Tom Lee: Why are there so many crypto treasury companies emerging?

Source: Pantera; Compiled by: AIMan@Golden Finance

Recently, Tom Lee, chairman of Ethereum Treasury Company BitMine, and Cosmo Jiang, partner of Pantera Capital, had a dialogue to analyze the reasons for investing in digital asset treasury companies (DAT). The two discussed and explained why DAT may be a better crypto investment tool than holding ETFs or underlying tokens themselves, the driving factors behind the emergence of DATs, why BitMine chose the Ethereum Treasury, and the possible risks of DAT. The following are highlights of the dialogue:

Cosmo: What is the current market setting and market structure? What really drives the rise of digital assets?

Tom Lee: Looking forward to 2025, market leaders will come from two areas. One is still AI, MAG 7 and similar complexes, but this year, cryptocurrency-related stocks have also become another market leader...

I think the boom in AI is actually an empowerment because it clearly shows investors that the digital economy is emerging. I think it's captured people's imaginations, and there's a lot of investor interest in programmable money right now. I think the reason stablecoins are the ChatGPT story in crypto is precisely because we've seen mainstream adoption from consumers, merchants, and banks.

Cosmo:For digital asset treasury companies, what does the investor base look like that investment opportunity?

Tom Lee:The interest in digital assets from both institutional and retail investors has been remarkable. On the institutional side, I think not only Circle, but also MicroStrategy, because MicroStrategy has really changed the nature of the convertible bond market and the bond market because the bonds that they've issued - both senior notes, convertible bonds, and bonds - have been the best performers in their category. If you didn't own MicroStrategy bonds, you would have consistently underperformed those broad market indices...

I'm as surprised as you are. I was like, "When ETFs come, do you really need MicroStrategy? Because, you can buy Bitcoin at NAV, and minus a small fee, it's Bitcoin forever." It turns out that these digital asset treasury companies, the ones that do it right, can actually increase your cryptocurrency holdings per share. That's a big advantage over just owning an ETF directly. Because both of them go up with the price, but one of them gives you an additional unit of cryptocurrency every year.

Cosmo: People think that digital asset treasuries are just highly leveraged cryptocurrency investments, but the reality is much more nuanced. How do you analyze the main drivers of the performance of digital asset treasury companies?

Tom Lee:  I think there are five major advantages to crypto treasury companies, and it all comes down to the sixth element, which is management. But the first driver is the capital markets. If a crypto treasury company is trading at a premium, let's say, a two-times premium. That means that every time they issue shares, they buy two units for one unit that they sell after the issue because that's the premium. They're actually increasing your holdings by selling shares, which is a very strange concept, but it's a real value-add. The second driver is the cost of funds that ETF holders have to bear. Let's say you go to an institution to borrow money, and the interest rate is 10%. First of all, the holders of cryptocurrency ETFs are companies, so they have a lower cost to borrow money than most individual investors. Second, crypto treasury companies can take advantage of the volatility of cryptocurrencies and reduce their cost of funds by using convertible bonds, derivatives, and even bond markets. So, they can actually borrow money at almost zero interest, while MicroStrategy borrowed money at 0% interest. The third advantage is that publicly traded companies can actually issue shares. Imagine another digital asset treasury company—suppose there's one, or two, companies holding Ethereum, but one trading at net asset value (NAV). The company acquiring the other at a premium could then acquire the other at NAV, and suddenly their ETH holdings per share would increase. Another difference is that they can establish an operating company, thereby increasing their holdings per share. For example, within Ethereum, this Ethereum treasury company could actually participate in the Ethereum ecosystem, accumulating more ETH and ultimately earning a profit. Ultimately, however, it depends on whether the market buys into this story. So I think it's critical that the current management team has a clear vision of how to achieve all of the goals that I just described. I think that those tokens that the market believes in, will trade at a pretty significant premium. That's why Metaplanets is trading at a seven-times premium. And I think, especially in the emerging token space, these tokens can actually maintain a five- to seven-times premium over the long term.

Cosmo: Yeah, I think the last two points you talked about, this ability to generate yield and participate in the development of the ecosystem is unique to non-Bitcoin treasury companies.

Cosmo:You made an interesting analogy to another industry in the past that was also valued based on reserves, but traded at a premium to the value of the reserves. What was that like? Why?

Tom Lee:There are some precedents, and I think the easiest one for people to think of is probably the oil industry or commodities...

The largest stock by market cap in 1990 was ExxonMobil, and for 25 years, it was in the top five of the S&P 500. So, throughout your career, you might say, "Well, the biggest stock in the market is Exxon." And the interesting thing is, it never trades on earnings, it only trades on proved reserves, and it always trades at a premium to proved reserves. Because investors will say, "Hey, it's Exxon. They're smart, they drill, they always find more oil." So, you're always valuing it at a premium to its underlying oil holdings.

