Loading summary
Transcript44 lines
- [00:25]
A
Ladies and gentlemen, what you are about to hear may be amazing, but it is not financial advice. It is for informational and educational purposes only. Nothing in this discussion should be considered investment advice or the offering of any security or other investment product. Please consult your own investment and tax advisors. And now I'll hand it over to the True north team for your regularly scheduled programming.
- [00:51]
B
Woo.
- [00:52]
C
Welcome back, True North. Episode 73 Investment Grade Bitcoin Podcast. We are back. Summer school is in session. Episode 73. That's the same number as Barry Bond single season home run record. For those that are aware, I was a big Barry Bonds fan growing up. So I'm excited to get to this big milestone and let's have some fun. We're going to be quick today. Going to be an hour. We're going to talk about strategy, the balance sheet, what's happening, Q2, start to zoom out a little bit. Have a discussion around the preferred equities, just the status of what's going on in this landscape. Think about summer capital markets. And then part two of this, we're going to get into what is capital. Let's talk about capital markets, bitcoin loans, preferred equities, the comparison of the two, underwriting a loan from the lender's perspective and try to demystify capital markets. I think that's truly been a goal of this entire podcast since the very beginning. Capital markets is inherently very sophisticated. We are trying to peel back the veil on capital markets and what's happening in the entire ecosystem because bitcoin is capital. It is being used as capital. It is the most sophisticated and future proof form of capital. And we are building an entirely new capital market on top of bitcoin as capital. So we're going to focus on that a lot today. And with me today, I've got myself, your host, Jeff Walton, and then I'm over to Joe Burnett. We're going to be bringing on some guests into the future as well in the summer sessions and future sessions. And we've got Dan Hillary from a sunny room on the East Coast. It looks fantastic over there. So let's make sure to make this quick so we could get Dan out on a boat and enjoying some sunshine. And so without further ado, a lot of development here over the last couple weeks. Of course, a lot is happening in the markets. Strategy has sold around 3,500 bitcoin over the last week. That was around $215 million that they were able to monetize on bitcoin sales. However, if you zoom out and you look at the activity that's happened over the last quarter, there was a significant amount of bitcoin that was purchased on behalf of Strategy. And yeah, we're here to talk about it, so maybe I'll kick it over to you, Joe first. And just like a lay of the land. What's the sentiment? The sentiment is pretty poor out there. Everybody was losing their heads in both directions. SDRC is unsustainable. Now they're selling bitcoin. People think it's a death spiral or doom loop, but in reality people are using the bitcoin as collateral. So yeah, over to you.
- [03:34]
B
Yeah, absolutely. I mean, it's definitely an interesting time in bitcoin and amplified bitcoin as well, with strategy, Strive and all the others out there. I mean, I think I always like to go back to the basics when sentiment is this bad. Like I still view bitcoin as digital capital, this best form of money that's ever been discovered. The fundamentals of bitcoin remain completely intact in my opinion. Strategy. While there have been various tactical changes with the strategy, obviously over the years, in my mind the fundamental strategy of amplified bitcoin hasn't really changed from the beginning. Initially was pairing it with convertible notes, now moving obviously to perpetual preferred equities, then focusing mainly on strc. It's really just been this never ending search of trying to construct the most low risk amplified bitcoin position that you can possibly construct. And I think that strategy, Strive and others have done a good job of doing that. But yeah, sentiment is horrible. I mean, I think that if you compare bitcoin to The S&P 500, the typical TradFi individual, or even just high net worth individual that just mostly stores their wealth in passive index funds, they freak out when the S and P falls 5% or 10%. It's almost the end of the world where Bitcoin falls 50%. Longtime Bitcoiners don't really bat an eye. That's normal. Obviously if bitcoin falls 50%, amplified bitcoin should fall more than that. And it certainly has. And that obviously can really melt people's brains. But at the end of the day, I think the fundamental idea of bitcoin being this long duration savings technology, this digital capital that over 4 or 5, 10 year period should do exceptionally well, hasn't changed really at all. It's just the volatility is so extreme relative to what virtually everyone is used to. It takes a toll on so many people's emotions. And once you introduce actual leverage into bitcoin on top of that or amplification obviously as well. It can just really play with people's brains and I think that's kind of just what we've seen. But at the end of the day, I mean a 50% drop in Bitcoin isn't, isn't anything unusual. It's just kind of par for the course.
- [06:02]
C
Yeah, agree some volatility here. And we're going into the summer months which is historically the lowest trading volume in capital markets. So I'm, I wouldn't be surprised if we chop around here for a couple months while everybody is out enjoying the sunshine on the east coast. Over to you Dan. What's, what are you thinking about? What's, what's top of your mind at the moment and what are you thinking about?
