By John Reed Stark*

This year MicroStrategy relished in a good problem to have – a half a billion dollars of cash in its bank account and not sure what to do with it. The company could have paid its shareholders a hefty dividend, bought back a truckload of its stock, invested in R&D, financed new acquisitions or pursued other traditional financial endeavors. 

But the NASDAQ-traded tech firm got creative, and instead opted to buy $425 million worth of bitcoin, converting MicroStrategy’s “primary treasury reserve asset” into bitcoin.

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Just visit the unique bitcoin information link on MicroStrategy’s website and read all about MicroStrategy’s bitcoin gambit. The site contains a slew of bitcoin-related promotional media, and at last count, 12 different video interviews from various newscasts and podcasts featuring MicroStrategy’s colorful CEO, Michael Saylor, waxing poetic on the wonderment of bitcoin investing.

Yes, that’s right, Saylor is brazenly hyping bitcoin, the computer generated chattel that dwells amid a sinister and underground economic realm of competing bandits. Hence the genesis of the bitcoin balance sheet, and, in my opinion, a new chapter of shameful, reckless, and irresponsible corporate behavior.

A New Low

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Consider first and foremost bitcoin’s most notorious use: money laundering, ransomware, terrorism, illicit drug, gun and child pornography sales and the list goes on. That is why, ironically, one of bitcoin’s most convenient criminal attributes is its use for the theft of other bitcoin.

By elevating bitcoin profiteering into a core businesses line, MicroStrategy is not only facilitating a new brand of corporate harm, but also presenting a rather poor example of corporate ESG (environmental, social, governance) to say the least.

Consider also bitcoin’s unregulated marketplace, replete with: rampant manipulation; wild price volatility; pervasive cybersecurity vulnerabilities; hidden tax and capital gain burdens; and a litany of other entanglement mishaps. Indeed, bitcoin’s anarchistic valuations remain generally unregulated and without any meaningful oversight, leaving them easily susceptible to fraud and chicanery by insiders, management and better-informed traders and market participants.

MicroStrategy’s Bitcoin Disclosure

If there is any doubt relating to the perils of MicroStrategy’s bitcoin foray, look no further than MicroStrategy’s own Risk Factors set forth in its September 30, 2020 quarterly filing with the U.S. Securities and Exchange Commission

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The Risk Factors discuss dangers associated with bitcoin’s price volatility; bitcoin’s potential lack of liquidity and bitcoin’s overall “regulatory, commercial and technical” uncertainty. For instance, the Risk Factors of the Form 10-Q state:

“Historically, the Bitcoin market has been characterized by more price volatility, less liquidity, and lower trading volumes compared to sovereign currencies markets, as well as relative anonymity, a developing regulatory landscape, susceptibility to market abuse and manipulation, and various other risks inherent in its entirely electronic, virtual form and decentralized network. During times of market instability, we may not be able to sell our bitcoins at reasonable prices or at all. . . . Because bitcoins have no physical existence beyond the record of transactions on the Bitcoin blockchain, a variety of technical factors related to the Bitcoin blockchain could also impact the price of bitcoin . . . [M]alicious attacks by “miners” who validate bitcoin transactions, inadequate mining fees to incentivize validating of bitcoin transactions, hard “forks” of the Bitcoin blockchain into multiple blockchains, and advances in quantum computing could undercut the integrity of the Bitcoin blockchain and negatively affect the price of bitcoin.”

Even more foreboding are the Risk Factors relating to bitcoin and cybersecurity, stating:

“Security breaches and cyberattacks are of particular concern with respect to our bitcoin. Bitcoin, as well as other blockchain-based cryptocurrencies, have been, and may in the future be, subject to security breaches, cyberattacks, or other malicious activities . . . a successful security breach or cyberattack could result in a partial or total loss of our bitcoins in a manner that may not be covered by insurance or indemnity provisions of our custody agreements with those custodians . . . While the Bitcoin and blockchain ledger require a public key relating to a digital wallet to be published when used in a transaction, private keys must be safeguarded and kept private in order to prevent a third party from accessing the bitcoins held in such wallet. To the extent our private key is lost, destroyed, or otherwise compromised and no backup of the private key is accessible, we will be unable to access the bitcoins held in the related digital wallet. Furthermore, we cannot provide assurance that our digital wallets will not be compromised as a result of a cyberattack. The Bitcoin and blockchain ledger, as well as other cryptocurrencies and blockchain technologies, have been, and may in the future be, subject to security breaches, cyberattacks, or other malicious activities.” 

Déjà Vu all Over Again

MicroStrategy’s bitcoin Jurassic Park is eerily reminiscent of when P&G and Gibson Greetings lost a reported $200M and $20M respectively in the early 1990s by investing in complex and risky derivatives products. I was working at the U.S. Securities and Exchange Commission’s enforcement division at the time, and what struck me back then was how the company execs, at the cajoling of some devious bankers at Bankers Trust Co., failed miserably in their attempt to turn their respective corporate treasury departments into financial profit centers. The same could someday be said for MicroStrategy’s venture into bitcoin.

