This episode scrutinizes the surge of crypto treasury companies, questioning their sky-high valuations and exploring the potential for them to trigger systemic risk within the crypto industry, drawing parallels to past market collapses.
The Rise of Crypto Treasury Companies
- Steve Erlic, executive editor at Unchained, explains that the trend of crypto treasury companies is largely driven by an attempt to capitalize on the momentum from Donald Trump's embrace of crypto and Bitcoin's significant price increase.
- While Bitcoin has reached new all-time highs, many altcoins (cryptocurrencies other than Bitcoin) have not experienced a similar surge, leading traders to seek leveraged exposure to high-performing assets like Bitcoin.
- Bitcoin treasury companies, which hold Bitcoin on their balance sheets, have been outperforming Bitcoin itself. Erlic notes, "Bitcoin was up over about 120% since the ETF started trading in January of 2024. MicroStrategy or I guess Strategy now is up over 500% over that period of time."
- These companies often trade at a significant premium to the Net Asset Value (NAV) – the actual market value of the Bitcoin they hold. For instance, Strategy (formerly MicroStrategy) trades at approximately 1.7 times its Bitcoin NAV.
- This outperformance and premium create compelling economics for traders, leading to a proliferation of copycat companies.
Sustainability of Premiums and Market Dynamics
- Laura Shin questions the sustainability of these high premiums across all new treasury companies.
- Erlic initially expected Strategy's premium to decrease as arbitrageurs (traders who profit from price differences in different markets) and investors moved towards Bitcoin ETFs from major asset managers like BlackRock and Fidelity.
- However, Strategy's premium has persisted, which Erlic attributes to a "feeding frenzy for its options contracts [and] its convertible debt," allowing it to "defy gravity." Options contracts give the buyer the right, but not the obligation, to buy or sell an asset at a set price on or before a certain date. Convertible debt is a type of loan that can be converted into equity (shares) of the issuing company.
- Erlic expresses skepticism that the numerous copycat companies can replicate Strategy's unique success, noting some are trading at premiums of "80 times that the NAV which is completely I guess insane."
- He suggests that the law of efficient markets will likely bring these extreme premiums down as more companies enter the space.
Potential for Systemic Risk and Contagion
- The core concern explored is how these companies, judged by their ability to maintain premiums and outperform Bitcoin, might take on poorly managed risks.
- Erlic highlights the potential for these companies to engage in risky behaviors that could lead to contagion – the spread of financial problems from one institution or market to others – and broader issues in the crypto ecosystem.
- This sets the stage for discussing how these new entities could mirror past systemic failures.
The GBTC Analogy: Parallels to the 2022 Collapses
- Laura Shin points out that concerns about systemic risk from crypto treasury companies often draw comparisons to the Grayscale Bitcoin Trust (GBTC) and its role in the 2022 crypto market collapses. GBTC is a financial product that allows investors to gain exposure to Bitcoin without directly holding it; for a long time, it traded as a closed-end fund, meaning it had a fixed number of shares.
- Erlic explains the "widowmaker trade" associated with GBTC. For years, GBTC traded at a significant premium (up to 120% at one point), making it seem like a safe and profitable investment.
- This perceived safety led to GBTC shares permeating trading and lending desks across the crypto industry.
- When the GBTC premium reversed into a discount that couldn't be rectified, it triggered "cascading bankruptcies and liquidations for formerly bluechip companies like Terra Luna and 3AC and BlockFi and Voyager and obviously FTX as well."
- The parallel to current crypto treasury companies lies in their shares also trading at massive premiums to NAV, raising questions about the risks if these premiums collapse.
How Crypto Treasury Company Shares Could Become Risky Collateral
- Erlic details how GBTC shares were used as collateral for loans by trading desks and crypto lenders, seen as safe due to being backed by Bitcoin and their historical premium.
- Similarly, shares of these new crypto treasury companies are backed by crypto (though clarity on whether this crypto is rehypothecated – pledged as collateral for the company's own debts – is sometimes lacking) and are liquid, tradable on brokerage accounts.
- Erlic, drawing on insights from his sources, states that while it's not happening yet, "it only takes one or two prime brokers [or] trading desks [or] OTC desks to start accepting these shares of stock as forms of collateral to extend out margin." Prime brokers offer a suite of services to hedge funds and other large institutional investors. OTC (Over-The-Counter) desks facilitate large trades directly between two parties rather than on a public exchange. Margin refers to borrowing funds to trade larger positions.
- Once a few entities start accepting these shares as collateral, the "copycat industry" nature of crypto could lead to widespread adoption of this practice.
The Risk of a Cascading Crash and a Call for Caution
- Erlic outlines a scenario where a market reversal could prevent these companies from rolling over their debt or cause equity grants to fall out of the money. This could force them to sell off their crypto holdings to repay large loans, potentially leading to a "cascading series of crashes."
- He emphasizes that while the system isn't set up for this immediate collapse, it's still "very, very early days" for this new industry segment.
- Steve Erlic's reporting aims to serve as a warning: "it's important to remember the lessons that we learned from the collapse of GBTC so that unnecessary risk-taking or irresponsible risk-taking when it comes to these types of companies and these types of shares of stock don't happen again."
- Laura Shin adds that competition could drive firms to offer better short-term borrowing terms using these shares as collateral, which might not be sustainable systemically.
This discussion highlights the precarious nature of crypto treasury company valuations and the potential for their shares to become a source of systemic risk if used as widespread collateral. Crypto AI investors and researchers should monitor the leverage and collateral practices involving these companies, as a downturn could trigger cascading liquidations similar to the GBTC fallout.
