Updated: Sep 5
By Bernard at IntuitEcon
Nothing published or said by IntuitEcon is a recommendation to buy/sell/or trade any security. Please consult an financial planner before making important financial decisions.
DeFi Technologies (“DeFi Tech” ticker $DeFi, $DEFTF) provides a unique investment vehicle for gaining exposure to decentralized finance. We view DeFi Tech as highly complex and risky investment compared to investing directly in DeFi Protocols. However, we also see the potential upside being much higher than the crypto space generally.
Specifically, we view DeFi Tech as having perhaps a 3-5% probability of catastrophic failure as a result of operational and counterparty risks relating specifically to the structure of their flagship service, Exchange Traded Products and Treasury Services. These ETPs are not collateralized and are essentially fully dependent on DeFi Tech as counterparty. However, should DeFi Tech succeed in executing on their business model we believe they could potentially appreciate in value far more than even say Ethereum over the next 1-2 years.
This potential upside is even higher should they improve transparency, legal structures and financial engineering techniques to reduce or eliminate these operational and counterparty risks. We have reached out to DeFi Tech to offer assistance in this regard and await their response.
What follows in our investing thesis, broken into three parts:
We hold a 6% position in $DEFTF relative to NAV.
DeFi Tech has a colorful history that began with Fred Leigh, then CEO of Routemaster Capital, buying the top of the last Crypto Bubble. Routemaster Capital would later become DeFi Technologies, but before late 2017 they focused primarily involved in mining activities in Canada. That changed on December 14th 2017 with the 49% stake in Pinedale, a Bitcoin mining facility, within a couple weeks of the crypto market peak. A few months later, Fred resigned on March 14, 2018 .... but then returned in March 2020.
At the same time of Fred's return to Routemaster Capital, Oliver Newton Co-Founded DeFi Holdings ... the precursor to DeFi Tech with a focus on investing, incubating and managing trading technologies associated with the fast-growing decentralised finance market. Oliver's timing in the space could not have been much better.
During the crypto bear market Routemaster Capital continued to invest in the space despite having initially invested at the worst possible time. That's a testament to the board's staying power in a space that many left for dead by 2019. On October 6, 2020, the Company announced that it has entered into a binding Letter of Intent (“LOI”) to acquire a
49% equity interest in DeFi Holdings. That was just a week before Bitcoin really started its epic rise last fall.
Routemaster completed the acquisition of DeFi Holdings and changed its name to DeFi Tech in January 2021. In February of 2021 it acquired 20% of Valour, now a wholly owned subsidiary of DeFi Tech which operates its ETPS. The best source of facts on DeFi Tech can be found in ints most recent annual report.
Many people and companies came together to form DeFi Tech...making it a rather complex company to wrap one's head around. Let's start with the facts
DeFi Tech is led by co-founders Wouter Witvoet and Olivier Roussy Newton, who have positioned DeFi Tech to be the only publicly traded near pure play in Decentralized Finance (DeFi). This article assumes knowledge of DeFi which DeFi Tech explains at a high level in this marketing deck. The market size for the industry grew from essentially zero in 2017 to around $100 Billion as of this writing and spans multiple sectors, including insurance, derivatives, credit and lending, asset management, and exchanges. DeFi Tech operates across four service lines that essentially provide a gateway for investors to buy DeFi exposure using public securities or in house services.
DeFi Technologies mission is to, “give institutional and retail investors easy access to previously unseen returns through this newly emerged decentralized financial market.” They state that they want to, “help drive investments into decentralized finance and incubate new projects to further develop groundbreaking protocols that will continue to fundamentally reshape the global financial system.”
They do this through four service offerings that they describe in their marketing material on their website and short promo movie. These material are extremely effective in persuading investors of the value of DeFi Tech as an investment...but do little to provide investors with transparency into the risks of the company.
