Note Tokens: The Biggest Business in the World
Lending is the largest business in the world. Whether it’s commercial paper, mortgages, credit cards or US treasuries — the vast majority of the world’s money is invested in loans of various forms.
Market makers and proprietary traders (prop firms) are a huge segment of the borrowing market. Over the last few decades, algorithmic trading firms have taken over the majority of volume on all financial markets. Privately owned trading firms have taken over the role of Liquidity Provider that was formerly dominated by banks. The logic is simple: nimble, hungry and entrepreneurial traders at prop firms can iterate faster (less red tape) and make more money because their pay is more directly tied to the profits they generate. Also the barriers to entry to setting up a prop trading firm have lowered over time, compared to the barriers to setting up a hedge fund (harder) or a bank (practically impossible).
For a trader armed with algos and consistently profitable strategies, the only constraint to making more money is capital. Borrowing capital is extremely enticing for a prop firm. If you know your strategy scales to $10M earning 50% APR and $100M earning 20% APR, then anything you borrow under 20% is extra profit for you every single day.
Prop firms are highly secretive about their strategies, codebase and returns. If their competitors know what they are doing, they could lose the “edge” they’ve developed by investigating, researching and experimenting in the markets. Since prop firms usually have no outside investors, borrowing money is the best way to scale up their activities, compared to a hedge fund which increases its pool of LPs (Limited Partners that invest in the fund). Nonetheless, banks have been risk adverse to lending capital to prop trading firms for crypto trading as they view crypto as a risky and volatile market. In reality crypto markets are now frequently trading more volumes than many equities exchanges per day and are liquid 24/7/365 with zero downtime for the whole market. Also unlike many traditional markets, which are dominated by sharp algorithms, crypto markets offer “Direct Market Access” to individuals all over the world, which creates a wider array of opportunities for market makers.
CoinFLEX has built a product to solve the borrowing problem, Note Tokens. A market making firm that trades on CoinFLEX can borrow capital via a Promissory Note between the firm and CoinFLEX’s Trust company. CoinFLEX’s Trust issues Promissory Notes to CoinFLEX users in the form of ERC20 and SLP tokens. Anyone holding the Note Tokens can come to CoinFLEX and redeem them for $1 USDC in the redemption window (every 30 days) or continue to hold the note and roll the loan to the next 30-day period. CoinFLEX also pays the Note Token holders 30% of the firm’s trading fees on CoinFLEX as an incentive to buy the notes.
CoinFLEX is part of the next evolution in technological innovation in financial services taking place on the blockchain, observes my cofounder, Sudhu, a market maker on the floor of LIFFE who made the transition from the “pit” to the “screen” — the move to electronic trading. He ran trading businesses for DRW and Merrill Lynch, and was a Partner at Sequoia Capital. The discovery that was collectively made all those years ago was that man + machine was infinitely more scalable, capable and lower risk than pure human decision making and calculating. The beneficiaries of this discovery have been the traders themselves, the owners of the firms and the market as a whole, which has become more efficient.
But remember, the majority of the world’s capital is invested in loans of various forms. To a market making firm confident of 20%+ returns, a 5–10% interest rate loan is not only tolerable, it might even be cheap. To a person earning 0% in the bank, the prospect of earning 5–10% per year + 30% of the trading firm’s fees (could be an additional 10%) sounds incredible.
CoinFLEX is aiming to bridge these two markets: the market of savers and lenders and fixed yield collectors, and that of market making firms that run highly scalable automated strategies. Traders have already traded over $2two billion dollars in the CoinFLEX repo market. We think CoinFLEX Note Tokens lending can scale to hundreds of millions in 2021 and tens of billions over time, providing enormous value to both sides of the equation.
What do we get out of it? Well, every trading firm in crypto and the world wants to borrow capital and the requirement with Note Tokens is that the borrower has to actively trade and market make on CoinFLEX. The more they trade the more they can borrow and the lower their interest rate should be. — The 30% fees kickback means that Note Token buyers will prefer the highest volume trading firms over lower volume ones.
Our strategy is to become the largest exchange in crypto by being the dominant source of cheap and scalable trading capital for trading firms. We think this is a perfect alignment between an exchange, a trading firm and a lender.
About CoinFLEX
CoinFLEX is the platform behind flexUSD, the only stablecoin to pay interest on-chain.
