Given that it's a currency outside the command of any government or central bank, Bitcoin (BTC -3.18%) is inherently an outsider's challenge to the traditional financial system. Every dollar stored on its blockchain is a dollar that isn't liquid in a fiat currency or invested in a stock, bond, or other traditional asset. Under the right set of conditions, it's feasible that it could one day outlive or even precipitate the downfall of the government-issued currencies that most of us depend on in our everyday lives, as it's broadly quite inconvenient to pay for actual goods and services with cryptocurrencies, and especially so with Bitcoin.
Enter Strategy (MSTR -3.62%), formerly known as MicroStrategy, a company that's taking an extremely ambitious investment approach that calls for buying a lot of Bitcoin. It might even be buying so much of the coin that it could destabilize the financial markets and perhaps even the wider financial system, assuming its plans eventually fail rather than succeed. Here's what you need to know and what you can do about it.
CRYPTO: BTC
Key Data Points
This tactic looks ingenious, as long as it keeps working
Strategy's strategy is essentially to issue convertible debt and equity to finance the purchase of billions of dollars of Bitcoin. It already holds around $41.6 billion worth of the coin.
The idea is that, as the price of Bitcoin rises, the value of the business and its stock price will thus also rise due to how much of the coin the business holds. Then, with a higher stock price, it can safely issue more debt and equity without irritating its shareholders with dilution of their value. Afterward, it can buy more Bitcoin, potentially repeating the process over and over. The more investors that buy the stock, the higher its price gets bid up, enabling even more purchases in a self-sustaining cycle.
Between March 10 and March 16, Strategy bought 130 BTC. On March 17, the company announced that it'd be issuing as much as $21 billion of its stock to finance future purchases. That's a lot of buying pressure, even for an asset with a market cap in excess of $1.7 trillion like Bitcoin. And it probably won't be the last time it uses that same move.
But how might that break the financial system? In short, many institutional investors buy Strategy's stock because they aren't legally allowed to invest directly in Bitcoin, at least not yet.
Because the company finances some of its purchases with debt, there is a price of Bitcoin beneath which its assets will be insufficient collateral from the perspective of those who loaned money to it. At that point, investors would be heavily incentivized to sell their shares, as they would not have any hope of getting their dollars back in the event of bankruptcy. Well before that point, Strategy would be forced to liquidate its coins to cover its debt and its financing costs -- another incentive for investors to sell, as the core assets of the company would be diminishing.
Strategy offloading its coins in forced sales would hammer the price of Bitcoin, potentially creating a cascade that would force its share prices down further in the reverse of the virtuous cycle it took advantage of at the start. At that point, the institutional investors holding its shares would be getting hammered, and they might also no longer have enough assets to cover their collateral needs. That problem would be especially acute if they were invested in exchange-traded funds (ETFs) holding Bitcoin, which might also be crashing.
Therefore, the spiral might then widen into a full-blown financial crisis or market crash very rapidly.
NASDAQ: MSTR
Key Data Points
There's no need to complicate this
Will any of this actually happen?
Probably not. The price of Bitcoin would need to fall extremely far from its present level to threaten Strategy to the extent that would force it to liquidate its coins. In other words, a flash crash of Bitcoin, should that occur, would probably not cause the aforementioned problems even if the asset lost more than 50% of its value.
Still, investors have an opportunity to take advantage of the upside driven by Strategy's relentless purchasing of Bitcoin, and it's very simple. Strategy will be driving up the price of Bitcoin by issuing stock to buy and then hold it. You can simply buy Bitcoin and hold it to get upside from the company doing that.
If one day Strategy does accidentally crash the market or cause the financial system to lock up, it'll just mean that Bitcoin will be on a deep sale in the period that follows. There's nothing about the core investment thesis that's being disproven -- or proven -- by what the business is doing, so it isn't worth worrying too much about until there's clearer evidence that the risks are more than theoretical.
