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Introduction
This year, we have witnessed a new trend of corporate treasuries allocating to bitcoin. MicroStrategy Incorporated (MSTR) adopted bitcoin as its primary treasury reserve, buying 38,250 BTC for $425 million between August and September 2020i. In a similar move, Square, Inc. (SQ), which supports bitcoin buying and selling via Cash App, purchased $50 million worth of bitcoin (or 4,709 bitcoins) in October 2020.ii Additionally, companies and institutional investors such as Stone Ridge,iii Mode Global Holdings PLC,iv and Tudor Investment Corporationv have also announced bitcoin allocations this year.
One of corporate treasury's primary responsibilities is cash and liquidity management for the business. Depending on the size of the balance sheet and the nature of the business, corporate treasuries may hold a range of assets to manage risk and enhance returns. To find the balance between risk and yield, they must consider short and long-term liquidity needs, changes in foreign exchange rates, changes in interest rates, the macro environment, among other factors that could affect their business. Traditionally, corporate treasuries have managed cash conservatively, by allocating the majority of capital to low-risk assets (e.g., bank deposits, money market funds, treasury bills, commercial paper, and repurchase agreements),vi but the evolving economic climate may be causing treasurers to reconsider the viability of such strategies.
In this piece, we examine the risks corporate treasurers face as a result of the coronavirus pandemic and historic fiscal and monetary policy expansion, and why they may consider a balance sheet allocation to bitcoin.
The economic environment and its impact on corporate treasury
Lockdowns to contain the virus and unemployment as a consequence of economic shutdown decreased cash flows for businesses in multiple sectors. Simultaneously, central banks and governments responded by lowering interest rates to (and even below) the zero lower bound and injecting trillions of dollars' worth of stimulus into economies globally. These developments have led to diminished profits, low yields on excess cash, and potential depreciation of cash and cash equivalents. As a result, common corporate treasury functions such as cash and liquidity management, operational risk management, and capital optimization have faced several challenges.
Cash Flows and Profitability
The consumer demand shock caused by the pandemic damaged corporate balance sheets, cash flows, and profitability, putting companies in a precarious financial position. All eleven S&P 500 sectors had lower than expected net profit margins in Q2 2020 versus the same year-ago period, and nine sectors had lower expected net profit margins relative to their five-year average.vii The decline in cash flows driven by the pandemic has raised the importance of having excess funds, liquidity, and uncorrelated investments on hand to recession-proof business models and better withstand crises.
Interest Rates
The world's largest countries have lowered interest rates to try and boost their economies with inexpensive credit in 2020. In the U.S., the Federal Open Market Committee (FOMC) lowered the Federal Funds Rate by 150bps to 0-25bps, significantly reducing interest rates across the board.viii In the U.K., the Bank of England reduced the main lending rate twice from 75bps to 10bps after the second cut.ix The European Central Bank sets three key rates – main refinancing operations, marginal lending facility, and deposit facility, which are 0bps, 25bps, and -50bps, respectively.x
Low interest rates can be a double-edged sword for corporate treasury departments. On one hand, companies may take on new debt or refinance existing debt at less expensive rates. On the other hand, companies with excess cash suffer because they cannot earn attractive yields via traditional income-producing investments. Additionally, companies sitting on substantial excess cash and low-yield financial instruments may face pressure from shareholders for holding unproductive funds. Sitting on substantial amounts of cash in an environment with record low interest rates and historic levels of money printing could destroy the real value of capital over time, thus destroying shareholder value, which conflicts with the need to set aside funds to be prepared for crises.
