코인톡

[Corrected] Digital Credit Cost of Capital - Update #1

(I published a version of this post previously but it contained an error egregious enough that it seemed prudent to remove)

This week's update includes some major additions to the calculation of the Digital Credit cost of capital, and it has some interesting implications.

These modifications address the two following concerns:
1. Cash reserve
2. Equity compensation dilution

The first, the cash reserve, needs to be accounted for since it reduces the exposure to Bitcoin. To account for this, all one needs to do is determine the proportion of raised capital deployed to Bitcoin instead of the cash reserve, and base the cost of capital on that (i.e. bitcoin_deployed / annual_dividend).

The second, equity compensation dilution, is an indirect cost to the common holder, who experiences the entire burden of the cost of capital. Since equity dilution pays for preferred dividends, it is reasonable to consider any other dilution (e.g. equity grants) as a fungible cost to the common holder for this purpose.

There are two types of equity compensation dilution:
1. Fixed equity comp dilution
2. Bitcoin-per-share performance-based equity comp dilution

@strategy and @Strive opt for the first, meaning the equity compensation dilution is baked in at a fixed number of shares (or a fixed rate, which is how I have it modeled). @BitcoinTCAB decided on a more novel, performance-based dilution, where equity comp is determined by the company's ability to increase bitcoin-per-share.

Now, you can (and should) take a look through this spreadsheet and make note of the impact these factors have on the "net cost of capital" at the bottom of the sheet. But I want to point out a few things. The cash reserve has a material impact on the cost of capital. Yes, it makes the preferred equity more durable (in theory), but the common holder needs to be aware of it; and if taken to its logical extreme, where the cash reserve is 50% or more of the raised capital, the cost of capital blows up. Since that would make the common stock less durable, it paradoxically would make the preferred less durable. So there is a balance that must be struck, and it seems like all three companies have found a reasonable spot.

The other thing to make note of is that equity compensation dilution has a substantive impact on the cost of capital. And as it stands, it raises Strive's net cost of capital (from the perspective of the common shareholder) by 2.5pp to about 21.8%. The large amplification/leverage is doing a lot of lifting to minimize the impact of equity compensation dilution - if amplification were at 30% instead, the incremental cost of capital would be 5.7%.

I think what this shows is that Strive could to commit to a more conservative equity compensation structure going forward (or perhaps a "net" bitcoin-per-share performance-based one - as you will see explained below). This of course is quite a big ask in one sense, but in another it is also a compelling change; a potential reduction to the cost of capital of 2.5pp (or 5.7pp amplification is a more modest 30%) is an opportunity to increase the pool of potential common stock holders - it increases positive expected value by both decreasing costs to the common shareholder as well as increasing demand and the chance at reflexivity.

Now on to the topic of the other company purely capitalized from preferreds (and no debt): Bitcoin Treasury Capital.

@BitcoinTCAB has a "gross" bitcoin-per-share performance equity compensation structure; 20% of the gross BPS increase is realized as equity compensation for management (the only compensation that management receives). This has the not-so-great effect of increasing the cost of capital to the common holder by 25%. @BitcoinTCAB could easily negate that effect by committing to a "net" bitcoin-per-share performance structure, and then they would have the lowest Digital Credit cost of capital.

And I think that choice is a no-brainer; the pool of interested customers at a 12.5% cost of capital is going to be much larger than the pool at 15.6%. So management, who are holders of common stock themselves, are not only increasing the cost of capital they are exposed to (granted, they get it back in compensation) along with their shareholders, they are reducing the potential pool of common stock customers, all just to have exposure to Bitcoin upside under 12.5% CAGR.

If @BitcoinTCAB committed to a "net" BPS performance structure, they could not only have the lowest Digital Credit cost of capital, they would also send a strong message of their bullish outlook on Bitcoin and confidence in the common shares of their own company, and by increasing the potential pool of customers, increase positive EV and the chance at reflexivity.