The following is an opinion piece by Robert Schmitt, the creative force behind Cork Protocol.
Many perceive crypto treasury firms as essentially a leveraged play on digital assets. To a large extent, this is accurate. These businesses aim to boost investment returns by actively acquiring and handling crypto assets as part of their financial strategy. But, due to the inherent leverage, a market dip could seriously hurt prices and cause instability across the wider crypto landscape, similar to the meltdowns witnessed during the previous crypto downturn.
So, are these companies financial masterminds or a disaster waiting to happen?
To gauge the inherent risks, it’s important to fully understand what a treasury approach entails. There’s no universal strategy; it’s a range of financial methods, each with advantages and disadvantages, needing careful risk evaluation.
The primary goal is to increase crypto holdings for each share outstanding, which in effect produces a “yield” for investors. This is done as each share represents an increasing amount of crypto, owing to the firm’s financial engineering. This approach has become well-known because of companies like MicroStrategy, which, according to their investor relations page, holds over 600,000 BTC.
Peering Behind the Curtain
When the stock price exceeds its Net Asset Value (NAV) – the market value of the crypto assets backing each share – the firm can issue new shares and sell them through At-The-Market (ATM) offerings. The funds generated are used to purchase additional cryptocurrency. Keeping other variables constant, this increases the crypto assets held per share, based on the premium the stock commands over NAV.
To raise capital from investors who buy fixed-income assets, the treasury company might issue preferred stock. For example, MicroStrategy has issued preferred shares, raising over $6 billion while paying out dividends at approximately 8–10% annually, according to their filings with the SEC.
Treasury businesses can also generate capital through convertible notes. These are loans with low-interest rates that feature call options, enabling lenders to convert the debt into equity at a predetermined price. Because lenders benefit from the upside if the crypto asset’s value increases, these usually have very low coupon rates (0–1%).
Some firms also use their crypto holdings in staking or DeFi methods to generate extra yield for investors. However, specifics can differ between businesses. Not every company actively stakes or restakes their assets.
If the stock price drops below NAV, firms might repurchase shares, increasing the crypto per share. The funds used for these repurchases can originate from cash on hand or by selling portions of their crypto holdings.
The most significant risk in a market downturn arises from the use of debt and preferred stock since both lead to future cash obligations. Depending on their scale relative to the company’s assets, these methods of raising capital, which don’t dilute share value, can amplify the risk.
The Arbitrage Seesaw
Issuing stock and conducting buybacks are two sides of the same strategy. Treasury managers issue new shares when the price is above NAV and repurchase shares when below NAV, thus controlling the crypto value held per share. This is similar, but not identical, to the ETF creation and redemption mechanism that ties ETF prices to NAV.
Importantly, the treasury setup captures variations between the stock price and NAV through these trading actions, impacting crypto holdings per share. When the stock is trading at a premium, treasury companies, in practice, create buying power in the underlying cryptocurrency. In contrast, buybacks when trading at a discount could apply selling power if crypto assets are liquidated to fund the repurchases.
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For many investors, treasury company stocks are seen as a “trade”. During bear markets, substantial outflows may force asset sales, intensifying the downward pressure on cryptocurrency prices.
Investing in a treasury firm provides direct exposure to the specified underlying crypto, so stock values follow the asset’s price closely and can significantly contribute to buying or selling forces on the cryptocurrency itself.
Understanding the Risks
As crypto treasury businesses expand, their potential downsides increase, mainly due to three reasons:
First, debts must be paid at maturity. For example, MicroStrategy owns roughly 630,000 BTC but has about $8.2 billion in convertible debt set to mature between 2028 and 2032. Even though this period allows leeway and opportunities for refinancing, a sharp fall in Bitcoin’s price could restrict options.
Given current holdings, a Bitcoin price of approximately $13,000 might trigger a default, which is severe but not impossible, based on historical bear markets. It’s likely that the market considers this risk, spurring MicroStrategy’s initiatives to preemptively convert debt to equity while the stock trades above conversion values, as detailed in MicroStrategy’s Debt Maturity Schedule.
Second, the $3.95 billion in preferred stock from MicroStrategy results in annual cash outflows near $395 million because of the 8–10% dividend rate. In a down market, where stock trades near or below NAV, raising capital through stock issuances may become difficult, perhaps causing Bitcoin sales or shareholder dilution. These can risk further pressure on the price.
Lastly, in bear markets, raising capital through new issuances is more challenging when the stock is trading near or under NAV. This can potentially force asset sales or dilution. Persistent trading below NAV during outflows can cause treasury companies to liquidate crypto assets to fund buybacks, worsening price declines and potentially triggering a negative spiral.
The Intertwined Relationship Between Crypto and Financial Markets
When markets are growing, leverage increases volume and valuations, which then further enables more leverage. In downturns, leverage is forcefully reversed, reducing activity.
This interaction is at the heart of the risk and reward profile of treasury tools. Although these vehicles generally improve the ecosystem, significant amounts of short-term speculative capital follow their stocks, which may cause quick outflows upon a change in market sentiment.
The crypto treasury strategy is effective when managing risk prudently to prevent blowups.
Currently, most major market participants are choosing conservative strategies. However, as crypto prices grow, leverage becomes appealing. Aggressive issuing of debt and preferred stock, in an attempt to control treasury assets, could cause significant systemic risk.
Many treasury businesses currently use zero or minimal leverage, supported by notable balance sheets. If leverage increases dramatically and becomes unstable, the outcomes are sure to be disastrous — but that scenario is not here as of yet.