- [06:24]
D
Yeah, I think the pivot in direction on strategy with regards to share buyback programs and capital management of their bitcoin stack, specifically the sale of bitcoin, the meaningful sale of bitcoin over the last week has really changed the construction of the company and people aren't giving it enough credence. I know talking with some people in New York when we were at the event, the bitcoin for corporations, eventually a lot of reputable people in the space said no strategy will never announce the authorization of buybacks across the press stack for various reasons. And clearly they have announced that authorization. I think while they may not use it, we saw Meta Planet use the authorization of share purchases to bottom their mnav. And I think this sort of decision could be the same bottoming process for the preferred equities themselves. And you know, the way I think about it a lot too is there's certain regulations that make buybacks of press tricky. But I think long term the stretch management of price around that $100 peg is going to be a lot, lot more nuanced than simply selling at 100 because we know that now there has to be some sort of kind of backups in place for putting in a bottom in the price during kind of market turmoil. And then also with the movement to buy, excuse me, semi monthly dividends, we're going to see more disincentive for a risk free short at 100. But I still think that's a massive problem for Stretch in its current form. But clearly just the repurchasing or the potential repurchase of Stretch means that the equity is evolving. And I think Stretch will look a little bit different than it does today in five years, but it'll be a lot, lot more stable at that desired price point. So we're all learning in real time.
- [08:13]
C
Yeah, learning in real time. There's. Yeah, it's fascinating watching this thing trade. I mean if you go back and you look in the last six months, STRC is down 13%, IBIT's down 30%. If you look at since inception, STRC I think is down 2%, Ibit's down 50%. So you can visually see that this instrument is also pulling volatility off of the underlying bitcoin on the balance sheet. Strategy is using that senior position in the capital structure as collateral. Not necessarily the bitcoin as collateral, but the senior position as collateral. And you're seeing that dampening effect. Yeah, the, the thought on share buybacks is interesting. I think that's, it's now a tool in their toolkit. I think one thing that may become tricky is if you're buying back shares, how long do you have to wait before you can sell shares too? So for STRC and thinking about managing a hundred dollar peg, that' that's a. Something to contemplate of like how, how delicate are you with a share repurchase. But the fact that is, the fact is that there is a, there is a toolkit there and yeah, interesting to see how this evolves. And the short interest is something that we've seen which has been pretty fascinating to watch on SATA, our instrument. Watching the spreads between SATA and Stretch, it looks like there was a potential spread play between the two instruments and that spread has blown out pretty significantly in the last month. And the short interest on SATA has also increased pretty significantly in the last month. So we're kind of watching to see how people are starting to trade these instruments back and forth together and how they're looking at the relative risk return. And what I think makes complicated is that the difference in the difference in dividend payment schedule, how they operate, interact with each other, the different investor base, how they're, how defi is using them, where it's involved in ETFs and those types of things. It's, I think what people thought is maybe a very basic trade has turned into a much more sophisticated trade. And I think that's also resulted in why we're seeing some of this volatility. I wouldn't be surprised if, you know, we take a month or a month or so to kind of get back to par on these instruments. What it will take is capital coming in the door, identifying the unique risk return opportunity to bring to capture the spread between par. What is that 80 between $86 as a close today to 100. And the high yield on top of it. And the fact that strategy is now signaled that they're willing to sell the bitcoin in order to pay the dividends, I think that does attract a different buyer base that's willing to understand and underwrite that liquidity in the capital markets. And I pointed this out on a tweet that I had earlier this week. They sold $215 million of Bitcoin and they cleared it like it was liquid. That is a crazy amount of capital to clear and have liquid in a short period of time. If you had that much capital tied up in real estate or property or bonds, it's really difficult to get that capital liquid that quickly. And I think that's one of the. We talk about liquidity a lot, but that's one of the really unique things here with bitcoin is that it's liquid 24, 7, 365. You could do that on Sunday if you wanted to. It would be a little bit less liquid on Sunday. But it's the only thing that is trading like that with that depth of liquidity. So I think that's really impressive, the fact that it is that liquid. And I think we'll continue to see how that evolves. That's just showing. Strategy sold $215 million worth of Bitcoin and the price of bitcoin actually went up. I think their average sale price on that bitcoin is like 59,000 60,000. And on Monday morning, the price of bitcoin went up to 64,000. Just in the face of all of the bears talking about all of the fud. The price of bitcoin moved up despite strategy selling. So did they need to? No. But is it a good tool to emphasize in their toolkit? Absolutely. Okay, cool. I'm going to shift gears. We're going to talk over MSTR Q2 stats because I think it's helpful just zoom out a little bit here. And a lot of people aren't necessarily contemplating how like how the balance sheet looks over time. It seems that because the company itself has been incredibly transparent and comes out with an 8k every single week, there's this hyper transparency on a week to week market movement as opposed to a zoomed out view of what the company is doing on a broad scale. There are decisions that you may make week to week or month to month that may influence a short term decision in order to make a long term impact. And so when they're looking at how do you manage this balance sheet and be a, a manager or a steward of capital into the future? You're taking a long term view. So let's just look here. Starting Bitcoin, this is MSTR, Q2 stats here. Let's zoom this in a little bit, make it easier to see for all the people watching on cell phones. Okay, so in