BitMEX: Analyzing whether it will sell BTC from MicroStrategy's new debt instrument STRC

Source: BitMEX Research; Compilation: Golden Finance

Key Points

We analyzed Stretch ($STRC), an extremely innovative MSTR (Strategy) debt instrument designed to maintain price stability by adjusting the dividend yield monthly based on bond market prices. Therefore, the product is promoted as low-risk and compared to short-term U.S. Treasuries. This is yet another attempt by Mr. Michael Saylor to invade the financial system, with the goal of accumulating more Bitcoin. We reviewed documents from the U.S. Securities and Exchange Commission (SEC), and based on our understanding, MSTR can waive its price stability target, reducing dividends by up to 25 basis points per month, which could bring the dividend yield down to zero over a little more than three years. Thus, we believe this product benefits MSTR and, from an investment perspective, carries risks far higher than short-term Treasuries.

Overview

In November 2024, we published an article titled “We Calculated the Mathematical Principles of a Ponzi Scheme.”

This approach is relatively simple, focusing solely on the stock itself. Besides the stock, MSTR offers a range of other financial products for investors to choose from. Notably, the company has launched a series of relatively new perpetual preferred bonds:

This article will focus on what we consider the most interesting of the four products—STRC. Especially following our November 2024 article, STRC has received the most questions. For example: What happens when the music stops and new funds flowing into MSTR dry up? How will MSTR pay dividends on STRC at that time? Will MSTR be forced to sell Bitcoin? Is STRC a Ponzi scheme? Given these questions, we decided to write this brief article to share our basic views on STRC.

What is STRC?

STRC is promoted as the lowest-risk part of the MSTR series of investment products. In fact, its risk is so low that it can be compared to U.S. Treasuries or stablecoins. However, its yield is much higher than these low-risk alternatives. The chart below, from MSTR’s recent investor presentation, compares STRC with “creditworthiness of bonds.”

Source: Strategy document

Recently, the price of STRC has risen to its face value of $100. This indicates some success, and the price remains relatively stable.

How is the interest rate determined?

The goal of STRC seems to be to maintain a trading price around $100. Dividends are typically paid monthly, and the company can adjust the dividend amount at its discretion. The idea is that if STRC’s trading price falls below $100, dividends can be increased to push up MSTR’s price. Conversely, if STRC’s trading price exceeds $100, dividends can be reduced, theoretically bringing the price back near $100. Therefore, this tool should be very stable, always trading around $100. This makes STRC a cash-like instrument and an alternative investment to short-term Treasuries. A key difference is that the funds raised by issuing STRC are used to buy Bitcoin. This is yet another attempt to invade the financial system, aiming to buy more Bitcoin.

To our knowledge, STRC is a completely new product. Currently, there are no other similar debt instruments on the market. Debt instruments typically have fixed or floating coupons, with interest rates that vary based on other rates in the economy (e.g., the federal funds rate). We have not found any other debt instruments that maintain market price stability through interest rate adjustments. MSTR seems confident because it previously successfully exploited loopholes in the financial system—selling its own stock at a premium to buy Bitcoin—and now has come up with an even more audacious trick: issuing bonds to buy Bitcoin. Due to some novel mechanism, these bonds appear to carry the same risk as short-term Treasuries.

At first glance, this new debt issuance model seems unsustainable for the company. If the company uses fixed coupons, its liabilities won’t change even if it gets into trouble. However, if it uses floating coupons aimed at maintaining debt prices, then as the company faces difficulties and its credit risk rises, it will need to increase coupon payments to keep debt prices stable. This means that as the company encounters trouble, its liabilities will also increase. Consequently, the company could fall into a vicious cycle, with credit ratings continuously declining until bankruptcy. Therefore, these new tools could exacerbate the company’s instability. Take MSTR as an example: a decline in Bitcoin’s price could reduce STRC’s value, which would increase MSTR’s monthly payment obligations, creating a vicious cycle.

What are the interest rate rules?

Given the above mechanism, it’s important to focus on the rules for setting monthly dividend payments, not just the goal of maintaining STRC’s stock price stability. Particular attention should be paid to rules related to lowering the face interest rate. These rules are detailed below, but due to somewhat obscure wording, they may be difficult to fully understand.