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By employing financial engineering to guard against inflation while simultaneously generating profits, MicroStrategy is orchestrating the same hedging objective with bitcoin that P&G and Gibson Greetings tried to do with derivatives. Unfortunately, just like P&G and Gibson Greetings, MicroStrategy is investing in complex instruments that they do not understand; that experience routine extreme price volatility and liquidity pressures; and that trade in a financial environment that is not at all understood or closely monitored by regulators.

Even worse, MicroStrategy’s bitcoin exploits tragically hurt all of society (while P&G and Gibson Greetings arguably only hurt their shareholders). From the hospitals who cannot operate because ransomware attackers have locked up critical patient data, to the terrorists, drug dealers and child pornographers who use bitcoin to peddle their wares and conceal their tracks, MicroStrategy’s bitcoin ventures have deadly global repercussions. 

PTSD and The Bankers Trust Tapes

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As part of a private lawsuit filed by P&G, Bankers Trust was forced to turn over some 6,500 tapes of recorded conversations (like many registered financial firms, Bankers Trust recorded phone conversations of its traders). The inculpatory evidence of the tapes was mesmerizing, where employees discussed how the P&G derivative contracts were akin to kegs of gunpowder waiting to explode. The tapes recorded Kevin Hudson, the trader who sold P&G the two derivatives contracts, saying, “It’s like Russian roulette, and I keep putting another bullet in the revolver every time I do one of these.” No doubt that similar conversations could be overheard among the unregulated, self-anointed “bitcoin traders.” Only this time, those conversations are not recorded, but instead part of the encrypted texts bitcoin promoters typically use to communicate on the dark web.

Warren Buffett, whose use of derivatives has always been begrudging, commented extensively on the P&G, Gibson Greetings debacle in his 2002 Berkshire Hathaway Annual Report. Buffet stated, “I view derivatives as time bombs, both for the parties that deal in them and the economic system . . . derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.” Today, Buffett admonishes a similar refrain regarding bitcoin, calling cryptocurrency “rat poison squared . . . You can’t do anything with it except sell it to somebody else.”

Looking Ahead

Conceivably, the blockchain technology on which bitcoin is based could turn out to be the most exciting, disruptive, transformative and efficiency enhancing breakthrough since sliced bread. But in the meantime, and aside from complex issues of privacy, security, ethics and simple practicality, blockchain technology remains embryonic; has still yet to be proven; and happens to operate within an economic ecosystem rife with fraud, deceit, dishonesty and thievery. Bitcoin is arguably blockchain’s most celebrated accomplishment, yet much of bitcoin’s value, outside of mere speculation, derives from its ability to facilitate criminal activity. 

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Financial mechanisms and practices promoted by self-anointed fintech professionals extolling the virtues of the“new blockchain economy” have no place in corporate treasury departments. Indeed, given how far astray bitcoin hedging is from its business of building “intelligent business platforms,” perhaps MicroStrategy should reorganize, re-task itself as an investment company and register with the SEC. But then again perhaps not.

To me, MicroStrategy is executing an investment strategy akin to buying tulips in 1637, and, in the event of a bitcoin crash, MicroStrategy (and its officers and directors) could face debilitating class action lawsuits and derivative actions. Like so many bitcoin investors, MicroStrategy is ascribing to the greater fool theory, betting that there will always be a “greater fool” poised to pay a higher price.

Even worse, it’s a flashback to the crazy penny stock frauds of the eighties, and riding the momentum of someone else’s bogus boiler-room penny stock promotion, hoping to lock in investment gains before the scheme is discovered, and before the stock drops down to zero. While the conduct might not rise to the level of fraud, betting on bitcoin allows for profiting from the unlawful acts of terrorists, extortionists, drug dealers and the rest of the iniquitous dark web. Such irresponsible corporate investing seems wholly inconsistent with, and in stark contrast to, any company’s fiduciary duty to shareholders.

Moreover, despite what MicroStrategy discloses in its Form 10-Q Risk Factors, the values of digital assets like bitcoin are not connected or correlated to traditional economic or market forces, and can decline rapidly, including to zero. Along these lines, it will always remain challenging to “disclose away” the dramatic, foreseeable and perilous risks associated with undertaking such an outrageously bitcoin-centric corporate and investment strategy.

Finally, given the SEC’s current cryptocurrency crackdown, and the fact that MicroStrategy CEO Michael Saylor personally bought 17,732 bitcoin before MicroStrategy bought its 38,250 bitcoin, inviting further federal regulatory scrutiny is probably the last thing that MicroStrategy (or Saylor) has in mind.

*John Reed Stark is president of John Reed Stark Consulting LLC, a data breach response and digital compliance firm. Formerly, Mr. Stark served for almost 20 years in the Enforcement Division of the U.S. Securities and Exchange Commission, the last 11 of which as Chief of its Office of Internet Enforcement. He currently teaches a cyber-law course as a Senior Lecturing Fellow at Duke Law School. Mr. Stark also worked for 15 years as an Adjunct Professor of Law at the Georgetown University Law Center, where he taught several courses on the juxtaposition of law, technology and crime, and for five years as managing director of global data breach response firm, Stroz Friedberg, including three years heading its Washington, D.C. office. Mr. Stark is the author of “The Cybersecurity Due Diligence Handbook.”