Denominate Your Assets In Your Liabilities
Key lessons from the failure of centralized entities
What’s Happening Today
Readers may think the collapse of FTX is something new, but I’m here to tell you this type of thing happens all the time due to one core issue. Namely companies failing to denominate their assets in the same things as their liabilities. So when the FTT token price fell there wasn’t enough value to cover debts that are owned in USD, BTC, ETH and so forth. It’s also true that customer balances should never have been swapped for FTT tokens in the first place, but this whole situation points to an important business principle. Responsible companies should, as much as possible, denominate their assets & revenues in the same type of token or currency as their liabilities.
Let me explain.
The Broader Principle
It’s easy to think Toys R Us went out of business recently because people stopped buying toys. However, that is not the case, as they had a profitable enterprise. They borrowed against their company and then took out positions in the equities markets. When those positions dropped in value that decision came home to roost, which caused them to go bankrupt and had nothing to do with their core business.
One of the absurd things about the modern period we’re in, is that we have an official interest rate that does not reflect the reality of actual inflation rates, i.e. the official rate is over 7%, but the actual inflation rate is around 15% based on older definitions of the consumer price index. So, every business, in addition to its core competency, needs to run an FX shop just to recover some of the losses from the 15% annual drop in purchasing power due to exposure to the dollar.
The Principle Applied To Bitcoin & Crypto
Bitcoin mining operators are no different from any other business in their problematic exposure to the dollar. Their core competency is creating Bitcoin via Bitcoin data centers, and they are not sophisticated about how to minimize their exposure. Many mining companies are using complex financial wizardry to generate debt and equity instruments to try and keep up with inflation. Which is fine, but those instruments are typically also denominated in dollars. This extends liability not only for the core competency but for the generated revenue in relation to the dollar. So what they have just done is financialize their core competency away from what they do into running an FX shop that’s constantly risk managing that liability against the dollar’s performance.
We saw a multitude of mining operations this quarter significantly liquidating their Bitcoin positions, not because they got any less profitable, but because they now as the Bitcoin price declined have a massive dollar liability related to their equipment and are now struggling to service their debt. One of the fundamental aspects we have always been aware of is the boundary between being an operator and needing to make one of our core competencies, a 24/7 FX shop. In taking severe directional risk related to the asset price, especially in the short term, you are a hedge fund, not an operator. Therefore, it impacts what you are producing and your operational cost.
A fitting example is the 2017 bubble, where many companies raised Bitcoin and Ethereum. Companies kept the assets in their treasury even though their costs were not denominated in Bitcoin or Ethereum. Instead, the denominations were dollars or euros owed to developers to build their platforms. The companies that did not place their treasury in the same denomination were at significant risk and ended up running out of fiat. We’ve observed this recurring pattern not only on the operational side but also on the side of production.
How DLTx Was Built on This Principle
All of this is why DLTx’s ethos is to match (as much as possible) the production of the same asset that it owes. We have made the fundamental choice to be an operator in its purest form.
This is true not just of our Bitcoin operations, but with respect to our Filecoin operations as well. DLTx’s Filecoin division mines Filecoin, borrows Filecoin, and repays the tokens denominated in Filecoin. As much as possible, all liabilities are denominated in Filecoin. We do not have fundamental exposure to Filecoin in dollar terms, borrowed from an institutional lender. We know with a high probability the number of Filecoin we will produce (thanks to the Filecoin reward algorithm) and forecast the interest we will pay. And because it is all denominated in Filecoin, we are highly confident that we can commit to those payments because they are all denominated in the token that we are producing.
Conclusion
The focus we have on limiting exposure by matching our liabilities to our assets, is core to the DLTx business model across all our divisions. This is why while others are shrinking, DLTx continues to grow its operations even at the bottom of a bear market.
