The fund shorting MicroStrategy has targeted the Ethereum treasury company.

Original Title: "The Fund Shorting MicroStrategy Targets Ethereum Treasury Company"

Original author: Eric, Foresight News

Reprinted: White55, Mars Finance

At 21:47 Beijing time on October 8, and at 8:47 AM local time in New York on the same day, the short-selling firm Kerrisdale Capital publicly announced on X that it has shorted the stock BMNR of the Ethereum treasury company BitMine. Kerrisdale stated in a tweet that it does not have a negative outlook on Ethereum, but believes that the premium of BitMine's stock price relative to its net assets due to the treasury company model is about to disappear, and Kerrisdale is betting on a decline back to parity or even a discount.

This is not the first time Kerrisdale Capital has shorted a crypto concept stock; it shorted Bitcoin mining company Riot and the original Strategy of DAT (then known as MicroStrategy) in mid-2024, and the stock prices of the companies being shorted clearly dropped after the news of Kerrisdale's shorting came out. This time, after announcing the short on BMNR, the stock price did not immediately show a significant decline, and last night's sharp drop was more in line with the overall market trend. However, in terms of price, BMNR's closing price of $52.47 on October 10, local U.S. time, also represented a drop of over 10% from the closing price of $60 on the 8th.

A close reading of the shorting report reveals that Kerrisdale's six reasons for shorting BitMine stock hit the nail on the head. Compared to their hedging operation of going long on Bitcoin while shorting Riot and Strategy, this time the naked shorting of BMNR also reflects Kerrisdale's extreme pessimism towards BitMine.

The "flywheel" has become the "death spiral".

Kerrisdale's reasons for shorting BitMine mainly include six aspects:

1. Each share of Ethereum has been severely diluted: BMNR has issued over 240 million shares through ATM (at-the-market) in just three months, raising over 10 billion USD, with an average daily financing of about 170 million USD, severely diluting the Ethereum content per share;

2. mNAV continues to decline: The market capitalization of BMNR has decreased its premium over the net crypto asset value (mNAV) from 2.0 times in August to 1.4 times, and the trend continues to worsen;

3. Using financial means to conceal the reality of cashing out: The recent $365 million "premium" financing is actually at a deep discount, and the accompanying warrants significantly dilute the value of common stock;

4. Lack of Transparency: The company has stopped disclosing the NAV per share and total equity since August 25, making it impossible for investors to determine whether the "content" of each Ether has increased;

5. Increased competition: 154 companies in the United States plan to raise nearly $100 billion for cryptocurrency financial strategies, and the launch of ETFs will further weaken the scarcity of DAT.

6. Strategy model failure: The mNAV premium of Strategy (formerly known as MicroStrategy), the ancestor of DAT, has fallen from 2.5 times to 1.4 times, shaking the market's confidence in this model.

To understand the logic of shorting, we first need to explain the core logic of how DAT company operates. As Kerrisdale mentioned in their report, the core logic is: issue shares at a price higher than the book value of tokens → raise capital → buy more coins → increase the amount of coins per share → maintain the premium → issue shares again, forming a self-reinforcing cycle.

For example, if Company A has Bitcoin worth 1 billion dollars on its balance sheet and a total share capital of 100 million shares, Company A issues new shares to raise funds at a price higher than 10 dollars per share. This is because investors anticipate that after the fundraising, the company's continued purchase of Bitcoin will increase the "content" of Bitcoin per share, thereby driving up the stock price, making them willing to purchase the new shares at a premium. In this way, after completing the fundraising, Company A continues to buy Bitcoin, increasing the Bitcoin content per share and simultaneously raising the stock price. Subsequently, Company A can continuously carry out such operations to keep driving up the stock price.

But to maintain this cycle, there are two necessary conditions: first, in the initial stage, mNAV needs to have a premium or at least an expectation of generating a premium subsequently; second, the premium and premium rate must be sustained. If the premium rate is 0 or even negative, investors might as well directly purchase the corresponding crypto assets.

Thus, we can combine points 1, 2, and 4 to explain the reasons for shorting. According to the report, Kerrisdale estimates that as of October 6, BitMine has issued over 240 million shares, bringing the total share capital to 311.7 million shares. Although from July to August, BitMine increased the content from 2.7 ETH per thousand shares to 7 ETH per thousand shares through a flywheel, Kerrisdale estimates that from August 25 to October 6, the company's Ethereum holdings increased by 65%, while the Ethereum content per share only increased by 17%.

In other words, Kerrisdale believes that the dilution means the growth rate of the content will continue to lag behind the growth rate of Ethereum holdings. Additionally, the mNAV has already fallen from 2 times in August to 1.4 times. The decrease in content growth and the decline in premium may lead to a vicious cycle, causing both numbers to continuously decrease under mutual influence, ultimately resulting in parity or even a discount.

If the data still contains an element of speculation, then BitMine's decision to stop disclosing the NAV per share and total equity starting August 25 solidifies Kerrisdale's judgment, as they stated on X: "If earnings per share improve, they should promote it vigorously."

The "premium placement" is actually "discount cashing out".

BitMine announced on September 22 that it has entered into a securities purchase agreement with a certain institutional investor to offer 5,217,715 shares of common stock at a price of $70 per share through a registered direct offering, and granted warrants to purchase up to 10,435,430 shares of common stock (exercise price $87.50 per share). Before deducting placement agent fees and other estimated issuance expenses, the company expects total proceeds from this offering to be approximately $365.24 million.

