The Bitfinex hack and subsequent release of BFX Coin is a seminal moment in cryptofinance.
BFX Coin is a promise of Bitfinex to pay $1 in the future. If their exchange recovers from the hack, and grows, then it’s feasible they pay this. The value of the coin will rise toward its $1 par value. If their exchange stagnates or fails, then it’s not feasible. The value of the coin will fall toward $0.
Buying the coin at any given price thus expresses one’s opinion of the likelihood of success and repayment. Everyone will disagree, and the beauty of an open market will enable that disagreement to form a book of bids and asks for the asset, and ultimately a market price which rises and falls upon the aggregate sentiment of the investors and holders. The opinions of both the most starry-eyed cheerleaders and vitriolic critics are counted equally, and each can profit from their perspective, if they’re correct.
Even the company itself, as insiders, could participate (though Bitfinex in this case has stated categorically they will not). If the company knows it will be able to recover and repay, then it is encouraged to buy up the coins below par. The ethics of insider trading and the value it brings to a market are debatable, and not the subject of this post; they should be explored separately.
Regardless, I said recently I think the BFX Coin is an elegant and innovative way to handle the $72mm loss Bitfinex faced.
But the model is far more consequential than this single case.
What Bitfinex has done, essentially, is create a “cryptobond.” Maybe there’s a better name for it. But basically, a cryptobond is a debt token that lives on the blockchain, with the expectation of repayment of par value. Par value can always equal $1 for simplicity.
And cryptobonds have the same practical purpose as normal bonds: they allow a company to pay in the future for a benefit today. In Bitfinex’s case, the benefit today is that they aren’t forced into liquidation/bankruptcy. I argue, as one of the victims of that hack, that this benefit is shared by me: I’m better off as a creditor due to the cryptobond. Why? Three reasons:
- Avoiding bankruptcy avoids millions of dollars in legal fees, which are a dead weight loss to all creditors.
- I have a chance, even if small, of getting all of the lost money back. Impossible in a bankruptcy scenario.
- Most importantly: I have immediate liquidity. I can sell my cryptobond 24/7, depending on my cashflow needs and sentiment about the future. This is where the cryptobond really shines. If bankruptcy happened instead, whatever scraps I get back will take years.
So the cryptobond can clearly benefit both the debtor (the company) and the creditor (the bond buyer).
And looking at the future, cryptobonds could become normal, not just in crisis scenarios but in normal business activities. A company could sell $1mm of cryptobonds at, perhaps, $0.90 on the dollar. The company raises $900k of capital, and owes $1mm. It can fetch a price of $.90 on the dollar if its prospects are good and its case compelling. If not, maybe it can only get $0.20 on the dollar, and maybe that’s worth it to the company.
The economics of the relationship are simple: if there is a price at which the company benefits from selling the cryptobond, and a price at which investors expect gains, then a market for the cryptobond should form, and a net economic benefit occurs. If the company and investors can’t meet on a price of the cryptobond, it won’t happen.
None of this should be new – it is done all the time in the corporate (and government) world with normal bonds. But with blockchain tokenization, the efficiency and borderless nature of the cryptobond enables a whole new class of bond market to form and operate. Cryptobonds will be cheaper to create, faster to transact, and can reach much broader markets. A Bangladeshi businessman can’t easily buy US corporate bonds. But in about 5 minutes he can acquire BFX Coin from his cell phone.
Again again, cynics, if you think BFX Coin is a scam, go short it. The market is open for you and will benefit from your wisdom.
Cryptobonds can further act in parallel or replace equity rounds for startup companies. There are times when companies are cashflowing and growing slowly, but they need $X of capital to seize an opportunity. Banks are notoriously stubborn in originating loans for startups. They don’t have the bandwidth to accurately assess the prospects of thousands of small projects in innovative fields: like the blockchain industry, for example.
However, thousands of participants in the Bitcoin community are far better placed to vet and bet on startups. Some of them will find value in some offerings of cryptobonds. That company gets to raise capital via debt instead of equity, and sometimes that makes a lot of sense.
Next, consider that in a world where cryptobonds were commonplace, a culture demanding transparency would exist. Buyers of the bonds want to know the financials of the companies. In the normal bond world, this is already available because the companies are publicly listed. But in the cryptobond market, the companies will mostly be private still. This will encourage a class of “autopublic” companies – companies that opt to make their information public to the market automatically, without regulatory requirement to do so. If they don’t provide transparency, they won’t get anywhere near the same value for their cryptobond offering.
Still don’t trust the company? Fine, demand a formal audit from a major accounting firm. Demand background checks on the directors. Demand whatever you want – you are the one offering bids on the cryptobonds. And if you smell a scam, short the bond and bring down the company before it grows bigger.
Cryptobonds are equally important for market participants to express bullishness and bearishness on a business entity. Value for the market is created in both directions.
And upon a marketplace of cryptobonds, you would discover the emergence of bond funds. Groups that acquired bonds in reputable companies and offered index funds in aggregate. Those too could be tokenized as metabonds.
Further, cryptobonds could be secured against digital assets like Bitcoin. Imagine a company with $2mm in Bitcoin, that needs cash today and doens’t want to liquidate its coins (because to the moon!). Putting the BTC in a smart-contract tied to repayment of the cryptobond could be an amazing way to raise low-interest debt.
Just as upon cryptocurrency a whole wave of financial innovation is occurring, so too upon cryptobonds entirely new financial mechanisms can be built. Are you listening, Jamie Dimon? Or are you still busy scoffing at Bitcoin and pretending your mobile app is innovative?
Central to the whole value proposition of cryptobonds is the democratization of investment opportunity. Access to capital markets, both for companies and individuals, is largely siloed today. Certain people can invest in certain ways in certain places. Some of these restrictions are regulatory, but some are simply geographic, technical, or efficiency-related. A small startup can not really “sell a bond” for $50k to raise money in today’s economy.
But now cryptobonds are a thing. And if the market can find a way toward more efficient capital allocation, it will.