The bloom is off: the start of the DAT crash?

Matt Levine used to joke that crypto was speed running all of financial history. Often, that speed run saw crypto see some type of regulation or standard in the financial market, happily ignore the regulation or even mock it as outdated / stupid…. and then implode spectacularly a few months later when something the regulation / standard would have prevented them from doing went south.

Even given that history of crypto speed running financial history and my noted skepticism of Digital Asset Treasury (DAT) companies (see part 1 and part 2 of my DAT series for more background), I’ve been surprised by how quickly DATs have mirrored the history of closed end funds. When I was writing my series ~a month ago, MSTR was trading for ~2x mNAV, and every company that announced a DAT deal with any crypto was seeing their stock price skyrocket.

Today, things have changed dramatically. Yes, you’ll still get an occasional squeeze on a buzzy deal in a company with a tiny float (see: OCTO jumping ~2500% on a worldcoin DAT strategy), but for the most part things have cooled down. Just take a look at the king of DATs: MSTR¹ has traded down to ~1.5x mNAV….

….significantly underperforming BTC…

… and the market seems to be looking at their strategy with increasing skepticism; most of their preferreds are trading below par (in the case of STRD, well below par), and, despite the drop in MSTR’s mNAV, MSTR has been forced to shift most of their capital raise to their ATM program in order to continue to buy bitcoin.

And MSTR is doing better than the majority of DATs! A casual look at blockworks treasury tracker shows ~half of DATs are trading below mNAV (note: given how rapidly these companies issue securities / evolve, any individual number from blockworks is likely to be off…. I just kind of like the screenshot as an overarching view, not for any specificity into one company)…..

And we’re already seeing formerly hot DATs need to pivot their strategy as their stocks trade below mNAV. For example, SBET has announced a share repurchase program as their stock slipped below mNAV, and they’re not alone. My favorite is Empery Digital, which announced a share repurchase program and had their CEO make an impassioned plea to shareholders about buying their stock to get discounted access to BTC.

I’ll pause here to note: I applaud those companies for buying back shares below mNAV. That’s a very shareholder friendly move, and I will be honest that I did not think share buybacks below mNAV was a move most DATs would make willingly. My model for DATs has been and remains closed end funds, and closed end funds are generally loathe to buyback shares because doing show shrinks their AUM and thus their management fees. Most closed end funds don’t buy back shares until an activist basically forces them to; I would have suspected that DATs would only consider capital returns when they had no other options / would get dragged their kicking and screaming by unhappy shareholders.

Despite the shareholder friendliness of the buybacks, I suspect they are a band aid on a bullet wound for most DATs.

Why?

Most of these DATs have fully deployed all of the proceeds they raised into their underlying assets. SBET, for example, has purchased over $3.5B of ETH and had just ~$72m in cash on their balance sheet at their last update; that’s a pittance versus their >$3B market cap. With most of their cash deployed, DATs face three choices:

1. They can make token share repurchases using whatever remaining cash they have lying around

2. They can lever up (generally by taking margin style loans against their crypto) in order to buy back shares.

3. They can sell their underlying crypto to buyback shares

Option 1 (token repurchases) is nice but, again, it doesn’t really move the needle with most of the cash already out the door.

Option 2 (levering up) is interesting and it appears to be what some DATs are doing; however, it turns these vehicles from “we will buy and hold this crypto forever no matter what” into “we could be margin called at any time if we enter a crypto winter / crypto prices go against us.” It also raises cash flow issues for DATs; while crypto can generate some yield from staking, in general the staking yields for DATs are below the interest cost on margin loans, so you put yourself into a negative cash flow scenario pretty quickly (creating the long term need to generate more cash, perhaps from betting that the stock will trade at a premium to NAV sometime down the road and you can issue stock then, or perhaps from being a forced seller of crypto in the long term).

Option 3 (selling crypto to buyback shares) would probably make the most sense, but to date we haven’t seen DATs really execute that strategy and, if and when they do, it kind of starts to call into question the purpose of a DAT company versus individuals just buying and holding the underlying crypto directly (as a friend texted me recently, “what’s the point of having a DAT if you can’t issue equity at a premium?”).

So those are the options DATs are facing…. but I think what’s really interesting about the bloom coming off DATs (the premiums fading away) is that it’s happened while crypto is still generally in favor. ETH is up ~70% over the past three months, while Bitcoin is up ~5%.

If DATs are starting to go out of favor will the underlying crypto is still doing reasonably well, what would happen if we hit another crypto winter and crypto prices traded down meaningfully?

And, if I might speculate a bit, if a lot of the recent rise in crypto has been caused by the huge rush of capital into DATs (which then gets deployed into the crypto, thus supporting the price), what would happen if that unwound for some reason? What if a bunch of DATs said “we’re trading at a discount to NAV; let’s practice good corporate governance, sell crypto, and buy our stock back (option 3 above)”? Or what if a bunch of DATs practice option 2 (leveraging crypto to buy back stock) and get margin called?

I suspect the underlying crypto could go a lot lower real fast as the same flywheel effect that’s sent crypto up recently unwinds.

To wrap this up: I’ll admit my bias; I have been and remain hugely skeptical of DATs. But I certainly could be wrong on them in the near term; crypto could get real hot again and the prices of all of these could moon. But I suspect the recent share weakness is just a sign of things to come at DATs; it’s a poor business model, and I’d be surprised if we didn’t see the majority of them get liquidated in the long run.

PS- I mentioned this in the article, but I will re-note it again here: you have to give the DATs huge credit for implementing share repurchase programs quickly once they started to trade below NAV. I will note one quirk to DATs: a lot of them were started because insiders traded appreciated tokens for equity in the DAT (i.e. I own $100m of BTC with a cost basis of $10m; I’ll swap that for $100m of equity in a DAT). That equity history might create more alignment than I’ve generally given DATs credit for; having a bunch of investors who minted crypto fortunes sitting around in illiquid shares trading at a discount is not exactly a recipe for shareholder happiness, and that could be a big driver behind these quickly rolling out repurchase programs when the stocks trade below NAV.

PPS- Again, I’m a DAT skeptic, but I’m also an asset value junkie. I will admit to starting to poke around some of the more busted DATs; while I generally think most crypto is magic beans, we’re starting to see NAV discounts that would make all but the most poorly run closed end fund blush. That can offer interesting trade structures; if you’ve got any you’re interested in, I’m happy to take a look / swap notes!

1. Disclosure: a very small short position in MSTR; largely against a long in some busted DATs