Q1, this is MSTR. This is directly from their website. Q1 they grew. Bitcoin 13 went from 670, 72,000 to 762,000. Q2 they grew at 11% from 762 to 843. Now people are going to say, oh, but they sold equity, Jeff. Well, okay, the, the number of diluted shares outstanding went up 10% relative to 13% increase in Bitcoin. And Q2, the shares went up 6% relative to an 11% increase in Bitcoin. So you can say that the bitcoin per share actually had increased. So your potency of how much bitcoin exposure you have per share has actually increased over both of those time horizons. Your percentage change in Q1, 3 percentage change in Q2, about 4%, which I think tracks pretty closely with their website. Something around 7.7% Bitcoin yield for the year. Now a couple other things to point out. Over that time, the value of the balance sheet in Q1 went down 12%. So went from 58 billion down to 51 billion. And in Q2, the balance sheet went up 2% from 51.5 billion to 52.3 billion. And this is just the bitcoin value. So you know, if you're zooming out and you're looking at this balance sheet and let's just say you're not on Twitter and you're not watching the 8Ks go every week, I'd be pretty happy with this result, to be honest. I would look at this and be like, yeah, okay, the company is growing their balance sheet. They're doing it in what looks to be a sustainable manner and relative, relative terms and what else happened? So obviously the other question is. But Jeff, you know, the equity and cash and credit and you know, all this other stuff. Okay, well let's look at it. Over Q1, the debt remained constant, so zero change in debt over Q2, they retired 1 1/2 billion dollars of debt, so the debt actually decreased 18%. So what does that mean? That reduces the cliff maturity that they have on the horizon by 18%. I think if you're a long term shareholder, that reduces some Risk. That is a good decision. I mean, we can argue on timing and cash and all of those things, but just zooming out, they reduce the cliff maturity exposure by 18%. Okay, what else happened? So the credit over Q1 credit went from 7.9 billion to 10 billion, so increased 26%. And in Q2 went from 10 billion to 15.4 billion. A change of 55%. And the great thing about perpetual preferred equity is there's no cliff maturity. So that's not a something that they've got to pay back on the horizon. And the annual interest had gone up 32%, so from 827 million to about 1 billion in Q1 and from about 1 billion to 1.7 billion. So about change of 62% increase in Q2 now you say 62%, that's a lot. But the nominal figure is actually not very much relative to the balance sheet value. And so I've got this number in here. The interest as a percentage of the bitcoin holdings has gone from about 2.12% to about 3.37%. So this is that number that strategy has posted. They need their bitcoin on the balance sheet to go up 3.37% annually in order to be able to pay the dividends and depreciation into perpetuity. I think if you're a long term underwriter of bitcoin, generally you're probably looking at underwriting greater than a 3.37% compound annual growth rate. The 99th percentile of four year compound annual growth rate periods is like 9%. The M2 money supply is growing at 7 and a half percent for the last 50 years in a row. We're underwriting a number that's significantly larger than this. And this is that this is effectively the carry trade. On top of that they've got cash on the balance sheet. They've got now two and a half billion dollars of cash on the balance sheet. So that interest as a percentage of total balance sheet, including bitcoin and cash is about 3.21%. So again zooming out here. I like the stock. Like I. What do you, what do you guys think? Like, are you viewing it the same? What's your thoughts here, Dan? I know you've had some volatile opinions on the equity. Are you looking at leverage here? There's a lot of fear and blood in the streets. What are you thinking about?
- [17:57]
D
Yeah, I think recently I've been talking a lot with certain people in the market about this and I think looking at it in the short term, the way the hedge funds and institutions are looking at the equity is important for understanding how kind of the different instruments have traded.
- [18:13]
E
Right.
- [18:13]
D
So we've seen massive trade offs and stretch and the other preferreds. And that's not by design specifically for stretch. And I think you'd want to be going to these things eyes wide open. The general hedge fund institutional partners have been. Market sentiment is such that Strategy has roughly $12 billion of outstanding liabilities over the next 24 months because of the put date on the converts, plus the annual dividend obligations of the preferred equities. And so I think there's a lot of fear.
- [18:43]
C
Say that again, say that again, say that again. 12 billion back into it.
- [18:47]
D
Yeah, excuse me, it's between 10 and 12, but you have all the converts, which are about 8 billion. And then you have two years of dividend payments. So that's 11.3 billion.
- [18:59]
C
3.4. Yeah, 3.4.
- [19:03]
D
And because the put dates are 12 months before the actual maturities of the convertible securities, that's the real maturity, more or less. So call it 24 to 36 months. You've got whatever it is that represents that amount of outlay capital outlay represents about 30% of the total market capitalization of the common equity at this moment. So the way the big players I think are looking at it is they're seeing this number and they're thinking if bitcoin goes to 40k and MSTR being the amplified Bitcoin derivative that it is, falls to 50% of its value. Now you then are Looking at, in 24 to 36 months, 50% plus of the total equity value of the common needing to be either sold, diluted, or the Bitcoin itself sold to meet those obligations. Over the past year, we've seen no Bitcoin sales to cover liabilities. We've seen the sale of MSTR common. So I think one of the biggest boogeymans overhanging both Bitcoin and MSTR over the past six months, which I didn't come to realize until the last month, was simply that if Bitcoin continues to fall, the math gets pretty ugly for MSTR Common with regards to negative Bitcoin per share over the next year. If you're still a long term believer, and I am, of Bitcoin performing and essentially uplifting both the common equity and shrinking the liabilities relative to total capital assets, then this is a big problem. But in the short term, the leverage or the amplification of MSTR works in both ways. And I think you're seeing kind of capital allocators derating the preferred, the credit of the preferreds because of this convertible capital outlay that's on the horizon and sooner than is listed on this chart.