Even countries that have not reduced rates below zero may be facing negative real interest rates (the nominal interest rate less inflation). For example, all U.S. Daily Treasury Real Yield Curve Rates are currently negative.xi Even the real yield on Bloomberg Barclays investment-grade corporate bond index was 0.2% as of mid-November 2020.xii
Money Printing and Potential Inflation
The magnitude and coordinated nature of monetary and fiscal policy response to the pandemic has been, for lack of a better word, unprecedented. According to McKinsey's study of 54 economies that represent 93% of global GDP, governments announced $10 trillion in stimulus in two months, three times more than they did during the 2008-09 Global Financial Crisis (GFC).xiii In the U.S. alone, the Federal Reserve pledged to buy an unlimited amount of government-backed debt (also known as quantitative easing or QE),xiv and for the first time, billions of dollars in corporate bonds, including the riskiest investment-grade debt.xv
Additionally, during the GFC, central banks like the Federal Reserve printed funds that were given to banks who used them to expand reserves rather than create new loans, meaning funds did not make their way into the broad money supply and circulate in the real economy. This time, banks are well capitalized, and governments have transmitted newly printed money funded by central banks directly to individuals and businesses. For example, in the U.S., Congress passed the $2 trillion CARES Act to provide direct fiscal stimulus, contributing to growth in the broad money supply (or M2) from ~$15 trillion in February 2020 to ~$19 trillion as of November 2020. xvi The increase in M2 from January 2008 to January 2010, over a two-year period, was less than $1 trillion in comparison.xvii The Federal Reserve defines M2 as M1 (the sum of currency held by the public and deposits at depository institutions) plus savings deposits, small denomination ($100,000) time deposits, and retail money market mutual fund shares.xviii
'QE alone is not inflationary and mostly stays in bank reserves, but QE combined with massive fiscal deficits, is inflationary, and gets the funds out into the broad money supply, out into commercial bank deposits of the public.'
Lyn Alden (Lyn Alden Investment Strategy)xix
While there are deflationary forces at play (job losses, lockdowns, supply chain disruptions, aging demographics, and technological progress), the rapidly expanding broad money supply as measured by M2 and the coordinated loose monetary and fiscal policy could create a situation where too many dollars are chasing too few assets and/or goods and services – in other words, inflation, and a more rapid decline in the purchasing power of fiat currencies. Corporates would then be confronted with inflation risks, where the purchasing power of their cash declines relative to the price of goods, services, and investments.
Lyn Alden describes three types of inflation – monetary inflation, asset inflation, and consumer price inflation (CPI). Monetary inflation (an increase in the broad money supply as measured by M2) does not guarantee but is a precursor to asset inflation (an increase in the price and valuation of investable assets) and consumer price inflation (an increase in the price level of non-financial goods and services).xx
Depending on the type of business, corporations could be impacted to a lesser or greater extent by both asset price inflation and consumer price inflation. For example, asset price inflation could lead to an increase in the value of assets a corporate may want to invest in or acquire, and consumer price inflation could lead to greater inventory costs relative to the purchasing power of cash.
Why corporate treasurers may consider bitcoin
Anyone with a significant cash position – retail investors, institutional investors, and, as of 2020, public companies - is evaluating how to address the unique health and economic situation and the historic monetary and fiscal policy response. Several of these stakeholders are concluding that an unprecedented economic situation calls for an unprecedented response – bitcoin.
Corporate treasurers allocate to bitcoin
Bitcoin's potential to address challenges created by the current economic environment has led multiple companies, including Square, MicroStrategy, and Stone Ridge Holdings Group, to make a balance sheet allocation to bitcoin.
Square
Jack Dorsey, CEO of Square and Twitter, believes bitcoin has the potential to become the native currency of the internet: 'The world ultimately will have a single currency, the internet will have a single currency. I personally believe that it will be bitcoin.'xxi Similarly, Square has positioned bitcoin as having the potential to be a more ubiquitous currency in the future, leading the company to make a $50 million balance sheet investment in bitcoin (1% of total assets as of Q2 2020). According to Square, this complements the company's bitcoin services (Cash App), development efforts (Square Crypto), and consortium efforts (Cryptocurrency Open Patent Alliance). Square's justification was to align financially with its mission of furthering economic empowerment and facilitating a more inclusionary financial system.xxii
MicroStrategy
MicroStrategy (MSTR) was the first public company to make a substantial balance sheet allocation to bitcoin (starting with $250 million in August 2020, $175 million in September 2020, and most recently, an additional $50 million in December 2020), resulting from its new capital allocation and treasury management strategy on capital in excess of working capital requirements.xxiii The decision was driven by the company's search for a new treasury reserve asset that protects against asset inflation.xxiv According to Michael Saylor, the CEO of MicroStrategy, the company's $500 million in cash was 'a melting ice cube.'xxv This led Michael Saylor and the broader company and board of directors to contemplate and eventually allocate a significant amount of capital to bitcoin.
