How Strategy’s Bitcoin lending plan inadvertently helps hedge fund shorts

Strategy, formerly known as MicroStrategy, is considering a pivot that would fundamentally alter the risk profile of the world’s largest corporate Bitcoin treasury.

For a decade, the company sold Wall Street on a singular thesis: it was a digital vault, offering unencumbered exposure to Bitcoin without the risks of custody or counterparty risk. That stand is changing as it is now exploring an entry into the crypto lending market.

On Dec. 2, Strategy CEO Phong Le told Bloomberg the firm was in talks with banks about lending out its holdings. However, he cautioned that the firm was still waiting for major financial institutions to enter the space before making any decision.

He said:

While framed as a maturation of the business, the move exposes the company to re-hypothecation risks that contradict the “cold storage” ethos that built its $55 billion reserve.

Nonetheless, the pivot signals that Strategy is moving from a passive holding company to an active credit desk.

This shift is driven by the need to justify its valuation premium in a market where spot ETFs have commoditized Bitcoin access.

The yield trap

Strategy currently holds 650,000 BTC. Historically, this stockpile has sat idle in the firm’s coffers.

So, lending it out would generate revenue. However, it introduces a paradox as the primary institutional demand for borrowing Bitcoin comes from market makers and hedge funds looking to short the asset.

To understand the risk, one must look at the mechanics of the trade.

In the institutional market, demand for borrowing Bitcoin is rarely for holding, as it is almost exclusively for selling to hedge derivative exposure.

By injecting its massive reserves into the lending market, Strategy would effectively lower the “cost to borrow,” a key friction that typically discouraged short sellers.

Consequently, Strategy would effectively be supplying the inventory used to bet against the price appreciation of its own reserve by opening a lending desk.

Moreover, the move introduces counterparty risk to a balance sheet that had previously been defined by its simplicity.

Notably, the crypto credit market collapsed spectacularly in 2022 after lenders like BlockFi and Celsius mispriced the risk of lending to opaque borrowers.

While Le insists that Strategy will partner only with top-tier banks, the core premise remains that Bitcoin will leave its vault.

So, in the event of a banking failure or a credit seizure, Strategy would transition from an owner of property to an unsecured creditor.

Defending the premium

Meanwhile, Strategy’s search for yield appears tied to its compressing stock valuation.

The company’s model relies on trading at a premium to its Net Asset Value (NAV), allowing it to issue equity at inflated prices to buy more Bitcoin. That premium, once as high as 2.5x, has cooled. As of Dec. 3, Strategy’s multiple to NAV (mNAV) stood at 1.15.

In a candid admission, the firm recently admitted that it would consider selling Bitcoin if the mNAV falls below 1.

This creates a potential “reflexivity loop” in the market: if Strategy’s share price falters, the company could be forced to liquidate Bitcoin, driving spot prices down and further depressing the share price.

To prevent this, the Michael Saylor-led firm needs to offer investors something the ETFs cannot: yield.

Moreover, the company recently raised $1.44 billion in equity to cover dividend obligations on its preferred shares, stressing the cash-flow strain of maintaining its current capital structure.

Considering this, lending the Bitcoin stack is one of the only ways to fund these payouts without diluting common shareholders or selling the underlying asset.

A crowded trade

If Strategy enters the lending arena, it faces a market significantly different from the uncollateralized “Wild West” of 2021.

According to Galaxy Digital, stablecoin issuer Tether currently dominates centralized lending with a $14.6 billion book.

However, Tether lends stablecoins (USDT), fueling leverage for buyers. Strategy would be lending Bitcoin, fueling supply for borrowers.

The sheer size of Strategy’s 650,000 BTC reserve significantly dwarfs the collateral pools of competitors like Nexo and Galaxy and could potentially distort the market. If even a fraction of that supply hits the lending desks, the cost to borrow Bitcoin could collapse, crushing yields across the sector.

Essentially, Strategy is betting that it can transform itself from a passive wrapper into a sophisticated financial operator. But in doing so, it risks trading the clarity of “digital gold” for the opacity of structured credit.

For investors who bought Strategy as a proxy for pristine collateral, the vault door is beginning to look worryingly open.

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