Fidelity: Why Corporate Treasury Should Consider Bitcoin

Written by Ria Bhutoria and Tess McCurdy, both from Fidelity Digital Assets

This year, we have witnessed a new trend of corporate treasury allocation to Bitcoin. MicroStrategy Incorporated (MSTR) has made Bitcoin its main asset reserve, buying 38,250 Bitcoins for $425 million between August and September 2020.

Square, Inc. (SQ), which supports the buying and selling of Bitcoin through Cash App, has also taken similar actions. The company purchased $50 million worth of Bitcoin (approximately 4,709 Bitcoins) in October 2020. In addition, companies and institutional investors such as Stone Ridge, Mode Global Holdings PLC and Tudor Investment Corporation have also announced Bitcoin allocations this year.

One of the main responsibilities of corporate treasury is to manage the cash and liquidity of the company. Depending on the size of the balance sheet and the nature of the business, corporate treasury can hold a range of assets to manage risk and improve returns. In order to find a balance between risk and return, they must consider short-term and long-term liquidity needs, exchange rate changes, interest rate changes, macroeconomic environment and other factors that may affect their business. Traditionally, corporate treasury has been conservative in managing cash and has allocated most of its capital in low-risk assets (such as bank deposits, money market funds, treasury bills, commercial paper and repurchase agreements), but the changing economic environment may prompt treasurers to reconsider the feasibility of these strategies.

In this article, we examine the risks corporate treasuries face due to the coronavirus pandemic and historic fiscal and monetary policy expansions, and why they might consider allocating Bitcoin to their balance sheets.

Economic environment and its impact on corporate treasury

The lockdowns imposed to contain the pandemic, and the resulting job losses from the economic shutdown, have reduced cash flows for companies across multiple industries. At the same time, central banks and governments have cut interest rates to zero (or even below) and pumped trillions of dollars of stimulus into the global economy. These developments have led to reduced corporate profits, low yields on excess cash, and a potential depreciation in the value of cash and cash equivalents. As a result, common corporate treasury functions such as cash and liquidity management, operational risk management, and capital optimization face several challenges.

Cash Flow and Profitability

The pandemic has caused a shock to consumer demand, which has damaged corporate balance sheets, cash flow and profitability, leaving companies in a precarious financial position. In the second quarter of 2020, all 11 industries in the S&P 500 had net profit margins below expectations, and nine industries had net profit margins below the five-year average. The pandemic has caused cash flow to fall, making it particularly important to have excess funds and liquidity on hand, as well as "non-correlated" investments that are recession-resistant to better withstand the crisis.

interest rate

The world's largest countries have cut interest rates in an attempt to boost their economies through cheap credit in 2020. In the United States, the Federal Open Market Committee (FOMC) cut the federal funds rate by 150 basis points to 0-25 basis points, a sharp rate cut across the board. In the United Kingdom, the Bank of England cut its main lending rate twice from 75 basis points to 10 basis points after the second rate cut. The European Central Bank sets three key interest rates - the main refinancing operation rate, the marginal lending facility rate and the deposit facility rate - at 0 basis points, 25 basis points and -50 basis points respectively.

Low interest rates can be a double-edged sword for corporate treasuries. On the one hand, companies may borrow new debt or refinance existing debt at lower interest rates. On the other hand, companies with excess cash will be affected because they cannot earn attractive yields through traditional income-generating investments. In addition, companies sitting on large amounts of excess cash and low-yielding financial instruments may face shareholder pressure for holding unproductive funds. In an environment of record low interest rates and record high levels of money printing, sitting on large amounts of cash may destroy the real value of capital and therefore shareholder value over time, which conflicts with the need to set aside funds for crises.

Even those countries that have not cut interest rates below zero may face negative real interest rates (i.e., nominal interest rates minus inflation). For example, the U.S. Treasury daily real yield curve is currently negative for all bonds. Even the Bloomberg Barclays Investment Grade Corporate Bond Index had a real yield of only 0.2% as of mid-November 2020.

Money printing and potential inflation

The scale and coordinated nature of the monetary and fiscal policy response to the coronavirus pandemic are unprecedented. In two months, governments announced $10 trillion in stimulus packages, triple the amount during the 2008-2009 global financial crisis, according to a McKinsey study of 54 economies representing 93% of global GDP. In the United States alone, the Federal Reserve has pledged to buy unlimited amounts of government-guaranteed bonds (also known as quantitative easing, or QE) and, for the first time, has committed to buying billions of dollars in corporate bonds, including the riskiest investment-grade bonds.

