Banks Are Pushing Bitcoin Into the Death Spiral

So there's a theory out there that says the reason Bitcoin isn't worth several hundred thousand dollars by now is because it's being manipulated by the banks. You might've seen this on Twitter. People have been revolting against JP Morgan for allegedly shorting a company called MicroStrategy. Now, MicroStrategy is a company whose whole purpose is just to raise money so that it can buy Bitcoin. And at one point, very recently, the price of the stock went down to a level where the value of the whole company was $10 billion less than the value of all of its Bitcoin holdings. And that meant by buying MicroStrategy, investors were basically able to buy Bitcoin at a discount. Now, when I first heard about this, I didn't really want to make that video about the banks because it was just a rumor. But I started researching anyway. And what I found is one of the most interesting stories in all of history about something called the death or debt spiral. Now, I want to give credit to a publication in the Journal of Economics released in 2004. And what that paper found was that companies using structures that mechanically looked like what MicroStrategy is doing today ended up having their stock prices collapse. How? So let me give you a simple example throughout history and then hopefully later on it'll all make sense. Back in the late 1800s, the Ottoman Empire borrowed a lot of money from the French and British banks, but their debt was denominated in gold. And then in 1873, the world went through one of the first big global financial crises. The European banks stopped lending, interest rates went way up, and all of a sudden the Ottomans couldn't create new bonds to pay for the old ones. At the same time, their currency was getting weaker. And how that looked like to them is the same way things look like to us today, which is things relative to that money go up in price. In this case, gold. We're like, oh, look, gold is becoming more valuable. No, your currency is just getting weaker. OK, so eventually the Ottomans couldn't pay it back and they defaulted. But the banks were like, you still owe us money, though, right? So in return, the bondholders, which were the French and British banks, forced the Ottomans to create a new institution called the Ottoman Public Debt Administration. It was basically a foreign group of bankers that took control of the empire and their money, specifically the control of how taxes were collected and paid back to them. Now, this happens time and time again throughout history, though. Greece, for example, more recently borrowed hundreds of billions of euros, a money they could not print more of themselves. So in 2010, when their economy collapsed and their borrowing costs went way up, they couldn't pay it back. So the IMF, which is the International Monetary Fund, forced Greece to create a special fund called the Hellenic Republic Asset Development Fund. And its whole purpose was to take control of the most valuable pieces of the country and sell them off so that they could pay their debt. Now, these are just two overly simple examples of the death spiral happening to countries and empires throughout history. But what's even more interesting is that this can also happen to companies and their assets. And that's where this story begins. So with that said, let's get into it. Hi, my name is Andrei Jikh. Hope you're doing well. Come for the finance and stay for the debt spiral. So here's where things get really interesting. In the early 2000s, regulators discovered something that sort of paralleled what I described, and it destroyed hundreds of companies. In 2001, the SEC actually opened investigations into a financing structure called pipes, which is short for private investments in public equity. Now, a portion of those pipes were what's called floorless convertibles, meaning the lower the company's stock price went, the more shares the lender got when converting their debt. And what that meant was that lenders could hedge by shorting the stock knowing their bond still guaranteed repayment. So the falling stock price didn't hurt them. And here's how this looked like in reality. First, a company like a tech startup or an Internet company would run out of money. So traditional banks wouldn't want to lend them money because they were considered too risky. So in comes a hedge fund or a specialized investment bank offering something that sounds really helpful. We're going to lend you money, but instead of paying us back, you could give us more shares. We'll just take your stock. And if your stock goes down, don't worry. We just get more stock, right? Easy. It adjusts automatically. Now, to a desperate company, that sounds really good. But this adjustment mechanism where the lower the stock price goes and the more shares the lender gets is what gives financial incentive for the company's stock price to fall. Because the lower it goes, the more shares the lender gets. And once they get those extra shares, they could sell them into the market, which does what? Pushes the price down even more, which gives them even more shares, which they could sell again and so on and so forth. In a study published in 2001, the SEC reviewed hundreds of these cases. And what they found was that on average, investors who bought the stocks of these companies lost about 34 percent of their value within one year. And this happened during a bull market where stocks were going up. By the end of it, about 85 percent of those companies had negative returns after creating their toxic debt. And about half of them didn't survive. 