DeFi Tech’s four service offerings are listed below. These four service offering make DeFi Tech highly sensitive to the actual and perceived success of DeFi as an investment. The range of protocols they are exposed to is wide enough to be considered highly concentrated in DeFi , diversified within this space. Thus, so long as DeFi Tech remains a going concern and can execute then they would likely appreciate by even more than the underlying DeFi space should DeFi continue to grow in acceptance. No other publicly traded company provides such exposure to DeFi.
Arguably the most important are their exchange traded notes (ETNs). Leadership tries to equate these to ETFs, but they are very different. For one they are not collateralized. DeFi Tech essentially creates contracts referencing crypto-assets like Bitcoin that they mark to market and agree to exchange for dollars at market prices. However, their ability to make good on this promise depends on their ability to remain a going concern. This is entirely different from ETFs that collateralize their security with the underlying stocks and bonds. By comparison, Grayscale funds may trade at premiums or more recently discounts to the underlying, but are at least backed by the underlying collateral. The structure of the ETNs is such that they are likely to trade very close to the underlying...unless counterparty risk to DeFi Tech becomes a concern. We will describe this risk in more detail later.
DeFi Treasury is arguably the second most valuable service given the high yields that DeFi can provide without market risk to the underlying compared to sovereign bonds in Europe. DeFi Tech is primarily targeting investors in Europe. Same goes for their ETPs. The negative yielding sovereign bond market is so large relative to DeFi Tech that the existence of DeFi Tech’s offerings here could materially increase demand for DeFi protocols. This is similar to the impact buying Bitcoin via Grayscale had on the price of Bitcoin from November through February 2021. Another analogy is the gold bull market from the early 2000s that was fueled in part by the creation of gold ETFs like GLD in 2004. In short, by making DeFi easier to buy, DeFi Tech may actually impact the price of DeFi coins. DeFi Treasury appears more likely to generate this type of market moving impact because the market cap of DeFi tokens is so small relative to the European sovereign debt market.
DeFi Ventures is perhaps the third most important value proposition, but it’s hard to say given the lack of transparency and recent acquisitions. We think of this segment as being similar to that of Overstock’s “Medici Ventures” in terms of the opacity but potential for upside. The size of DeFi’s holdings and their exposure to operational risks like losing keys, hacks, or storage on centralized exchanges is all unknown to us after reading through the financials. Presumably the exposures through DeFi Ventures is how DeFi Tech makes good on ETP price appreciation, but this is also not clear from the prospectus on say Bitcoin Zero (their largest ETP).
DeFi Governance value in our view. Some DeFi protocols rely on data from outside the Blockchain economy. For example, insurance contracts need to verify the estimated cost of damage done to a house, or verify that a claim is not a fraud. Coins like Tellor are working to make this happen in a decentralized way, but until that happens there is a valuable use case for companies like DeFi Tech.
DeFi Tech has some heavy hitters on their leadership team. The inclusion of Pomp as an advisor is notable given the gravity that he brings to the table. Here is a video of Pomp discussing DeFi with the CEO Wouter Witvoet. Messaging from leadership and backers like Teeka Tiwari are very similar to the promotional videos and material on the website.
We are glad to see Oliver on a leadership position given how important he was to the companies history. Surprisingly they do not include Johan Wattenström, who was the original CEO and Co-Founder of XBT Provider, who launched the world’s first Crypto ETN back in 2015. XBT Provider was the precursor to Valour which became a wholly owned subsidiary of DeFi Tech in the Spring. Valour operates the ETPs that we argue are the most important service provided by DeFi Tech. Diana Biggs is the CEO of Valour, but only just took the position in February. Johan is listed in the leadership team as well.
We will be watching especially closely to see if Johan continues to playa key role at DeFi Tech given that is arguably the true visionary.
DeFi Tech has many of the risks they describe as risks to centralized finance...which is a bit ironic. We point out several risks in this section, the most important being that they are a centralized solution to decentralization. We are also concerned about the CEO's lack of DeFi experience and unproven track record in the space. There is also a general lack of transparency regarding risks on the website and in marketing material. This lack of transparency adds to the very material operational and counterparty risks in the company's most important service, the ETPs.