There are many factors that Michael Saylor and MicroStrategy have cited in allocating to bitcoin, but, at a high level, their decision was driven by the belief that bitcoin is better than precious metals like gold (e.g., because it is more scarce and inelastic)xxvi and offers the potential asymmetric upside that big tech offered ten years ago.xxvii
MicroStrategy also initially proposed a tender offer to shareholders in August 2020 to repurchase up to $250 million in shares over a 12-month period through a modified Dutch auction.xxviii Certain shareholders took advantage of this option leading MicroStrategy to repurchase ~430K shares for ~$60 million. Once the tender offer expired, MicroStrategy leveraged $175 million in remaining funds set aside for the tender offer to buy bitcoin.xxix
Stone Ridge Holdings Group
Stone Ridge Holdings Group (SRHG) is the parent company of Stone Ridge Asset Management (a $10 billion asset manager) and New York Digital Investment Group (NYDIG). SRHG announced that it has more than 10,000 bitcoins as the primary component of its treasury reserve strategy, citing bitcoin's superiority to cash, 'unchecked' and 'unbacked' global money printing, and real yields that are increasingly negative.xxx
How Bitcoin can address the current economic climate
Cash Flows and Profitability
As we discussed in our report on Bitcoin's Role as an Alternative Investment, bitcoin is generally uncorrelated to the demand shocks created by the health and economic crisis. Thus, companies may also benefit from bitcoin's diversification benefits, potential outperformance, and liquidity profile when the core business and other potential investments are disadvantaged by the state of the economy. Bitcoin offers the upside potential of longer-term investments while providing the liquidity profile of shorter-term investments. Thus, an allocation to bitcoin could allow companies to preserve and potentially grow purchasing power over time, providing a buffer during periods of low profitability and cash flows while being liquid enough to meet short-term obligations.
Interest Rates
Assets like bitcoin and gold are sometimes criticized because they do not natively generate yield. However, with yields at or below zero, the opportunity cost of an allocation to bitcoin has gone down significantly, and the attractiveness of holding a non-yielding asset (versus holding a negative yielding asset – either in nominal or real terms) with an asymmetric risk vs. return profile has gone up significantly. Just as institutional investors are re-evaluating their allocation to fixed income securities offering, we are seeing some corporate treasures do the same.
Money Printing and Potential Inflation
Bitcoin is a verifiably scarce asset with a transparent monetary policy, which presents a stark contrast to the unlimited expansion in the supply of fiat currencies. The inelasticity and predictability of Bitcoin's monetary policy and the growing importance of these characteristics have helped drive bitcoin's 'store of value' narrative. In other words, certain institutional investors and companies have come to see bitcoin as an emerging store of value that could benefit from asset inflation of fixed quantity assets and/or provide a wealth preservation tool in light of purchasing power loss of fiat currencies due to potential consumer price inflation.
Summary of risk management with bitcoin
As we discuss above, treasurers are exposed to multiple risks in managing cash, and many of these risks are heightened due to the current health and economic situation. As businesses look for new ways to optimize their balance sheets, many are turning to bitcoin to offset potential losses. In this table, we summarize many of the risks corporate treasurers face both in times of economic growth and decline, and how bitcoin could provide a potential solution.
Bitcoin Depository Companies
Conclusion
The unparalleled nature of the current economic crisis is pushing forward-thinking corporate treasurers to consider adding bitcoin to their balance sheets. The recent announcements from Square, MicroStrategy, Stone Ridge Holdings Group, and others represent a trend that could continue to grow as businesses weigh the risks of historically low-interest rates, diminished liquidity due to the coronavirus pandemic, and the potential loss of purchasing power of cash due to coordinated monetary and fiscal stimulus.
Bitcoin Depository Stock
Companies that chose to allocate to bitcoin have benefited from recent outperformance due to bitcoin's value rising from under $12,000 to over $19,000 from August to December. For example, Square's position of ~4,709 bitcoinsxxxi (acquired in October 2020) is worth ~$90 million and MicroStrategy's position of ~40,824 bitcoinsxxxii (acquired in August, September, and December 2020) is worth ~$780 million as of December 7, 2020. On the other hand, the value of cash has depreciated this year relative to goods consumers buy and other fiat currencies. According to Bloomberg's dollar spot index, it is down 5% YTD.xxxiii
Bitcoin Depository Bitcoin
We expect the trend of diversity in bitcoin participants to continue as different types of investors look for investments with an asymmetric return profile and low correlation to traditional markets.