Latest / The Income Show / A Quant Breaks Down Why STRC Broke $100 | The Income Show | Ep. 12

Transcript

A Quant Breaks Down Why STRC Broke $100 | The Income Show | Ep. 12 · The Income Show

0:00
Let's just skip through and talk to the elephant in the room, which is like Stretch has basically
0:04
crashed and not done what it was supposed to do, right?
0:08
The yield comes from selling Bitcoin or at least selling exposure to Bitcoin, right?
0:12
And the common ATM is just a way to sell exposure to Bitcoin.
0:17
S&P's credit rating on strategy, it valued all of that Bitcoin at zero.
0:22
So that is a 100% haircut.
0:25
So basically you have an asset and it's like, okay, that asset is completely worthless.
0:28
We do not view this as an asset at all.
0:39
Hey, everybody.
0:40
Welcome back to The Income Show.
0:42
This week I have on Allard Ping.
0:44
Allard, welcome.
0:45
Hey, Joe.
0:46
Good to be here.
0:48
Great to have you here.
0:49
Allard, let's maybe start with your background.
0:53
Where did you come from?
0:54
How did you originally get interested in Bitcoin and ultimately digital credit?
0:58
I guess like for the audience that doesn't know, you've published some pretty good research reports trying to think about digital credit, the risk, the return, etc.
1:08
So maybe like let's start with your background and how did you get into all of this?
1:12
Yeah, sure.
1:14
Well, I have an economics like education from college.
1:19
I've always been interested in markets and just like investing in general.
1:24
um had some internships at some funds um and i really got into like originally i got to bitcoin
1:33
through crypto at first um i was very fascinated by defi and then around 2023 after uh you know
1:41
just digging for what is the investment signal within crypto um i of course landed on the fact
1:48
that it was bitcoin and like bitcoin is the only signal within digital assets so after that i i
1:54
I view myself as Bitcoin class of 2023, even though formally I've been involved in crypto
2:00
since 2022.
2:02
So yeah, like afterwards, I just resolved that I do want to eventually start working
2:08
in Bitcoin.
2:09
And then by mid 2025, I first started working as a quant research developer at Bitfarms
2:17
for the market operations desk over there.
2:20
I was making basically options, risk, and pricing models, right, for their options desk.
2:28
So that's like my background over there.
2:32
And then like afterwards, Bitfarms decided to pivot away from Bitcoin.
2:36
They've gone fully into like AI and data centers and all that.
2:43
They even renamed themselves to Keel Infrastructure.
2:46
So that kind of shows you like they've fully gone off from Bitcoin.
2:51
And at that point, I started working at Bitcoin for corporations as the research analyst.
2:55
So that brings us to today.
2:57
Awesome.
2:58
Yeah, it's great background.
3:00
It's good is fairly interesting how a lot of the early Bitcoin, public Bitcoin miners
3:05
kind of pivoted towards AI.
3:07
Maybe we can talk about that at some point.
3:10
But maybe like, let's also start with like, how you think about investing in capital allocation
3:16
broadly like you said you have a background economics you kind of have a background like
3:21
quantitative finance maybe like before bitcoin how did you think about investing and then like
3:26
after bitcoin you understanding bitcoin did your philosophy for investment change like how do you
3:32
broadly think about it yeah um i can definitely tell you it's evolved a lot um you know since
3:40
when I first started.
3:43
You know, like, I think originally if you get into
3:47
and you start doing research,
3:48
like you start from the perspective of like,
3:51
oh, like this is a discounted cash flow analysis, right?
3:54
Like you have the DCF.
3:56
And then later on you realize,
3:58
okay, like DCF is kind of garbage in, garbage out.
4:00
So you use like relative valuation, like multiples, right?
4:04
So this would be looking at,
4:06
price to earnings is a good one.
4:08
And it's like, there's also EBITDA, stuff like that.
4:12
And these are kind of ways to, I guess, contextualize the value of different investments against
4:20
each other of the same similar risk profiles and industry and whatnot.
4:27
So that's like, you know, you start to get into there.
4:31
And of course, like, I think ultimately with investing, right, your goal as the investor
4:37
is just to grow your capital.
4:39
And of course, from there,
4:40
you might have to define like what is capital.
4:43
I don't really think we need to go down that route.
4:46
I could just define it right now.
4:47
It's like, just pick a unit of account
4:49
that you want to work with.
4:51
And as long as that number is going up,
4:53
then you've compounded, right?
4:56
Of course, there's a hurdle rate to all of this.
4:58
If your goal is to compound your capital,
5:02
there necessarily is a rate
5:04
by which you can always compound it at.
5:07
in traditional finance or like academic finance,
5:12
they might call that the risk-free rate, right?
5:14
And that's traditionally viewed
5:16
as your US treasury debt security
5:20
that has the same time horizon that you're investing in.
5:26
But I also think that's somewhat accurate,
5:32
but also there's like you would also,
5:36
So like investing in general, right?
5:40
This can go down many different rabbit holes.
5:43
I'm not totally like pushing back against
5:47
that that's the risk-free rate,
5:48
but also it's like there's clearly situations
5:51
that can emerge throughout history
5:53
that have shown that these things
5:55
aren't fully risk-free, right?
5:58
And then it's just building off of those foundations.
6:01
Once you have a risk-free rate,
6:03
what is the risk premium?
6:04
What kind of compensation are you getting for taking these other risks?
6:10
And then eventually it's like, ultimately it's all about like being able to be compensated,
6:16
like overly compensated for risks that you're taking.
6:21
And if you can consistently enter yourself into positions that are like that, then I
6:26
think you will probably outperform your hurdle rate.
6:30
so I think broadly that's could be a simple way to that I could think about it right now
6:36
there's definitely different avenues I'm happy to go down it depends on where this conversation goes
6:42
yeah no it was very well said for a solid high level overview I'm curious from your perspective
6:50
having like this more like technical quantitative background how do you think the like traditional
6:55
retail investor thinks about capital allocation and then on top of that like how do you how do you
6:59
think about like an institution? How do you think they think about capital allocation?
