Investing in Bitcoin: Buying Strategy Stock vs. Buying Bitcoin Directly

Given that it's a currency outside the command of any government or central bank, Bitcoin (CRYPTO: BTC) is inherently an outsider's challenge to the traditional financial system. And Strategy (NASDAQ: MSTR), formerly known as MicroStrategy, is all-in. It calls itself "the world’s first and largest Bitcoin Treasury Company" and says it has "adopted Bitcoin as our primary treasury reserve asset. ... we strategically accumulate Bitcoin and advocate for its role as digital capital."

Strategy's extremely ambitious investment approach, which calls for using equity and debt financing as well as cash to buy a lot of Bitcoin, leaves investors with an interesting question: Is it better to simply buy Bitcoin directly, or might the returns from buying the stock be even higher?

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Here's what you need to know to chart a course.

This tactic looks ingenious, as long as it keeps working

Strategy's strategy is essentially to issue convertible debt and equity to finance the purchase of billions of dollars of Bitcoin. It currently holds around $44 billion worth of the coin.

The idea is that, as the price of Bitcoin rises, the value of the business and its stock price will also rise. Then, with a higher stock price, it can issue more debt and equity without irritating its shareholders with dilution of their value. Afterward, it can buy more Bitcoin, potentially repeating the process over and over. The more investors that buy the stock, the higher its price gets bid up, enabling even more purchases in a self-sustaining cycle.

Between March 10 and March 16, Strategy bought 130 Bitcoins for roughly $10.7 million in cash, bringing its holdings to about half a million of the coins. On March 10, the company had announced that it would be issuing as much as $21 billion of preferred stock to finance future Bitcoin purchases as well provide working capital. That could be 's a lot of buying pressure, even for an asset with a market cap in excess of $1.7 trillion like Bitcoin. On the week ending on March 23, Strategy bought another 6,911 BTC for $584.1 million in total.

And it probably won't be the last time Strategy buys Bitcoin. The advantage here is that the company's share price has tended to rise faster than Bitcoin's price because it uses leverage to make its purchases. So investors who buy it have a good shot at outperforming a move of just buying and holding Bitcoin; over the last 12 months, Strategy's stock is up by 115% compared to Bitcoin's gain of 33%.

But there's a major risk here.

Because the company finances some of its purchases with debt, there is a price of Bitcoin beneath which the company's assets will be insufficient collateral from the perspective of those who loaned money to it. At that point, investors would be heavily incentivized to sell their shares, as they would not have any hope of getting their dollars back in the event of a bankruptcy filing. Well before that point, Strategy would be forced to liquidate its coins to cover its debt and its financing costs -- another incentive for investors to sell, as the core assets of the company would be diminishing.

Strategy offloading its coins in forced sales would likely hammer the price of Bitcoin, potentially creating a cascade that would force its share price down further in the reverse of the virtuous cycle it took advantage of at the start. In this scenario, shareholders would be hit significantly harder than those who merely bought and held Bitcoin, likely erasing their higher returns and, in all probability, causing them to suffer deep losses.

There's no need to complicate this

Will this risk end up sinking Strategy?

Probably not. The price of Bitcoin would need to fall extremely far from its present level to threaten Strategy to the extent that would force it to liquidate its coins. In other words, a flash crash of Bitcoin, should that occur, would probably not cause the aforementioned problems even if the asset lost more than 50% of its value.

Still, investors have an opportunity to take advantage of the upside driven by Strategy's relentless purchasing of Bitcoin, and it's very simple. You just can buy Bitcoin and hold it to get upside from the company doing that. That won't expose you to any additional risk caused by a business's use of leverage and a clever financial trick. And over the long run, that's why it's the better decision here.

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Alex Carchidi has positions in Bitcoin. The Motley Fool has positions in and recommends Bitcoin. The Motley Fool has a disclosure policy.