leverage risk of encryption treasury companies

In the article the day before yesterday, I shared the history of Evergrande's collapse ultimately triggered by debt risks. Some readers associated this history with the similar risks that some listed encryption treasury companies may currently face.

A couple of days ago, Vitalik also mentioned this risk in his Twitter comments. This risk is indeed very concerning, even though it is not an apparent risk at the moment. However, I am always a bit worried that these companies' increasingly aggressive operations might trigger this risk in the future.

The book "Classic Cases of Value Investing: China Evergrande" was published at that time to prove the author's firm optimism about Evergrande.

In order to prove this "steadfastness", the author detailed the debt risks of Evergrande at various stages as assessed by various investment banks and institutions in the market at that time, and thus used this to demonstrate his continued optimism towards it.

Today I read this book, and my focus was not on its conclusions, but rather on the series of risks listed within the book-----these risks are in fact more valuable historical clues.

All these risks can be summarized as:

Evergrande's approach is to finance through public listings, issuing new shares, issuing perpetual bonds, and mortgaging assets, while trying to extend the payment period for the tail payments and making multiple installments to delay payments.

Why do this? To pursue scale. What is the result? It becomes trapped in a debt trap and cannot extricate itself.

In order to mask this situation, Evergrande is aggressively borrowing money to buy back stocks and inflate stock prices on one hand, in order to stabilize investors' confidence; on the other hand, it is aggressively diversifying and creating a strong company image to showcase the company's strength.

This series of actions seems to have repeatedly "blown up" short sellers and "countered" the bearish critics, captivating a large number of domestic investment banks, brokerages, and investors.

On the contrary, well-known overseas investment banks (such as Goldman Sachs) have remained exceptionally clear-headed, completely uninterested in these practices, and have been closely monitoring the deteriorating debt and cash flow.

Looking back at this history, it is actually very simple to pierce through the surface of such enterprises and get to their core:

It is about judging with common sense.

What common sense?

Is everything it does weakening its core business? Is it increasing debt? Is it reducing free cash flow? Is it making the company's operations increasingly tense? Is it making it more difficult for the company to cope with changes in the external environment?

Anything else that appears (rising stock prices, grand advertisements, ubiquitous celebrity effects...) is all just temporary and does not play a decisive role.

We can also use this set of standards to measure the status of those listed encryption treasury companies.

These companies' current approach is to purchase encryption assets through financing. There are basically three ways they finance: issuing stocks, issuing convertible bonds, or directly issuing bonds.

Among these three financing methods, the risk of financing through issuing stocks is relatively controllable, while the risk of direct borrowing is worth paying attention to.

Because once a company's debts can no longer be covered, they will inevitably be forced to sell their held encryption assets to repay the debts. And once this selling occurs, the encryption assets may trigger a chain reaction.

So to assess whether these companies are at risk, I look at whether their free cash flow can support the operation of the business and whether it can cover the debt risk of the company.

For companies that purchase Bitcoin, since Bitcoin does not earn interest, this part of the business that holds Bitcoin does not generate cash flow. For companies that purchase Ethereum, the staking of Ethereum currently offers around 3% to 4% staking returns, so the held Ethereum can generate some cash flow through staking.

Compared to these two types of companies, those that hold Ethereum seem to have cash flow and lower risk. However, I actually think that its hidden risks may be greater.

Because the price of Ethereum will have a leveraged effect on staking returns: when Ethereum rises, holders enjoy fixed staking returns while also benefiting from the appreciation of the "local currency".

This effect itself can easily provoke the operator's greed and complacency, and if the operator is not sufficiently principled and is very aggressive, it becomes very dangerous.

MicroStrategy currently has some debt, which indeed poses certain risks. However, there is another company within the Ethereum treasury that is more worrisome. That company loudly claims that its goal is "to hold 5% of Ethereum."

Seeing this goal, I am reminded of a saying by Duan Yongping (the gist is):

He will avoid companies that set goals like "becoming one of the Fortune Global 500" or "achieving revenue of XXX."

Because the company's goal is not numbers, but to serve customers and the end consumers. "Becoming one of the Fortune 500" and "achieving revenue of XXX" are all naturally accomplished in the process of serving customers and consumers. If we can do it, we do it; if we can't, that's okay. In his view, any company that does not aim to serve customers and consumers is not a proper company.

I completely agree with this viewpoint.

I can't determine whether that goal of the Ethereum treasury company counts as serving customers, but I always feel that the goal sounds very awkward.

To achieve that goal, this company has taken significant actions recently. For example, its next move is to issue stocks, and the amount it plans to raise exceeds several times its current market value.

If it's just issuing stocks to raise funds to buy Ethereum, the risk is manageable. However, I am very concerned that under the motivation of such "exciting" slogans, it could become overly ambitious, further pursuing scale and leading to debt, constantly increasing leverage.

And when it is overwhelmed by debt and has to sell off its assets to pay off the debt, it will be a disaster for the entire encryption ecosystem.