7:05
Yeah. So I want to step back by saying like, I'm not sure that the line is as distinct,
7:15
right? Like I think there's a lot more blurriness to that line just because it's all human action.
7:22
This is what economics is, right? It's the product of human action. One of the greatest
7:27
books in economics was literally titled human action right so um you have so that i think that
7:35
needs to be said first up um in terms of like distinctions like i i think it is fair to
7:42
characterize uh retail as being more free to do things and i think this is probably the biggest
7:49
real distinction um like retail is more free to do things and so if retail like does their
7:57
research really well and is able to look around and notice trends before it happens um he is
8:04
perfectly free to make a rather uh you know what would traditionally be regarded as a risky bet
8:13
um he might go all in go all in with leverage you know and then like he could he could stand to like
8:20
gain a lot right and because of that there's also the flip side to that which is he's also free to
8:26
go all in on something completely stupid and lose everything.
8:30
So I think with retail, that's the core characterization
8:34
of it that because they are more free the variance of potential returns is just much larger Institutions I would say like they broadly bounded by mandate And that probably the only distinction
8:48
of the institution.
8:49
That mandate oftentimes creates good guardrails, okay?
8:53
And it oftentimes also causes them to be forced
8:58
to give up on otherwise good opportunities.
9:02
So I'd say like, that's kind of,
9:04
the lay of the land of those two categories
9:08
that you've mentioned, right?
9:10
But within institutions,
9:12
you of course have many different divergences, right?
9:15
Like a long only fund is necessarily different
9:19
from a options market maker.
9:22
A quantitative fund that runs
9:25
like market neutral strategies,
9:27
that's necessarily different from your long only fund.
9:31
Your mutual fund that tracks an index
9:34
is necessarily different from an actively managed, closed, and fun, right? So those are,
9:41
the heterogeneity here is, you know, can be quite extensive over there. And I think like,
9:49
what often happens is, like, within institutions, a good distinction is like, those who are active,
9:58
And therefore, by definition, they're actively seeking alpha, seeking to outperform and taking advantage of market inefficiencies to earn an excess return.
10:08
And then there's those passive investors.
10:11
And frankly, like you could think of retail as breaking up into those categories as well.
10:15
But I think with institutions, those categories are more clearly delineated.
10:20
And there's a good balancing act between those two as well.
10:24
So we can also talk about that.
10:26
But yeah, those are kind of the categories of the museum.
10:30
How do you think about the difference between growth investing and income investing?
10:35
You know, you made the point that retail has more freedom and therefore the ability to take on more risk, whether that ends up in their favor or extremely not in their favor.
10:45
And then institutions tend to have these guardrails.
10:47
How do you see like growth investing and income investing fitting in, you know, boxes that those two groups can kind of allocate to?
10:56
Yeah, I think really the traditional advice of how to allocate as you progress through your life is basically the relevant factor over here.
11:11
Like if you're younger and you have more time, you can swing for the fences with more growth allocations.
11:20
if you are, if you don't have much time left and, you know, you just want to like live out the rest
11:26
of your days in peace and sleep well at night, then you now, you know, your incentives align
11:32
towards like more income investing, right? So that could look like, well, the most extreme form of it
11:38
would be short term, like treasuries, right? Like this is basically like, you're not really going to
11:45
lose anything on that in nominal terms.
11:48
And then a step up from that is probably longer duration, fixed income.
11:52
And then step higher from that is probably like your very low risk dividend stocks, right?
11:58
So these are, that's kind of, oh, I mean, I guess between those, like you could add preferred
12:03
stock as well, right?
12:04
So like in terms of like income investing, that's your step up ladder of risk level.
12:12
And then if you wanted to push that even further, eventually you get to a point where the securities are invested in.
12:19
They don't pay income anymore because it's fully a operation where they're trying to reinvest all their cash to grow their business as much as possible.
12:27
Then you're fully in the territory of growth investment.
12:30
And I think the older you get, the more like lower down on the risk curve you want to be at.
12:36
And then the younger you are and the more risk seeking slash risk neutral you are, then you want to be further out because you just have better upside over there.
12:48
Right.
12:48
So I think that's that's like how I would think about it.
12:52
I don't know if it needs to be more complicated than that.
12:55
So, yeah.
12:57
Yeah, it's a really good point.
12:58
Obviously, growth investing tends to be characterized with higher risk.
13:03
Income investing tends to be characterized with lower risk.
13:07
From your perspective, what do you think risk actually is?
13:10
Is risk volatility?
13:13
Are they the same thing?
13:14
Are they different?
13:15
How do you think about that?
13:17
No, so risk is the set of all unhedged returns, like all unhedged exposures, I should say,
13:25
So risk is the set of all your unhedged exposures. So basically risk is everywhere. And frankly, there's no way to fully eliminate all risk. Even walking outside your house to get yourself a bagel, you're incurring risk to do that.
13:44
Right, so yeah, like risk is just uncertainty of all forms.
13:52
It is anything that includes stuff that you don't know about
13:57
and includes stuff that you do know about.
14:01
So yeah, it's a very big like black box.
14:04
I think where it becomes more relevant to investing
14:09
is when you can try to quantify risk
14:11
as well as quantify what you're getting
14:14
for taking on the risk.
14:16
And that's the concept of the risk premium.
14:18
So that's what I'd say to that.
14:21
I think the volatility and risk thing,
14:26
it does kind of get a bad rap.
14:28
On the one hand, it's inaccurate because like,
14:32
yeah, I guess volatility is not the same thing
14:35
as uncertainty, right?
14:37
Volatility is a market's expression
14:40
of some forms of uncertainty,
14:42
but also there's also other things
14:45
that the market might not even be aware of, right?
14:48
And that would be a risk
14:49
that might not even be expressed as volatility.