Furthermore, during the global financial crisis, central banks such as the Federal Reserve printed money and gave it to banks, who used it to expand their reserves rather than create new loans, meaning that the money did not enter the broad money supply and circulate in the real economy. This time around, banks are well capitalized and governments are distributing newly printed central bank money directly to individuals and businesses. In the United States, for example, Congress passed the $2 trillion CARES Act, which directly provided fiscal stimulus and boosted the growth of the broad money supply (M2), from $15 trillion in February 2020 to $19 trillion in November. In contrast, the growth of M2 in the two years from January 2008 to January 2010 was less than $1 trillion. The Federal Reserve defines M2 as M1 (the sum of money held by the public and deposits with depository institutions) plus savings deposits, small-denomination ($100,000) time deposits, and retail money market mutual fund shares.

QE itself is not inflationary and most of it stays in bank reserves. But QE combined with large fiscal deficits is inflationary, which causes money to flow into the broad money supply and into the public deposits in commercial banks.
Lyn Alden, Founder of Lyn Alden Investment Strategy

While there are deflationary forces at work (job losses, lockdowns, supply chain disruptions, an aging population, and technological advances), the rapid expansion of the broad money supply as measured by M2, coupled with correspondingly loose monetary and fiscal policies, could create a situation where too many dollars are chasing too few assets and/or goods and services - in other words, inflation, and a more rapid decline in the purchasing power of money. Businesses would then be exposed to inflationary risks, as the purchasing power of cash begins to decline relative to the prices of goods, services, and investments.

Lyn Alden describes three types of inflation - monetary inflation, asset inflation and consumer price inflation (CPI). The presence of monetary inflation (an increase in the broad money supply as measured by M2) does not necessarily guarantee the presence of asset inflation (an increase in investable asset prices and valuations) and consumer price inflation (an increase in the price level of non-financial goods and services), but it is usually a precursor to the latter two.

Depending on the type of business, companies may be affected by asset price inflation and consumer price inflation to varying degrees. For example, asset price inflation may cause the value of assets that a company wants to invest in or acquire to increase, while consumer price inflation may cause the cost of inventory to increase relative to the purchasing power of cash.

Why Corporate Treasury Should Consider Bitcoin

Anyone with a large cash position — retail investors, institutional investors, and, as of 2020, public companies — is evaluating how to respond to the unique health and economic situation and the historic monetary and fiscal policy responses. Some of these stakeholders have concluded that an unprecedented economic situation requires an unprecedented response: Bitcoin.

Corporate Treasury Allocation of Bitcoin

Bitcoin's unique potential to address the challenges posed by the current economic environment has led several companies, including Square, MicroStrategy and Stone Ridge Holdings Group, to allocate Bitcoin on their balance sheets.

Square

Jack Dorsey, CEO of Square and Twitter, believes that Bitcoin has the potential to become the native currency of the Internet: "The world will eventually have a single currency, the Internet will have a single currency. I personally think it will be Bitcoin."

Square positions Bitcoin as having the potential to become a more ubiquitous currency in the future, which has led the company to invest $50 million in Bitcoin on its balance sheet (1% of total assets in Q2 2020). Square says this is complementary to the company's Bitcoin services (Cash App), development work (Square Crypto), and alliance work (Crypto Open Patent Alliance). Square's rationale is that it is financially aligned with its mission to promote economic empowerment and enable a more inclusive financial system.

MicroStrategy

MicroStrategy (MSTR) is the first public company to have a significant allocation of Bitcoin on its balance sheet, starting with $250 million in August 2020, $175 million in September 2020, and an additional $50 million in December 2020, as a result of its new capital allocation and financial management strategy for capital that exceeds working capital needs. The driving factor behind this decision is that the company is looking for a new financial reserve asset to protect against asset inflation.

According to MicroStrategy CEO Michael Saylor, the company’s $500 million in cash was like “a melting ice cube.” This prompted Saylor, as well as the broader company and board, to consider and ultimately allocate significant amounts of capital to Bitcoin.