48 percent of those companies were delisted. And I think this has some parallels because MicroStrategy does have several billion dollars of convertible notes, even though lenders don't receive more shares if the price falls. The risk does not come from the conversion. It comes from the moment that they run out of cash while the stock is trading under value. So that's why people worry that MicroStrategy has either has to sell more stock or sell their Bitcoin. And that would be the beginning of the debt or death spiral. So question is, who's doing this and why? And to answer that, I need to break down exactly what kind of debt MicroStrategy has, who they owe it to, what the terms look like, when the bonds mature and whether there's any realistic scenario where Michael Saylor has to sell his Bitcoin so that it triggers this death spiral. But first, here's something I've been personally doing to keep stacking stats while all of this plays out with the Gemini credit card, the sponsor of this segment. It's a card I've been using for a while now, and all opinions are my own and they were not influenced by Gemini. I use it like any other regular credit card for gas, groceries and travel, but I earn Bitcoin every time I use it. It has no annual fee and you can see rates and fees in the description for more info. You get up to 4% back in over 50 cryptocurrencies instantly and you can choose which one you want. Personally, I have mine set to Bitcoin, but that's 4% on gas, transit and rideshare, 3% on dining, 2% on groceries and 1% on everything else. It's a master card world elite. I've used it internationally with no problems. And every time I use it, it adds Bitcoin to my portfolio. And the best part is you're investing as you spend. In fact, according to Gemini, cardholders who earned and held their Bitcoin for one year saw an average appreciation of 279%. And those are not your typical credit card points. So if you're interested, click the link in the description or go to Gemini.com forward slash Andre to get $200 in Bitcoin when you spend $3,000 in your first 90 days. Thank you, Gemini, for sponsoring this segment. And now let's get back to it. So let's talk about what MicroStrategy actually looks like today. And I want you to get comfortable because I'm probably going to put you to sleep. This is about to get very nerdy. You're like, oh, now it's about to get nerdy. All right. So MicroStrategy is basically a giant Bitcoin fund with a small software company stapled to the side of it. And in their latest presentation, they showed that they now hold around 650,000 Bitcoin that's worth roughly 59 billion dollars, depending on the day you look at it. Now, that 59 billion dollar pile of Bitcoin cost them about 48 billion. In other words, they are now sitting on an unrealized gain of more than 10 billion dollars. And now they control something like 3 percent of all the Bitcoin that will ever exist. OK, so those are their assets. Now, against that are their liabilities, which is about 16 billion dollars worth of obligations or debt versus the 59 billion dollars worth of Bitcoin. This is why they love to say that their LTV or loan to value ratio is about 11 percent. Now, is that good or bad? Right. For context, 40 to 60 percent loan to value is generally considered acceptable for the stock market. So, yes, 11 percent is very low. It's good. And it sounds very conservative. If I stop the story here, it sounds like there's no way anything could go wrong. They own a mountain of Bitcoin, right. And a small pile of IOUs. But there is a catch to all this. That 16 billion dollar IOU pile has a price. Between the interest on their debt and dividends on all those preferred shares, MicroStrategy now owes about 800 million dollars a year just to keep the machine running. That's over two million dollars per day. Now, unlike a normal common stock dividend, and if you're a dividend investor, you already know this, but a preferred stock dividend cannot be turned off. A common stock dividend, a company can just stop paying you the dividends whenever it wants, but not preferred dividends. Why? Because those preferred investors bought what are essentially Bitcoin linked bonds with a promise, as of now, to be paid double digit dividend yields. So the question is, where does MicroStrategy get the cash to pay dividend investors? Where does it come from? The software side of the business is nice, but it's not throwing off 800 million dollars of free cash flow a year. So in the latest presentation, they revealed the answer to that question. They created a separate U.S. dollar reserve, which right now is about 1.4 billion dollars in cash. And that cash pile's whole job is just to pay those dividends and interest. And at today's run rate, that gives them about 21 months of coverage, about close to two years, without ever having to touch a single Bitcoin. Now, this is where I have to explain another nerdy concept of the stock market called the MNAV conversion, because it's really important. On one of the slides, they split the strategy into two different outcomes above one times MNAV and below one times MNAV. By the way, MNAV just stands for the multiple to the net asset value, which is their way of saying the stock price is trading at a premium to the value of their Bitcoin. And I know all that still sounds insanely complicated, makes no sense. In other words, an MNAV of more than one means their company is worth more than all their Bitcoin. And below one times MNAV means their company is worth less than all their Bitcoin. OK, so if the stock is trading at above one times MNAV, that is good. That is what they want. In other words, when the market is willing to pay a premium for a share of micro strategy that's worth more than the underlying value of Bitcoin it represents. Then in that case, MNAV more than one, they will sell their stock into that premium. This allows them to raise dollars cheaply and then to use those dollars to top up the cash reserves, which is what is used to pay the dividends. Hopefully that's clear. That's how they built the one point four billion dollar cash buffer. But then there's the other outcome, right, the not so good one. And here's where they show what happens if the stock ever trades at a discount to their Bitcoin. Remember, that's when the MNAV is below times one, right? It says sell Bitcoin, sell Bitcoin derivatives. In other words, the moment the market stops overpaying for their Bitcoin, everything flips. They stop issuing shares