Cosmo: Not all of these digital asset treasuries are created equal. What are the qualities and characteristics of a good DAT in your opinion?

Tom Lee:What's really important for an investor or an equity investor is that they believe in two things about a company. One, that the company's operations have intrinsic value, and two, that they believe that the company can earn more than its cost of capital, so they reward the company...

The second point is, you have to find really reliable leading investors. The challenge for digital asset treasury companies is that you have to demonstrate trust in the crypto world that they will work with you, as well as trust in the traditional financial world, which is Wall Street. I think that's going to be very difficult for a lot of digital asset treasury companies to find that...

Cosmo: I've probably looked at 70 projects, and 60 of them have been successful. I couldn't agree more with you. The team is one of the most important factors. Obviously, you need a capital markets engine, you need a good marketing engine.

Cosmo:BitMine is an Ethereum treasury company. Why Ethereum?

Tom Lee:For us, Ethereum seemed like the perfect starting point for a digital asset treasury company.Ethereum really caught our attention because we realized that Ethereum is the place to tokenize real-world assets and put them on the blockchain.That's the case for most real-world assets. Stablecoins are a great example.

Cosmo:BitMine is an Ethereum treasury company.Why Ethereum?

Tom Lee:Ethereum seemed like the perfect starting point for us to start a digital asset treasury company.Ethereum really caught our attention because we realized that Ethereum is the place to tokenize real-world assets and put them on the blockchain.That's the case for most real-world assets. Stablecoins are a great example.

Cosmo:BitMine is an Ethereum treasury company.Why Ethereum?

Tom Lee:Ethereum really caught our attention because we realized that Ethereum is the place to tokenize real-world assets and put them on the blockchain.That's the case for most real-world assets.Stablecoins are a great example.

Cosmo: Stablecoins, which is what Circle is getting its IPO from, are essentially putting dollars on a blockchain, and then you can trade crypto with it… Now banks are actually interested in this. So, JPMorgan is going to create its own stablecoin, and so is Goldman Sachs. JPMorgan is going to use Ethereum. Robinhood just announced some tokenization plans to tokenize some private assets. But again, a lot of this is ultimately going to be on the Ethereum blockchain. Think of Ethereum as software, some people say it's like oil, but it's actually software that drives all of this activity. If you look at the technology stack, typically when you get to that layer, you typically get the highest multiples. So I think Ethereum is probably significantly undervalued relative to Circle. Of course, we think the demand for stablecoins could actually grow 10 times. Treasury Secretary Bessant thinks it could be a $2 trillion market. From over $200 billion today, that's a 10-fold increase. That's exponential. That's going to drive exponential demand for Ethereum.  

Cosmo:What are the risks that you see, or what we should be thinking about, and what we might be overlooking?

Tom Lee:There are certainly risks, but actually what’s interesting is that one could argue that in some ways, digital asset treasuries might be less risky than ETFs.

I think the first risk that both of them share is that there is a so-called “crypto winter,” where prices go through a cycle, reach a peak, and then prices fall. With an ETF, you hold a fixed amount of cryptocurrency, like one share of Ethereum. So if the price of Ethereum falls, your losses increase accordingly. But during the time that you held the ETH treasury, that entity might have tripled or even tenfolded your Ethereum holdings.

Let's say a digital asset treasury company has $4 worth of Ethereum, but two years later, their Ethereum per share is worth $20, or $30. If Ethereum goes into a bear market and drops 40%, your stock price won't actually drop because the value of the ETH you own per share has increased significantly. I guess that's one of the risks, but the value of ETH per share can grow, so the risk can be mitigated.

Second, the capital markets become unfriendly, and financing becomes very difficult. So the five or six engines that I mentioned earlier now become only one or two ways to increase the net asset value per share, and the price-to-earnings ratio may also decline. I think that's possible. But again, since it's a publicly traded stock, this will really stimulate the desire for consolidation, which will create scarcity again, and the premium may return. I think there are methods, there are risks, but there are also offsets for these risks.

Cosmo: There are risks, there are definitely fluctuations...

But I basically agree with you that there are a lot of offsets. One thing people like to bring up is its relationship with Grayscale, right? I think Grayscale's Bitcoin ended up trading at a discount to net asset value (NAV) for a long time. That's a very different situation. In fact, Grayscale is a closed-end trust. Digital asset treasury companies are not closed-end investment vehicles, they are public companies. So, they can do buybacks when they eventually integrate, and they can do mergers and acquisitions on any of these transactions at a price below one times NAV.

Tom Lee:Actually, Cosmo's point makes sense. Not that any digital asset treasury would want to do this, but if they were trading at a discount to NAV, in theory they would sell digital assets and buy back shares because that's what an efficient market expects. Or, by the same token, that could be a reason to push the two companies to merge.