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Is MicroStrategy Over-Exposed to Bitcoin?(5 min read)

In August 2020, business intelligence firm MicroStrategy became the first publicly-traded company to bet on bitcoin—making the pioneering cryptocurrency the primary asset in its treasury reserve strategy. But with such a concentrated position, coupled with the asset’s inherent volatility, could MicroStrategy’s bond for bitcoin come unstuck?

Like many other firms, the depressed macroeconomic environment ushered by Covid took its toll on the company. In Q1, MicroStrategy (MSTR) saw 36% wiped from its stock, as it fell in tandem with the broader market.

In Q2, to offset and counter losses, the company devised a new capital allocation strategy.

Within its quarterly earnings call, Microstrategy pledged to invest up to $250 million in one or more investments, including stocks, bonds, gold,  and “digital assets such as bitcoin.”

By August 11th, that strategy had been put into effect. But, instead of diversifying into a variety of assets, the firm opted to swap out a quarter of a million dollars for 21,454 BTC.

Following the announcement, MSTR rallied over 16%—signifying that investors were on board with the strategy.

Source: Yahoo Finance

As for the rationale, MicroStrategy argued that between global quantitative easing, and a looming inflationary environment, bitcoin’s hard-coded fixed supply provided a more reliable store of value and a higher appreciation potential than fiat alone.

Over the next few months, the company doubled down and stashed a further $226 million in bitcoin.

The brazen strategy was a triumph. With a purchase price of $475 million, and the firm’s bitcoin fund worth over $700 million as of writing, MicroStrategy has managed to capture an ROI of 65% since August—not to mention the advance on company shares.

And now it’s looking to double down again.

Is MicroStrategy facing a concentration risk?

On December 9th, MicroStrategy announced a follow-up to its bitcoin spending spree. Rather than digging into its cash reserves, the firm plans on selling $550 million in convertible senior notes to add yet more BTC to its balance sheet.

On the day of the announcement, MicroStrategy closed down 14% on near-record volumes, signifying that shareholder’s appetite for risk only goes so far. 

And it’s no wonder. Another $550 million investment would push MicroStrategy’s exposure to bitcoin beyond the $1 billion mark—meaning the firm’s bitcoin strategy would account for over a third of its current $2.6 billion market cap.

It wasn’t just investors raising concerns either; Citibank analyst Tyler Radke lowered MSTR from “neutral” to a “sell” recommendation. According to Radke, the downgrade was due to the firm’s “disproportionate focus” on bitcoin.

The issue seems to boil down to bitcoin’s identity crisis.

For many, bitcoin represents a store of value akin to gold. For others, it’s a medium of exchange. Arguably it represents both.

However, because of its volatile nature, bitcoin isn’t what investors imagine when they envision a safe-haven asset. Yet it’s long-term price trend says otherwise. Even Citibank themselves recently analogised bitcoin’s 2020 rally to that of gold in the 1970’s—forecasting BTC to surpass $300,000 by the end of 2021.

Regardless of the bullish sentiment, no-one, company or otherwise, should underestimate the risk of over-exposure.  Should bitcoin slide to the downside, MSTR shareholders—who may not be as accustomed to bitcoin’s volatility as cryptocurrency investors—may hastily jump ship. Therefore, it’s not just MicroStrategy’s value that will suffer, but its reputation too.

Why diversification matters

At present MicroStrategy represents a high risk-high reward venture, but if the firm reduces its reliance on bitcoin, it needn’t be too risky.

Modern Portfolio Theory (MPT) dictates that assembling a portfolio from several non-correlated assets, regardless of the risk each brings to the table, can lessen exposure to risk and do so without diminishing returns.

Moreover, studies have shown that the optimal allocation to bitcoin stands at 6%, after which a portfolio’s Sharpe ratio—a metric gauging the return of an investment compared to its risk—starts to decline as exposure is scaled, making for a riskier venture.

It isn’t only bitcoin’s volatility to consider. The cryptocurrency market, as diverse and pluralistic as it is, holds huge opportunities outside of the bitcoin niche. For illustration, while the headlines have been captivated by BTC this year, Ethereum, the second-largest cryptocurrency by market cap, has outperformed bitcoin by double—advancing 330% YTD, while bitcoin mustered a 146% advance.

MicroStrategy’s move may have acted as a green light to the corporate and investment sectors, but it also functioned as a warning. Overexposure to any asset, no matter how innovative, can pose an acute risk.

Identifying these risks is one of the core tenets of the Evai ratings system. The platform will allow investors to curate their own analytics dashboard built around the metrics that matter most to them. Evai will then render an automated rating tailored for each asset and every investor.

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Disclaimer: Opinions expressed in this article do not constitute investment advice from Evai

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