The essence of strategy is Arbitrage business.

Author: Dio Casares

Compiled by: Deep Tide TechFlow

In the past 5 years, Strategy has spent $40.8 billion, equivalent to Iceland's GDP, acquiring over 580,000 bitcoins. This accounts for 2.9% of the bitcoin supply or nearly 10% of the active bitcoins (1).

The stock code of Strategy, $MSTR, has increased by 1600% over the past three years, while Bitcoin has only risen by about 420% during the same period. This significant growth has pushed Strategy's valuation to over $100 billion, and it has been included in the Nasdaq 100 Index.

This massive growth has also brought about skepticism. Some claim that $MSTR will become a trillion-dollar company, while others are sounding the alarm, questioning whether Strategy will be forced to sell its Bitcoin, potentially triggering a massive panic that could depress Bitcoin prices for years.

However, although 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 is a significant risk in Bitcoin acquisition or a revolutionary model.

How did Strategy buy so many bitcoins?

Note: Due to new financing and other reasons, the data may differ from what it was at the time of writing.

In a broad sense, Strategy mainly obtains funds to purchase Bitcoin in three ways: revenue from its operating business, selling stocks/equity, and debt. Among these three methods, debt is undoubtedly the most scrutinized. People tend to pay a lot of attention to debt, but in reality, the vast majority of the funds used by Strategy to purchase Bitcoin comes from issuance, that is, selling stocks to the public and using the proceeds to buy Bitcoin.

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

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

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

These authorizations allow investors to be assured that, for example, a fund that only invests in stocks will not purchase sovereign debt, and vice versa. It forces fund managers and regulated entities (such as banks and insurance companies) to be more responsible, taking on only specific types of risks rather than being able to take on any type of risk at will. After all, the risk of buying Nvidia stock is completely different from the risk of purchasing U.S. Treasury bonds or putting funds into the money market.

Due to the highly conservative nature of these authorizations, a lot of capital that remains in funds and entities is "locked up" and cannot enter emerging industries or opportunity areas, including cryptocurrencies, especially unable to directly access Bitcoin, even if the managers of these funds and related personnel wish to engage with Bitcoin in some way.

The founder and executive chairman of Strategy, Michael Saylor (@saylor), has recognized the disparity between these entities' hopes of gaining asset exposure and the actual risks they can bear, and has capitalized on this. 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 Bitcoin. This meant that Strategy's stock often traded at a premium, as demand for $MSTR exceeded the supply of its shares. Strategy continuously capitalizes on this premium, which is the difference between the value of $MSTR shares and the value of the Bitcoin contained in each share, to purchase more Bitcoin while increasing the amount of Bitcoin per share.

In the past two years, if you held $MSTR, your "return" in Bitcoin terms reached 134%, which is the highest among large-scale Bitcoin investment returns in the market. The products of Strategy directly meet the needs of entities that usually cannot access Bitcoin.

This is a typical case of "Mandate Arbitrage." Before the launch of the Bitcoin ETF, as mentioned, 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 Bitcoin ($BTC). Even though the Bitcoin ETF has recently been launched, it is completely erroneous to believe that this strategy is no longer effective, as many funds are still prohibited from investing in ETFs, including most mutual funds that manage $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 has become one of the few tools CII uses to gain exposure to Bitcoin price fluctuations. In fact, CII has such high confidence in Strategy that it holds about 12% of Strategy's shares, making CII one of the largest non-insider shareholders.

Debt terms: binding for other companies, but supportive for Strategy.

In addition to a positive supply situation, Strategy also has certain advantages regarding the debts 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 is usually over 20%. Margin loans are typically loans issued against your existing assets (usually stocks) as collateral; if the total value of your assets is close to 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) using a loan, while only paying the monthly interest on the loan (i.e., mortgage repayments).

Although this is not entirely risk-free, especially in the current interest rate environment where interest may 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 the monthly payments are made on time, the assets will not be seized.

Generally speaking, mortgages are limited to housing. However, business loans can sometimes operate similarly to mortgages, meaning that interest is paid within a specified timeframe, while the principal amount of the loan (i.e., the initial amount of the loan) is only required to be repaid at the end of that term. Although loan terms can vary significantly, as long as interest is paid on time, debt holders do not have the right to sell the company's assets.

Chart source: @glxyresearch

This flexibility allows corporate borrowers like Strategy to better cope with market fluctuations, which also makes $MSTR a way to "harvest" the volatility of the crypto market. However, this does not mean that the risks are completely eliminated.

Conclusion

Strategy is not in leveraged trading, but in arbitrage trading.

Although it currently does hold a certain amount of debt, the price of Bitcoin would need to drop to around $15,000 per coin within five years to pose a serious risk to Strategy. With the expansion of "Treasury Companies" (referring to companies that replicate the Strategy Bitcoin accumulation strategy), including several companies such as MetaPlanet and Nakamoto by @DavidFBailey, this will become a focal point of another topic.

However, if these vault companies stop charging premiums to compete with each other and begin to take on excessive debt, the entire situation will change and may lead to serious consequences.