The latent tail risks in digital credit are clearer after June 2026. Read our post-mortem analysis of the June crash here.
Given these recent events, this article is a proposal on what can be done to upgrade digital credit.
Context about market behaviors and credit investors
First—since the goal is to sell to credit investors—let’s get into the mind of credit investors. Credit investors expect to get their principal back. A bond gives the investor a much better answer by maturing. If a five-year bond falls to 80 cents on the dollar, the holder can find the exact date he will be repaid: in five years the borrower must repay, refinance, or default. Any fear still has to compete with the reality of a coming principal repayment.
Digital credit does not do this. A perpetual preferred stock does not answer the question of when the money can be repaid. A $100 liquidation preference helps only in a liquidation. The high dividend is nice if the dividend remains unskipped. A minutely price quote is good only if the market gives an exit without slippage. If buyers vanish, the preferred holder owns a security with no repayment date and only an equity dividend which may even be suspended at the company’s election.
This is a serious issue for digital credit, causing its price to move completely on whim of the market, which—because this is also a liquid market—very often will use leverage that sets the stage for violent wipeouts. This is what we saw in June.
After a wipeout happens, the market must determine a new price without the influence of the leverage that was embedded in the system. Without a repayment date, it becomes much harder to get a good understanding of the risk, because everyone knows their principal (which—without repayment—is just the market price at the time they decide to sell) is wholly dependent on the market forces caused by all the other market participants.
Furthermore, this whole process must repeat over and over because the promise to raise the dividend to bring it up to the stated amount all while offering such a high yield invites more and more levered traders, which is what enabled a liquidation event in the first place. Eventually the leverage would build up so much that even lowering the dividend would create problems.
Consider if the marginal leveraged trader had a 11.25% cost of capital and was long credit paying 11.5%. As soon as the rate is cut to 11.25%, this trader would not be making positive carry. They will sell and this first step out breaches the risk limits of others and causes a waterfall of selling. The company would therefore be forced to raise the dividend again, without ever having the option to lower it. The higher the rate, the more leverage will be possible, and the less likely they will be able to lower it.
This entire ordeal could be avoided if we had any one of these three things. For completeness, let’s also list the downside of doing these things:
- Set a repayment date. This creates a clear time and price. Downside is it cannot be perpetual.
- Don’t have it be a security where retail traders with 8–9% margin interest rates can leverage up on margin. Downside is it cannot be exchange-listed.
- Drop the intention to keep the price at $100. Downside is it won’t be price stable and loses some appeal.
No matter what, the volatility invited by leverage is not good for digital credit because no sensible credit investor will invest in credit that has the volatility profile of a generic common stock.
Now that we understand the issue, here are three potential solutions.
Improvement 1: Periodic put
The first improvement is a periodic investor put. Imagine if every five years, preferred investors have the right to sell the preferred back to the company at a set price. The strike could sit below $100, perhaps at $90 or $95.
A preferred trading at $75 with a $90 put date 30 months away would have a different character from today’s digital credit. Everyone can see that they can at least get $90 back within 30 months as long as the company has enough assets by then. This becomes a much easier risk to underwrite than something that has no put provision.
The credit investor would own the income plus a dated claim. The market would constantly price this dated claim. If the shares traded above or at the strike, the investor could keep collecting dividends. If the shares traded below the strike, he could take the exit.
The result—contingent on the firm possessing sufficient assets—is that a market price below the strike will naturally gravitate toward that strike level as the exercise window nears. Rather than exercising, the investor can sell the stock to another investor. If an investor insists on exercising, the company can use the ATM program to issue more at the spot price (which is now the strike price) to perfectly match the buybacks. (Note that technically speaking, the market price should gravitate to above the strike price, since not exercising means access to future dividends)
The safety offered by the put anchors the price action around something tangible and similar to existing credit. The instrument is still perpetual and liquid, but now it also behaves more like the credit that most credit investors are familiar with.
This provision also restrains the issuer. A company that may have to buy back preferred shares in year 5 will sell less of them in year 2. That may reduce total issuance, but it also gives more protection and grounding to the credit investor. A periodic put forces management to think about liquidity before the market forces the issue via massive volatility that damages the reputation and credibility of the company.