- [21:00]
C
Right. Okay. So yeah, you're looking at the first put date of the converts being September of 27. So you're looking at 12, 15 months from now. And that's a billion dollars. So that's something on the horizon. And then the next one is another. Was that eight months, nine months after that. So in 2028. So it becomes the question of what is, what does the balance sheet look like in 2020, even really 12 months? Like what does the balance sheet look like 12 months from now? What does that forward looking price of the put date exposure look like? Because this is. Right, $6 billion plus the preferred equity coupon coupon payment over that time. Yeah, I get it. It's just stress. It's like correlated stress to the downside. Right. There's, there is debt exposure now that's also underwriting a significant drop in the price of bitcoin. It's possible. It's not, I think there is a probability greater than zero. But you know, there's, there's many things to take into consideration within the marketplace there too. What's your thought, Joe?
- [22:13]
B
Yeah, I mean, I think really big picture. Something that I think is kind of funny when it comes to people generally talking about strategy and a lot of bitcoin treasury companies in general is like people made fun of strategy back in 2024 at the peak for buying a bunch of bitcoin near the top, like late 2024, early 2024, 2025. Right. Part of the reason why, you know, Saylor gets made fun of for, you know, buying the top and now, you know, ironically, kind of like selling the bottom possibly is like, it's kind of like by design of the structure of the company. Right. Like if the, if the stock is trading at a very high premium, it's not completely irrational for Saylor back at the end of 2024 to just be selling like billions of dollars of stock a week to, to buy additional bitcoin. And whenever there's a massive amount of demand for amplified bitcoin, that's probably going to be occurring when the market is super overheated. And then so simultaneously, I think it's kind of funny now that strategy is selling bitcoin near the bottom, like a small amount of bitcoin, pretty much a tiny amount of bitcoin relative to their Overall stack just to make the payments, Maybe because it made it made less sense to sell the stock. Likely because just amplified bitcoin is out of favor at the moment. Right? Like if bitcoin is down 50%, the market generally wants less amplified bitcoin exposure. Why would you want amplified exposure to something that's, that's going down? And so kind of like by design or by coincidence, strategy probably always will be, you know, buying the tops and slowly selling the bottoms. And I still think that even if they do that over time, they'll probably still end up outperforming bitcoin. As long as bitcoin's CAGR is something like, I might expect 20% over a long period of time, 30%, 40% maybe even higher when you're at levels near where it is today. And so I think it's just kind of funny to see the sentiment around strategies buys and sells. And I think that's just another factor that kind of plays with people's brains. But again, Jeff, when you were looking at the excel sheet and kind of zooming out and not looking at, okay, over a one week or two week period, was the BTC yield or bitcoin per share negative or what was happening here? It's like actually over both quarters this year, bitcoin per share is increasing. It seems like that's probably going to be the case, in my opinion, for the foreseeable future. And even if it's not for a short period of time, I don't think that's the end of the world. I think at the end of the day it's still an amplified bitcoin position. You're betting that bitcoin will go up over a longer period of time. And if that thesis doesn't necessarily play out, then you're obviously wrong. But I obviously think that that thesis probably will play out over a long period of time.
- [25:10]
C
Yeah. I'm just struggling to back into the numbers that you're getting to, Dan. I get the concept. I was just playing around with it here. Just bitcoin price at 40,000, that drops the ending bitcoin value to something like 33.7 billion. They've got two and a quarter billion or two and a half billion of cash on the balance sheet. That's about 18 months. I would assume they're probably raising capital during that period of time as well, both on the common and potentially strc. You're looking at $6.7 billion of debt being 20% of the Bitcoin value at that point in time. Yeah, I mean, there's, there's correlated downside stress, but I think that, Yeah, I
- [25:52]
D
mean, I don't think you can assume they can raise capital in either the common or the, or the stretch in a further downside scenario.
- [26:02]
C
Yeah, I mean, the, the question is like, do you want.
- [26:06]
D
And I'm not saying, I'm not saying
- [26:07]
B
this is what I believe.
- [26:08]
D
I'm saying this is kind of how the hedge funds, I think, are, are, are pricing the credit of some of the preferreds. I mean, obviously they're trading at 50% their liquidation preference. So like, clearly people are pricing them lower than their fair value claim over the assets.
