Odd LotsLots More with Matt Levine on MicroStrategy's Infinite Money Machine
Everyone knows by now that MicroStrategy looks a lot like a giant Bitcoin ETF. Its founder, Michael Saylor, is a huge supporter of the cryptocurrency and his company has been snapping up billions of dollars worth of the coins. The strategy has so far proved successful. In fact, MicroStrategy is trading at a market cap that's worth more than the value of its entire Bitcoin portfolio. How does this happen? And how long can it keep going? In this episode, we speak with Bloomberg Opinion's Matt Levine. We talk to him about how MicroStrategy has created a sort of "perpetual motion machine" of investment and how the strategy is starting to expand to other companies, too.
Money Stuff: Crypto Perpetual Motion Machines
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And we really do have the perfect guest. So I went to write one of our Odd Lots newsletters recently, and I was going to write about micro strategy, and I had this idea. I was going to call it micro's Strategy's infinite money loop. And then I was researching on the terminal and I stumbled on a bunch of Matt Levine columns where you actually titled it crypto's perpetual motion machine. And then I thought, well, I'm not even going to try to compete with Matt. I'm just going to ask him to come on the show and explaining cases.
Yeah, cases, but at least he'll come on the podcast.
So here we are with Matt Levine, who is of course the author of the money Stuff column but also the co host of the New money Stuff podcast.
I keep thinking it's two months old. It was the year.
I really.
Wow time.
I always think twenty twenty was two years ago.
Same time. Time.
Yeah, time is a flat circle. Matt, what is micro Strategy's perpetual motion machine?
Micro strategy? I keep saying perpetual motion machine. I think I'm kidding. I think I'm kidding. I keep hoping that I'm kidding. So micro strategy is a pot of bitcoins that issues stock, and the stock trades at call it two times the value of the pot of bitcoins. And so if you have that situation, you sell more stock to buy bitcoins because like classically that's an arbitrage, and you close the arbitrage, right, you sell stock that brings down the price of your stock. You buy bigcoins, that brings up the price of bitcoin. Eventually you get to the point where you're stock and the value of the underlying bitcoins is the same mecro strategy, Like it never gets any closer. So that keep selling more stock and buying more bitcoins, and that keeps driving the value of the company up, and so they keep getting more and more valuable.
They have an as it so to speak, it's not bitcoin, and that asset is the ability to get like non margin callable leverage.
Right, So I mean like like if.
I wanted to borrow bitcoin or borrow money to buy bitcoin, I could, but there is a chance that bitcoin goes down tomorrow, they ask for my money back, and I'm homeless.
So this is a thing that they say, and that has some truth to it, but this is not a leveraged way to buy bitcoin. And the way you know that is that the market cap of the company is two x the value of its bitcoins. Right, So it's like a it's like an anti leveraged way to buy bitcoin, right, Like if you put two dollars into micro strategy, you get back one dollar of bitcoin, which is the opposite of leverage. Now it's true that like and they did. And by the way, also like they do have the ability to like they're right, like they've sort of touted this as their strategy, like we are a better mouse trap for buying bitcoin because we can get leverage. They do a lot of convertible bonds. They don't. I don't think I have a ton of like you know, just sort of regular, non like non marginal leverage other than the converts. But like, yeah, like that's a that's a theoretical case. It's just like it's just not like true as a matter of pricing.
Wait, the convertible bonds are actually what like initially caught my eye because I think they issued at like one of the recent ones zero percent with a conversion premium of fifty five percent. And that's like already when the stock is trading at this massive premium to the value of its assets. And so you know, usually the higher the conversion premium and the lower the coupon. The less attractive that would be for investors, but clearly people are buying this stuff because they keep doing it.
Yeah, Like a convert is just like it can convert. You just plug into a model, right, Like, well, sorry, I taking a step back.
I actually need you to explain convertible arbitrage.
Team. So there's there's two things there. There's convertible arbitrage. So there's also a lot of like fundamental investors you think about like the micro shadowy convertible never mind convertible arbitrage. There are people in the wor world who run I don't know, fixed income funds who run you know, like convertible fundamental funds, who run various sorts of funds who wake up in the morning thinking I want to buy some bitcoin, and they can't because their mandate doesn't include bitcoin. It might not even include micro strategy stock or micro strategy stock might be too rich for them. But they like they can buy a fixed income product that has some bitcoin upside. They're like, yeah, that's great, right. So part of the investment thesis for these bonds, and there's like a lot of these bonds is something like that. It's like this is a way to get bitcoin upside with downside protection. But the convert arbitrage strategy is this is the way to get micro strategy volatility, and micro strategy is so volatile in part because it's crazy, but in part because of like technical factors involving their ETPs, and so a convert arb is just an options trading strategy, like like you're buying call options on micro strategy, and call options are more valuable the more volatile the company is, more volatile the stock is. And this is a very you know has like one hundred percent annual volatility, and then you know what you're doing is like get you buy a convertible, You sell some stock to hedge, and you adjust your hedge over time as the con the convertible gets more or less in the money. And the way you do that is basically, every time the stock goes up, you're selling more stock to get shorter, and every time the stock goes down, you buy back stock to reduce your hedge. And if the stock is constantly bouncing around, you're constantly buying low and selling high and making a lot of money. So it's a good volatility trade. And those convertible terms you know, it's like zeros up fifty five is like that sounds outrageous, but you plug it into the model and you put in you know, one hundred percent of volatility and that's cheap, and so like people want to buy it.
Joe, I didn't realize this until recently, but you know, if you go and look at some of micro Strategies earning presentations, so they actually have slides on there that are basically like boasting about how volatile the stock is. Have you seen these, Matt I think so, yeah, it's like MSTR is more volatile than any other s and P five hundred stock there's another market.