because that would be like selling a dollar of Bitcoin for 80 to 90 cents. You don't want to be selling your Bitcoin at a discount to anyone, right? And if the cash reserves are not enough and they run out, the only way to keep paying those preferred dividend investors is to start selling pieces of the Bitcoin pile. That is the structural comparison that people say looks a lot like a modern version of what could end up becoming the death spiral. By the way, the death spiral looks like this. Once the cash pile runs dry, they're forced to sell Bitcoin. Selling Bitcoin pushes the price down, which makes the company worth less, which means they have to sell even more Bitcoin later to fund their debt obligations. So it has this cascading effect, especially when the stock is not trading above MNAV. That just means investors would not be willing to pay a premium for the company, which could realistically end up happening. And that would be very bad for the entire industry. And of course, the price of Bitcoin. So I've put you to sleep. Let me just tie everything together and make it super simple. How long will MicroStrategy survive if there is an activation of this debt spiral? And here's how you can think about it. It'll go one of two ways. If the stock trades above the value of their Bitcoin, they can raise cash by selling their shares at a premium. That's how they've been able to get as much Bitcoin as they have today. And it's also why the share price just does not get above a certain price point, because the moment it does, Michael Saylor rings the cash register and sells equity to get more money. So the stock goes down. That's outcome number one, which is the one that they prefer. Outcome number two, though, if the value of the stock trades below the value of their Bitcoin, they stop issuing equity because that would be like selling a dollar of Bitcoin for 80 cents, which is obviously not good. And they don't want to do that. Instead, they'll be using the cash pile. So that means the cash reserve pile starts draining. And at today's burn rate, they have about 21 months before the cash runs out. If that continues and the cash pile does run out, the only way to keep the machine running is to start selling pieces of the Bitcoin pile itself. And that's what could trigger the debt spiral. That would be very bad for the company and obviously very bad for Bitcoin. So that brings me full circle. Back to the question of what's happening. Why isn't Bitcoin at $200,000 right now? Because think about it. We're seeing these two forces at play. One that has the incentive of this flywheel to just keep going because that makes the Bitcoin price go up. And the other force, which has the incentive to keep the price suppressed for as long as possible, which in this case at today's present value is for at least another 21 months. And this, I think, is where the JP Morgan and the banks are a fun part of the story. The conspiracy version of this theory says that big banks are shorting micro strategy on purpose so that they could buy their Bitcoin cheaper than Michael Saylor did. Now, I wish I could sit here and tell you, yeah, it's the banks, right? But the truth is, I don't know why this is happening. I don't know who's behind this, if anyone. There's lots of little reasons that I've talked about in another video. But when you actually look at what we can prove in the real world and things like the public filings, research notes and the trading data, at least so far, there's no evidence that there is a coordinated bank attack. But it wouldn't surprise me if later we learned that it was the case because it's nothing new. Now, to be fair, it's also true that JP Morgan has published research that is very negative on micro strategy and Bitcoin. They've said that if the stock fell far enough and stayed there, it could trigger them getting removed from the indexes and then losing billions of dollars of inflows. They've said that the company would face refinancing risk in that kind of scenario. And I think you could look at what they've said and argue that they're creating fear and negative sentiment, right? Why? What's in it for them to do that? And I think what we're missing, though, is the link between that and the profit motive. But there are other real links like Jim Chanos's hedge fund, which has openly shorted micro strategy in the past. Michael Saylor is a wonderful salesman, but that's what he is. He's a salesman. And what he's selling investors is the concept that you give me your money and I'm just going to go buy Bitcoin. And hopefully the value of my stock trades at a premium to the value of that Bitcoin. And so as long as I can keep doing that, I generate value. And this is, of course, I called it financial gibberish. There are people who would love to see this stock blow up just so they could say, I told you so. Right. Or just so they could maybe buy Bitcoin cheaper. I don't have the evidence of some coordinated campaign where one institution is manipulating the price. But what I do see is some people are hedging against Bitcoin. Some people are betting against Saylor and some people are trading the technicals. But you put it all together and I think it does feel like some coordinated attack. But what it probably is, is just a lot of different people responding to the same set of incentives, which at the end of the day is just to make money. So time will tell how it's going to play out. But personally, I'm still holding on to my Bitcoin. And if anything, I'm more excited about Bitcoin when there's a lot of negativity around it, because that is the fuel. If everyone agreed that Bitcoin should be worth a million dollars, it would already be worth a million dollars. I'd love to hear your thoughts, though, on what you think is going to happen and if this death spiral will actually trigger. Let me know down in the comments below. As always, I hope you have a wonderful rest of your day. Smash the like button. Subscribe if you haven't already. I'd love to see you back here next week. I'll see you soon. Bye bye.