- [26:25]
C
Right, right, right. You're talking the other ones too, like stride and strike and strike, et cetera. Yeah, yeah, yeah. It's interesting. It's an interesting perspective. I'm, I'm, I'm long the bitcoin here. Just every, everything that's on the horizon. Right. Like, does look, does the liquidity of bitcoin remain high? Does the liquidity of the common stock remain high? Is there continued demand for amplified bitcoin? Does that remain high? I mean, just looking at today, right, Today is an incredibly low volume day strategy traded $1.7 billion of stock. Like, I wouldn't be surprised if they're raising capital at some point. Maybe not today, but within the week, there's some sort of capital markets activities that common stock remains high. I think that they're going to play with the relative proportion of cash to Bitcoin and how that composition changes that underwriting perspective of the underlying credit instrument. And I mean, I'm curious to see just how this plays out over the next couple of months as we have seen some strength come back to strc. I mean, today was a little bit of a weak day, but that relativity is moving and pushing higher. So it seems like the market has liked the cash trade, but it will probably take some time to work its way through. Okay, cool. Thanks for your perspective. Good stuff. Looking at balance sheet week over week, I just told everybody to zoom out, but let's look at week over week. The balance sheet, the debt to asset ratio has actually gone down because the price of bitcoin has gone up and the cash is relatively flat. So the balance sheet is looking relatively unchanged week over week despite having sold some bitcoin on the balance sheet. The bitcoin price being a little bit higher than last week does help with that. That's what gets that BTC asset number higher. So I think the balance sheet again looks incredibly healthy here. You can underwrite tail downside risk? That is a probabilistic curve. But the question is how long does it stay down there? Does it go the other direction? What's the depth and duration? The biggest question in underwriting this balance sheet is depth and duration, not necessarily just underwriting downside depth. So how long does it stay down there? Does the market change, does clarity act come into play? Does the spam war have an impact on the Bitcoin price? Does the war in Iran have an impact on the bitcoin price? What happens at midterms? Does M2 money supply change? Does the Fed change interest rates? Do interest rates come down because of inflationary pressure and changes in the data that are used there? I think there's a lot of catalysts that could be good for the underlying price of Bitcoin here and Eric Balchunas posted about this yesterday, which I thought was an interesting perspective. It's kind of aligned with my long term thesis on what's happening in the stock market. ETFs have a they're systemically important to the architectural economic ecosystem of America and these companies are included within these ETFs. And as if there's any bear market in the future, especially with the fact that you've now got these Trump accounts, that these people are holding these Trump accounts for their kids in the future, and Social Security and pensions and all of those things, there will be incentive for the Fed to step in and prop up the markets because of how systemically important and integrated all of these components are in the entire ecosystem. So again, thinking about a corporate infrastructure and how it's tied to ETF's market cap weighted index funds. As the market cap rises of companies within index funds, the relative proportion of new dollar flow that's coming in the door increases relative to the market cap increase. So this is something I've seen over time. This is something we saw with strategy over the last year. This is one of the reasons, in my opinion, they were able to raise a significant amount of capital in November of 2020, top of the price of Bitcoin going up. It was also like Q. Q. Q. Inclusion and any capital that came in the door that way. So by having an ATM on the balance sheet, they were able to capitalize and monetize that additional capital that was coming in the door and that helps boost the market cap. That boosts the reflexivity of that potential into the future. Now that also goes both directions and it cuts both ways. As the market cap drops, the relative proportion in the index also starts to drop, and that results in a reflexive downside. So that. That actually increases volatility in both directions, particularly for a balance sheet that's denominated in a volatile asset like bitcoin. So that is on the horizon. All right, the last half of this conversation here, I want to talk about capital. And because strategy and Michael Saylor have docked, and we talk about this a lot, but bitcoin is capital. So I wanted to take a moment and talk about what is capital strategy, or Michael Saylor refers to it as digital capital. It's really just capital. Like, bitcoin is capital. And I'm going to kick it over to you guys. What does capital mean to you? And how do you think about it? And we'll talk about it.
- [32:10]
B
Yeah, maybe I can start and then we can go to Dan. I mean, my mind, capital is effectively an economic resource, which is kind of like a very broad term. But I. I think, like, that's kind of like a typical definition of. Of capital. And that could be like anything, right? Like, that could be a factory, that could be a building, that could be a business, that could be a financial asset, that can be, you know, a wide variety of things. And in my. My opinion, it can also be money. I think of bitcoin as like, a emerging form of money. I think of the dollar as a form of money. I think of gold could be argued as a historical form of money as well. And I think money is a specific subset, or monies are a subset of capital, like certain capital, like buildings and factories. Those can be productive capital in a way. Like, okay, if you have a factory, you can produce specific goods. You can then sell those goods. As long as your revenue exceeds your expenses, you can be generating cash flow, et cetera, et cetera. Money is like a unique kind of form of capital because it's just like a tool. In my view, money is like the most saleable or most marketable tool because it has what I would call, like, unique monetary properties. It's scarce, portable, durable, divisible, and fungible. It's the tool that everyone wants, and everyone can use it to acquire other capital out there, like factories, like real estate, like businesses, or consumer goods as well. And so in my mind, bitcoin or, you know, bitcoin is digital capital. I think, like, Michael Saylor is dead on there. I think he uses that term because most people don't think of bitcoin as money, Even though I personally think of bitcoin as money, and I think it's more correctly I Think it's like an emerging form of money. And therefore bitcoin as digital capital kind of makes it more clear to the 99% of people that think of money being this stable dollar instrument that has little to no volatility. Maybe it pays a yield if it's in a bank account or a T bill or money market fund. Maybe it doesn't pay a yield if it's physical, like dollar cash. But most people think of money as like a stable dollar instrument. So I think that's why Saylor uses the term digital capital when communicating with, you know, traditional finance individuals and institutions, because that's kind of like more in their realm of what they think of Bitcoin actually is relative to this concept of. Of money. Of course, I think it's an emerging form of money. And I think, you know, bitcoin money, money is capital, assets are capital, you know, factories, whatever is capital. It's very broad term. So probably a lot of, yeah, it's.