Yeah.
Yeah, they're clearly like marketing the volatility is a selling.
Point, like they know what they're doing, like like this is important. This is like they're they're like sort of using every part of like this strategy to raise money, which is like they're really like thoughtful about it and like selling lots of volatility is very helpful to them. And the punde that the ETF is like you know, convert investor buys low cells high right, every time the stock goes down, you have to buy back some stock every time the stock goes up, you have to sell some stock. That is, you're profiting from volatility, but you're also damping volatility, right because like then the stock goes down, you're buying. So if you issue a lot of convertibles, you dampen the volatility in your stock. Micro Strategy doesn't have this problem because they also have these LeVert ETFs which so much increase the volatility of the stock. Because a LEVERTYTF every time the stock goes up, they have to buy more stock every time the thought goes down if the sell stock, and so the Leverty TTF is like jacking up the volatility, which is part of why the stock is so validle.
So it does a perpetual motion machine. It's solved, No, okay.
The what the thing that I don't understand is the premium of the stock, like the volatility Like yeah, like that that that works, right? The volatility trade is a good trade the stock, Like why is the stock worth twice the value of the underlying big guys? I don't know.
Yeah, it's weird. A big crash in bigcoin would be really bad, right, and that's very possible because it's crashed many times in this history.
Yeah, you know, like your guess is as good as mine. About like what that does to the premium, Like if Bitcoin goes down by fifty percent, does this stock go down by fifty percent because it go do go down by ninety percent? Who knows?
Could I start my own perpetual money making machine where I just have a pot of something and then I try to make my stock as volatile as possible, Like maybe I just say stuff and constantly do it.
Like everybody's are trying. No one's like at this scale, but like a lot of companies have looked at this and said we should do that, and so some of them should do it. Some of them do it, like dogecoin, you know, like you can have other there's.
Like random like kind of dt.
I wrote about the half choking crypto thing that's doing it called you know, there's like a crypto called part coin.
There's a strategy.
Yeah it was not a company.
Yeah yeah, replicated on chain?
So yeah, yeah, well it can like the mechanics can can the premium be replicated on chain? I don't know. I mean you can sort of sell anything, but like I think part of the premium here comes from it being a real corporation, right, I mean one thing that's like attried to put up micro strategy, Like they're trying to get into the S and P five hundred Yeah, which is a fascinating Like that turns on a change in the accounting rules that allow for them to take to account for their bitcoin gains as profits.
I didn't love it.
Yeah, So like they may not get into the SMP anyway, but like they they have not been profitable enough to get into the SMP, but like the bitcoin gains, they have had biggining gains most of the time, and like that will become accounting profit for them.
I want to ask you a question that touches in one of Tracy's favorite topics, and it's actually a little bit adjacent here. What would be the problem of just having an index that's just these are the five hundred biggest companies. Is there any like what's better about having an S and P that sometimes has some discretion versus just like you're the five hundred biggest companies.
In the world, in the US whatever in this immediate case, like what is a company? Like is spy a company? Oh? Interesting, because like this is this is an etf right, I mean, like, arguably this is an eat, right, it's in the trappings of a tech company. But like if you said the biggest company as well, you know, like is it S and P five hundred? Fun a company? But away from that now, I mean, like people definitely have very rule driven indices. I think part of the appeal of the SMP is, you know, it's a product that's sold to fund managers, right, and like if if every fund manager says I don't want to own, you know, for a while, the SMP was for a while a lot of indexes were excluding dual class stocks because like fund managers would call the index providers and say, we don't want to own dual class stocks, were bound to buy the index, so take them out of the index. And then like they changed their mind because all the dual class stocks were doing well and so they had to put them back in the index. But it's like it's just a market driven thing, right, Like if people want a certain index, they get that index. Was something wrong with having the top five hundred companies the index.
Like nowadays everyone has started custom indexing as well, right, so like if you don't like the S and P five hundred, you can just ask for your own index and that's why there's a billion indexes.
Now.
The other thing I saw was there was a bitcoin minor I think it was called Mara or something, Marara Holdings, and they said they weren't going to issue converts basically to do the same thing as micro strategy. So it's almost like, is this going to be like an asset class a thing that stays with us?
Yeah? You know, the people in the convert market talk about being saturated with with like crypto converts. Right, Like if you like grew up as a convert investor, you're like you're like portfolio and crypto, right part because like you think about like the volatility and like the technical aspect of making money on the trading, the volatility that depends on the credit being good, and like no one really knows the credit here, right. If there's a big crypto crash, all of these credits like in a very correlated way become terrible, and so like your whole you know, asset class falls apart.
Prior to all this, what was the canonical use case of who and why issue converts?
Oh?
Uh, I seem to remember energy companies.
Energy did a lot. I mean, like the canonical case is like tech biotech like but a lot of energy too. You know, it's like it's like companies that are volatile, companies that often don't want to get credit ratings. Companies that you know, like what you're saying telling is in some sense equity upside and in some other sense equity volatility, and that's more attractive to converted Like they're companies that have attried to equity volatility and not such attractive credit to like traditional credit investors, and so they can do that trade rather than a sharing bonds.
You have a deep seat, take.
Various takes. My main take was today, like your old that you know, the way to monetize deep seek was short video.
I was my old blog at the star war dot com in like two thousand. This was when, you know what I thought about this When Google introduced sheets or when they came out with their Access competitor, I was like, some companies should start doing this. When they short Microsoft for some reason, Sheets never really took off and became an Excel competitor on a real level. But back when it was so much free web two dot software, I thought, give up free software and short your competitor.
Anyway, Yeah, I mean there's no evidence that Deep Yeah, it'd be cool if they did.
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