Digital Asset Treasury (DAT) Companies Explained

The term digital asset treasury companies, known as DAT or DATCO, has become one of the buzzwords in the digital currency sector this year, offering investors a new way to play crypto, but with new risks.

A DAT is actually a publicly traded entity that holds cryptocurrencies like bitcoin Or ether and provides investors with exposure to the underlying digital currency. DATs aim to outperform the price action of the cryptocurrency they hold.

But as crypto markets have seen a sharp fall in recent weeks, DAT strategies have come under scrutiny and raised concerns over whether they could add further pressure to an already weak crypto market.

A digital asset treasury is a type of business that buys and holds cryptocurrencies directly on its balance sheet. Investors can purchase shares of this entity to gain exposure to the underlying digital asset.

The original — and one of the biggest DATs — is by Michael Saylor. Strategy who started buying Bitcoin in 2020 and has been doing so ever since.

But more recently, we have seen an explosion of this type of vehicle. In 2021, according to DLA Piper, fewer than 10 companies held bitcoin in their treasury. That number has since grown to 190 companies, while in September another 10 to 20 companies were focused on alternative digital assets, DLA Piper said.

These DATs contain approximately $100 billion in cryptocurrencies combined, according to data from The Block.

The DAT explosion this year is due to the dynamism of crypto markets and more favorable regulations in the United States towards the industry.

But their growth has also occurred at a time when it is easier than ever to purchase cryptocurrencies directly or invest in the asset through other regulated entities like exchange-traded funds (ETFs).

DATs are intended to outperform the underlying assets they hold. They can achieve this through various strategies aimed at maximizing returns. In contrast, ETFs passively hold the cryptocurrency and issue shares backed by the real asset.

DATs can also provide regulatory certainty for investors, according to a Macquarie note published last week. They “package crypto assets into SEC-regulated securities,” the investment bank’s analysts said. “This eliminates any regulatory ambiguity and ensures the same public reporting, disclosures and investor protections as any public action.”

Carol Alexander, professor of finance at the University of Sussex, told CNBC that DATs also provide an option for “institutional and professional investors facing regulatory, fiduciary or operational constraints that make direct ownership of crypto tokens or ETFs inappropriate.”

DATs offer unique capabilities that ETFs cannot, using a range of strategies to enhance investor returns.

To evaluate the performance of these DATs, a metric known as market net asset value, or mNAV, is closely monitored. It compares the enterprise value of a company to the value of its digital assets. It can show the amount of premium that investors assign to a DAT, with an mNAV greater than 1 signifying a premium.

DATs can use an in-market action (ATM) program to increase their crypto holdings. When its stock price exceeds the net asset value of crypto holdings, a DAT can issue more shares at a premium and therefore raise liquidity. This allows DAT to fund the purchase of more cryptocurrencies, as has been the case for Strategy.

“This creates an accretive feedback loop of cryptocurrency per share: the issuer raises equity, accumulates tokens and sees its net asset value per share increase, further increasing the premium, which represents accretive dilution,” Macquarie explained.

Staking is another strategy used by DATs. It allows a cryptocurrency holder to earn a return, similar to interest, on their assets. To stake, an investor effectively locks their crypto onto a blockchain to help the network function better. In return, the investor receives a return in the form of more crypto. However, removing staking can take several weeks, which may prevent ETFs and similar products from fully adopting staking, given their need for liquidity and stable asset values.

Staking creates free cash flow that “can be redeployed toward mergers and acquisitions (M&A), token purchases, on-chain opportunities, or distributions to shareholders,” ARK Invest said in a note last month.

As the market progresses, new trading strategies will likely be used by DATs.

DATs have become a priority amid recent crypto market turmoil, with bitcoin falling well short of its all-time high.

As cryptocurrency prices fall, mNAV can fall below 1, meaning companies are trading at a lower price than their cryptocurrency holdings. This can create a number of problems.

“When the crypto market pulls back, DATCOs come under pressure and have a limited menu of realistic responses,” Alexander said.

“Some may double down and hold their investment, viewing the decline as a buying opportunity for future appreciation. Others may need liquidity, particularly those who have used financing (e.g. debt, convertible bonds, equity issuance), which may force them to sell some of their token holdings.”

And an mNAV premium is essential for the DAT market.

“The viability of DATCOs is closely linked to the persistence of a stock premium to net asset value. If this premium erodes or turns into a discount, the model will face significant challenges,” Macquarie analysts said.

The investment bank also notes that if A As DAT’s stock price falls or approaches NAV, the stock issue becomes dilutive, meaning that “new shares issued no longer increase the crypto per share, but rather dilute the exposure of existing shareholders.” This can break the self-reinforcing cycle that maintains the premium.”

At the same time, the explosion in the number of DATs and growing investor interest creates its own risks.

“The sector is increasingly crowded, with capital flowing in in a set pattern. This influx, however, increases structural fragility. If any of the key variables – investor sentiment, cryptocurrency prices or capital market liquidity – were to fall, the DATCO model could collapse,” Macquarie said.

The strategy sought to protect against the economic downturn. On Monday, the company announced a reserve of $1.44 billion, funded by the sale of additional shares. The reserve is designed to support dividend payments and debt service, Strategy said.

James Butterfill, head of research at CoinShares, said other DATs could follow Strategy’s move to dilute shareholders.

“This does not particularly inspire confidence: it highlights both their dependence and their expectation of a recovery in token prices,” Butterfill told CNBC.

“We expect a rebound in token prices, particularly if the Federal Reserve cuts rates in December, which should help these companies avoid forced liquidations. Nonetheless, this episode highlights the inherent fragility of the DAT model.”

If mNAVs continue to decline and DATs cannot afford to stay afloat, they could turn to selling digital tokens, which could put pressure on crypto markets.

“As token prices fall, even the most high-profile DATs have started to decline. This can amplify volatility in broader crypto markets because DATs are large holders: their sales, even if staggered, increase supply in already weakened liquidity conditions,” Alexander said.

For now, DAT digital currency holdings represent less than 1% of the total crypto market. But as their influence grows, they could have a greater impact on larger markets.

“As DATCOs evolve, their market influence increases; an unwind could weaken a major crypto tailwind, namely the normalization of digital assets on company balance sheets,” Macquarie said. “This, in turn, could dampen public equity interest in exposure to digital assets, slow crypto ETF inflows and pressure cryptocurrency prices.”

The DAT space is currently in a bubble, according to Alexander of the University of Sussex.

“The DATCO model appears to have attracted many entrants motivated more by marketing, hype and easy capital than by sustainable business fundamentals,” she told CNBC.

CoinShares’ Butterfill said “the bubble has already burst decisively,” with many DATs now trading at mNAVs below 1 and a “clear signal that the market fears” that these companies will be forced to sell their digital assets.

However, both experts said DATs could evolve in the future.

“Longer term, investors will likely demand a more measured approach,” Butterfill said.

“Tolerance for shareholder dilution and extremely high token concentrations without associated revenue streams will diminish. The recent token accumulation frenzy has, in many ways, undermined the original intent of the DAT concept: credible global companies seeking to diversify from fiat currency and depreciation risks.”

Alexander said these digital asset treasury companies could also start diversifying their holdings into non-crypto assets.

“I believe those who move towards operations such as generating yield through staking, increasing the diversification of their tokens, and mixing with traditional tokenized assets like cash or treasuries, can survive as legitimate players in the digital asset infrastructure,” Alexander said.