Two decades ago, MicroStrategy chief Michael Saylor was embroiled in fraud charges and settling US Securities and Exchange Commission (SEC) investigations into cooking his company’s books. Now, he’s a Bitcoin celebrity.
MicroStrategy owns 122,478 BTC ($5.95 billion). Saylor acquired most of this Bitcoin by selling junk-rated bonds.
He funnels cash from MicroStrategy’s legacy software business to fund even more purchases, and regularly applies for additional debt.
- Rehypothecation utilizes assets posted by borrowers as collateral for additional purposes.
- Depending on the loan agreement, borrowers can agree to rehypothecation of their collateral in exchange for compensation, such as reduced fees or a lower cost of borrowing.
- Saylor has also diluted prior shareholders through “equity shelf offerings.”
The thing is, Bitcoin already collateralizes MicroStrategy’s bonds, and bondholders are senior to common MicroStrategy shareholders on the company’s cap table.
So, rehypothecation of MicroStrategy’s crypto collateral would further reduce shareholders’ technical claim to that Bitcoin.
MicroStrategy wants to put its Bitcoin to work
If Saylor rehypothecates to generate yield, it will be his first use of MicroStrategy’s Bitcoin for any business purpose.
Opportunities for yield generation could include using it as collateral for mortgages, long-term debt notes, or lending it to a yield-generating counterparty, Saylor said during a routine investor call with shareholders last week.
In June, MicroStrategy issued a $500 million tranche of junk bonds. As usual, it was fully subscribed.
Financial leverage has rewarded MicroStrategy shareholders during Bitcoin’s most-recent bull market. Leverage always works well when prices move favorably.
But a few insiders have expressed doubts. Buyers of the bond receive a 6.125% coupon — far less than BTC’s historical price gains.
“You might as well just buy the Bitcoin,” said ViableMkts chief Christopher White (via Bloomberg).
Compounding risks with DeFi
MicroStrategy’s most likely option for yield generation is through an institution. But, consider some risk disclosures from even the most reputable yield-offering Bitcoin depository institution: Circle Yield.
Circle Yield’s fine print states its Bermuda-headquartered wing manages the product, and that Circle Bermuda maintains lending arrangements with “one or more institutional borrowers” — including Genesis Global Capital.
“These lenders pledge and transfer Bitcoin into custody with a third party custodian as collateral for their USDC borrowings and Circle Yield investors benefit from a security interest in Circle Bermuda’s security interest in the pledged Bitcoin.”
“Circle is not a bank; your Circle Account is not a bank account, and any funds are not insured by the Federal Deposit Insurance Corporation, the Securities Investor Protection Corporation or by any US or foreign government agency, insurance fund, person or entity,” warns Circle Yield.
So, to summarize the chain of risk in the scenario where MicroStrategy seeks yield on its Bitcoin via Circle Yield:
- Shareholders’ Bitcoin is currently 70% controlled by the voting power of Saylor.
- Saylor has promised bondholders they can redeem most of their notes for shares in the company and/or Bitcoin.
- If Saylor chooses to lend the company’s Bitcoin to an institution like Circle, Circle would then lend it to its subsidiary in Bermuda.
- Circle Bermuda would then lend the Bitcoin to “one or more institutional borrowers.”
- Those unnamed borrowers would then pledge and transfer Bitcoin with another “third party custodian.”
Through rehypothecation of its bondholders’ Bitcoin in this manner, MicroStrategy will earn yield.
For instance, Circle Yield offers a 5.65% 12-month fixed rate on stablecoin deposits (Circle, like any institution, would quote a custom rate for a Bitcoin loan of MicroStrategy’s magnitude).
Don’t call it a (dot-com) comeback
In 2000, MicroStrategy executives (including Saylor) agreed to pay fines to settle SEC allegations of civil accounting fraud.
The three execs involved also repaid a total of $10 million in ill-gotten gains to settle private lawsuits. Saylor and his colleagues did not admit wrongdoing in their settlements.
At the time, the SEC alleged that they misled investors about MicroStrategy’s revenue and earnings. The SEC said that MicroStrategy improperly booked contracts to license its data mining software to achieve “desired quarterly results.”
Regulators said MicroStrategy executives frequently included the value of unsigned contracts in quarterly earnings reports.
MicroStrategy’s improper accounting backfired at the peak of the dot-com bubble. On December 31, 1999, negotiations between MicroStrategy and financial information company Primark fell through.
MicroStrategy had already logged it as a $5 million deal.
The SEC also alleged that MicroStrategy logged revenue from its contracts as a single lump sum, instead of spreading it out over the length of the agreements.
In March 2000, MicroStrategy’s stock price plummeted from $3,130 to just $15 — along with the rest of the frothy tech market at the turn of the millennium.
More than two decades later, the company’s share price is $560 — all thanks to Bitcoin.
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