- [34:57]
C
It's super broad. And like, go look it up. Like, go look up the, like, what is capital? And you'll get kind of these various definitions. Well, and you'd fail the elevator pitch on what is capital? Right. It's like, what, what is. Well, it's, you know, to me, capital is an asset that you can put to work, any asset. And, like, put to work. Well, what does that mean? It's like, it means several things. And I used to work in the capital markets in the reinsurance world. Like, of course I worked in reinsurance. But like, the capital, it's like, you think about what wealthy people do. You've heard the. Most people have probably heard the strategy like, buy, borrow, die. And it's like, okay, that's what medium wealthy people do, is they buy assets, they borrow against the assets, and they die. It's like a tax arbitrage strategy. But what the uber wealthy people do is they buy, they borrow, and they buy again. You're taking this carry trade, or you're taking on risk on the asset that you're holding in any one direction. And then the entire world, the entire world of capital markets is looking to find alpha so they can go arbitrage more opportunity in the capital markets. Like, why do all of the high rises in New York City exist? Is because they're all operating in the capital markets. They're buying assets, they're taking risk on those assets. And taking risk comes in so many forms, right? Like there's equity market risk, there's debt market risk, there's insurance risk. There's interest rate risk, there's time duration risk. There's so many different types of risk that you can take with capital. And there are different forms of capital. Real estate is capital like you said, a warehouse could be capital. Bitcoin is capital, Fiat is capital. Equities are capital. Now when you're thinking about taking risk with that capital, having liquid capital allows you to take different, more flexible types of risks. You can now take duration risk and be certain that you have liquidity. That is a, a me like this is an evolving market. We're talking about a market that moves incredibly slowly and it will continue to change over the next 20 years and we're living right in the middle of it. So like you hear all this FUD on X and it's all just like completely blown out of proportion and doesn't understand like how the capital markets move and evolve. But we are living through a transformation of the capital markets with a change in the underlying capital. And you think about even ETFs, people for perspective. In the reinsurance market, people take assets and they go park it as collateral somewhere to take on risk on a one year duration hurricane hitting Miami. And that's one example that happens thousands of different places. And that's just the reinsurance market. And then you can think of the insurance market. It's like insurance companies are holding capital and they're putting that capital at risk. They're putting their entire bond portfolio at risk, they're putting their entire equity portfolio at risk. They're putting their balance sheet at risk to go acquire more assets. That's like the entire design. That's effectively what bitcoin treasury companies are doing. We have balance sheet capital. It's just highly liquid, highly volatile balance sheet capital. We are putting that capital at risk to go acquire more Bitcoin. And that is the fundamental design. And when regulators or rating agencies are looking at this stuff, they're completely, completely ignoring liquidity profile of the underlying capital instrument. Right now, right. Bitcoin is from Basel 3 risk rating standpoint has a 1,250 risk weighting, meaning there's like, there's no. Basically the, the rating agencies are saying this is like low quality capital when in reality it's very high quality capital because it's very liquid. It's the most liquid you can actually trade it. It's very, very deep in liquidity and you could trade it 24, 7, 365. And that evolution, it just takes time for people to understand how to use these things. And for the volatility to kind of work its way out. And I think as we get further into Bitcoin's history here and get further into the supply curve trending towards zero, I think we're going to start seeing a lot less volatility. Balance sheet management starts to become a little bit more easy to grasp and understand and, and like that's effectively what all of us are doing right now is just kind of front running that market understanding of that market accelerating. A lot of words there, Dan. Oh, like you have, you have thoughts on, on capital markets. I mean you've been traveling now around New York. You're talking more to these people and you're, you're thinking about capital markets all the time. What's, what's your perspective?
- [40:14]
E
Yeah, I mean, I don't think necessarily, I guess I would consider capital, anything that appreciates relative to currency. And in a monetary system where the currency does not store value, then capital and currency cannot be the same thing. But in a world of strong money, then capital currency could theoretically be the same type of asset. And so that's my point there. And I think in a bitcoin world there always will be some form of denomination or in the next 20 to 30 years, denomination using USD. But if you ever reached a world where prices were denominated in Bitcoin, then you'd have, you know, you could denominate things in a capital asset. That being Bitcoin and money should theoretically be a index for global productivity.
- [41:02]
D
Right.
- [41:03]
E
The technology, this is a Jeff Booth idea where technology driven advancements should ultimately benefit the end consumer and that should be reflected as lower prices. But if you have an ever expanding supply of the ledger via US currency, then that can never really be the case. So bitcoin as a capital asset would mesh and blend into what is currency. So in hyper bitcoinization there may be no difference between capital and currency.
