by Shai Phillips, Vice President, Head of Corporate & Finance Practice
Just a few short years ago, you would not have been faulted for opining that DeFi was a fad, not to be taken seriously, or too risky to dip your toe in the water. In 2021, that same opinion is far more dangerous, and not what the facts on the ground suggest. As such, the question presents itself: is it really viable for your Treasurer to avoid the area of DeFi entirely, either by active decision or simply by neglecting the issue? And if not, what should you be asking your incumbent and/or prospective Treasury executives about their knowledge, experience, and capabilities in this emergent space?
Wait…what do you mean by DeFi?
DeFi (Decentralized Finance) is built on the concept of The Blockchain: an automatically trustable, broadly distributed network that cuts out the middle man, which largely equates to eliminating the bank or brokerage. In reality, it’s not THE Blockchain, but rather many blockchains, each with its own, yes, that’s right, you guessed it, cryptocurrency, or “coin”. Some DeFi projects piggybank on other blockchains and their cryptocurrencies are called “tokens” rather than coins. Each also has its own ecosystem, which is typically complex, with its own rules and regulations. Together they form a bustling, burgeoning Two-Trillion-dollar economy where many earn income, and this is just the start.
Journey a littler deeper, and you will realize just how unfathomably revolutionary blockchains truly are. Besides application in private industry for traceability, privacy, and other such use cases, they go beyond simply decentralizing finance. Follow through to their inevitable mainstay, and you will realize that, in actuality, they are the decentralization of all information. In this digital world, that means products and services too. As the speed and scalability of blockchains swiftly increase, with projects/companies like Solana (Sol) and Polygon (Matic), so does their ability to host decentralized applications (“DApps”) and exchanges (“DEXes”) using “smart contract” enabled technology.
These blockchains are also becoming much better at talking to each other, with projects/companies such as Cosmos (Atom), and Polkadot (Dot), and as this happens The Blockchain is becoming ever more intertwined with the internet, and will soon be inextricably linked. Eventually, The Blockchain could very well become the internet. Digital products and services would migrate off the currently centralized internet and move to the decentralized network of The Blockchain, its numerous nodes dispersed across the globe so that centralized hosts such as Amazon Web Services would play a much smaller role. In fact, one company is already claiming to be this exact first attempt to achieve a fully decentralized internet on The Blockchain – a project called Internet Computer Protocol (ICP), which seems eerily similar to that of Richard Hendrix in the TV show, ‘Silicon Valley’. Thankfully, we don’t seem to need “lossless middle-out compression” algorithms to get there in reality!
The oft-declared opinion that cryptocurrency “has no intrinsic value” is thus enormously misguided. There could not be greater utility, governance and value in an asset class. Investing in cryptocurrency is participating in the financial success and innovation gains of an expansive and unique new market. Buying into a specific coin or token is investing in the promise of that particular project/company, as well as a market that provides advantages and outsized returns (by far…like…really far) to traditional financing options. Are there risks? Sure. There always are. And they need to be assessed. But not participating at all may be a mistake of vast proportions, especially while your competitors exploit this new asset class. Companies like Tesla and Square are already deeply entrenched. Let’s take a look at the biggest risk of all – the nascent stage of the industry…
The North Remembers
We in the northern and western hemispheres know all too well. We sorely remember the era of the dot com boom and it’s catastrophic subsequent bust. So when a new tech industry like this springs to life, we hesitate. We REALLY hesitate. There are similarities here of course, but there are also big differences. Such as these:
The Front-Runners Help
Just like the dot com boom, there are so many companies to choose from! How to decide? Hindsight is 2020 but back in the late 90’s, it seemed impossible to distinguish the Amazon.coms from the eToys.coms or Pets.coms. There were no clear front-runners. Enter Bitcoin and Ethereum. Whatever the future of The Blockchain, these two are not going anywhere. Or if they are, it would take massive declines to put them out of the game. As long as you’re with these two, your safety level is high.
Building on vs. Building IT
By the year 2000, the internet was built. I mean, it’s hard to forget just how slow it was, and who can forget that modem noise? Eeeeiiii-errrrrrr-hhhhhrrrr. Wow. But it was built. The companies that stacked themselves on top of it, the dot.com companies, were not participating in its construction, they were merely exploiting it, or trying to. With The Blockchain, these companies ARE the internet. They are building it as we speak. Some will fail, others will succeed, but there is certainly room for many blockchains, and by extension, many “internets”.
Broad Mainstream Adoption and the NFT
The widespread adoption of cryptocurrencies, in particular Bitcoin and Ether, by large institutions across the world adds an extra layer of credibility and another sure sign that DeFi is here to stay: You can now use crypto for your morning coffee at Starbucks; You can book a luxury hotel stay at the Chedi Andermatt in the Swiss Alps with Bitcoin or Ether; Major global payment providers Visa, Mastercard, and PayPal accommodate crypto transactions; Financial news outlets Bloomberg and CNBC report on the price of Bitcoin as frequently as the S&P 500 (and other major coins alongside the price of gold and oil); The first country has declared Bitcoin legal tender (El Salvador). Whether you use crypto as a store-of-value (“digital gold”), a diversified hedge against inflationary pressure, or for any other purpose, its mainstream adoption is at this point inarguable. Even the establishment of creative intellectual property – high-priced works of art and minted collectibles in the form of Non-Fungible Tokens (NFTs) – has demonstrated unmistakable broad adoption. With the prestigious Christie’s Auction House having sold an NFT on the blockchain for an astounding $69 Million, this puts NFTs in the same price category as a corporeal Jackson Pollock or a tangible Andy Warhol.
Let’s get into some specifics here. Why is DeFi worth the risk? Well, its financing options and ROI mechanisms are plentiful, and they are unparalleled in the world of traditional capital markets. As a result, major banks like BNY Mellon, Goldman Sachs, and JPMorgan have been lining up to enter this market and provide DeFi solutions to institutional investors. Similarly, dedicated DeFi banks like Silvergate Capital offer sophisticated cryptocurrency instruments to service their institutional base.
Properly reaping rewards in DeFi can be complicated. There are new ecosystems to learn, rules of various coins, exchanges, and mechanisms to absorb, and these can be laborious, cumbersome, and time consuming. If you don’t know what you’re doing, it can be a risky endeavor too. Everything from storage to transfer transactions requires specialized knowledge. For example, setting up “cold storage hardware wallets” provides protection against hacking, versus keeping coins on centralized exchanges and so-called “hot wallets” (online software wallets). Hot wallets can nonetheless make things a little easier and more convenient. Then the financing options are plentiful: Trade? Hold? Lend? Stake? Yield farm? Add to liquidity pools? Stake liquidity tokens? Validate? Nominate? The list of advanced financing strategies goes on, and so do the returns: the riskiest of mechanisms and coins have been known to yield annual interest in excess of 1,000% APR. (No, that’s not a typo). Less risky approaches can still generate around 300%, and safe-ish coins can return up to 100%. Heck, even lending fiat currencies like USD can give you 2%+ yearly interest – Show me that at your local high street bank these days! Volatility is higher than more conventional capital markets, but a well-balanced portfolio can hedge against that volatility risk. Don’t you think? Mr./Ms. CFO?