The DeFi Frontier
Tesla’s experiment & the crypto liquidity conundrum
Chasing Paper is a newsletter giving my perspectives on finance, strategy, tech & innovation - and how they interact. It’s aimed at CFOs and other people with entrepreneurial endeavors who are looking for tools and ideas to improve the handling of finances in their companies.
Many of you joined the community after the last issue was sent out so let me bid you a warm welcome! And to the others, welcome back!
I have been caught up by many an (actual) CFO duty lately, which is the reason why no issues have been sent. And with everything that’s happened in the finance world since then, I have plenty of stuff to talk about.
For starters, this week I wanted to explore the crypto space from a CFO’s perspective: namely what can and should be done within this (not so) nascent space.
I first heard about cryptocurrencies in 2011. My dear friend Alex Hamou kept ranting about his investments in Bitcoin (huh?), using obscure words such as ‘protocols’, ‘blockchain’, ‘decentralized’, etc. I didn’t pay much attention, since he had a history of not-so-great alternative investments (fortunately, his acumen is better now).
Fast forward 10 years, cryptocurrencies have become ubiquitous for anyone remotely interested in finance, investment or technology. They have become an asset class in which many investors - retail or institutional - deploy capital, and more and more entrepreneurs are launching projects to take decentralized finance further.
And yet not many companies outside of the crypto space have made incursions into what’s called DeFi (Decentralized Finance). CFOs remain skeptical, or interested but ignorant about it all, although there is now clear demand for experience in Bitcoin on the CFO’s skill list.
So as the manager of your company’s finances, what approach should you take?
Master of Coin
In February 2021, Elon Musk decided that Tesla should buy $1.5bn in Bitcoin and that the company would begin accepting Bitcoin as payment.
Musk being Musk, this decision naturally caused a surge in the price of Bitcoin: tons of retail investors on the Internet love Elon, and anything he says or does has an impact on market prices. At this point, Musk is basically living proof of the signalling theory (if you’re interested, there are many other aspects to the Elon Musk effect, as I wrote in this 2019 piece).
Then in March 2021, Tesla sold about 10% of its total Bitcoin stake, leading to a drop in the cryptocurrency’s market rate. While certain commentators regarded this as a “pump & dump” move (Tesla buys Bitcoin, Elon brags about it on Twitter, price goes up, Tesla sells, price goes down), the Technoking of Tesla has guaranteed that the ultimate motive was to “prove liquidity of Bitcoin as an alternative to holding cash on the balance sheet”. And as his Master of Coin [that’s CFO in the common tongue] Zachary Kikhorn later confirmed in the quarterly earnings call, the company was “quite pleased with how much liquidity there is in the Bitcoin market”. Oh, and they also made $101M in realized capital gains and $929M in unrealized capital gains in the process.
Now, if you’re Tesla and you have an Elon Musk up your sleeve, you would be missing out on a lot of fun (and profits) if you didn’t put this type of power into use regularly. Imagine being able to boost your earnings by a few % just by sending out a few tweets?!
The question remains, for all you non-Tesla CFOs: is Bitcoin a credible alternative to cash in the bank? Is it diligent & prudent for a CFO to hold such an unstable asset on the company’s balance sheet?
The answer sounds simple, simplistic even: if you’re a crypto-enthusiast, stack up!
As very well explained by Byrne Hobart in Can an Unstable Asset be a Store of Value, the bull case for Bitcoin dictates that its price will fluctuate violently over time, until it doesn’t:
“The bet for Bitcoin is that a predictable supply will make it a wealth-preserving asset when the money supply rises, but the only way to bootstrap from "free" to "the same market capitalization as gold" is for the price to go up. And prices don't go up in a straight line. Any given Bitcoin price represents the odds that it will replace gold or the dollar as a major reserve asset. But its odds of doing so are also a function of price and volatility: Bitcoin is only as widely-adopted as gold if its market capitalization is equal to gold's, and it's only as good a store of value if its volatility is the same as gold's. (...)
So the paradox of Bitcoin is that the process for becoming a good store of value requires a stage of being a terrible store of value but a very exciting vehicle for speculation.”
In a way, Tesla has found a way to take advantage of both timeframes: it speculates (while saying it doesn’t) in the short term and builds up a position in an asset for which it (has to) believe the price will increase tremendously over the long term.
Note that this applies to believers in the bull case for Bitcoin. Other, more prudent approaches, could lead to devising strategies to hedge your cryptocurrency risk, in the same way you would hedge a regular currency risk.
But above all, I think the debate should be larger than just Bitcoin (or any other single currency for that matter). Similarly, it’s not just a matter of whether or not your company should hold cryptocurrencies as an asset on its balance sheet. Those are mostly questions if you’re an investor (or a bank).
To me, the important matter is how to leverage Decentralized Finance to your advantage.
Decentralized Finance (or DeFi) can be defined as the sum of all cryptocurrencies, decentralized applications (Dapps) and protocols built on top of a blockchain (usually the Ethereum blockchain) that aim to replicate and improve legacy financial infrastructures (banks, payment gateways, etc.).
By their very nature, the services offered by DeFi players are interesting for CFOs: they provide innovative, state-of-the-art financial services that can tremendously improve your financial management.
I would highly recommend reading the excellent guide prepared by the folks at Multis: Breaking Legacy: a CFO’s guide to DeFi & Crypto. It gives an excellent idea of what kind of improvements you can expect from DeFi in your business operations. However, below are some of the direct use cases that can apply to your business which I found interesting.