- [41:36]
C
Yeah, I mean the currency right now is being used as Capital. The dollars, 90, 95% of the 90% of the reinsurance transactions I worked on used treasuries as the collateral asset. To take risk, it's like you have to, the regulators say you need to have tier one capital as your collateral. So if you wanted to take hurricane risk, it's like you've gotta go post tier one treasury capital, I guess, like effectively currency as your collateral. And I think that's going to evolve pretty drastically over the next couple years. Here. The other thing I wanted to talk about. Thanks for your perspective, Daniel. The other thing I wanted to talk about which is this evolving use case here is the bitcoin backed loans we just saw strike came out with a bitcoin backed loan. It was volatility protected, effectively non liquidation bitcoin backed loan with a shorter term, smaller ltv. And I just wanted to provide some perspective on how, how this trade is happening behind the scenes because I think it's a valuable perspective to understand and this is something I noticed. So when I left the reinsurance world, I took a six month break in my career to go to bitcoin events and identify where there was opportunity in the industry. And part of that was talking to as many people as I possibly could, trying to identify who was doing what and where energy was being spent, spent to build the ecosystem. And one thing that I noticed pretty quickly, that there was several people, I want to say like 50 different people, different companies probably that are working on some sort of form of a bitcoin backed loan. So if you have bitcoin, somebody giving you dollars in exchange for an interest rate so you can borrow against your bitcoin, that seemed like like 90% of where the energy was denominated was going towards that problem. Now I found a challenge with that problem, is that it's really difficult to convince people to take the other side of that trade. Right? Bitcoiners want to borrow against their bitcoin. Why? Because you want to short the dollar like everybody wants to short the dollar. Now the, the problem is the sophisticated capital that would typically be willing to take the other side of the trade. If you underwrite this, if you're lending dollars, this looks like a bad trade. If I'm lending dollars for 12% in exchange for taking on the bitcoin volatility risk, why don't I just buy the bitcoin? Buying the bitcoin actually looks like a better long term trade if you actually underwrite the entire ecosystem. And so it kind of comes up with this adverse selection problem where you've got anybody that's underwriting the entire ecosystem is probably long to instrument. And the tail risk of lending out dollars in exchange to take on bitcoin volatility risk, the tail risk is the dollar disappears and you don't get anything back. And that tail risk weighs super heavily on in the expected loss outcome of that trade. So I'm not talking about the bitcoiner's point of view, the person that wants to borrow the dollars, I'm talking about the other side of the trade. So the person that's willing to lend you dollars, that's A difficult risk calculus. I can't make it work personally. And that's where this perspective of let's flip it upside down, which is how we got to perpetual preferred equity, is. Let's have a company take the bitcoin volatility risk and issue credit against it. In my opinion. I think that total addressable market is significantly greater now. That dynamic may change over time as more people natively hold bitcoin and that potentially grows. I'm bullish in that scenario. But the total addressable market of something, that of somebody that wants a yield product, where a company, a corporation is taking on the volatility risk, I think that total addressable market is vastly greater than the number of sophisticated people that hold Bitcoin that can quantify the risk exposure and take the volatility exposure and continuously monitor it. You have margin risk, LTV risk, duration risk, cleft maturity risk. If you have somebody that's sophisticated enough to understand that calculus and be willing to take that risk, that's the type of buyer that you need. Whereas underwriting a company that's taking the volatility off of the instrument, I think is a little bit easier to quantify and the total addressable market is materially larger. Joe, I asked you to do some research on this as well. How do you view these instruments?
- [47:00]
B
Yeah, no, it's super interesting because I've worked for a number of bitcoin companies. One was Unchained, which I don't know if they were the first company to start bitcoin collateralized loans, but certainly one of the first. I believe that was the original product by unchained, released in 2016. And it's funny because the problem over the years before I even joined Unchained and even when I joined Unchained is like exactly kind of what you're talking about. It's like the idea behind a bitcoin collateralized loan is super interesting. And you can make arguments as to why rates should be very low. But it's like, okay, well, at a certain point there's this adverse selection problem where it's like, all right, well, why would I lend money out at a certain rate if I can just buy bitcoin, earn that same amount? I think part of the genius behind digital credit and perpetual preferred equity is it is it makes that double digit dollar yield. Again, coming from a corporation, like your perspective, and also like publicly traded, it's liquid. It's very. You can sell it Monday through Friday. There's a lot of beauty with that. And I think that that's like part of the genius behind the perpetual performance convert equity. The other thing, flipping it back around of why take the amplified bitcoin position? I mean my whole bitcoin experience, I've always wanted to have more bitcoin. Right. Every bitcoiner wants to do that. Obviously there's so many problems with borrowing against your bitcoin specifically. The liquidation risk is one, but also the duration risk is arguably just as important, if not more important. If you're borrowing against your bitcoin on a one year time horizon, that's extremely risky because I have no idea what bitcoin is going to be one year from now. I tend to believe it's going to be higher, which is why I want to do it. But I'm a lot more confident on a 4, 5, 10 year time horizon that bitcoin is going to be better. And that's the genius behind pairing bitcoin being this extremely long duration asset with this perpetual preferred equity. It's just kind of like a match made in, you know, in heaven.
- [49:15]
C
And like that's the duration matching. Yeah, you've got a, you've got a perpetual asset and you've got a perpetual liability that never comes due. And whereas the, the opposite is true for bitcoin loans, you've got a, a very long duration perpetual asset and you've got a short duration loan that's difficult to underwrite directionally. I, I think it could make a lot of sense for miners. Like if your cash flow is a function of mining bitcoin and the compute infrastructure and you, you needed to go build a couple of things here and there and you know, like you could take on that, that risk and you've got a little bit of a balance sheet. But I think it's really tricky for an individual to underwrite some of this risk themselves. Not to say it doesn't make sense for some people. I think it can absolutely make sense for some people, but it's very, it's a difficult thing to underwrite. Dan, you've got perspective on these bitcoin loans?