However, we shall not reduce the annual monthly fixed dividend rate applicable to any periodic dividend period: (i) The reduction shall not exceed the following amount: (1) 25 basis points; and (2) (x) the sum of the minimum of the annual monthly SOFR (defined in the supplement to this prospectus) and the lowest SOFR rate on each business day during the period from the first business day of the preceding dividend period to the last business day, or (ii) reduce to a level below the SOFR rate effective on the business day before the next dividend rate notice is issued.

Source: SEC

Note: SOFR is a market-based overnight interest rate benchmark in the U.S. designed to replace LIBOR, which is more susceptible to manipulation by certain banks.

Our understanding of the above is that, regardless of other circumstances, MSTR has the right to decide to reduce the dividend rate by up to 25 basis points each month. Whether the market price of STRC or overall market conditions change, the dividend rate can be lowered by 25 basis points monthly. This amounts to 300 basis points or 3 percentage points per year. Therefore, at the current dividend yield of 10%, it would take about three years and four months to reduce the dividend yield to zero at the maximum allowed rate. In some cases, if the overall market interest rates decline, the company could lower the dividend rate even faster each month. For example, if the overnight rate drops by 100 basis points within a month (from the beginning to the end of the month), then STRC’s dividend rate could decrease by 125 basis points in any given month (100 + 25). This seems reasonable—if the benchmark rate falls, STRC should be able to adjust accordingly.

If MSTR fails to pay the declared dividends, complex consequences will ensue. In such cases, unpaid dividends will continue to accumulate. Our understanding is that before paying any dividends on “any class or series of preferred stock,” MSTR cannot pay dividends on STRC unless it also pays the accumulated dividends on STRC, and the proportion of STRC dividends to the total accumulated unpaid dividends is not lower than the same proportion for other dividend-paying stock classes. In other words, the higher the accumulated unpaid dividends, the more difficult it becomes to pay significant dividends on other stock classes. Therefore, if MSTR begins accumulating unpaid dividends on STRC, paying dividends on any other stock becomes more difficult. However, there are currently no guarantees or bankruptcy risks—if the company chooses not to pay, it can simply withhold dividends from STRC holders.

Is STRC a Ponzi scheme?

Having understood how STRC operates, we can explore whether it resembles a Ponzi scheme. Of course, it is not a strict Ponzi scheme, as it is not based on lies or fraud. However, if a certain pattern shares many similarities with a Ponzi scheme—such as providing investors with seemingly generous and stable returns, but maintaining these returns relies on a continuous influx of new funds—then it is reasonable to compare it to a Ponzi scheme. Once the inflow of new funds stops, the entire system collapses.

From a cash flow perspective, STRC’s costs are quite high. Its issuance volume is about $3 billion, and at a 10% yield, annual dividend payments amount to $300 million. If MSTR does not raise new funds or sell Bitcoin, it cannot sustain such high dividend payments. In this sense, STRC is somewhat like a Ponzi scheme. However, considering that the company can fully autonomously gradually reduce dividend payments to manageable levels, it is not truly a Ponzi scheme. Overall, we believe STRC is not a Ponzi scheme. Nonetheless, investing in STRC at $100 does not demonstrate exceptional insight. In our view, the risks of STRC are far higher than those of short-term U.S. Treasuries.

Conclusion

If the music stops, MSTR faces challenges. Instead of selling Bitcoin, MSTR could simply abandon its strategy of aiming for stability through STRC. The company can choose any easier approach. MSTR can reduce the dividend rate on STRC by 25 basis points each month. At the current 10.5% dividend yield, it would take about three and a half years to reach zero. As the dividend yield decreases, the cost of paying dividends also diminishes. We believe this is very favorable for MSTR, making current dividend payments sustainable and affordable. Of course, this means the price of STRC could plummet—by as much as 87%—to the present value of future cash flows over the next three and a half years.

The story of MSTR may not be what some skeptics expect. We believe that MSTR’s debt does not necessarily force a forced sale of Bitcoin, leading to a price spiral and eventual bankruptcy. We need to understand that the Strategy debt instrument is highly innovative, not an ordinary debt instrument, but one designed specifically for its own needs. Saylor is no ordinary figure! He is a genius of our time, often leveraging peculiar mechanisms (whether debt or equity) to raise billions of dollars for the company. Regardless of Bitcoin’s price or capital flows, MSTR remains unaffected. Conversely, when everything comes to a halt, investors may feel dissatisfied. We believe STRC is a perfect example of this phenomenon.