14:52
So I would say volatility could be a component of risk,
14:56
but it's not the full expression of risk.
15:01
At the same time, right?
15:03
You also can't discount volatility altogether
15:06
because at the end of the day,
15:08
like volatility is what people experience.
15:12
And if everything is downstream from human action
15:16
and you're saying that like we experience volatility
15:19
as a very real reality,
15:21
then yeah, then this is going to be a important variable
15:26
in the analysis of a particular investment.
15:32
So I think like it kind of gets a bad rap in that way.
15:35
Like it's, it's a, you know, it's inaccurate in some ways, but it's also quite accurate and you shouldn't be fully dismissive of it.
15:45
Makes a lot of sense.
15:46
Now that we have those kind of fundamentals down, I want to shift towards more towards digital credit since this is the income show.
15:54
First, I kind of want to start with like, what was your first impression of digital credit when Michael Saylor started releasing these perpetual preferred equities?
16:03
yeah i mean so actually um my first impression of it actually happened before like it really
16:11
existed like i had started talking about like uh they could probably release a type of stock
16:18
that pays a dividend and then from there that could be uh you know another financing tool uh
16:25
outside of just the convertibles and then like january rode around january 2025 rode around and
16:31
strike was the first one, right? So my, I mean, so my first impression, like when it came out,
16:36
was like, oh yeah, this is exactly what I said was going to happen. And I was like, all right,
16:40
cool. And I did some analysis on strike at the time, just like going through what exactly it was,
16:49
because if you recall, like the strike when it was first, I think even to this day, right,
16:54
There's a huge amount of misconception
16:56
of what exactly the security is.
17:00
Like is the call strike at 1000 or not, right?
17:04
I mean, the answer is no.
17:05
The answer is no, it's not.
17:07
It's just convertible to a 10th of a share of MSTR.
17:11
And the terms at the time, I guess,
17:14
if you didn't read it carefully,
17:16
you could think that it was 1000 and that was just the strike price And yeah so I think like when I first saw it
17:27
it was interesting and I thought that,
17:31
you know, this is a very natural next step
17:36
for the company in their like journey
17:38
to acquire more Bitcoin
17:39
and ultimately just grow the balance sheet.
17:42
Eventually I think my, I wouldn't say my thesis has
17:45
on that has like evolved materially,
17:48
but I think definitely more nuances have been,
17:53
I kind of like uncovered more nuances to it, right?
17:57
And so here's one aspect of it.
18:00
Like at the simplest level,
18:05
you could think about this as just a massive
18:09
financing operation, right?
18:10
You're kind of, I mean, this metaphor
18:13
had already been used like well before,
18:16
I believe in mid 2024, this metaphor was used,
18:18
like the concept of the Bitcoin development company
18:21
where they buy Bitcoin and then they develop it
18:25
and then they can finance more and then buy more Bitcoin.
18:31
And like the analog version of that
18:35
as the comparison would be real estate, right?
18:37
You buy real estate, you develop it
18:39
and then finance that, do more real estate development.
18:43
This makes total sense to me. I guess one thing is if people disagree with the Bitcoin thesis, then it might not make sense. But if you think that Bitcoin is a superior store of value, I mean, I think it's superior money, but if you just say store of value as one of the three functions of money, if I say it's a superior store of value, then absolutely you can do this kind of thing where you're financing it.
19:13
in order to gradually accumulate more of it
19:16
and thereby generate value.
19:19
So yeah, I do see digital credit
19:22
as the natural way to attain to that.
19:27
But where things really started to change
19:30
was I think when Stretch was released.
19:34
And with Stretch, it was like,
19:37
you know, for me,
19:39
so I think I was one of the first people
19:42
to put out on Twitter saying that with Stretch,
19:48
this was basically MSTR going into the territory
19:52
of what is effectively central banking.
19:54
That was the words that I used at the time.
19:58
And I won't comment on whether that's a good thing or a bad thing.
20:02
I think it's just economics itself is not good or bad or anything.
20:08
Things just are.
20:09
Humans just make decisions,
20:10
and we just have to deal with those decisions.
20:13
But I characterized it as central banking
20:15
primarily because you could see like many parallels
20:21
between how Stretch was designed to be
20:25
with how a small country foreign central bank
20:29
would manage its own issued fiat currency.
20:33
And there's many, many parallels.
20:34
Like one example is the reserve asset
20:39
of a traditional small country central bank
20:42
might be like debt, right?
20:45
It's like other sovereign debt.
20:46
It could be their own debt.
20:47
It could be gold or stuff like that.
20:50
And then the reserve asset for the strategy central bank
20:52
is just Bitcoin, right?
20:54
So you have that as a common thread.
20:59
You also have, of course, the stated intention
21:02
of maintaining a fixed trading price
21:05
or fixed trading price range, right?
21:08
So within, you know, like international economics, that's called a price peg.
21:13
Within the context of a NASDAQ listed preferred stock, you know, you probably can't call it
21:20
a peg technically, but I do use the word peg because I think the economic connotation
21:26
is important to communicate.
21:29
Like fundamentally, like it kind of does resemble this intention to create this kind of peg
21:36
and the maintenance of that peg is enforced using like the dividend rate,
21:42
which is to a small central bank, that would be their monetary policy, right?
21:47
So there are these commonalities.
21:49
And I think like before Stretch even IPO, like I'd written a post about this.
21:55
And yeah, like I think things have elapsed a lot like how I thought things would go.
22:02
I did not expect that Bitcoin would have a bear market the way it did, though.
22:07
So I think that was the major thing that changed some of my expectations.
22:13
But yeah, otherwise, digital credit has been, I think it's a very natural development.
22:19
Leaning into that idea of Stretch being a central bank-like type thing, what do you think that implies for the future of Stretch?
22:32
Like, do you still believe it to be like something like that? Do you think that that has implications for like how large it could become and how people interact with it? How do you think about that?
22:43
Yeah, I do.
