Is the future of corporate finance really decentralized?
Enthusiasts of cryptocurrencies believe they can force banks out of the lending business. That would be an aberration. Why “crypto finance” and “stable coins” are simply no good for CFOs.
Bitcoin, the best-known cryptocurrency, is highly attractive to many capital market participants, but that leads to a big problem: extreme volatility. The significant fluctuations in value make it especially difficult for companies to invest in such cryptocurrencies or use them in payment transactions. To address this weakness, so-called “stable coins” have been developed. Stable coins are linked one-to-one to an underlying value such as the euro or US dollar. Does this solve the volatility problem and pave the way for cryptocurrencies to move into corporate finance?
Not at all, because the true value of stable coins depends on the market value of the reserves, i.e. the portfolio of assets purchased as “collateral” with the issue proceeds of the issued stable coins in the fiat currency (for example, dollars or euros). And there are critical issues here.
First, the investments made are generally not audited. And this leads directly to the second problem: In reality, stable coin issuers have so far acquired as “collateral” everything from risk-free assets (good) to receivables from loans made by the issuer to affiliated companies or third parties (quite bad). Because the issuer’s stable coins have not yet been protected from the issuer’s general bankruptcy risk or collateral default, stable coin users are holding a perpetual non-interest-bearing high-yield bond with high default risks. Issuers, on the other hand, can theoretically collect high returns on the underlying assets of the stable coin.
Will stable coins make banks obsolete?
Nonetheless, cryptocurrency enthusiasts rave that the increasing use of “decentralized finance” and private stable coins will supposedly lead to an “unbundling” of banks’ traditional corporate finance business: Instead of working with banks, the CFO and treasury would in the future use software to conduct borrowing and trading primarily in a decentralized manner on a peer-2-peer network, the idea goes.
The deals are expected to look like this: Transparent protocols based on blockchain will allow treasury to borrow without the help of traditional bank balance sheets, while interest and repayments will be secured by smart contracts based on blockchain Ethereum technology, for example, and backed by stable coins in the form of Ethereum tokens.
But is this really the future of corporate finance? Will banks soon be superfluous in loan financing? Will peer-2-peer networks suffice companies for investment financing in the future, matching them with savers and then providing financing collateralized with Stable coins?
If so, that would be the end of Schumpeter’s analysis that banked creation of new purchasing power through credit is regularly the most interesting type of financing, which in fact intrudes wherever there is newness to finance. Without bank credit, “the financing of modern industrial development would have been impossible at all, and the pace of that development much slower, ” the brilliant economist concluded.
It’s all asset-based finance
As disruptive as the ideas of cryptocurrency enthusiasts may sound, under no circumstances should we be blinded by them. Because de facto, the supposed future model of “decentralized finance” is merely a niche for collateralized “asset-based” financing. Why?
“Central banks are working on launching their own digital currency. This would prevent the worst from happening.”
First, companies on peer-2-peer networks do not get ad hoc access to credit for real investments or acquisitions. A financial system with Decentralized Finance would deprive them of unsecured (bridge) loans and cash flow-based acquisition loans that provide companies with immediate liquidity before they can obtain long-term funding in the capital markets.
Second, this would not be typical loan financing for companies and would especially not help larger companies that regularly fund on a cash flow basis without collateral. Decentralized Crypto Finance is nothing more than financing the special case of a company holding crypto assets on its balance sheet in the form of stableboys and lending them out at interest like institutional investors do with securities lending or borrowing in a fiat currency like dollars or euros to use as a balance sheet asset to acquire stable coins. Corporate growth financing looks different.
Moreover, crypto assets are neither working capital on the asset side of a company’s balance sheet that can be separately refinanced, nor a hedge. The reason: no company — not even Tesla, the best-known Bitcoin user — realizes significant revenues in a cryptocurrency so far. On the contrary, it would even be a Texas hedge, as the transaction accumulates price risk, because then no loan is taken out in a cryptocurrency, but in dollars or euros.
What on earth was Elon Musk thinking?
So, what was Tesla CEO Elon Musk thinking when he invested in a non-operational asset like bitcoin for the electric car maker? It would have been better to put the free cash into the growing company, push other capital measures, or distribute the cash to shareholders. After all, investors could also decide for themselves whether they want to invest their money in cryptocurrencies after a distribution, if they feel like it. In any case, Musk’s Bitcoin investment has not done Tesla’s share price any good.
So — despite all the euphoria surrounding decentralized finance — an important question remains: Wouldn’t an advance of this type of financing set our credit economy far back? This concern seems to be shared by central banks around the world, which are currently working on launching their own digital currency, including in Europe. This is to be designed in such a way that it prevents two things: a disintermediation of the banking sector with fatal effects on the banks’ lending business and keeping the default risks of stable coins described above out of payment transactions.
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