What Is Execution Risk?
Lesson P: Not Making an Ass Out of You and Me
“The best laid plans of mice and men often go awry . . .”
(“The best-laid schemes o’ mice an’ men / Gang aft agley . . .”)
— Robbie Burns (1759–1796)
When things go poorly or even fail with respect to defined goals, then one can say that the execution of the plan has not been realized as intened and the current course of action is not working out.
Execution risk is the possibility of the failure of some aspect of a firm’s or organization’s plans to achieve specific goals. Because an organization is often complex, the failure of one or several aspects of its plans does not necessarily mean complete failure. But it can mean the loss in the value of an investment in the short or long term.
One of the key factors prompting the introduction of a new plan for an organization or business is a change in the financial or regulatory landscape. A good way to think about change in this respect is that it is something mostly, if not entirely, outside one’s control. In other words, an organization and its executives cannot stop the change from happening. How they adapt to change is often referred to as transitioning.
Plans to adapt to change comprise a strategy to transition the organization from one state of operation to another. Transition not only affects the structure and procedures of an organization, but also its people. Transition management famously tries to take the complexity of both structural and human relations into the fold in order to make for successful transitions.
Taking Ethereum’s Merge as an example, one can say there are a few changes in the technological landscape that required addressing. One demand involved moving from a high energy consumptive method of transaction validation (i.e. Proof-of-work) to a more energy-friendly method in Proof-of-stake. A second demand concerned attempting to solve scalability issues with decentralized protocols. Ethereum was notoriously slow, but moving to Proof-of-stake set the stage for quicker validation and eventually lower gas fees (with the Shanghai upgrade).
Let’s see how execution risk can play out in relation to two key components of business: how it affects people and how it affects investments.
Execution Risk with Employment
With the transition to Proof-of-stake, the Ethereum miners who made their livelihood from Proof-of-work validating lose out. They not only suffer loss of return on the capital investment they made in very expensive computer technology, but they lose out on future opportunities to mine. One way miners responded and attempted to transition was by forking the Ethereum protocol, making their own Proof-of-work platform post-Merge.
To its credit, the miners have adapted, but things don’t look rosy. The project is still alive but barely kicking:
The future may hold more opportunities for miners and their computer equipment as AI protocols will most like use Proof-of-work validation to provide AI compute power via their distributed networks.
Execution Risk with Crypto Investment
SEC and EU regulation is coming down harder and harder on cryptocurrencies with respect to whether they are unregulated securities. To get a sense of whether a specific cryptocurrency qualifies as such, at least for US regulation, you can apply the “Howey Test”.
For the sake of simplicity, let’s assume that ACME is a cryptocurrency protocol offering certain services. Its native token is $ACME, and investors really like $ACME because the protocol is host to the world’s most fluid and frictionless producer of Roadrunner NFTs. (Ok, admittedly not much of a market there!).
As with all projects, it’s easier for ACME to succeed if, in its initial phases of development, it is operated by a small team of technicians and executives. That is to say, it is centralized. So far, $ACME would count as a security because people are buying the token with an expectation of profit.
ACME executives understand this problem. It’s a regulatory change that at first was more of a rumor but is now more of an imminent threat. So it’s a challenge that it must address. So they plan to transition the protocol from centralized control to purely decentralized governance via its DAO.
Their plan is to distribute governance shares to its protocol users based on their activity and involvement in the protocol — the more they buy, trade, and share via social media, the more governance shares they are rewarded.
What’s important to note about their execution strategy is that they are relying on the fact that pure decentralization exempts ACME from being considered a broker of securities. Why?
The BCLP law firm puts this well in a report:
“If the network around a cryptoasset or DeFi Platform decentralized to such an extent that investors would not expect the offeror or promoter to perform the essential managerial or entrepreneurial efforts, an investment contract may no longer exist. And he pointed out that if that third party’s efforts were no longer driving the enterprise’s success, information asymmetries between that enterprise and its investors might diminish to the point where the protections of the securities laws were no longer necessary.”
So with respect to execution risk, there are at least two concerns:
- Can ACME’s strategy to decentralize work? Will users snap up the governance shares?
- Even if the decentralization strategy works, will the SEC consider decentralized protocols as “no longer driving the enterprise’s success” in view of the expectation of investor profit?
If you were an investor in $ACME, these two factors present execution risks in regard to how much you paid to buy the ACME token and what you might have been expecting as a return.
You may simply HODL and wait. Or you may wait to see if ACME can execute (1) and sell out before (2) can adversely affect its price, even though the opposite might be the case.
This article is a part of the Crypto Industry Essentials educational program presented by 1.2 Labs (formerly The Art of the Bubble).
Though this article is credited to me, it contains some written material by Sebastian Purcell, PhD from his 1.2 Labs education series on cryptocurrencies.
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This content is provided for educational and entertainment purposes only. You should expect no financial returns one way or another based on the statements contained herein.Robin Technologies and Analytics LLC is the firm that distributes The Art of The Bubble products. The firm does not provide individually tailored investment advice and does not take a subscriber’s or anyone’s personal circumstances into consideration when discussing investments; nor is Robin Technologies and Analytics LLC registered as an investment adviser or broker-dealer in any jurisdiction.
