Bitcoin-Backed Securities Under Scrutiny

A recent analysis has shed light on the risks associated with certain bitcoin-backed securities, specifically Strategy's preferred stack, STRC, and SATA. These securities are being marketed to bitcoin holders as a safer, smarter way to access bitcoin exposure, with promises of tax-favored, 11.5% income, and a money-market-like risk profile. However, a closer examination of the capital structure reveals a different story.

STRC is an unsecured, subordinated, perpetual preferred equity with no maturity date and no lien on Strategy's bitcoin treasury. The dividend is discretionary, meaning the board can cut it at any time without notice or remedy. This information is not disclosed in the marketing materials, which instead emphasize the security's supposed safety and attractiveness.

The reality is that STRC is a speculative-grade credit-like product dressed in safe-income marketing. The funding mechanism is reflexive, relying on the issuance of new shares to pay existing holders, which creates a self-sustaining loop that can break if the price of STRC falls. This has significant implications for the 82.7% of retail buyers who hold $8.8 billion worth of STRC, concentrated in a single junk credit.

The structural risk in STRC is not just the high dividend, but the fact that it cannot be funded out of the business. Strategy's underlying software business produces $477 million in annual revenue, while total preferred dividend obligations exceed $1.2 billion, a ratio of 3.5 to 1. This gap is closed by issuing new STRC shares at or above par, or diluting common shareholders, which creates a vicious cycle that can lead to a rapid decline in the security's value.

The standard defense of the Digital Credit category is that informed institutional capital is on the other side, but the math tells a different story. Each monthly increase in the dividend rate makes the funding gap wider, the share issuance more dilutive, and the price floor harder to hold. This creates a situation where the mechanism designed to keep STRC attractive to new buyers is the same mechanism that compounds the burden on the issuer and accelerates the run on the funding loop when stress arrives.

The implications of this are far-reaching, with potential consequences for not just retail buyers but also institutional investors and the broader market. As the use of technology-driven automation and workflow transformation continues to grow in the finance industry, it is essential to examine the risks and benefits of these innovations and ensure that investors are adequately protected.