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I went to write one of our othlots newsletters recently, and I was going to write about micro-strategy, and I had this idea. I was going to call it micro-strategy's infinite money loop. Then I was researching on the terminal, and I stumbled on a bunch of Matt Levine columns where you actually titled it cryptos perpetual motion machine. Then I thought, well, I'm not even going to try to compete with Matt. I'm just going to ask him to come on the show and explain it to us. Many such cases. Many such cases, but at least he'll come on the podcast.
So here we are with Matt Levine, who is, of course, the author of the Money Stuff column, but also the cohost of the new Money Stuff podcast. That's pretty new. You're old. I can't think of you. It's two months old, but it was the year. Yeah. It's like nine months ago. I always think 2020 was two years ago. Time is a flat circle. Matt, what is micro strategies perpetual motion machine?
MicroStrategy, I keep saying Professional Motion Machine, I think I'm kidding. I keep hoping that I'm kidding. MicroStrategy is a pot of bitcoins that issue stock, and the stock trades that call it two times the value of the pot of bitcoins. If you have that situation, you sell more stock to buy bitcoins.
Because like classically, that's an arbitrage and you close the arbitrage, right? You sell stock that brings down the price of your stock. You buy bitcoins that brings up the price of Bitcoin. Eventually, you get to the point where you're stuck and the value of the underlying bitcoins is the same. You're like, it never gets any closer. So it keeps like more stock and buying more bitcoins and it keeps driving the value of the company up. And so they keep getting more and more valuable.
They have an asset, so to speak, that's not Bitcoin and that asset is the ability to get like non-margin callable leverage, right? So, I mean, like, like if I wanted to borrow Bitcoin or borrow money to buy Bitcoin, I could, but there was a chance that Bitcoin goes down tomorrow. They asked for my money back and I'm homeless. So this is a thing that they say and that has some truth to it, but
This is not a levered way to buy Bitcoin. And the way you know that is that the market cap of the company is 2x the value of its Bitcoin. So it's like an anti-levered way to buy Bitcoin. If you put $2 into mega strategy, you get that $1 Bitcoin, which is the opposite of leverage.
No, it's true. And they do have the ability to, they're right. They've sort of touted this as their strategy. We are a better master for buying Bitcoin because we can get leverage. They do a lot of convertible bonds. I don't think I have a ton of just regular, non-marginal leverage, other than the converts. But yeah, that's a theoretical case. It's just not true as a matter of pricing.
Wait, the convertible bonds are actually what like initially caught my eye because I think they issued at like one of the recent ones, 0% with the conversion premium of 55%. And that's like already when the stock is trading at this massive premium to the value of its assets. And so I, you know, usually the higher the conversion premium and the lower the coupon, the less attractive that would be for investors, but clearly people are buying this stuff because they keep doing it.
Yeah, like a convert is just like, you just plug into a model, right? Like, well, sorry, I'm taking a step back. Actually, you do explain convertible arbitrage to me. So there's two things, there's convertible arbitrage. There's also a lot of like fundamental investors. You think about like a micro-shadow you convertible, never mind convertible arbitrage. There are people in the world who run, I don't know, fixed income funds who run, you know, like,
convertible fundamental funds who run various sorts of funds who make up in the morning thinking, I want to buy some Bitcoin and they can't because their mandate doesn't include Bitcoin. It might not even include micro strategy stock or micro strategy stock might be too rich for them, but they like they can buy a fixed income product that has some Bitcoin upside. They're like, yeah, that's great. So part of the investment thesis for these bonds and there's like a lot of these bonds is something like that. It's like, this is a way to get Bitcoin upside with downside protection.
But the convert arbitrage strategy is, this is the way to get micro-strategy volatility and micro-strategy is so volatile, in part because it's crazy, but in part because of like technical factors involving the ETFs. And so convert arbitrage is just an options trading strategy, like you're buying call options on micro-strategy and call options are more valuable, the more volatile the company is, more volatile the stock is. And this is a very, you know, has like a hundred percent annualized volatility.
And what you're doing is you buy a convertible, you sell some stock to hedge, and you adjust your hedge over time as the convertible gets more or less in the money. And the way you do that is basically every time the stock goes up, you're selling more stock to get shorter. And every time the stock goes down, you buy back stock to reduce your hedge. And if the stock is constantly bouncing around, you're constantly buying low and selling high and making a lot of money.
So it's a good volatility trade. And those convertible terms, it's like zero is up 55, is like that sounds outrageous, but you plug it into the model and you put in 100% volatility and that's cheap. And so people want to buy it. Joe, I didn't realize this until recently, but if you go and look at some of MicroStrategies earning presentations for Q1, Q4. I should check those out. They actually have slides on there that are basically like boasting about how volatile the stock is. Have you seen these, Matt?
I think so. Yeah. It's like MSTR is more volatile than any other S&P 500 stock. There's another one. They're marketing the volatility as a selling point. They know what they're doing.
This is important. They're sort of using every part of this strategy to raise money. They're really thoughtful about it, and selling lots of volatility is very helpful to them. And the point about the ETFs is convert investor buys low sales high. Every time the stock goes down, you have to buy back some stock, every time the stock goes up, you have to sell some stock. That is, you're profiting from volatility.
but you're also damping volatility, right? Because then the stock goes down, you're buying. So if you issue a lot of convertibles, you dampen the volatility in your stock. Micro strategy doesn't have this problem because they also have these levered ETFs, which so much increase the volatility of the stock. Because a levered ETF, every time the stock goes up, they have to buy more stock. Every time the stock goes down, they have to sell stock. And so the levered ETF is like jacking up the volatility, which is part of why the stock is so volatile.
