In terms of borrowing to buy Bitcoin, MicroStrategy is an experienced player, while newcomers like Bitcoin mining companies and Semler may find themselves facing greater risks.

Written by: Tom Carreras, James Van Straten, Stephen Alpher

Translated by: BitpushNews

Have Michael Saylor and MicroStrategy (MSTR) discovered a financial "loophole" for making money?

It's hard to blame people for thinking that way.

Although the company led by Saylor started purchasing Bitcoin (BTC) over four years ago, in the past 10 months, MicroStrategy has raised over $6 billion using a unique strategy aimed explicitly at increasing more Bitcoin on its balance sheet. As of December 15, the number of Bitcoins on its balance sheet reached 439,000, valued at $46 billion, with the current price around $106,000.

MicroStrategy did not raise these funds through loans or issuing more company stock (although it has separately issued billions of dollars worth of stock). Instead, the company sold convertible bonds—debt securities that can be converted into stock on specific dates or under special conditions. And it doesn't stop there: according to a plan set in October, Saylor and the company intend to raise at least another $18 billion through such bonds over the next three years.

The demand for these convertible notes is so high that other companies, including Bitcoin miner MARA Holdings (MARA), have also adopted similar practices, raising billions to bolster their finances.

But this raises a question: will issuing so much debt ultimately pose a danger to these companies and the entire cryptocurrency market?

Quinn Thompson, founder of the crypto hedge fund Lekker Capital, told CoinDesk: "If Bitcoin prices remain low or decline for an extended period, [these companies] may have to issue more stock to raise funds, which would dilute existing shareholders' stakes… [or] sell Bitcoin at prices below their purchase price." However, Thompson believes these companies will not go bankrupt.

How Convertible Notes Work

Convertible bonds are a financial instrument that helps companies raise funds quickly without providing collateral (like loans) or immediately diluting their stock. The pricing of these bonds is based on the interest rate they carry, the underlying stock of the company, the volatility of that stock, and the company's credit quality.

For example, in November, Bitcoin mining company Bitdeer (BTDR) raised $360 million by issuing convertible bonds with a 5.25% interest rate. These bonds will mature on December 1, 2029, priced at $15.95 per share—about 42.5% higher than the trading price of those stocks when the convertible bonds were issued on November 21.

In other words, investors do not have to simply buy the company's stock on the open market; they can earn substantial returns by holding these notes while also benefiting when the stock price surges. Even better, convertible notes also have a downside protection feature. On specific dates, such bonds can be redeemed for cash, amounting to the original investment plus interest. In other words, even if the stock plummets before the notes mature, investors can almost guarantee the return of their funds.

But MicroStrategy's situation is quite unique, as the company has found that despite the U.S. benchmark interest rate being close to 5%, there is still demand for 0% interest convertible bonds. Why? Because of volatility. MicroStrategy's common stock is essentially a leveraged play on Bitcoin, with a recent 30-day average implied volatility of 106, even higher previously. In contrast, the implied volatility of the S&P 500 index is typically around 15, while Bitcoin's implied volatility is 60.

Stock volatility affects the price movements of MSTR convertible bonds, and experienced market participants can earn substantial profits by trading this volatility in a market-neutral manner.

Richard Byworth, a convertible bond expert and managing partner at asset management firm Syz Capital, stated in an interview on the On The Margin podcast that he had spoken with a convertible note arbitrage trader.

This trader described his current frenzied work state, saying, "Richard, I've turned into a 'Degen' trader in crypto… it's so crazy that if I don't adjust all my deltas (Greek letters used to describe the sensitivity of option prices to other factors) while I'm in the bathroom, I could come back to face millions of dollars in risk; the market moves too fast."

Thus, the demand for MicroStrategy's convertible bonds is enormous, allowing the company to sell a significant amount of bonds—issuing five times in one year, which is unprecedented.

As of now, the company has six outstanding convertible bonds, maturing between 2027 and 2032. Two of these have a 0% interest rate, two others have 0.625%, the fifth has 0.875%, and the last one has 2.25%. Due to these very low interest rates, MicroStrategy can sell stock at prices far above the current stock price while only paying an average debt interest rate of 0.811%, or $35 million annually, an amount easily covered by the company's revenue.

Greg Magadini, director of derivatives at crypto data company Amberdata, told CoinDesk: "If implied volatility remains high, I bet MSTR will sell more and more convertible bonds… this means they will buy more and more Bitcoin. For me, the first sign of a Bitcoin rebound 'TOP' will coincide with a decline in MSTR's implied volatility."

The Convertible Bond Craze

In addition to the aforementioned Bitcoin mining companies, there is also the medical device company Semler Scientific (SMLR), which announced its Bitcoin financial strategy at the end of May. While the company has so far only used cash on its balance sheet and funds raised through stock sales to purchase Bitcoin, its stock received options in the market on Tuesday, making bond issuance more attractive to investors and traders seeking debt yields similar to MicroStrategy's.

According to MinerMag, from June to December 5 alone, Bitcoin miners took on about $5.2 billion in debt. Some convertible notes issued by companies like MARA and Core Scientific have a 0% interest rate, while others like Bitdeer, IREN (IREN), and TeraWulf (WULF) issued these notes at rates ranging from 2.75% to 8.5%.

However, not every company adopts this strategy for the same reasons. MARA and Riot Platforms (RIOT) are following MicroStrategy's lead, using the proceeds from convertible bonds to increase more Bitcoin on their balance sheets, while companies like Core Scientific aim to use the funds to cover operating expenses, capital expenditures, and potential acquisitions. Meanwhile, Bitdeer stated that its goal is to further develop its mining equipment manufacturing business.

There’s Always a Maturity Day

However, convertible bonds are not free money. As mentioned earlier, once the bonds mature, holders can decide to convert them into stock at the agreed price per share or redeem them for cash if the stock performs below expectations.

The danger lies in the fact that these companies' stock prices could significantly decline for an extended period, incentivizing holders to redeem the notes for cash rather than stock. For MicroStrategy, this could force the company to sell some Bitcoin assets to repay investors, while Bitcoin mining companies might be compelled to sell various mining assets. In the worst-case scenario, these companies could ultimately face bankruptcy.

Forced sales of Bitcoin are not necessarily the end of the world, at least as long as the company's average purchase price is below its selling price. For example, MicroStrategy's reserves were acquired at an average price of $61,725 per Bitcoin, giving the company some breathing room. The problem is that it is well known that Bitcoin can drop 80% every few years. Just this year—in the middle of a bull market—the price dropped nearly 40%, so there is no guarantee that BTC will never fall below MicroStrategy's average purchase price.

Even so, MicroStrategy's bonds are staggered in issuance, meaning they have different maturity years. This reduces the company's risk, as it does not need to repay all its debt at once. In other words, Bitcoin and MSTR need to remain in a prolonged slump for the company's situation to become truly dangerous. Most of MicroStrategy's bonds have already met conversion requirements, which is another advantage for the company, and it can always choose to extend its debt by issuing new convertible bonds, even if the terms of those bonds are less favorable.

In a sense, when it comes to borrowing to buy Bitcoin, MicroStrategy is an experienced player, while newcomers like Bitcoin mining companies and Semler (if it indeed chooses to issue bonds) may find themselves facing greater risks as they take on significant debt near the potential market cycle top.

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