22:49
So main thing is like, I guess let's just skip through and talk to the elephant in the room,
22:58
which is like Stretch has basically crashed and not done what it was supposed to do, right?
23:04
And I think this is, well, so there's a few things here.
23:10
One is like,
23:13
obviously by virtue of it trying to maintain this $100 trading range,
23:20
it was exposed to the impossible trinity.
23:23
Do I have to go through what the impossible trinity is?
23:27
Like, should I?
23:28
Yeah, maybe do that.
23:30
Okay, sure.
23:30
So the impossible trinity is this like pretty old concept in international economics
23:36
where it basically stays up
23:40
like within any economic system
23:43
or ecosystem or region or block,
23:47
you have three things
23:49
where you can only have two of those three things.
23:52
And those three things are a fixed exchange rate,
23:55
which in this case is your $100 stated amount
23:59
that like making the price trade at that.
24:02
The second thing is like free capital flow.
24:06
So basically anyone can buy or sell, anyone can like invest in this economy or block or whatnot, and they can also exit very freely. So that's free capital flow. And then the third thing is your sovereign monetary policy. So in this case, it would be like the issuer has the ability to set the dividend. So those are your three things. You can only pick two.
24:28
All right, so the fact that you listed it on the NASDAQ,
24:33
automatically you've already selected
24:35
that you will definitely have like free capital flows, right?
24:41
Because NASDAQ security, anyone can buy or sell.
24:44
So you've already selected one.
24:46
So now it's just between the other two.
24:48
Like you have to only select one
24:49
and the other one like is just left up to the market
24:52
and you are completely vulnerable
24:54
to be told what to do effectively.
24:56
So remember, those three, you've already selected capital controls.
25:03
You've already selected free capital flows.
25:06
So now you just have the fixed trading range versus your sovereign dividend policy, right?
25:14
So that's ultimately, I think, the root of the problem that we're seeing today.
25:20
it's that if you do assert that we are going to enforce this $100 trading range you necessarily
25:30
invite the entire market to try to test that because they'll be like okay so you're gonna
25:36
keep raising the dividend right all right cool so I'm gonna run these carry strategies
25:39
and I'm going to uh you know like leverage up and like I'll borrow money at 10 percent and I'll buy
25:48
by stretch paying 11 and a half,
25:51
or by stretch paying that 12.
25:53
And if it goes down, like I trust
25:55
that you will raise the dividend further to like push it back to par So think about like the second order incentives over here right You now have leverage built up into the system and now any wick any initial wick down creates
26:11
the cascading effect that we saw in June, right?
26:15
So largely the reports that I was writing, that kind of addresses like basically what
26:24
happened, right?
26:24
You have a lot of leverage positions, which actually makes complete sense because if you're
26:30
absolutely confident that the dividend will be maintained such that your principal is
26:38
secured, then you have every incentive to try to lever up on it to squeeze out as much
26:43
return as possible.
26:44
And if everybody starts doing that, or maybe not everybody, but if a significant amount
26:48
of the market starts doing that, then you now have embedded leverage within the system.
26:54
And frankly, it's not just people doing that through their brokerage accounts. You also have tokenized versions of STRC that is on various blockchain rails. And you have protocols that are able to leverage that. Like in crypto, it's called looping or something like that. It's just leveraging upon itself.
27:15
so yeah like if you have that leverage you necessarily create fragility if you create
27:24
fragility you necessarily create this path where now the dividend rate is not up for you to decide
27:34
as the issuer like now wherever the market pushes the price you now have to honor your previous
27:41
is commitment to keep the price trading at 100.
27:44
So you have to keep raising the dividend.
27:46
What happens if you keep raising the dividend?
27:48
Well, before, when the dividend was 11.5%,
27:52
someone that can borrow capital at 10%,
27:58
they can make quite a profit, right?
28:00
But someone who can only borrow at 11.5%,
28:02
they won't do that trade.
28:04
But your dividend is now like at 12%.
28:07
Now the guy who borrows at 11.5% can now come in, right?
28:10
So it invites even more leverage.
28:13
So you can kind of see how like this,
28:16
like as long as you are holding to the,
28:19
I'm going to maintain the fixed trading price,
28:22
you necessarily are forced
28:24
to keep raising the dividend over time.
28:28
Yeah, so this was something that,
28:31
frankly, I didn't expect it would come out in this way.
28:36
Like I did, of course, was aware of the impossible Trinity
28:39
And I'd spoken about it in the past.
28:43
But yeah, like the fact that it would rear its head
28:46
by virtue of the fact that others would start to leverage
28:49
on the instrument and this leverage would create fragility
28:53
that I did not anticipate.
28:55
And I think we're kind of watching
28:56
a lot of these incentives play out in a very dynamic way.
29:02
I do view that like strategy's last announcement
29:06
to basically like they kind of revamped everything
29:12
and like it was like,
29:13
hey, we have this kind of policy for our cash.
29:16
We have this digital credit buyback policy.
29:18
We have this Bitcoin monetization policy.
29:21
I viewed that as them saying basically like,
29:25
we will do what's in the best interest of the shareholders.
29:31
And ultimately like that $100 stated amount trading range
29:35
like you know we're not going to completely raise the dividend every single time just because it's
29:42
below that so i viewed that as like hey effectively the hundred dollar trading range thing is like
29:49
we're not going to do that anymore and we're going to retain some control over the dividend
29:53
policy right so at that point it's like okay we now see along which two edges of the impossible
30:00
with Trinity that they are now choosing.
30:03
And eventually, like you do choose that.
30:04
You do choose to retain control over your monetary policy.
30:09
How do you see that playing out over the coming months or even years?
30:14
Like, does that, do you think stretch will grow to a side, like significantly from here
30:20
still?
30:21
Do you think that like this kind of discovery and this leverage washout, as you described
30:25
pretty well, I think, is slowing digital credit adoption?
30:31
Or how do you think about that?
30:33
Yeah, that's a good question.
30:35
I think, like, I certainly don't think it's dead.
