The Craziest Thing I've Seen All Year

Thinking through a bizarre move by Bitcoin-bros into private credit.

H/T @thestalwart

Private Credit Crazy

Generally speaking, if you lend money to anyone there are two basic expectations underpinning the transaction:

1. You will get your cash back, and

2. you will receive additional cash in the form of interest.

That’s kind of the bedrock on which pretty much every credit offering operates¹. There are also generally accepted risks to investing in credit. Chief among these is counterparty risk, or the risk that the company or person you lend money to folds or skips town, leaving you to figure out how to get at least some of your money back.

One mechanism by which you can protect yourself is the interest rate you assign to the loan. More perceived risk? Higher rate.

Equity investments don’t work that way. In an equity investment, you give money to a company in exchange for fractional ownership. You aren’t entitled to a dividend, you aren’t even entitled to get all your money back (the business can fail). Now, if you do get those things, then great! You make an equity investing in the belief that the company will do well and return to you an amount of money many times greater than your investment. But it’s not a guarantee.

In other words, in an equity investment you trade the risk of principal in exchange for uncapped potential upside. In a credit investment, you are expressly seeking to avoid principal risk and accept a capped upside in return.

Now, what if I told you there was a strategy that plans to offer you the worst of both worlds: a private credit fund that offers not only capped upside but also stomach-churning volatility with your principal?

From Coindesk:

Bitcoin-focused financial services company Meanwhile Group, backed by OpenAI CEO Sam Altman, has started a bitcoin (BTC) private credit fund, the firm announced Thursday.

The closed-end fund seeks to entice institutional investors in part by offering a "conservative" 5% yield denominated in bitcoin, the press release said. Investors will contribute U.S. dollars to the fund, which will be converted to bitcoin, with fees being also charged in the cryptocurrency.

Private credit – where non-bank institutions lend money to enterprises and individuals – is already a massive business in traditional financial markets, and BlackRock forecasts the sector will grow to $3.5 trillion by 2028.

Yes, you read that right: a Bitcoin private credit fund. I have… a lot of questions.

First off, what is Bitcoin exactly? Is it a security? A currency? Whatever it is, it’s not obvious that Bitcoin has a lot of usefulness in credit transactions. For instance, what sort of company is the target for these investments? More to the point, is there really a plethora of companies out there that are willing to book Bitcoin denominated debt onto their balance sheets?

Let’s think this through. You’re the CFO of company Z, and you take a loan from this fund worth 100 BTC ($4.4 million USD as of this writing). What do you do with it? Well, unless you’re going to transact business exclusively in El Salvador or do things you don’t want OFAC to know about, you’re gonna have to convert most or all of that Bitcoin to USD or something else to use it.

So company Z goes about its business with debt of 100 BTC on its balance sheet that it exchanged for $4.4 million. Now lets suppose few years later debt comes due and now the 100 BTC loan is worth $10 million USD. That’s a bad day! Of course, Bitcoin could always take a nose dive and you might have to pony up less than $4.4 million USD worth of Bitcoin, but that’s missing a broader point: any entity that onboards debt denominated in Bitcoin onto its balance sheet is inviting a tremendous amount of exchange rate risk.

Bitcoin diehards will argue that this risk exists everywhere in credit transactions, and sure, I suppose in some ethereal way it could, but a vast, vast majority of all credit transactions in the corporate world conducted in dollars do not involve this risk in any material way.

Bitcoin bros will inevitably say that those companies could take hedging positions. And sure, I suppose they could. But companies don’t typically hedge their own debt. Why? Because they don’t need to! Adding in new costs associated with taking the loan isn’t exactly enticing.

Now change gears and put yourself in the shoes of the fund investors—Bitcoin is not exactly a stable store of value, and deals take time, so before an investment is even made, congratulations! Your cash is now invested in one of those most volatile assets in finance. The fund could, in theory

1. gather $100 million worth of Bitcoin,

2. have Bitcoin collapse 20%, and

3. now only have $80 million worth of Bitcoin to invest.

As an investor, that’s a pretty steep risk to take in exchange for 'a “conservative” 5% yield denominated in Bitcoin.’ Do I even need to mention that this is only ~80 bps away from the current 10-year yield? I’m sure institutional investors are beating down the doors as we speak.

If you think I’m perhaps oversimplifying how this works, I’m not. I present to you an explanation of the fund given by Danny Baer, Director of Wealth & Asset Management at Meanwhile Group, the fund’s parent company (emphasis added):

BitcoinNews: What makes Meanwhile BTC Private Credit Fund LP unique compared to other bitcoin-based investment vehicles?

Baer: It is a single illiquid closed-end fund with all fund economics in BTC. Returns, management fees and carried interest are in BTC. LPs contribute USD, immediately after the single close we will convert the USD to BTC so LPs have 100% exposure to BTC through the life of the fund, then we give them the option to receive distributions in BTC or convert back to a currency of their choice.

It is open only to Qualified Purchasers (UHNW & Institutions) and the target return is 5%. The idea is for people that want to increase their allocation to BTC to have a BTC-yield vehicle. You contribute 100 BTC worth of USD, we convert it to 100 BTC, after a year you now have 105 BTC assuming a 5% BTC return. Doesn’t matter if BTC is worth $40k or $100k, your returns are in BTC.

Sounds great, right? I don’t mean to beat a dead horse, but here’s a thought experiment to replicate what’s happening here. I have made Ironside Coins. I say they are worth $1 per coin. You give me $100. We meet after a year and I say great news! You now have 105 Ironside Coins.

That’s fantastic, you say.

One quick, unimportant detail, I say, Ironside Coins are now worth $0.05. But you still made 5% on your Ironside Coins!

In what world is this optimal? The attractiveness of the dollar as a store of value is based on its stability. It’s not volatile and that’s the point. People don’t people flock to the Lira in times of uncertainty. This all feels like some insane fever dream where Bitcoin bros want us all to return to the free-wheeling insanity of the free banking era.

Reading the interview except above, it almost seems as though Baer believes that Bitcoin exists as its own economic ecosystem, separated from the dollar and that investors will treat BTC/USD fluctuations as casually as folks traveling abroad who check the exchange rates in the morning.

But of course, Bitcoin is not a fully formed ecosystem that casts a wide net of usefulness. You can’t tip your server or order a pizza in Bitcoin². I can’t fill up my car with Bitcoin. I can’t get my bank statements sent to me with Bitcoin as the denominating currency. So the idea that investors—institutional investors!—would shrug off massive fluctuations in BTC/USD because they have 5% more Bitcoin than they did last year seems like an… interesting thought.

In the real world (you know, credit denominated in dollars), lenders and borrowers don’t necessarily have an opinion on where the dollar is going to go. They just lend and repay. The Bitcoin debt world, however, creates opposition between lenders and borrowers. I guess in kind of makes sense that borrowing in Bitcoin is kind of implicit bet on Bitcoin falling, and lending in Bitcoin is an implicit bet that Bitcoin will rise.

In short, as a credit product, this seems like a tough sell for borrowers of the fund because of the risk that their loans could suddenly cost a lot more to pay back, and its a tough sell for investors because of the volatility of the principal.

In the grand ranking of Solutions Seeking Problems, this one has to come close to the top of the list.

Disclaimer: This is wholly a work of opinion and is not (I repeat not!) investment advice. Please consult with an appropriate advisor before making any financial decisions.

1. OK, maybe not if you’re buying Japanese government bonds, sure, you got me.

2. Yes, I am aware that these things have been done, but not without great friction in the transaction.