Hi Investors!

Welcome back to Market Movers, where I keep you up to date with some of the latest opportunities and interesting financial news I've stumbled across.

In this issue I want to touch on Microstrategy in more depth after receiving some interesting feedback on the last newsletter which touched on the high level case for investing. I also want to touch on Decentralised Finance.

Don't forget to check out the Risk On Investor resources page for access to the growing selection of calculators, tools and video guides to help you become a better investor. There is also more content posted frequently on the YouTube channel to keep you informed and entertained - you can also read back on previous newsletters if you're a new joiner to the investor club

View the Investor Resources Page (Constantly Updated)

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Have a great weekend

Chaz (RiskOnInvestor.com)

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Disclaimer - The opinions of the author in this newsletter should not be taken as financial advice. Any mention of investment products is not a recommendation to buy.

If you are looking for financial advice, please seek the services of an industry professional and do your own research.

Capital is at risk when investing

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Portfolio Update

It turns out I have a lot to thank Trump for.

The Trump pump after the election saw the value of my investments fly and I'm rapidly closing in on some of my financial targets

For those of you who have been following my journey for a while you will know that Microstrategy has been my biggest holding and I've now completely sold out in my pension - I tried to capture the moment I could sell for a nice big £500k but missed it by a rounding error(!) - I now consider my pension 'complete'

By that I mean it will now be invested into a global index fund, earning ~5% real (inflation accounted for - 5% is the long term average for a globally diversified portfolio based on data from the last century) and I'll be sitting pretty with around £2m in todays purchasing power (likely somewhere around £4m nominal) when I can draw on it

My crypto portfolio is now heavily skewed towards $ETH and some Bitcoin miners so I'm reliant on a nice final blow-off top to the crypto markets to push me over the line with my targets before I pay my taxes and look to settle into a lower risk strategy - having said that I am concerned that markets are quite frothy at the moment so it might be a more painful journey than expected

Hopefully I can get across the line in the next 6 months!

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When Will Microstrategy get Liquidated?

The question on everyone's lips (at least of those who have asked me!) is when will Microstrategy get liquidated and collapse?

Well, it turns out that there is a fine line between a ponzi scheme and financial genius, one which Michael Saylor, the chairman of Microstrategy is treading finely.

Of the two money raising levers he has the first is the simple 'at the market offering' (ATM) in other words selling more shares.

Michael Saylor has said he wants to increase the Bitcoin per share metric so the fundamental metric here is the asset value of Bitcoin it holds and the share price.

Below is a chart showing this ratio over the last year - as you can see it has broadly averaged around 2 (selling out of positions as it rises above this has generally been a good play and buying the dip)

This means the market capitalisation is approximately 2x the value of it's Bitcoin holdings.

In other words, every time Microstrategy sell a share, they can buy 2x the amount of Bitcoin they would be able to is the company was values at 1x NAV.

This means that every time there is an ATM the NAV premium is compressed a little.

Fine, simple enough, and you can't get liquidated doing this - so where is the risk?

Convertible notes

The risk comes from the convertible notes.

They are an interesting debt instrument which functions broadly as follows:

1. Microstrategy requests $1b
2. Microstrategy sets an interest rate (typically 0% and I've seen rumours they might try and negative interest note!)
3. The note has a duration, typically 3-5 years
4. At the end of the period Microstrategy will repay the note in cash or shares at a pre-agreed price when the note is issued
5. Alternatively, Microstategy can call a note and repay early in cash or shares if certain criteria are met, usually share price performance is significantly above a pre-agreed price

Why would anyone buy a note offering 0% interest (or negative!)?

Gamma trading

I'm not going to get into the details of how gamma trading works - go and read one of many online articles available if you want to dig in further, but the key to it is that Microstrategy is VERY volatile in share price.

This means the secondary market for these bonds is also very volatile

And volatility is the lifeblood of bond trading

The more volatile something is, the more money can be made. So these traders don't really care about the 0% interest on the notes because they can make far more on such a volatile instrument than they would be able to with the interest.

So where is the risk if everyone is happy?

Read back over the 5 points I outlined above and see if you can spot the flaw

Want a clue?

It comes down to 2 things.

Firstly the cash flow of Microstrategy and secondly the price of Bitcoin.

Since Microstrategy holds so much Bitcoin it's share price moves with a very high correlation to Bitcoin, so if Bitcoin rises, so does Microstrategy and vice versa.