This news, which usually drives stock prices up, is considered by Kerrisdale to be a discounted cash-out by BitMine through financial means.

The report states that the issuance price of $70 has a premium of about 14% compared to the closing price of $61.29 on that day, but each share comes with 2 warrants (exercise price of $87.5, with a term of 1.5 years). Based on Black-Scholes (vol 100%, rate 4%) and accounting for a 40% liquidity discount, each warrant is valued at approximately $14.

Black-Scholes is a mathematical model proposed by Fischer Black and Myron Scholes in 1973, which won the Nobel Prize in Economic Sciences, solving the problem of "how much a European option that can only be exercised at expiration should be worth today under given conditions." The calculation formula involves several set parameters, with Kerrisdale defining volatility (vol) at 100% (indicating high volatility for such stocks), and setting the risk-free rate at 4%, calculating that a warrant issued by BitMine on September 22 is worth approximately $14.

Therefore, if we exclude the two warrants currently valued at 14 dollars, BitMine's actual financing amount is only 220 million dollars, which means the actual issue price per share is only 42 dollars, representing a discount of about 31% compared to the closing price on that day. Kerrisdale believes that although this transaction may not result in a loss for investors, if a DAT company needs to raise funds through actual discounted methods, it has already invalidated one of the necessary conditions for the flywheel to turn, further indicating that BitMine's model has shown signs of fatigue.

DAT is no longer scarce.

The report states that when MicroStrategy launched its Bitcoin treasury strategy in 2020, the market lacked compliant and convenient investment tools for crypto assets. DAT became a "leveraged alternative." As of today, over 150 companies in the U.S. have announced similar strategies, planning to raise a total of nearly $100 billion. At the same time, the SEC has streamlined the ETF approval process, and a "tsunami of ETFs" is expected. Lower-cost, higher-liquidity investment channels for Ether may quickly dominate the market.

Kerrisdale stated that even the oldest Strategy's mNAV premium has fallen from a year-to-date high of 2.5 times to 1.4 times, indicating that market confidence in the DAT model has been shaken. Even Strategy itself suddenly canceled its commitment to issue new shares only at a premium rate of 2.5 times in August. Once this trust and discipline collapse, it is difficult to repair. Therefore, if the market lacks confidence in Strategy, or even in Strategy itself, then imitators are bound to collapse first.

Kerrisdale provided the best summary at the beginning of the report: we are not shorting Ethereum, but rather the notion that "investors should still pay a premium for ETH." If you want to hold ETH, you can simply buy it, stake it, or buy an ETF. The selling point of BMNR is that it is "worth more than ETH itself," but its strategy is mediocre, competition is fierce, disclosures are opaque, the growth rate per share of ETH is slowing, and the so-called "premium financing" is actually dilution (coupled with a lack of scarcity). Against this backdrop, BMNR's premium is destined to continue declining.

Kerrisdale, which is passionate about shorting, and the controversial DAT

Kerrisdale Capital is one of the most active "long-short hedge + event-driven" funds on Wall Street, known for its aggressive public shorting. In recent years, it has focused its firepower on areas such as the "valuation detachment from reality" cryptocurrency concept, quantum technology, and SPACs. At the end of 2023 and the beginning of 2024, Kerrisdale targeted Marathon Digital and Cipher Mining, both causing a single-day decline of 5% to 8%. In addition to cryptocurrency-related stocks, Kerrisdale shorted quantum computing concept stocks IonQ and D-Wave Quantum in the first half of the year, but both only saw minor declines on the day the short report was released, with significant gains following.

Sahm Adrangi, the founder and chief investment officer of Kerrisdale Capital, began his career at Deutsche Bank, working on high-yield bonds and leveraged loan debt financing, and served as a bankruptcy and out-of-court restructuring advisor to creditor committees at Chanin Capital Partners. Later, Adrangi worked as an analyst at Longacre Management, a distressed debt hedge fund with $2 billion in assets under management.

Sahm Adrangi is known for shorting and exposing fraudulent Chinese companies in 2010 and 2011, including China Marine Food Group, China-Biotics, and Lihua International. His then shorted targets, China Education Alliance and ChinaCast Education Corp, were subsequently investigated and penalized by the SEC.

Kerrisdale is not a fund company that only engages in shorting and does not go long, but recently it has focused its main efforts on companies with inflated valuations, with DAT being the latest target. As mentioned at the beginning, this kind of confident naked shorting operation must have discovered fundamental logical flaws. Kerrisdale's shorting performance this year has not been outstanding; most of the companies it shorted have turned to rise after a brief decline, but we still cannot ignore its unique insights on the DAT company's model.

Since the beginning of this year, although many publicly traded companies in the U.S. have started experimenting with the DAT company model for Bitcoin, Ether, and even other altcoins, there are also well-known investors rallying behind them. However, people in the Web3 industry, including Vitalik, have expressed some concerns. Now it seems that these concerns are not without reason. In a market where the concept is hot and liquidity is abundant, the stock price of DAT companies can indeed soar, but this kind of bubble-like accumulation in growth is bound to be unsustainable in the long run.

We do not deny that when the overall market is doing well, DAT Company can add fuel to the fire, but when the bubble bursts, whose eyes will be blinded by the ashes of this already carbonized fuel?