30:40
I think it's, I'm still quite bullish on the overall concept, right?
30:44
The overall concept rooted, like, fundamentally is absolutely sound.
30:50
It's just you have a store of value and you're financing it and you're buying more.
30:53
There's literally nothing wrong with that, right?
30:58
Now, implementations, like distinct implementations of a particular solution can have their own distinct problems, right?
31:09
And I think we are seeing some distinct problems that are specific to STRC and really like variable rate instruments which try to hold to par, right?
31:21
Like I would say more broadly, this is kind of what we are seeing.
31:27
So look, like digital credit, again, the fundamental case of it makes total sense.
31:35
Different implementations might have their problems.
31:38
I think that creates opportunity within the marketplace for investors who want, who desire to navigate through those and potentially earn an outsized return.
31:50
So that's how I would say that, right?
31:53
Like it presents opportunities.
31:56
The idea is fundamentally sound,
31:59
but within each implementation,
32:02
there could be inefficiencies and issues
32:05
and oversight about how we should have designed this thing.
32:12
Now, in terms of what happens to STRC in particular,
32:17
right uh look i would personally okay i would personally like propose a few different ways to
32:24
like revise how the security works that i think would give it more um stability and long-term
32:30
appeal so like the first thing is all variable rate all these like so-called floating rate
32:42
instruments you know how they float like they float because the sulfur floats okay so the way
32:49
they're priced is they'll take the sulfur rate they'll snapshot it every day and then they'll
32:55
just add a fixed basis point spread over sulfur now mind you that fixed spread is
33:02
um referenced to the principal value of that floating rate note right so it's the face value
33:10
of the notes, which is not something that moves, right?
33:13
It's not something that moves with the market.
33:15
It's just simply these are the terms of the security.
33:18
Now, that's the only way it floats.
33:22
It floats because SOFR floats, right?
33:24
Everything else, sorry, like, so STRC does not do that,
33:31
obviously.
33:32
STRC floats because the price could change.
33:36
And when the price changes, the dividend is adjusted
33:39
to cause the price to go back somewhere, right?
33:42
So you can see like that's a very big distinction.
33:45
One floats simply because sofa moves around, okay?
33:48
The other floats because the price moves around
33:51
and we're actively trying to target a specific price, right?
33:55
So those are two different causes
33:58
for why the floating happens.
34:01
So here's the thing,
34:01
like there's not much instruments
34:05
that do that second thing.
34:08
like stretch and set are probably the only ones that do that okay like that actively would try to
34:13
target this trading range um and of course the reason is like fundamentally the impossible trinity
34:20
like this is a hurdle that every issuer that tries to do this thing must overcome right and it's you
34:27
know it's called impossible for a reason because it cannot be overcome okay this this is just the
34:32
nature of the trade-offs.
34:34
So I think like it is worth just revising the policy
34:39
so that instead of floating
34:42
by virtue of like we're trying to target a price,
34:46
we'll just float based on sulfur.
34:48
Like how every other floating rate instrument floats.
34:52
So if you have this instrument be,
34:55
we're gonna snapshot sulfur every day
34:58
and then we're gonna apply 700 basis points
35:01
spread over sulfur.
35:03
And then we're just gonna let this thing trade
35:06
to wherever it trades, right?
35:09
That is probably going to be a lot more
35:12
familiar to people. It would, of course, lack the appeal of the stable price. But I think it would,
35:22
it would just be more comparable to other kinds of floating rate instruments that already exist.
35:30
So that's one thing. Another thing would be like floating rate notes, they tend to have a two-year
35:37
maturity. So, you know, no matter where the price goes today, like I can always look like,
35:45
hey, at least two years later, I'm going to get my full principal back. The fact that like digital
35:50
credit is perpetual, I mean, there's obviously positive aspects of that, but it does create
35:58
this scenario where as a credit investor, a credit investor is concerned with getting their
36:03
principal back at the very least. So if my principal does not come due at any time, that means that
36:11
it, like, I only get back my principal if and only if at a future time when I sell, I'm able to, like,
36:18
get the price that I'm audit at, right? This is, of course, very risky because at that future date,
36:24
the price is determined completely based on what all these other market participants are doing,
36:30
right and that can be you know so it can really be anywhere and so because of that
36:35
I don't think I think a core quality of credit is kind of lacking in digital credit right that that
36:44
fact that something comes due at some point now of course again the perpetual nature of digital
36:53
credit is absolutely beneficial in some ways, but it's also, it creates these, there's always
37:02
trade-offs and those are the trade-offs. It's that like traditional credit investors, when they look
37:06
at this, they're like, well, this thing doesn't come due. So it doesn't really fit what I would
37:11
normally try to get. And that's why we kind of see the investor demographics of something like
37:18
stretch it's about 80% retail you normally wouldn't see that with like a floating rate
37:23
instrument right you would like first off those are 144 is like you know retail wouldn't even be
37:29
allowed to touch it um so there's there's like that as a distinction and I think the solution
37:35
to that is if you attached an investor put onto the instrument now if you do that like imagine
37:42
something like every five years, the investor is allowed to force the company to buy back
37:51
the preferred stock at a certain price point. And that price point could be far below the stated
37:58
amount, right? It could be far below the stated amount. But the point is that by having that
38:04
mechanism, where at the very least I can get something back, it allows the market to then
38:09
anchor around that price punt. And that would give it, I guess, an objective valuation. Whereas
38:17
if you don't have something like that, you very much have the quandary of having to price a
38:26
perpetual credit instrument where obviously the present value of future cash flows is the fair
38:35
value of your bond, of your instrument. And because it's perpetual, it's like the future
38:45
streams are so far out that you don't know what discount rate makes sense. So all of those
38:52
traditional ways of pricing it like a bond kind of goes out the window. And now you have to look
38:58
at stuff like liquidity, like market forces, like who is levered on it, who is not levered on it,
39:03
how exposed is the leverage and when you have to like look at the market microstructures stuff like
39:08
that like then this becomes a thing where it doesn't feel like credit anymore it feels much
39:14
more like a uh like much more like a speculative instrument and so i think that is that's like
39:20
another thing that could be done to amend it and of course there's also problems with doing that
39:25
because if you do that then you kind of have um installed much more forced discipline upon the
39:32
issuer, which frankly, you know, the issuer probably doesn't want that, right? The issuer
39:37
wants to just issue this. And if need be, it could like suspend dividends for a period of time to,
39:44
to like outlast the bear market, for example, right? In a very bad case. So that's also an
39:52
option that now the issuer doesn't have. So, but, but, you know, that would be one way that could
39:58
potentially make this thing more like normal credit.
