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Coins coins coins! First US automaker Tesla announced it was purchasing $1.5 billion (£1.1 billion) worth of bitcoins on Monday. Then social media company Twitter’s Chief Financial Officer told a US television interviewer that Twitter is also considering moving some of its cash holdings into bitcoin. Now financial commentators we follow on both sides of the Atlantic Ocean are theorising many more companies could move part of their financial reserves into bitcoin. Most are focused on what this could mean for bitcoin’s price, and we have seen several cite it as a potential positive driver. However, we see this as a potential way that euphoria in cryptocurrency markets could spread to mainstream equity markets and—potentially—sow the seeds of the next equity bear market. Let us explore how this might work.
Bitcoin and its fellow cryptocurrencies, for those who haven’t followed the hype in recent years, are digital currencies that are not created or controlled by governments. Many are not backed by gold, hard currency or other tangible assets, and their value at any time depends solely on what buyers are willing to pay (and sellers are willing to accept). Their unique advantage, according to many of their proponents, is they have strictly limited issuance, making them scarce, and their use of a digital ledger called the blockchain, which records all past transactions and prevents counterfeiting. Some financial commentators see them as a commodity akin to gold or silver. Others tout cryptocurrencies as the future of money. And still others see them as purely speculative securities. We aren’t here to opine on any of this—this is simply the background.
In recent months, we have observed some publicly traded companies signalling their support for bitcoin’s use as money by moving some of their cash reserves (known formally as treasury assets) into bitcoins. One, a software company called MicroStrategy, has about $3.2 billion (£2.3 billion) worth of bitcoin, which represents more than one third of its a $9.0 billion (£6.5 billion) market capitalisation (a measure of a company’s total market value, calculated by multiplying share price by the number of shares outstanding).[i] It also just held a conference for businesses in swapping their cash stockpiles for bitcoins, arguing cryptos are a superior corporate treasury asset.
Payment processor Square owns about $212.8 million (£154.0) worth of bitcoins, but its market cap tops $100 billion (£72.4 billion), making its bitcoin holdings rather insignificant to its total balance sheet.[ii] Tesla’s market capitalisation exceeds $1 trillion (£723.6 billion), so $1.5 billion (£1.1 billion) worth of bitcoins is likely also less significant to its overall fortunes. But if more companies take more significant stakes, then corporate finances would likely be increasingly vulnerable to bitcoin’s swings. This could prove problematic, as bitcoin has been quite volatile in its short history, with large daily price swings and significant periods of boom and bust.[iii] Therefore, if Twitter’s public flirtation with bitcoin kicks off a frenzy amongst corporate treasurers, we think the situation will deserve close scrutiny.
For illustrative purposes, let us explore how this might enable a bitcoin crash to spill over into equity markets. In our view, based on all of this week’s chatter, it isn’t far-fetched to envisage a scenario where companies pile onto the bitcoin bandwagon en masse. Theoretically, they could get caught up in the speculative mania on the upside and get burned by a crash, which could hammer corporate balance sheets, taking equity markets with it.
US accounting rules could play a critical role here. As one Bloomberg analysis explained this week, American rules treat bitcoin not as a financial asset, but as intangible property.[iv] As such, a company that buys bitcoins must initially account for it at the cost of purchase, then write down the value of their holdings to market value if the price falls. However, once the value is written down, companies aren’t allowed to write the value back up even if bitcoin’s market value rises. Companies can realise the recovery only if and when they sell. So, in simple terms, if bitcoin’s value falls below a company’s purchase price, they are required to record a paper loss. That loss can turn into a profit only if they eventually sell at a gain, which is of course not guaranteed. As Bloomberg reported, Microstrategy has already taken several such writedowns.
If a critical mass of companies is eventually forced to take similar paper losses, it could damage earnings and corporate balance sheets alike, forcing companies to make cuts in order to reduce costs. That could frustrate investors who have been banking on continued expansion and profitability, driving share prices down. In an extreme case, investors could punish any and all companies owning bitcoin, much as they punished financial institutions indiscriminately in 2008.
Note, we aren’t saying this is likely. It is far from close at hand. Holdings in the single-digit billions of pounds pack little punch to the world equity market, which weighs in at £38.7 trillion in market capitalisation.[v] But our research shows bear markets generally emerge where no one is looking, which requires monitoring even far-fetched risks. So what if bitcoin bubbles spilled into equity markets? is one thing we think about, and this is one realistic way it could happen, should a considerable number of additional companies plough treasury cash in.
We don’t consider this reason for long-term growth investors to flee equities now, of course, or to base buying and selling decisions on whether the company has a stake in bitcoin. We think markets move on probabilities, not possibilities. But as sentiment keeps heating up and euphoria eventually spreads from niche assets like cryptocurrencies to the equity market mainstream, we think it will be increasingly critical to assess what creeping negatives the masses are overlooking. In our view, corporate bitcoin holdings might be one thing to add to your potentially ignored risk checklist.
[i] Source: FactSet and bitcointreasuries.org, as of 10/2/2021.
[iii] Source: FactSet, as of 10/2/2021.
[iv] “Elon Musk’s Bitcoin Bet Is a Bean Counter’s Nightmare,” Chris Bryant, Bloomberg, 9/2/2021. Accessed via Tech Central, https://techcentral.co.za/elon-musks-bitcoin-bet-is-a-bean-counters-nightmare/104871/.
[v] Source: FactSet, as of 10/2/2021. MSCI World Index market capitalisation in USD, as of 9/2/2021.
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