Saylor and MicroStrategy cite a lot of factors in their allocation to Bitcoin, but in large part their decision is driven by the belief that Bitcoin is a better bet than precious metals like gold (e.g., it’s more scarce and less elastic) and can offer potential asymmetric upside similar to what those big tech names did a decade ago.

MicroStrategy also initially made a tender offer to shareholders in August 2020 to repurchase up to $250 million of its shares over a 12-month period through a modified Dutch auction. Certain shareholders took advantage of this option, resulting in MicroStrategy repurchasing approximately 430,000 shares for approximately $60 million. After the tender offer expired, MicroStrategy used the remaining $175 million to acquire Bitcoin.

Stone Ridge Holdings Group

Stone Ridge Holdings Group (SRHG), the parent company of Stone Ridge Asset Management (a $10 billion asset manager) and New York Digital Investment Group (NYDIG), announced that it will hold more than 10,000 Bitcoins as a major component of its financial reserve strategy, citing Bitcoin’s advantages over cash, “uncontrolled” and “unsupported” global money printing, and increasingly negative real yields.

How Bitcoin Can Respond to the Current Economic Situation

Cash Flow and Profitability

As discussed in our report, Bitcoin’s Role as an Alternative Investment, Bitcoin is generally uncorrelated with demand shocks caused by health and economic crises. Therefore, companies may also benefit from Bitcoin’s diversification benefits, potential outperformance, and liquidity profile when core businesses and other potential investments are adversely affected by economic conditions. Bitcoin offers the upside potential of a long-term investment while providing the liquidity profile of a short-term investment. Therefore, an allocation to Bitcoin can allow a business’s purchasing power to be maintained and grown over time, providing a buffer during periods of low earnings and cash flow, while maintaining sufficient liquidity to repay short-term debt.

interest rate

Assets such as Bitcoin and gold are sometimes criticized because they do not generate income per se. However, with yields at or below zero, the opportunity cost of allocating to Bitcoin has fallen significantly, and the attractiveness of holding non-yielding assets with asymmetric risk-returns (relative to holding assets with negative returns, either nominal or real) has risen significantly. Just as institutional investors are reassessing their allocations to fixed income securities issuance, we are seeing some corporate treasuries doing the same.

Money printing and potential inflation

Bitcoin is a verifiably scarce asset with a transparent monetary policy, in stark contrast to the unlimited expansion of fiat money supply. The inelasticity and predictability of Bitcoin’s monetary policy, and the growing importance of these characteristics, have helped drive Bitcoin’s “store of value” narrative. In other words, certain institutional investors and businesses have begun to view Bitcoin as an emerging store of value that can benefit from asset inflation for a fixed amount of assets and/or provide a wealth preservation tool in the event that the purchasing power of fiat currencies declines due to potential consumer price inflation.

Summary of Bitcoin Risk Management

As we discussed above, treasurers face multiple risks when managing cash, many of which are exacerbated by current health and economic conditions. As companies look for new ways to optimize their balance sheets, many are turning to Bitcoin to offset potential losses. In this table, we summarize many of the risks that corporate treasuries face during periods of economic growth and recession, and how Bitcoin can offer a potential solution.

in conclusion

The current unprecedented economic crisis is prompting forward-looking corporate treasurers to consider adding Bitcoin to their balance sheets. Companies such as Square, MicroStrategy, Stone Ridge Holdings Group, and others represent a trend that is likely to continue to grow as companies weigh the risks of historically low interest rates, reduced liquidity due to the coronavirus pandemic, and the potential loss of cash’s purchasing power due to monetary and fiscal stimulus policies.

Companies that choose to allocate Bitcoin have benefited from recent outperformance, as the value of Bitcoin rose from less than $12,000 to more than $19,000 from August to December. For example, Square has about 4,709 Bitcoins (purchased in October 2020), worth about $90 million; MicroStrategy has about 40,824 Bitcoins (purchased in August, September, and December 2020), worth about $780 million as of December 7, 2020. On the other hand, the value of cash has depreciated this year relative to the goods and other fiat currencies purchased by consumers. According to Bloomberg's US Dollar Spot Index, it is down 5% so far this year.

We expect the trend of diversification among Bitcoin participants to continue as different types of investors seek investments with asymmetric returns and low correlation to traditional markets.