Well, if Bitcoin drops low enough, the share price will continue to sink. That's fine unless one of these convertible notes comes up for redemption at the same time.

The share price will be low, so Microstrategy won't be able to redeem the notes for shares and the bond holders will want cash instead and this leads us onto the second problem.

Microstrategy's software business simply doesn't throw off enough cash flow to repay these notes if they don't get redeemed for shares.

That means Microstrategy will have to issue new debt, and potentially issue it at a high interest rate (not 0%!) to repay the old debt and there is a limit to how much they can do this based on the cashflow the software business throws off.

So you can see that there isn't a liquidation price per say, it instead depends on the price of Microstrategy shares at convertible note redemption dates.

Oh - and did I mention that the notes are senior debt partners? In other words, would have first dibs on the Bitcoin over shareholders if everything goes belly up

That could potentially lead to a lot of shareholders - to borrow a crypto term - getting rekt.

What other business strategies can Microstrategy employ here?

Now that's all fine and dandy, but what can Microstrategy do to avoid this scenario playing out?

Firstly, the Microstrategy executive team's goal needs to be to convert as much of the debt obligation into shares as possible

So whenever a note meets conditions for an early redemption as shares, they want to do this (there is risk of scaring off bond traders with this method though) as it removes long term liability risk.

The other potential option I see, and what I believe they will do, is to start selling debt with a negative interest rate.

If you issue a $1b note at -5% interest, well you just generated $50m in cash flow for Microstrategy which will go a long way to either purchasing more Bitcoin, or building up a cash warchest to fight of bond holders if things start to go wrong.

So long as the volatility remains high I believe they'll be able to do this because bond holders can make more on the volatility than the interest cost

Long term sustainability

The other thing that concerns me with microstrategy is the long term viability of their current trajectory.

Currently they are buying Bitcoin hand over fist and now own more than 2% of the entire supply.

I think that the only thing justifying the NAV premium currently is that the executive board have said they want to keep increasing the Bitcoin per share at between 6-8% - If we assume thats how the market is pricing the shares that means the market is currently pricing Microstrategy at being able to continue this for 10 years (7% at 10 years is 2.0)

So far, so good (see chart below) but if this slows down then the NAV may drop and as such the effectiveness of the ATM cash raising method. Microstrategy would then either have to start a share buy-back scheme to artificially start raising the roof again (fed with cashflows from the negative earning notes?) or be satisfied with just a single cash raising strategy, notes.

How much longer will they be able to keep buying at this rate? I have no idea. My gut tells me it is measured in years rather than decades but I don't have any data to back that up.

I realise some of this sounds a bit doom and gloom, and that's simply because I wanted to draw the risks out to the forefront and show that this isn't an 'Infinite Money Glitch' but you can still make a lot of money from it.

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Decentralised Finance is back on the Menu

Back in 2020/2021 I dabbled in decentralised finance.

Back then there was only a few things I could actually do, borrow, lend and provide liquidity, none of which really made for a compelling ecosystem and the returns, unless you really went out on the risk curve were fairly small

What I like about decentralised finance (DeFi) is that it's not a ponzi scheme - which it feels like half of crypto is! There is actually money being generated from products.

Now, I can collect rent from actual houses where the rent is paid on chain through fractional ownership, taking one of the biggest risks of real estate investing away, being illiquid and not diversified by allowing me to spread money over multiple properties and be able to buy/sell in and out easily.

I can provide liquidity to traders on decentralised exchanges in more ways than I used to using concentrated liquidity and in return share in the fees traders pay to pools, here are examples where I can earn >20% annualised on stablecoins (beats a bank account!)

I can lend my money to people who want to take a loan, Aave is a platform with over $35billion (with a b!) on it and I can earn about 10% annualised on dollars there

Or how about something a bit more risky and get over 300% annualised on an Ethereum/Bitcoin liquidity pool?

While there is heightened activity on blockchains, there is going to be a lot more fees generated in the short to medium term so if you have some cash available to deploy, you could find worse places than DeFi at the moment.

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[DISCLOSURE - Chaz holds $MSTR, $RIOT, $IREN in an ISA and $wStETH and $GALA in unsheltered positions]

Have a great weekend!

Chaz

P.S - Want to work with me? Reach out by replying to this email and lets chat