Now, this is not as straightforward as one might think: Stripe notoriously ended their support for Bitcoin in 2018, arguing that as Bitcoin transitioned from a means of payment to an asset (I mean, one guy did pay for a pizza with 10,000 BTC - now worth > $500M), it didn’t make sense for their customers to accept payments in Bitcoin.
However, more and more companies (including Tesla, as I mentioned above) are accepting payments in Bitcoin and sometimes other cryptos. It’s easy enough to think of the benefits to doing so: instant global payments, no chargebacks, lower transaction fees, etc.
Still, within your business I think there should be a clear combination of factors justifying this:
First, you must have customers who are crypto-sensitive, which means they are either in the higher-end of the market (finance and investment-literate) or in the lower-end (locked out of all legacy payment methods because of where they live or their social status).
Second, you must know whether you want to clear every transaction to fiat currency as soon as possible (and in this case, you would need hedging) or if you want to build up your balance sheet by stacking cryptos. Basically, know if you are going to “hodl” the currency (thereby making it an asset for you) or if you just consider it a means of payment.
By the way, there’s a funny story about the unexpected virtues of having a bunch of Bitcoin sales lying around: there was an urban legend a few years ago that the rapper 50 Cent became a Bitcoin millionaire by allowing Bitcoin payments for his 2014 album “Animal Ambition”. The story was a hoax, but if you’re bullish on crypto, then you might very well be looking at significant capital gains triggered by Bitcoin-denominated sales. Have a hustler’s ambition, for God’s sake!
Run business operations
Because Dapps replicate and improve upon legacy financial infrastructure, making the decision to run your business operations on blockchain-fueled services can yield many positive results.
Basically, you’d be going from fragmented, outdated, slow, centralized, high-fee infrastructures to interoperable, innovative, instantaneous, decentralized, low-fee ones.
In a nutshell, you could be running your payroll, earning (high) interest on your savings account, managing your expenses and reconciling earnings, accounting and taxes through layers of connected apps. Bear in mind that blockchain transactions are programmatic, which means - as is very important in Chasing Paper - that you could automate many of the menial CFO tasks by simply updating your infrastructure.
While this all feels very futuristic - including for me - I’m convinced this is the future of FinOps (Financial Operations) for many CFOs, either through DeFi or through application layers built on top of legacy infrastructures (what we call FinTech, and I actually think the two will complement each other).
Digitize your business
This aspect is at the intersection of finance and what we call ‘product’ in the startup world.
The capabilities offered by blockchain can be used to propel your core business into the future, and this is particularly true of many financial businesses.
Loyalty programs, for instance, are an important financial addition to many businesses that can end up being worth more as a standalone business than the initial one. And by their very nature, rewards, points, cashback, etc. are very simple things to tokenize. One could easily imagine a company issuing their loyalty points in the forms of tokens, redeemable for various kinds of rewards. The business could then borrow with the tokens as collateral, make them a marketable security, or many other things. Closer to the ground, early in 2021, Visa has partnered with a DeFi company to start offering bitcoin rewards to new credit card holders.
Finding ways to implement tokens or blockchains in your business, if it makes sense, has a lot of upside. It adds speed and security to your processes while boosting your balance sheet with a new kind of financial security: your own. For instance, if Disney were to issue DisneyCoin in lieu of the late Disney Dollar, they could be a stablecoin (the value of 1 dollar to 1 Disney dollar is always 1) that could help improve many payment processes in their resorts, cruises, etc.; but these could also be NFTs (each Dollar is a limited edition), thereby creating another asset for Disney.
We are not there yet, but I am sure there will be many unexpected ways to use blockchain or crypto to transform large parts of existing businesses. Already, there are groundbreaking companies like Fairmint (we’ll talk about them more below) leveraging the power of DeFi to turn cost centers into profit centers: look how they made money out of their latest marketing material by turning it into an NFT. Genius! Being able to monetize your marketing spend really upends regular business dynamics, for the better.
Finally, another groundbreaking impact that DeFi could have on companies is on the financing side.
I just mentioned Fairmint, which to me is one of the most exciting companies of the 2020s already: they allow any company in the world to program their own equity and thus be in position to raise funds continuously - not only from investors but from all kinds of stakeholders (e.g. drivers for Uber or merchants for Shopify) - without needing to worry about dilution or paperwork. It’s fantastic!
So in the end, the question for a CFO is much larger than ‘should I invest in BitCoin?’. Sure, being knowledgeable about the space and making a first investment in a given cryptocurrency is where it starts, but there are many ways to leverage DeFi to transform your business, and it’s worth thinking about.
Until next time,
In the papers 🗞
Some finance-related content I enjoyed recently:
I was invited by CFO Connect to have a chat with their community of CFOs. We discussed many things that are pillars of Chasing Paper, including Finance Hacking. They turned the discussion into an episode of their podcast CFO Yeah!, that you can listen to on Spotify or Apple - or read the highlights here, if like me your brain does not do well with podcasts.
My firm (The Family) and Spendesk joined forces to build The Early-Stage Startup Finance Playbook: everything (well, not quite, but most things) there is to know about putting together your finance department when starting a company, including a checklist of simple steps to take. Read along.
I receive and read many newsletters on a daily/weekly basis, but one I make sure never to miss is Matt Levine’s Money Stuff. Matt’s writing is crisp and his insights about the financial markets and business at large are invaluable. I really recommend subscribing :)
Payment in Kind 🎁
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And now, let’s close with things I’ve found in pop culture that somehow relate to finance. This week: memes.
What’s really incredible is that memes now have an impact on stock market prices (e.g. ‘Dogecoin is up because it’s funny’).
Many accounts create and share memeable content about stock markets, corporate finance, cryptocurrencies, etc., and their audience is such that they can affect the general view the public has of a given company.