40:01
So I've kind of mentioned two different things over there.
40:04
And then the implied third thing is of course,
40:06
just allow it to trade wherever.
40:08
So like literally let it trade above 100 if need be.
40:12
Like if you really give this thing sulfur plus 700,
40:16
it's probably gonna go above par.
40:18
It probably would like in the longterm, right?
40:20
Cause all your other alternatives are sulfur
40:23
plus something much smaller.
40:25
yeah those are definitely some very interesting ideas um i guess thinking back to how like for
40:34
example stretch currently works today i think you made some really good points earlier of
40:38
okay well if it actually trades at a hundred dollars perfectly it invites people to do that
40:44
carry trade which invites leverage which creates fragility and as we saw like in june and you know
40:52
the price can fall and there's a cascading, you know, event of multiple liquidations of
40:58
four sellers. Let's say, for example, strategy doesn't pursue any of those like more unique
41:05
ideas that you just mentioned, and they continue down the path that they're currently going down,
41:11
where instead of okay, like maybe they're not going to aggressively raise the rate to, you know,
41:18
Let push the price back to 100 like every single month Maybe they be buying Bitcoin with common equity Maybe they be increasing their USD reserve as we seen Do you think that this will just kind of be like a repeating process where maybe you know there a sharp drawdown maybe as Bitcoin
41:39
starts to go up and as the balance sheet looks better with their capital markets activity,
41:44
stretch starts trending back towards 100, then it sits back at 100 again for an extended period of
41:49
time, volatility drops, leverage piles in again, fragility occurs, and then it washes out.
41:57
You know, again, is that like a possible scenario where this kind of just becomes like there's a
42:01
fire and then the fire goes out and then the fire comes back again? Do you see that playing out or
42:07
no? Yeah, I think that would be the base case. Like if indeed we just do exactly what we're doing,
42:15
I think that would be the base case.
42:18
And actually I think more precisely,
42:20
it would be like the return of,
42:25
let's just say the total return, right?
42:27
So the yield plus whatever price delta
42:30
that you experience.
42:32
I would say the total return in the long run
42:34
would dynamically start to reach an equilibrium
42:40
where it like basically matches
42:45
the extent of the wipeouts
42:49
when the wipeouts happen.
42:51
So I think like
42:52
what would happen is
42:55
you keep getting wipeouts,
43:00
the leverage people keep,
43:01
like the people who are able
43:03
to make the leverage work.
43:05
And what I mean by that is
43:06
they're in and then they're out
43:09
before the wipeout happens.
43:11
So like those parties,
43:13
like money basically goes
43:15
from those who are kind of like holding it long-term
43:19
or like trading it in a very like bad way
43:23
to those people who are able to like skillfully go in and out.
43:26
So it just really becomes a trading product at that point.
43:30
And I think like the overall total returns
43:33
will reach that equilibrium point
43:36
where if you were to hold this thing long-term,
43:39
like I believe your risk adjusted returns
43:43
will not really be impressive.
43:46
Like that's how I think it would settle too.
43:51
Yeah, so like, but you know, again,
43:54
this would be a credit instrument.
43:57
So your overall like for credit instruments,
44:00
like risk adjusted returns aren't super great, right?
44:03
But you would have like a much larger
44:08
and wilder ride than normal credit instruments.
44:11
And you're saying that or you're suggesting that because of the washouts, because of the leverage that's invited. Do you think like the market will learn over time?
44:24
Like, for example, I'd imagine a lot of the market participants that saw the last wipeout will possibly understand that, well, if this has happened in the past, maybe I should be more conservative on any sort of carry trade that I put on here.
44:38
And therefore, maybe it becomes less fragile over time.
44:43
Yeah, I mean, but that's that's the case of the dynamic equilibrium, right?
44:48
That's that's what I mean by the equilibrium.
44:50
Like eventually you get to a point where the returns are more or less justified by the frequency and magnitude of those washouts.
44:59
That makes sense.
45:01
Maybe taking a step back and thinking very big picture, when a Bitcoin skeptic or an outsider kind of sees digital credit and they see stretch paying 12%, theta paying 13% or whatnot,
45:16
I would imagine many people are very skeptical because it's like, how can, from their mind, they might think, how can Bitcoin, which natively generates zero dividends or cash flow, possibly generate cash flow for some other instrument that's effectively powered by Bitcoin?
45:37
What would be like your response to that to someone that's a Bitcoin skeptic?
45:41
maybe they don't think bitcoin's going to zero but maybe they don't buy you know michael saylor's
45:46
you know 30 k your analysis either yeah um yeah i mean i i think it's like i think the real question
45:56
you kind of asked there was uh like where does the yield come from like that's it's really a
46:03
derivative of that question um and i think like really people have too much over complicated this
46:11
question because the answer is the the yield comes from selling Bitcoin or at least selling
46:17
exposure to Bitcoin right and the common ATM is just a way to sell exposure to Bitcoin because if
46:25
the common stock owns the company and obviously there's caveats to this but like a lot this is an
46:33
illustrative point that like if the common stock owns the company and the company owns Bitcoin and
46:37
selling common stock is economically congruent with selling Bitcoin. So even if you are saying,
46:43
hey, they never sell Bitcoin or anything, like, just forget about like the sales in the last few,
46:48
but I'm just speaking like generally, like how the discourse has evolved. But yeah, even if you
46:55
say, oh, they never sell Bitcoin, like all of this is coming from new investors. Well, they've sold
47:01
off their Bitcoin exposure via dilution of the common stock. So ultimately it's still downstream
47:07
from selling off Bitcoin. And so now the question then becomes, okay, is it mathematically possible
47:15
to generate a yield by selling something? Yes, it is. Because you can just sell fractions of the
47:21
thing and now you have cash and now you can use the cash to pay a yield, right? Like that's
47:26
That's mathematically possible, obviously.
