The leverage risk of cryptocurrency treasury companies

In the article from the day before yesterday, I shared the history of how Evergrande's debt risks ultimately led to the company's collapse. Some readers associated this history with similar risks that some listed cryptocurrency treasury companies may currently face.

A couple of days ago, Vitalik also mentioned this risk in a comment on his Twitter. This risk is indeed very worthy of attention; even though it is not an explicit risk at the moment, I always worry that these companies' increasingly aggressive operations might trigger this risk in the future.

The book "Classic Cases of Value Investing: China Evergrande" was published at that time to demonstrate the author's firm optimism about Evergrande.

To prove this "firmness," the author detailed the various investment banks and institutions' assessments of Evergrande's debt risks at different stages, using this to substantiate his continued optimism.

Today, when I look at this book, I am not focused on its conclusions but rather on the series of risks listed in it—these risks are actually more valuable historical clues.

All these risks can be summarized as follows:

Evergrande's approach was to finance through listing, issuing new shares, issuing perpetual bonds, and mortgaging assets, trying to extend the payment cycle for liabilities and to delay payments through multiple installments.

Why do this? To pursue scale. What was the result? It led to a deep entrapment in a debt trap.

To mask this situation, Evergrande aggressively borrowed money to repurchase stocks and to prop up stock prices, in order to stabilize investor confidence; on the other hand, it aggressively diversified and created a corporate image to showcase the company's strength.

This series of actions seemed to repeatedly "squeeze" short sellers and "counterattack" the pessimists, mesmerizing a large number of domestic investment banks, brokerages, and investors.

In contrast, well-known overseas investment banks (like Goldman Sachs) remained unusually clear-headed, showing no interest in these practices, and consistently focused on the deteriorating debt and cash flow.

Looking back at this history, it is actually quite simple to pierce through the facade of such companies and get to their core:

It is about using common sense to judge.

What common sense?

Is everything they do weakening their core business? Is it increasing debt? Is it reducing free cash flow? Is it making the company's operations increasingly tense? Is it making it harder for the company to cope with changes in the external environment?

Any other superficial factors (soaring stock prices, grandiose advertisements, ubiquitous celebrity effects…) are all just temporary and do not play a decisive role.

We can also use this set of standards to evaluate the situation of those listed cryptocurrency treasury companies.

The current approach of these companies is to finance the purchase of cryptocurrency assets. Their financing methods are basically three: issuing stocks, issuing convertible bonds, or directly issuing bonds.

Among these three financing methods, issuing stocks carries relatively controllable risks, while directly borrowing carries significant risks.

Because once a company's debt cannot be covered, they will inevitably be forced to sell their held cryptocurrency assets to repay the debt. And once such selling occurs, it could trigger a chain reaction in the cryptocurrency market.

Therefore, to assess whether these companies are at risk, I look at whether their free cash flow can support the company's operations and cover the debt risks.

For companies that purchase Bitcoin, since Bitcoin does not generate interest, this part of the business does not produce cash flow. For companies that purchase Ethereum, staking Ethereum currently provides about 3% to 4% in staking rewards, so the held Ethereum can generate some cash flow through staking.

Comparing these two types of companies, it seems that the company holding Ethereum has cash flow and lower risk. However, I actually think its hidden risks might be greater.

Because the price of Ethereum can have a leverage effect on staking rewards: when Ethereum rises, holders enjoy fixed staking rewards while also benefiting from the appreciation of the "native currency."

This effect can easily trigger greed and complacency in operators, and if the operators are not prudent and are overly aggressive, it becomes very dangerous.

MicroStrategy currently has some debt, which indeed poses certain risks. But among the current Ethereum treasury companies, there is one that is even more concerning. That company loudly claims that its goal is "to hold 5% of Ethereum."

Upon seeing this goal, I recalled a saying by Duan Yongping (the gist being):

For companies that set goals like "becoming a Fortune 500 company" or "achieving revenue of XXX," he would avoid them.

Because a company's goal should not be a number, but rather to serve customers and the end consumers. "Becoming a Fortune 500 company" or "achieving revenue of XXX" should naturally occur in the process of serving customers and consumers. If it can be done, then do it; if it can't, that's fine. Any company that does not aim to serve customers and consumers, in his view, is not a principled company.

I strongly agree with this viewpoint.

For that Ethereum treasury company, I cannot currently judge whether its goal counts as serving customers, but I always feel that the goal sounds quite awkward.

For that goal, this company has recently taken significant actions. For example, its next move is to issue stocks, preparing to raise an amount that exceeds several times its current market value.

If it were merely issuing stocks to finance the purchase of Ethereum, the risk would still be relatively controllable. However, I am very concerned that under the motivation of such an "exciting" slogan, it might become overly enthusiastic and pursue scale further down the path of debt, continuously increasing leverage.

And when it is crushed by debt and forced to sell its assets to repay, it would be a disaster for the entire cryptocurrency ecosystem.