- [50:18]
E
Not as much as Joe, but I think you did a good job of recounting the idea behind a perpetual preferred equity. Obviously duration matching the capital which should be perpetual capital bitcoin. That's the whole idea. I'm in agreement that the thesis still stands. I do think somehow one of the missing pieces of a secured bitcoin loan or short duration bitcoin backed credit, which I believe to be similar to a T bill, if you had short duration secured Bitcoin lending. I think you could get the credit spread down a lot lower than we have on the preferred equities right now. So that's going to be something to consider moving forward. I think the fact that actually the rates or the credit spreads are so high on these preferred equities are actually a problem with regards to kind of building out a bitcoin risk curve and
- [51:14]
C
its relativity to an actual duration instrument.
- [51:18]
E
Exactly, yeah.
- [51:19]
C
The spread between a duration instrument and you think the spreads between a duration bitcoin instrument and a perpetual bitcoin instrument are going to widen?
- [51:29]
E
No, no, no, no. What I'm saying is I think the idea of a perpetual preferred kind of duration matched suite of securities, which is ultimately what strategy created the short duration credit stretch, longer duration credit like strife. Ultimately you'd want credit spreads that reflect the maturity risk or duration risk of those liabilities. If you were to build this with secured lending, Maple Finance is one company that's doing it. Obviously Unchained has done it in the past. Then you can get closer to a market aggregated real credit spread against the T bill rate or the 10 year rate, et cetera with the petrol preferreds. Right now we're seeing so much volatility
- [52:14]
D
in the preferreds that we don't have
- [52:15]
E
a good sense of what the bitcoin backed yield curve is. And so what I'm saying is over time, I think the bitcoin backed yield curve duration bitcoin backed yield curve is going to have to emerge. At the moment it does not seem like strategy preferred equities are creating that curve. And I think the main reason is because it's not secured debt. So maybe, who knows, in five years someone could come along and create secured financing against Bitcoin that actually does build
- [52:40]
C
out a risk curve.
- [52:41]
E
And the perpetual products are a whole different beast. I'm still not sure if this is the final incarnation of that.
- [52:47]
C
Oh yeah, I don't think we've reached final at all. I think there's, I mean a lot of work being done to look at different duration style instruments. It'll take time. I mean building this stuff doesn't, it doesn't move overnight. And thinking about structured finance and capital markets like again, track record needs to be taken into consideration. Building, building structured instruments is not something that is as quick to do like in defi land. And I think there's a, I agree with you. I think there's a lot of opportunity to kind of continue to build out this yield curve. I think that, I think you can say like what, what the, what the market is trying to dictate with the price and volatility of the preferreds is a forward looking view of the perpetual nature of bitcoins. Like, do you think bitcoin survives? And like that's like the arbitrage, right? Like, do you, do you think bitcoin survives perpetually? Like if yes, then if yes and it appreciates greater than the M2 money supply. The prefs are money good. Right. And if, if not, which it seems like some of the market like agree, like agrees with. You could see it on CNBC or Laura Chin, right? Like that, like there's definitely people that don't like these things and don't think they should exist and don't understand them and don't think that they're going to last forever. In my opinion. There's a lot of bad math and logic and rationality behind a lot of those arguments. But you know, that's, that's a conversation for another time. Yeah, it's fascinating everybody trying to wrap their, wrap their heads around these things and where they go. Okay, cool, we're right in an hour here. I'm going to pass it around for final thoughts and we'll end the summer session right there. I'm going to start with you, Dan, over to you. Final thoughts.
- [54:53]
E
I think these are the dog days of summer and generally things are slow. So don't get your hopes too high in the short term. But obviously the pivot in the capital management strategy is reassuring and they're going to continue to bolster and strengthen their products. And you know, bitcoin's here as liquid capital support those instruments. So don't get too shaken out of some of those preferred instruments. I think is very important.
- [55:20]
B
Yeah, I like that. And closing thoughts for me, I mean, zoom out. I think like that's kind of like probably the most important message that most people can, can see and hear at this point. And this is par for the course, right? I mean 50% drawdown in Bitcoin is nothing. If you look back at the historical lows of bitcoin over each cycle, it's still very clearly trending up. AI has sucked a lot of wind out of the room, obviously a lot of liquidity out of the room. I think eventually when growth maybe slows or there's a hiccup there or something and the liquidity spigot remains on or comes back on in a really big way, obviously I think bitcoin, Bitcoin will do quite well. And obviously I think amplified bitcoin will do quite well. So just a matter of like hanging in during the, the harder times and having a, a positive long term perspective and, you know, holding through the pain.
- [56:15]
C
Yeah, you guys both hit the nail on the head there. Capital wind sucked out of the market. War is. It's on, it's off, it's on, it's off, it's on, it's off. You've got Warsh, new chairman of the Fed. We'll see how interest rates evolve and change over time. It looks like we've now got committees to work on the. So I suspect the data will change and inflation's under control and interest rates come down. I think that's something we could potentially think about in Q3, Q4. Liquidity Midterms spam war on Bitcoin, Clarity Act. I wouldn't expect too much to move in July. Like you said, Dan, we're in the dog days of summer. All the people are out vacationing. I wouldn't expect too much to happen in July or August, but potentially some crab between there, here and there. Everybody's still working hard on the, on the bitcoin front, I can tell you that. And, and then, yeah, I think we, we can see some evolution here in Q3, Q4. So we'll, we'll keep pushing forward and appreciate the time as always. Episode 73 we'll catch you soon.