47:29
So that would answer the question just like that.
47:32
The yield comes from the fact that we do expect Bitcoin to appreciate.
47:37
And as the common stockholders would have this, they expect it enough such that they're willing to put up the rest of their Bitcoin within the company towards this kind of credit position.
47:54
wherein they would be on the hook for paying out coupons or dividends indefinitely, right?
48:02
Because they do view the probability that it's going to appreciate as worthwhile for taking on
48:09
that risk So to a person who like a you know not necessarily they think Bitcoin going to zero but maybe they don buy the 30 ARR To that person it really just like okay like so what ARR do we think
48:26
it's going to be? And also like, what your investment time horizon is, right? Like, frankly,
48:32
if you just need to invest in something for like, two, three years, and you don't want anything too
48:41
crazy, this probably would be fine, right? Like it probably would be okay to underwrite this risk
48:48
specifically of digital credit because like we can look at the options market for where the options
48:55
market think Bitcoin is going to fall to. And, you know, you can look at the Bitcoin coverage,
49:00
the BTC rating on these digital credit instruments. And that gives you a sense of like,
49:06
okay how far bitcoin actually has to fall so the options market tells you what is the cost to hedge
49:12
this bitcoin fall to a certain point and the btc rating tells you at what point btc needs to fall
49:21
in order for this thing to become undercover now you have all the tools you need to like
49:28
mathematically compute um what this risk premium should be like at least from the bitcoin perspective
49:35
from the Bitcoin price risk.
49:37
Then the rest of this is just saying,
49:39
do I trust governance enough?
49:42
Do I trust the issuer to be a proper steward of capital?
49:47
And if I trust them enough
49:49
that they're not going to completely create
49:51
a disaster situation,
49:53
then yeah, then this risk becomes worthwhile
49:56
for me to underwrite.
49:58
Another thing that Saylor has obviously talked a lot about
50:02
in the past is this concept of digital money built on top of digital credit you know so you know
50:08
before he spoke in bitcoin as this like 50 55 all asset digital credit as something lower than that
50:17
and then digital money being this like ideally close to zero volatility asset like normal people
50:25
think of money in their bank account or a money market fund do you see that the volatility that
50:31
we've seen in stretch like invalidate the idea that it's possible to build this idea of digital
50:38
money or do you think it's maybe still possible with the right structure yeah i mean i think it's
50:46
this is such a good question and and like we could probably talk a while about this topic
50:51
um i do think it's still possible i think frankly this concept is possible with almost any security
51:00
almost any asset that's out there, right?
51:04
Like, but ultimately, I think we have to peel back the layers
51:09
to figure out like what actually constitutes money
51:14
in the traditional fiat sense, right?
51:17
And it really is just a, it's like broad money or M2 or M3.
51:23
It's broadly just like this number that the bank is going to tell you
51:27
when you log into the app.
51:29
And the bank doesn't, the bank has those deposits as like numbers that it owes to its depositors.
51:38
But at the same time, it doesn't have like the M0 money within its own reserves, right?
51:45
So like this is the essence of fractional reserve banking.
51:50
So what is really going on over here?
51:54
Well, the bank has this balance sheet.
51:56
Here I'm talking about the commercial banks.
51:58
So at the L2 level of the fiat system, right?
52:03
So at the commercial bank level,
52:05
they have all of these assets on the balance sheet.
52:09
And all of these assets broadly are just credit instruments.
52:12
They could be mortgages, they could be car loans,
52:14
could be student debt, just like business loans,
52:17
stuff like that, right?
52:18
And these are all just credit instruments.
52:21
They're not as liquid as digital credit.
52:24
And a lot of them are actually like probably much less credible and much more vulnerable to certain, let's just call it like economic calamity risk, right?
52:38
So you have like fundamentally, that's what money is, right?
52:43
The fiat money in your bank, fundamentally, that's what it is.
52:46
It's some bank reserves, which is M0, which you could think about it as a ledger entry at the Federal Reserve.
52:54
So it's a ledger entry at the Federal Reserve
52:57
plus some credit instruments.
53:01
That's what everyone's money is, okay?
53:05
Or everyone's fiat money is.
53:07
Doesn't matter if you're in the US
53:08
or in some other country,
53:10
like that's fundamentally what your money is.
53:13
So clearly, if you just replaced
53:17
some of those credit instruments with digital credit
53:21
or with credit that is, you know,
53:24
just backed by some other assets
53:26
or frankly with just Bitcoin itself,
53:29
but you manage the risk adjusted like capital weights,
53:34
then you could create money, right?
53:36
You could create the fiat money,
53:37
at least the M2 fiat money.
53:39
So I really think it's like,
53:41
it really is mechanically as simple
53:45
as I stated it like that.
53:47
Now, there are some other things that go into this, right?
53:50
one of it is like, what can banks actually hold
53:55
in terms of their credit?
53:57
Like what can they actually hold on their balance sheet?
53:59
Now that's a question that frankly,
54:03
like we don't have a lot going for us
54:06
on the Bitcoin and digital credit side, right?
54:09
Because Bitcoin itself has a terrible risk weighting, right?
54:14
Like for example, with the S&P's credit rating on strategy,
54:18
it valued all of that Bitcoin at zero, right?
54:21
So that is a 100% haircut, right?
