a look at the quality of reserves, but above all, you have to take a look at the correlation of the assets that are in the reserve to what's actually on the balance sheet of the company. So for example, if your reserve has instruments in it that are highly correlated to your own performance, when you go through a drawdown, your reserves are going through a drawdown. That's not a great look. Especially when institutional capital is taking a look at you. If you can hedge that out, that's diversification, that's something that you want when you're in a left hand tail event, when people are sitting there and assessing, hey, do we give this company a discount because they're super highly correlated in a stress event, or do we let them continue to trade at an M nav of one or possibly greater? Because we know that as the market sells off, these guys are anti fragile, they actually get stronger. So I think it's incredibly important to look at the composition of that reserve. Then past that, let's keep it simple. Let's just say it's simple. USD reserve. It's nice to have a margin of safety for sure, that can give people some comfort. But again, spread across the dats, you constantly see the asset liability mismatch. Typically the assets are in BTC and the liabilities are in USD. So you need to make sure that whatever that reserve is has enough firepower to hedge that mismatch, especially in stress events. And you need to understand how long that company can stay stressed. So for example, we were talking about this put wall that's going to show up in about a year. Okay, what happens if Bitcoin stays in a bear market for another year, going on to two years? Because everyone sees this put wall coming and they're worried about how that's going to get funded. Okay, how long are your reserves? Can you do this for a couple of years or do you only have a couple months? If you only have a couple months, what needs to happen for you to be able to make good on your liabilities in the future? And more importantly, what can go wrong where you don't have the bullets to make good on your liabilities in the future? That's the scary risk that you need to be able to acknowledge exists. You need to be able to articulate it to the market and you need to be able to say this is our plan for how we're solving that. And it's that third step that I think is where the DATs are going to get a lot of value going forward. Because as soon as they can do that, that really helps fortify their credibility.
- [32:13]
A
Is there any other Commodity property, asset reserve, credit facility, like a line of credit. Any other tool that seems obvious to you that these companies could have in the toolbox that would both signal to the market and work in reality during a period of stress that that maybe hasn't been thought of or considered seriously or implemented.
- [32:43]
B
Sure. So that's actually something that we're starting to work on right now is when you take a look at all of these different loans and all of these different structures that we see come through, there seems to be a common thread across all of them. And that is if bitcoin goes down 50%, there's going to be a lot of problems. And this is just the price of doing business here. I mean, this is the volatility of the market. Like we've all heard the tagline that volatility is vitality. It's vitality. On the upside, it's great. If you're issuing converts and your convert holders are hedging your volatility, it's great. It gives you cheap funding. But you have to acknowledge that the downside volatility is a real tail event. And we can take a look at the options market and let's say we go out one year, two year, three years, what we're seeing is that the market is expecting a one standard deviation move, which happens about 68% of the time to be up or down, let's say 45%. So that means a two standard deviation move is down about 90%. This is real risk. So maybe there's only a 20% chance that we hit this existential left hand tail. But I don't really want to be running a public company that has a 20, 25% chance of failing publicly with my name attached to it. Like that's never going away. So I think it's incredibly important to manage that volatility on the downside. And that's a lot of the structures that we're starting to take a look at now and develop solutions for different investors is how can we still extend this credit, but how can we protect them in a capital efficient way? That's a big one. How do you protect them in a capital efficient way from the downside volatility? There's definitely ways to do it that are simple, there's ways to do it that are more sophisticated. And the trick is if you can put that protection on and have it carry flat or positive, that's 100% something you want on your balance sheet. And that's where the real value add starts to come in. When you start thinking about how to manage volatility and how to mitigate volatility while preserving the upside volatility that everyone is here for.
- [34:46]
A
As an example, what percentage of, of a firm's Bitcoin would you employ in one of these strategies? And how would you talk with an executive around the communication and the narrative, the public messaging of. We're long Bitcoin, yet we think that this is a thoughtful and prudent strategy at the same time.
- [35:13]
B
Sure. So that's definitely not a one size fits. All. Right, because everyone has a slightly different capital stack. And this goes back to using derivatives as balance sheet armor as opposed to just a yield tool. So if you have a lot of pref, or if you have a lot of convert, whatever you're doing to keep your business going right now, we need to analyze that first and then we need to do the analytics and the stress testing and say, okay, if Bitcoin draws down 25, 50, 75%, how does your capital stack behave? Okay, what can we do to protect that? Conversely, on the upside, how do you behave as bitcoin rallies to 2, 3, 500,000? Now, what are you willing to trade here and there to be able to protect some downside but still maintain that upside? So in terms of sizing, there's really not a one size fits all question. Once you have an understanding of the capital stack, once you have an understanding of how all the different products in the capital stack correlate, and remember, correlation typically goes higher in stressful events. So you can look back and you can say, oh, these products are not typically correlated, but in stress events they are. Once you understand all of those moving pieces, then you can start to do your derivatives armor. Once you put derivatives armor on it, you now know more or less how your company is going to behave in stressed markets and bullish markets and bearish markets and sideways markets. And that's when you can go to the capital markets and say, this is what we've done. This is how we perform more or less in these different scenarios. And here's the proof that we're going to stay solvent. Because when you take a look at all the DATs, I frequently see KPIs of maximizing Bitcoin per share. Less frequently, I see someone say, KPI number one, is staying solvent. And I think that's one of the areas that there's room for improvement. And this is a problem that is solvable. And I think the DATs that grab the bull by the horns and say, we're going to Solve this risk constraint here so that we can stay in the game. I think those guys will end up being the most successful. I mean, the cardinal rule in finance is never lose your seat.
- [37:20]
A
Can you walk us through what an engagement with Gammon Capital looks like? Maybe like day one to day 90?
- [37:28]
B
Sure. So the first thing that we do would just be a simple intro call. Let's get to understand each other, how each other works, what kind of problems you're looking to solve. And then after that, if it sounds like problems we can potentially solve, we'll do another call where we dive a little bit deeper, start to understand your balance sheet a little bit more. I have a number of proprietary tools as well, so I'll be able to come to that discussion fairly armed. But it's always good to hear it from the founders themselves. And then we'll take another look and we'll say, okay, if we have the ability, we will scope something out here and we can say, this is exactly the way that you're structured. These are exactly the different avenues that you have to improve your structure. This is the way that we can help. And then if that engagement goes through and we decide that we like the way that we work with each other and this has been proven to be value add, then we can always take a look at a longer, ongoing engagement.
- [38:20]
A
Where's the best place for people to find you?
- [38:23]
B
Online, so they can find us@gammoncap.com that's G A M M O N C A P dot com, like backgammon. Or they can find me directly on LinkedIn.
- [38:34]
A
Awesome. Michael, thanks for joining us.
- [38:37]
B
All right.
- [38:37]
A
Appreciate the time.
- [38:38]
B
Awesome. Appreciate it. Thank you.