So it is a perpetual motion machine. It's all, no, I don't care. The thing that I don't understand is the premium of stock. Like the volatility, like, yeah, like that works, right? The volatility trade is a good trade. The stock, like, why is the stock worth twice the value of the underlying big guys? I don't know. Yeah, that's weird. A big crash in Bitcoin would be really bad, right? And that's very possible because it's crashed many times in its history.
Yeah. Your guess is as good as mine about what that does to the premium. If Bitcoin goes down by 50%, does this stock go down by 50% because it goes down by 90%?
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Could I start my own perpetual money-making machine where I just have a pot of something and then I try to make my stock as volatile as possible? Maybe I just say stuff. I'll come back and constantly. Please do it. Companies are trying. No one's at this scale, but a lot of companies have looked at this and said, we should do that. Some of them should do it. Some of them do it like Dogecoin. You can have other
Who isn't it? There's like random like kind of positive kind of stuff. Yeah. I wrote about a half-choking crypto thing that's doing it called, you know, there's like a crypto called the Fartcoin. And there's a Fartcoin strategy. Yeah, it was like company. Yeah. And this can replicate it on chain. So, yeah. Sure. Yeah. Well, it can, like the mechanics can be replicated on chain. I don't know. I mean, you can sort of sell anything, but like, I think part of the premium here comes from
being a real corporation, right? I mean, one thing that's like attractive about micro strategy, like they're trying to get into the S&P 500, which is a fascinating, like, that turns on a change in the accounting rules that allow for them to take to account for their Bitcoin gains as profits. I didn't know that. Yeah. So like, they may not get into this in the anyway, but like,
They've not been profitable enough to get into the S&P, but the Bitcoin gains, they've had Bitcoin gains last time, and that will become accounting profit from them.
I want to ask you a question that touches on one of Tracy's favorite topics, and it's actually a little bit adjacent here. What would be the problem of just having an index that's just, these are the 500 biggest companies. Is there any, like, what's better about having an S&P that sometimes has some discretion versus just, like, here are the 500 biggest companies in the world, in the US, whatever? In this immediate case,
Like, what is a company? Like, is Spy a company? Oh, interesting. Because like, this is an ETF, right? I mean, like, arguably, this is an ETF, right? It's in the trappings of a tech company. But like, if you said the biggest company as well, you know, like, is it S&P 500 fun? Yeah. A company. But away from that, no, I mean, like, people definitely have very rule-driven indices. I think part of the appeal of the S&P is
It's a product that's sold to fund managers. If every fund manager says, I don't want to own, for a while, a lot of indexes were excluding dual class stocks because fund managers would call the index providers and say, we don't want to own dual class stocks. We're bound to buy the index, so take them out of the index. Then they changed their mind because all the dual class stocks were doing well, and so they had to put them back in the index. It's just a market driven thing. If people want a certain index, they get that index.
There's nothing wrong with having the top 500 companies be the index. Like nowadays, everyone has started custom indexing as well, right? So like, if you don't like the S&P 500, you can just ask for your own index. And that's why there's a billion indexes now. The other thing I saw was there was a Bitcoin miner. I think it was called Mara or something, Mara Holdings. And they said they were going to issue converts basically to do the same thing as micro strategy. So it's almost like, is this going to be like an asset class, a thing that stays with us?
Yeah, the people in the convert market talk about being saturated with.
with crypto converts, right? If you drop as a convert investor, you're like, I can't have nine percent of my portfolio in crypto, right? In part, because you think about the volatility and the technical aspect of making money on trading the volatility, that depends on the credit being good. And no one really knows the credit here, right? If there's a big crypto crash, all of these credits in a very correlated way become terrible. And so your whole asset class falls apart.
Prior to all this, what was the canonical use case of who and why issue converts? Oh. I seem to remember energy companies. Energy do a lot. I mean, the canonical case is tech, biotech, but a lot of energy too. It's companies that are volatile, companies that often don't want to get credit ratings, companies that what you're selling is
In some sense, equity upside and in some other sense, equity volatility, and that's more attractive to convert it. There are companies that have attractive equity volatility and not such attractive credit to traditional credit investors, and so they can do that trade rather than issuing bonds.
You have a deep-seek take? Oh, yeah. Deep-seek. Yeah, various takes. My main take was, I wrote today, like, your old take. I saw my main. You know, the way to monetize deep-seek was short in video. This is very incestuous. It's just like all three of us are referencing each other. I would say at my old blog at thestower.com in like 2000.
This was when, you know what I thought about this? When Google introduced sheets or when they came out with their Excel competitor, I was like, some companies should start doing this when they short Microsoft. For some reason, sheets never really took off and became an Excel competitor on a real level. But back when there was so much free web 2.0 software, I thought, give out free software in short or competitor. Anyway. Yeah. I mean, there's no evidence that deep-sink that would be cool if they did.
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Donald Trump has already changed the way we think about the US economy. Now he's back in the White House, and Bloomberg's Trumponomics podcast is here to help. I'm Stephanie Flanders, head of government and economics at Bloomberg. Whatever the big question of the week is, we'll have something interesting to tell you about it in a lively conversation with the reporters and analysts closest to the action. Listen to new episodes every Wednesday and follow Trumponomics on Apple Podcasts, Spotify, or wherever you listen.