News analysis
In February this year cryptocurrency enthusiasts were abuzz about one of the most notable Bitcoin transactions in recent history. Tesla Motors, led by controversial billionaire Elon Musk, announced it had purchased $1.5 billion worth of Bitcoin. However, with the cryptocurrency market now in shambles it appears Tesla, and by association Musk, may have lost hundreds of millions of dollars on its initial investment and should Bitcoin continue to plunge in value the company’s exposure to loss only gets worse.
Per a filing with the Securities and Exchange Commission the company said its acquisition was to provide “more flexibility to further diversity and maximize returns on our cash.”
At the time, Tesla also announced that it would start accepting payments in Bitcoin in exchange for its products “subject to applicable laws and initially on a limited basis.”
The move locked in a significant amount of Tesla’s free cash.
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CNBC reported at the time that the company “had more than $19 billion in cash and cash equivalents on hand at the end of 2020,” according to a recent filing.
Prior to the company’s purchase, Musk had taken to Twitter to communicate his support for the cryptocurrency adding the hashtag “#bitcoin” to his Twitter bio which briefly pushed the value of Bitcoin up by as much as 20 percent. He has since removed the hashtag from his Twitter bio.
In a conversation on the social media chat site Clubhouse, Musk said at the time, “I do at this point think bitcoin is a good thing, and I am a supporter of bitcoin.”
By the numbers
It’s unclear exactly how much Bitcoin Tesla purchased, however experts believe it was around 42,000 tokens and since Tesla purchased the massive amount of Bitcoin over several days it’s unclear how much per token the company paid but some reasonable assumptions can be made.
Taking the reported spend of $1.5 billion and a total coin count of roughly 42,000 Tesla would have paid around $35,714.00 per coin which would have been a steal since Bitcoin was trading on average of about $40,282.00 in the week prior to the announcement of the company’s purchase.
Today however, Bitcoin has plummeted to just $18,943.00 per coin meaning Tesla’s Bitcoin holdings, acquired in February, are now valued at around $795-million representing an astounding loss of value of some $705-million dollars.
Hedging bets
However, it’s important to note that Tesla is likely using a specific strategy to protect the cash value of its investment. The strategy is often referred to colloquially as “buy spot, sell futures,” but is also called “cash-and-carry arbitrage.”
Investopedia defines the strategy as, “Cash-and-carry-arbitrage is a market-neutral strategy combining the purchase of a long position in an asset such as a stock or commodity, and the sale (short) of a position in a futures contract on that same underlying asset.”
Most people are familiar with trades that involve buying, otherwise called “long” positions, where an investor or a speculator purchases, say, 1 Bitcoin for $20,000 and if the price goes up to $25,000, and they sell, they make $5,000.
Short trades, often referred to as “short selling” works in reverse. An investor or a speculator seeks to sell their 1 Bitcoin at, say, $35,000 and buy back at $20,000, leaving them with the same 1 BTC they had in the beginning, and an extra $15,000 as cash profit as icing on the cake.
In layman’s terms, this strategy allows major holders, such as Tesla, to preserve the coin-value of their Bitcoin holdings, while simultaneously profiting from market downturns by utilizing the futures market.
If their timing and/or analysis of market direction were wrong and the market were to go up, the increase in value of their Bitcoin holdings would offset or neutralize the losses on the future contract.
However, if the price is to go down, then the earnings from the futures contract will produce hard cash to buffer the paper loss of the market downturn.
The Bitcoin futures market has a unique and notable characteristic, however, in that they are completely financially settled, meaning short sellers do not have to post Bitcoin as collateral as they would in say the silver or crude oil markets.
Instead, the entire trade, and both the wins and losses endured, are both backed and settled entirely in USD, which means holders such as Tesla can trade short without having to move a single coin from their cold wallets.
Crypto market in free fall
The cryptocurrency markets are in free fall following an extended bull market. Over the past seven days Bitcoin has plummeted by almost 34 percent and Ethereum, the crypto world’s second largest token by market cap, has plunged over 36 percent, according to coinmarketcap.com.
In November 2021, Bitcoin reached a record high of nearly $70,000.00.
Popular meme coin, Dogecoin, which Musk has often touted on Twitter, has seen its value drop by almost 25 percent over the past seven days now trading at around $0.052 compared with a peak of almost $0.70 in June 2021.
Experts are pointing to several factors driving the historic losses however believe the Federal Reserve’s recent interest rate hikes are a primary culprit.
Hilary J. Allen, Professor of Law at American University’s Washington College of Law, told WUSA9, “The Federal Reserve is increasing interest rates … which is tightening the amount of money in the financial system. And so people are abandoning riskier investments in general.”
Robert J. Barbera, Lecturer and Director at the Center for Financial Economics at the Johns Hopkins University, agrees with this assessment telling WUSA9, “You do spectacularly well when money’s easy and things are going up. And it’s pretty breathtaking in the reverse.”
James Angel, Associate Professor and Academic Director of FINRA Certified Regulatory and Compliance Professional Program at Georgetown University, blames market confidence for the plummeting crypto valuations noting that the stock market is in free fall as well.
“The prices of all financial markets have been dropping. And the actual markets have always been volatile. They’ll always be volatile because their values based on what people expect is going to happen in the future. And nobody really knows what’s going to happen in the future. So the crowd can change its mind in a heartbeat, and usually does.”
