Shares of MicroStrategy (MSTR 11.16%) fell as much as 20.8% in the first four trading days of this week as Bitcoin prices fell and the company's premium for assets on its balance sheet declined. The stock was still down 22.5% for the week in Friday morning premarket trading, according to data provided by S&P Global Market Intelligence.
MicroStrategy and Bitcoin
What MicroStrategy is trying to do is use its own stock to buy more Bitcoin and increase its Bitcoin holdings per share. This strategy works if MicroStrategy's stock trades at a premium to the value of the Bitcoin it owns per share. MicroStrategy could issue shares to buy Bitcoin, increasing the amount of Bitcoin per share and potentially increasing the price of Bitcoin by taking more supply from the market.
This strategy works until the premium runs out or Bitcoin drops. Both happened this week. As I write this, Bitcoin is down 5.5% over the past 7 days, and MicroStrategy's large drop indicates that the premium is falling as well.
CEO Michael Saylor's Dangerous Game
The strategy of using MicroStrategy stock as arbitrage on Bitcoin prices is risky in the long run. This is an unusual situation because stocks that are valued based on their underlying assets, like Bitcoin, typically do not trade at a premium to the assets they own. And as that premium collapses, MicroStrategy's stock price could fall significantly.
MicroStrategy is also the largest buyer of Bitcoin on the public market, keeping the price up. If there is no premium for issuing shares and demand for Bitcoin falls, it could be a double whammy for stock prices. It doesn't seem like the slide is over for MicroStrategy, as the trades the company used to become a hot stock are starting to unwind.
Travis Hoium has no position in any stocks mentioned. The Motley Fool has a position in and recommends Bitcoin. The Motley Fool has a disclosure policy.
