source

When a conversation takes this turn, you know that it's going to be a fun ride. I have been following Parker Lewis's dissatisfaction with some of the suitcoiners linguistic feats and it has not disappointed. Indeed, you might say that today it burst into full flower.

"Digital credit is a dollar denominated income instrument issued by companies whose balance sheets are full of bitcoin.""Digital credit is a dollar denominated income instrument issued by companies whose balance sheets are full of bitcoin."

This is from a guy called Joe Burnett who is VP of Bitcoin Strategy at Strive. Burnett made a very sincere video some days ago. He called the video "The Mustard Seed" and said some very grand things in it:

source

Not least among these things was the above definition of digital credit. For all the solid sounding words in there, it strikes me that something is missing. Here's Burnett's more fulsome description of how digital credit works:

The investor buys the credit instrument with dollars. the issuer uses those dollars to acquire more bitcoin. The investor receives a dollar dividend paid monthly -- and soon daily -- in cash and then bitcoin's volatility is stripped out of the income product and transferred into the common equity of the bitcoin-powered issuer which there are a few of us that are happy to hold the amplified bitcoin and absorb the volatility.

So, obvious question, every has been asking it for months and months, and here I am late to the party, but here we go anyways: if the issuer uses the investor's dollars to buy bitcoin, from where do they get the dollars to pay the investor the dividend?

"Debt = Credit / Credit ≠ Debt""Debt = Credit / Credit ≠ Debt"

This, I think, is some of what Parker Lewis is getting at with his question -- which was not actually directed at Mr Burnett, but rather another Strive employee (Chief Risk Officer this time) named Jeff Walton. Walton replied to Parker's question with this impressive statement:

source

I am willing to believe some of Walton's statement here: I do think that people who are crazy-enough to buy STRC are doing some kind of assessment of Strategy's credit-risk. If such people aren't, I don't quite know what to say.

"It's not a credit instrument as anyone would define it in traditional credit markets and does not have protections of standard credit agreements.""It's not a credit instrument as anyone would define it in traditional credit markets and does not have protections of standard credit agreements."

Parker is having none of this and delivers a very enjoyable reply:

What are the risks that your preferred equity holders take that traditional creditors do not? The list is long but there are three very important ones. You know them so we'll see if you have the integrity to list them here for your stock holders. And calling it digital credit is just the tip of the spear. A summary:

1. You are gaslighting. You are making misleading statements and misleading comparisons (not limited to Digital Credit). You are selling it as a panacea...as somehow important to bitcoin or as Joe stated, "an inflection point for bitcoin". You are downplaying the risks and selling it somehow as a product for "credit" investors (the credit market is $[x] hundred trillion that can be unlocked!) and the reality is that a credit investor that does not understand bitcoin would never buy this preferred stock. The target customer is bitcoiners or people blindly sold on yield (what could go wrong).
2. Your direct incentive is to get people to buy your stock, and expressly not bitcoin. The direct incentive of every bitcoiner that has bought your stock is to get others to buy your stock and your preferred stock and expressly not bitcoin. There's a lack of honesty or at the very least a lack of self awareness around these incentives and how they can be perverted.
3. Your business is very fiat in nature. It's your time so to each their own.

Parker Lewis and Jeff Walton are no doubt highly familiar with the protections normally afforded by credit instruments, but I unfortunately needed to remind myself about what some of these protections might be:

A contractual obligation to pay interest.
A maturity date when principal must be repaid.
Events of default.
Acceleration rights if the borrower defaults.
Covenants limiting risky behavior.
Possible collateral or liens.
Creditor standing in bankruptcy.
A trustee, agent, or enforcement mechanism.
Restrictions on issuing more senior debt or moving assets away from creditors.

Also, the big obvious one: STRC holders are equity holders so in the event of a liquidation, they only get paid out after the people who hold Strategy's debt. By Chat's count, Strategy has $6.7 billion in convertible notes that would be ahead of STRC holders in the event of any kind of liquidation, as well as $1.28 billion STRF, which is also senior to STRC.

Parker lists these three as the main protections credit investors have that equity investors don't as:

source

So what the heck is digital credit?So what the heck is digital credit?

It's an equity that pays a dividend out of the proceeds from new investment in the equity. This sounds like a ponzi, and I think BitMex Research addressed this concern best:

Of course it's not literally a Ponzi scheme, because it's not based on lies or fraud, however if something shares a lot in common with a Ponzi scheme, such that it earns investors an apparently strong and consistent return, but financing this return it dependent on the constant flow of new capital into the system, such that when the flow stops, the thing crashes hard, then it's fair to contrast it to a Ponzi scheme.
I'll leave you with BitMex's conclusion about what happens if things take a turn for the worse:

When the music stops, if things become challenging for MSTR, instead of selling Bitcoin, MSTR could just abandon the narrative that STRC is targeting stability. The company could just choose whatever path is easier. MSTR could just then reduce the STRC dividend rate by 25 bps each month. At the current rate of 10.5%, this would take three and a half years to get to zero or just over two years to get to 4%. While the rate is declining, the dividend payments become more and more affordable. This feels very favourable for MSTR and the dividend payments are therefore quite sustainable and affordable, in our view. Of course, this means that the price of STRC should crash, perhaps by around 50%, to the present value of the cashflow based on a much lower dividend rate and the risks of the product.