The essence of strategy is arbitrage business

Original Title: You Don't Understand MSTR

Original Author: Dio Casares

Original Compilation: Deep Tide TechFlow

In the past five years, Strategy has spent $40.8 billion, equivalent to Iceland's GDP, to acquire over 580,000 bitcoins. This accounts for 2.9% of the bitcoin supply or nearly 10% of active bitcoins (1).

Strategy's stock code $MSTR has risen 1600% over the past three years, while bitcoin's increase during the same period was only about 420%. This significant growth has pushed Strategy's valuation above $100 billion, and it has been included in the Nasdaq 100 index.

This tremendous growth has also raised questions. Some claim that $MSTR will become a trillion-dollar company, while others sound the alarm, questioning whether Strategy will be forced to sell its bitcoins, potentially triggering a massive panic that could depress bitcoin prices for years.

However, while these concerns are not entirely unfounded, most people lack a basic understanding of how Strategy operates. This article will explore in detail how Strategy works and whether it poses a significant risk in bitcoin acquisition or represents a revolutionary model.

How does Strategy purchase so many bitcoins?

Note: Due to new financing and other reasons, the data may differ from when it was written.

Broadly speaking, Strategy primarily obtains funds to purchase bitcoins through three means: revenue from its operating business, selling stocks/equity, and debt. Among these three methods, debt is undoubtedly the most scrutinized. People tend to focus heavily on debt, but in reality, the vast majority of the funds Strategy uses to purchase bitcoins comes from issuing stock, i.e., selling shares to the public and using the proceeds to buy bitcoins.

This may seem somewhat counterintuitive; why would people buy shares of Strategy instead of directly purchasing bitcoins? The reason is quite simple, returning to the most favored business type in the cryptocurrency realm: arbitrage.

Why do people choose to buy $MSTR instead of directly buying $BTC?

Many institutions, funds, and regulated entities are restricted by "investment mandates." These mandates specify which assets a company can and cannot purchase. For example, credit funds can only buy credit instruments, equity funds can only buy stocks, and long-only funds can never short, and so on.

These mandates allow investors to be assured that, for instance, a fund that only invests in stocks will not purchase sovereign debt, and vice versa. They compel fund managers and regulated entities (like banks and insurance companies) to be more responsible, only taking on specific types of risks rather than being free to assume any type of risk. After all, the risk of buying Nvidia stock is entirely different from the risk of purchasing U.S. Treasury bonds or putting money into the money market.

Due to the highly conservative nature of these mandates, much of the capital sitting in funds and entities is "locked" and cannot enter emerging industries or opportunity areas, including cryptocurrencies, especially unable to directly access bitcoins, even if the managers and related personnel of these funds wish to engage with bitcoins in some way.

Michael Saylor, the founder and executive chairman of Strategy (@saylor), recognized the gap between these entities' desire for asset exposure and the actual risks they could take, and he capitalized on it. Before the emergence of bitcoin ETFs, $MSTR was one of the few reliable ways for these entities, which could only purchase stocks, to gain exposure to bitcoins. This meant that Strategy's stock often traded at a premium, as demand for $MSTR exceeded the supply of its shares. Strategy continuously leveraged this premium, the difference between the value of $MSTR stock and the value of the bitcoins contained in each share, to purchase more bitcoins while increasing the number of bitcoins per share.

Over the past two years, if you held $MSTR, your "returns" in bitcoin terms reached 134%, the highest among scaled bitcoin investment returns in the market. Strategy's product directly meets the needs of entities that typically cannot access bitcoins.

This is a classic case of "Mandate Arbitrage." Before the launch of bitcoin ETFs, as mentioned earlier, many market participants were unable to purchase non-exchange-traded stocks or securities. However, as a publicly traded company, Strategy was allowed to hold and purchase bitcoins ($BTC). Even with the recent launch of bitcoin ETFs, it is entirely incorrect to assume that this strategy is no longer effective, as many funds are still prohibited from investing in ETFs, including most mutual funds managing $25 trillion in assets.

A typical case study is Capital Group's Capital International Investors Fund (CII). This fund manages $509 billion in assets, but its investment scope is limited to equities and cannot directly hold commodities or ETFs (bitcoin is largely considered a commodity in the U.S.). Due to these restrictions, Strategy became one of the few tools for CII to gain exposure to bitcoin price fluctuations. In fact, CII has such high confidence in Strategy that it holds about 12% of Strategy's stock, making CII one of the largest non-insider shareholders.

Debt Terms: A Constraint for Other Companies, but a Boost for Strategy

In addition to the positive supply situation, Strategy also has certain advantages regarding the debt it undertakes. Not all debts are the same. Credit card debt, mortgages, margin loans—these are all distinctly different types of debt.

Credit card debt is personal debt, dependent on your salary and repayment ability rather than asset-backed, and the annual interest rate can often exceed 20%. Margin loans are typically loans secured by your existing assets (usually stocks), and if the total value of your assets approaches the amount you owe, your broker or bank may seize all your funds. Mortgages are considered the "holy grail" of debt because they allow you to purchase assets that typically appreciate (like houses) with a loan, while only paying monthly interest (i.e., mortgage payments).

While this is not entirely risk-free, especially in the current interest rate environment where interest can accumulate to unsustainable levels, it is still the most flexible compared to other types of loans, as the interest rates are lower, and as long as you make timely monthly payments, the assets will not be seized.

Generally, mortgages are limited to housing. However, corporate loans can sometimes operate similarly to mortgages, where interest is paid over a specified period, and the principal (i.e., the initial loan amount) only needs to be repaid at the end of that term. Although loan terms can vary significantly, typically, as long as interest is paid on time, debt holders have no right to sell the company's assets.

Chart Source: @glxyresearch

This flexibility allows corporate borrowers like Strategy to navigate market fluctuations more easily, making $MSTR a way to "harvest" the volatility of the crypto market. However, this does not mean that risks are entirely eliminated.

Conclusion

Strategy is not in the leverage business; it is in the arbitrage business.

While it does currently hold some debt, bitcoin prices would need to fall to about $15,000 per coin within five years to pose a serious risk to Strategy. With the expansion of "vault companies" (referring to companies replicating Strategy's bitcoin accumulation strategy), including MetaPlanet and @DavidFBailey's Nakamoto, this will become another focal point of discussion.

However, if these vault companies stop charging premiums in competition with each other and begin to take on excessive debt, the entire situation could change and potentially lead to severe consequences.