Inflation hedging is important for all companies that are profitable and have a free cash reserve. Among them, treasury bonds, cash-based mergers and acquisitions had a high popularity. However, the shift in corporate funding trends, failure of most new age startups, and the lessons learnt during COVID proved these traditional methods as ineffective.
As a result, several companies like GameStop have pivoted to Bitcoin as a mode of inflation hedging.
In this article, our focus will be on understanding how inflation impacts corporate earnings, what were the traditionally available modes of investment for corpations, why they proved ineffective, and why Bitcoin has emerged as a top choice for several companies.
Inflation Eats Corporate Cash Reserves
It takes a lot of effort to establish a company and make profits. Slow accumulation of consistent profits over a period of time forms the cash reserves that we see in today’s corporations.
The worst enemy of anyone’s cash, be it a company or an individual, is inflation.
Inflation eats the buying power of cash in a slow and consistent manner.
Anthony Pompliano, one of the well-known crypto investors and analysts, showcases how the value of the US dollar fell 25% from January 2020 to March 2024, the most inflationary years in recent US history. For other fiat currencies like the Turkish Lira and the Ruble (even if we discount the Russia-Ukraine War effect), the situation has been even worse.
Much of this inflation has been caused by post COVID fiscal stimulus given in multiple countries around the world. However, considering the damage has already been done, you might wonder why we need to act now. Inflation data for the past century shows that it is very likely that another high inflation period could be expected in the future.
Why Traditional Methods of Utilizing Cash Reserves Prove Ineffective?
Traditional methods are unable to generate as high returns as Bitcoin. Even when they do, they come with a very high default risk, such as in junk-grade bonds.
Did you know? The repackaging of low-value bonds into new securities (Collateralized Debt Obligations, or CDOs) and the subsequent craze for these repackaged securities caused the US Housing Crisis in 2007-08, which ultimately led to the 2008 Global Financial Crisis.
In this section, we explore investments from a corporate perspective, and not from an individual’s point of view.
Bonds
Bonds have a high reliability and a lower risk of default, but they seldom generate returns that are higher than 10%. Further, most bonds that offer a high interest rate do come with a very high default risk.
As a result, companies rarely buy these unless they want to utilize the money later and just want to park them to beat inflation, even if marginally.
Bitcoin provides a lot higher returns than not only inflation but also higher than each category of investment-grade bonds.
Competitor Acquisition
Several companies resort to competitor acquisition, especially those competitors that are at an initial stage. These acquisitions not only help companies acquire critical intellectual property but also help them eliminate competition.
However, these acquisitions come at a certain risk. Many startups these days do not have a concrete revenue model and acquiring those can lead to disastrous results. Further, a series of purchases could also bankrupt the parent company in the case of unfortunate events, e.g., Byjus, an ed-tech company that went bankrupt after a series of wrong acquisitions.
In those situations, it is difficult to generate cash by selling those companies ahead.
However, in the case of Bitcoin, a Treasury can easily sell their assets at any time, irrespective of the market condition and still manage to get most of their funds, if not more. The universal acceptance of Bitcoin greatly helps in maintaining its liquidity at the highest level.
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Why Pivot to Bitcoin Now?
Corporations would have pivoted to Bitcoin a long ago had there been sufficient regulatory clarity. Till 2020, when MicroStrategy started acquiring Bitcoins to build the first mainstream treasury, there was a very high risk of multiple governments banning Bitcoin.
This risk was still present till last year when the Biden administration vetoed a law that allowed regulated financial firms to hold Bitcoin.
Establishing a Bitcoin Reserve or Treasury would have been a lot more riskier in those uncertain times.
Further, the current pivot to Bitcoin is also driven by a high growth in the last year. Had this growth not been there, many treasuries would not have been established.
Strategic Considerations Before Establishing a Treasury
A lot of strategic thinking goes into creating a Bitcoin Treasury such as the source of funds, the ability to secure debt, the price of Bitcoin, the regulatory environment, and several others.
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Price
Price matters the most while establishing a treasury because entry during a market high or during a rally could lock the buyer inside a bull trap. Such traps could take years before yielding good returns.
Volatility
Bitcoin is still far away from being a mature asset, and therefore sees volatility as its mainstream adoption gets through multiple cycles. A treasury must ensure that it has adequate strategies to counter bouts of volatility in the future.
Hedging
Hedging is a critical requirement for all funds, irrespective of the assets they hold. Funds typically resort to derivatives markets to hedge their positions, and it plays a critical role in ensuring the stability of a Bitcoin Reserve, too.
Regulations
Regulations could be the deciding factor in the success and failure of a Bitcoin Treasury. Regulations could change easily in democracies because of frequent changes in the government. Once established, a Bitcoin reserve cannot just wind up like a company (due to active debt), if newer regulations turn against it.
We saw this playing out during the Biden administration, where MicroStrategy was often in a very tight spot due to a lack of regulatory clarity.
Security
Security of the Bitcoins in the Treasury remains a critical need. Companies can choose to secure their Bitcoins via self-custody or partner with a crypto custodian and let experts handle it for them.
Source of Funds
The source of funds to establish a treasury is the most important question. The funds should be easily available, should be available at a low cost and should not have short term obligations on the treasury.
Further, even if funds are readily available, the cost of funds can dictate the rate of success of a treasury. Cheaper funds (with low interest rates) can help a treasury break-even much faster.
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Bitcoin Treasuries vs Bitcoin ETFs
The question of whether to go for spot Bitcoin ETFs or directly purchase Bitcoin remains a tough one to answer.
When is an ETF Preferable?
For companies that do not have the resources to buy and own Bitcoin directly resort to ETFs. This aspect is also true for companies that are not legally allowed to buy Bitcoins due to any regulation. This way, they can reap all the benefits while letting the experts handle security.
However, in the case of ETFs, the return is way lesser than direct Bitcoin holdings.
Further, ETFs might dishonour your request to redeem Bitcoins, whether due to malice, regulatory pressure or worsening international relations.
When is a Bitcoin Treasury Preferable?
For companies that buy Bitcoin directly from the markets, they either partner with a crypto custodian or manage their custody, themselves. In the latter case, there is a requirement of an expert team to handle all the regular as well as special situations that may arise in the treasury, including crypto investigations.
A treasury also gives you the rightful ownership of your Bitcoins irrespective of policy changes, regulations, or market conditions.
However, the risk of theft, hacks, and compromises do rise significantly.
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