54:24
So basically you have an asset and it's like,
54:26
okay, that asset is completely worthless.
54:28
We do not like view this as an asset at all.
54:32
Okay, so that is a symptom
54:36
of like the structural institutional inertia
54:39
of the system, right?
54:42
And that's not something
54:44
that would be easy to bypass anytime soon.
54:48
But it clearly is something that like in principle,
54:53
if we just look at it,
54:54
hey, that is credit and this is credit.
54:56
And if more forms of credit could be viewed as acceptable to the fiat banking system to be put on the balance sheet on the asset side of the balance sheet of the commercial banks
55:10
then you have this digital money concept.
55:14
So that's a very high level view of this.
55:17
You could also look at it on a probably more simpler level.
55:22
Like if I were to design a portfolio for myself,
55:27
where I might want the portfolio value to be stable
55:32
to a fiat price or to stable in fiat terms,
55:37
but I want to pay additional to the risk-free rate.
55:42
How would I implement something like that?
55:44
Well, there's actually a number of instruments,
55:47
not just digital credit that do that thing fairly well.
55:51
So earlier in this call,
55:54
we had talked about these floating rate notes, right?
55:57
So floating rate notes are in fact issued
56:01
by like very big financial institutions
56:04
and really corporations everywhere.
56:07
And so you can purchase floating rate notes
56:10
and have a small, a very small credit spread on it, right?
56:16
Because it's obviously not your US treasury bills
56:19
or your US treasury floating rate notes.
56:21
It's like the balance sheet and cash flows of a corporation is what's behind it.
56:28
So there's a small credit spread.
56:29
But that credit spread, assuming you don't have broad economic malaise across the economy,
56:35
you'll probably get your money back.
56:38
So that's one way to do it, right?
56:40
Where if you had a bunch of cash and you're like,
56:44
I want this cash position to pay above the risk-free rate,
56:48
but still be more or less cash-like in terms of its volatility profile.
56:53
You could put it into very high-rated, like AAA-rated, AA-rated, A-rated floating rate notes.
57:02
Like that's one way to do it.
57:03
And it's actually kind of easy too because there are a lot of ETFs that allow you to have access to those kinds of things.
57:12
and you can look at their like 30-day SEC yields
57:15
and it's higher than the 30-day SEC yields
57:18
of something like SGOV,
57:21
which is iShares is zero to three month treasury bills, right?
57:26
So imagine constructing a portfolio
57:29
where you have a basket of those ETFs,
57:33
a little bit of something like SGOV,
57:35
and then you have a little sliver of digital credit as well.
57:38
and now what is the composite yield of this portfolio?
57:42
What is the composite volatility of this portfolio?
57:45
And from there, you can start to design something
57:48
that is kind of like this digital money concept
57:52
that we're talking about,
57:53
but it doesn't have to be purely based off of digital credit.
57:58
It doesn't have to be purely based off of stretch.
58:00
So yeah, that's how I would think through that.
58:05
But broadly, to turn it into something
58:08
that's would by law considered to be broad money fiat,
58:15
you would probably need to have those banking regulations
58:19
like software first and foremost.
58:23
Yeah, that's a very deep question
58:25
that we could probably talk about
58:27
for an entire podcast in of itself.
58:30
So very, very interesting stuff.
58:32
Maybe for final closing thoughts,
58:35
like where do you see digital credit,
58:37
evolving over the next three to five years?
58:41
How big could it be?
58:42
And kind of the same for Bitcoin
58:44
that we can close it out.
58:46
Sure, yeah.
58:47
Again, I think it's all downstream from Bitcoin.
58:50
So I think perhaps we should talk Bitcoin first.
58:55
I could see a few different paths.
58:57
Like I think my base case for Bitcoin
58:59
is probably like in the next five years,
59:03
around like 20 to 30% ARR, okay?
59:07
in terms of digital credit like i think that bodes positively for digital credit obviously
59:16
and eventually we'll have more companies that issue variations of digital credit like one thing
59:24
i'd love to see is a company that has a like pretty strong free cash flows as well as free
59:31
cash flow growth that builds up a Bitcoin treasury and then issues like these digital credit
59:38
instruments. And in this way, their cash flow is this buffer for the bear markets, right? Like that,
59:44
that I think is still a thing that we sorely need. And I'd be very interested to have that happen.
59:51
Or frankly, like imagine a company that only IPOs its preferred stock, right? It's just,
59:57
It just, IPOs is preferred stock, but it has a massive Bitcoin, it's like private, otherwise on the common equity side. I think that would be kind of interesting. So, you know, I think we'll see more issuers.
1:00:09
um broadly like in the long term i would say if you wanted to look at how digital credit
1:00:18
how big it could get i think you'd first think about um how big bitcoin gets and then how much
1:00:25
bitcoin ends up in the balance sheets of bitcoin treasury companies and then think about what is
1:00:31
the aggregated btc rating that the market will accept for for digital credit broadly right so
1:00:38
for example if you think bitcoin will reach uh 10 trillion dollars at a certain time in market cap
1:00:44
um and then you say like okay let's me think that 50 percent of all bitcoin will be held by treasury
1:00:51
companies and then of these treasury companies half of them will issue digital credit and then
1:00:58
the aggregate digital credit um btc rating will be about 2x which means like 2x coverage well that
1:01:07
In that case, your long-term, or at least within this time horizon, your long-term digital credit market cap will be an eighth of the Bitcoin market cap.
1:01:20
So that is how I would think through that question.
1:01:27
Very good.
1:01:28
Allard, thanks so much for taking the time to do this.
1:01:31
I think I could have asked you 500 more questions probably.
1:01:35
So I think that means we'll have to do this again at some point.
1:01:38
But thanks again for doing this.
1:01:40
Any final additional closing thoughts?
1:01:44
No, I think we covered a good amount.
1:01:46
But yeah, let's do this again some other time.
1:01:50
Awesome.
1:01:50
Sounds good.
1:01:51
Thanks, Allard.