To make the credit more attractive, the issuer can also allow the put strike to move up over time. This clearly raises the floor and protection level, which justifies a higher trading price for the credit.
Improvement 2: Floating Rate Referencing SOFR, Not Spot Price
Digital credit can be improved by setting their dividends to only reference SOFR and adding a fixed coupon (in this case “dividend”) spread.
For context, all floating rate notes do something like this:
- Reference SOFR daily
- Add the fixed spread over SOFR
- Compute interest for that day using the interest rate of SOFR + Spread
- Pay the total interest accumulated at the end of each month
- “Repayment in 2 years” causes the price to be around the par
STRC and SATA do this:
- Reference the spot price and volumes daily. This is VWAP.
- Over 30 days, if the VWAP is not $99-$101, raise the dividend. If VWAP is in that range, consider lowering the dividend.
- “Repayment in never” causes the price to jump around to whatever the market wills
Floating rate notes and floating rate digital credit therefore differ in very crucial ways. FRNs do not target a spot price. First, they have the repayment to help with that. Second, FRN interest is limited to SOFR plus the agreed-upon coupon spread. The rate only “floats” because SOFR floats. In contrast, STRC’s rate floats because the price can go anywhere and the dividend paid must change to bring the price back.
So the improvement is to reference SOFR and nothing else. If STRC changes its policy to SOFR + 700 bps, it instantly becomes a better floating rate yield than any other FRN. If it also has an investor put for every 2 years, then it starts to really approximate the term economics of FRN. The market will then set the price accordingly and it won’t have any reason to expect a higher and higher dividend when the price moves. The dividend’s only variation comes from SOFR.
We could also get more creative by making the spread a function of SOFR. For instance, maybe the spread is 500 + SOFR^0.5 (numbers are in basis points). This makes the instrument more convex to SOFR.
Improvement 3: Drop targeted trading range and issuer call
The $99-101 target range is not robustly enforceable. If the promise is to keep raising the dividend, then more leverage will build up to earn extra carry. As liquidation cascades happen, the dividend will get raised again and again. Higher dividends will lead to more leverage, since even those with higher costs of capital can now leverage up and earn a profit. The end result is that the dividend cannot be raised any more because the company cannot pay the money. Everything will then unwind permanently. This would be the worst way to break away from the targeted trading range.
Today, the issuer can buy STRC from investors by exercising a call at $101. The credit is therefore unable to go above this. The higher the price, the more money can be raised per share issued. Capping the upside like this works against the interests of the issuer. The $101 issuer call was meant to help with price stability. However, what actually helps with price stability is repayment and less leveraged carry traders and short sellers. Capping upside makes the instrument less attractive.
Applying the periodic put and the fixed coupon spread over SOFR is sufficient to make a highly attractive low-duration credit instrument. Drop all target price procedures and let the market decide.
Bottom Line
The events of June 2026 will have a long lasting impact on the future of digital credit. Issuers should find the lessons and make corrections.
Stable price via dividend policy is not going to work because it has been and will be exploited by the market. Leverage will create more instability and the dividend cannot be raised indefinitely. The lack of some kind of repayment provision means that market flows are the only deciding factor for return of principal. Digital credit today is therefore a volatile asset without traditional credit guarantees.
My proposal is for digital credit to be revised in three ways.
- Install a periodic investor put. This keeps the asset’s perpetual nature while replicating the anchoring effect of repayment.
- Revise the floating dividend rate to reference only SOFR. This change plus the periodic put makes digital credit more like a traditional FRN which credit investors understand.
- Remove the targeted $100 price and the $101 issuer call. Trying to enforce this peg creates only liabilities in the long term.
These would make digital credit more stable, more credit-like, and a lot more competitive in the sector of the market that it is actually looking to disrupt: credit.
Disclaimer: This content was prepared on behalf of Bitcoin For Corporations for informational purposes only. It reflects the author’s own analysis and opinion and should not be relied upon as investment advice. Nothing in this article constitutes an offer, invitation, or solicitation to purchase, sell, or subscribe for any security or financial product.