Centralized Solution to Decentralization
Specifically, they have a high degree of operational risk and are not particularly transparent about their history, financial statements, or mechanics of their exchange traded products (ETPs). This lack of transparency augments the operational risks we outline later.
DeFi Tech praises DeFi for the value that it brings in addressing the problems of centralized finance. But they do not bother to clarify that their products are not at all analogous to investing directly in DeFi. Specifically, DeFi Tech is not itself run on a Blockchain. They are thus not fully transparency. They are an intermediary. They have control, not the investor. This creates high counterparty risk and should they be at risk of bankruptcy then the value of their ETPs would likely suffer or potentially go to zero irregardless of the referenced DeFi coins.
The CEO Wouter Witvoet became CEO with the name change and focus in early 2021. Here he is in September 2019 describing his company SecFi, which he says helps people invest their equity. At no point does he mention crypto or DeFi. That’s perhaps understandable given that DeFi did not really take off until 2020, but not ideal. We would prefer to have a CEO at the helm that had a vision of what DeFi would become...not jump into it after it was already exploding.
That being said we do like CEOs of Startups and Wouter Witvoet is certainly that. Here is a Medium article he published to kick off his most recent venture SecFi before jumping into DeFi. The business model is practical and stems from his own experience handling the tax implications of equity shares he acquired while working at an earlier startup.
DeFi Tech is viewed as an still an unproven company ... however, the primary service offering in our view are the ETPs run by Valour, which technically started in 2015. That's not a bad track record. Other leadership team members have more experience in the space than the CEO so perhaps Wouter knows what he is doing.
Lack of Transparency
Investors are directed to view a deck describing DeFi Tech’s thesis on why they are poised for success. It’s a glowing perspective that provides little to no transparency into the risks associated with their products, especially their Exchange Traded Products (ETPs) as we describe below. They also fail to include links to recent financial statement directly from the investor website which is atypical.
There is also a lack of transparency generally into how the various pieces of the business fit together and principles / guidelines they apply when selecting investments, launching new ETPs, providing governance nodes, and making acquisitions.
This lack of transparency is part of the reason why the operational risk to their ETP business is so high as we discuss further in our final Thesis. The only place you can find some insight into these details are in the actual ETP prospectus we shared earlier. However, even this prospectus fails to provide any insight into the mechanism for operating their ETPs as we discuss below.
Bootstrapped Exchange Traded Products
Arguably the biggest risk (and opportunity) for DeFi Tech is in how it documents, communicates, and structures the ETPs it bought from Valour. As currently structured they have significant operational and counterparty risk. Their website and YouTube videos do a lot of comparing your ETPs with ETFs, but these comparisons are a stretch if our understanding is correct because...
1) ETPs like Bitcoin Zero are not collateralized
2) DeFi Tech is marking-to-market itself instead of using an independent third party or Blockchain protocol.
3) DeFi Tech is trading the underlying to hedge
4) DeFi is the sole custodian of the ETPs
Based on our read of thir public documentation, these ETP structures is not likely to allow DeFi Tech to achieve its mission of providing a one stop investment to give broad exposure to DeFi for all forms of investors. These ETPs contain one of the most extreme examples of counterparty risk we’ve seen in a security...which is ironic given their mission and name.
Our team has some experts in this area that could help to fix these issues with your ETPs. We’ve reached out to DeFi Tech and are in early discussions. We plan to buy more stock in DeFi Tech and perhaps even provide additional help and marketing services should they be transparent and willing to evaluate ways to improve their products.
We view DeFi Tech as having a unique risk profile that is highly sensitive to the growth in adoption of DeFi protocols. Our team is highly bullish on Ethereum in part because we are exceedingly bullish on DeFi protocols. No faith is required to see the value in DeFi … as DApps in this space rapidly grow in usefulness to fulfill needs such as censorship resistant insurance contracts, fixed income investments, exchanges, and a growing list of other financial services.
The key risk with DeFi Tech is operational...meaning that they could easily suffer a downward spiral of confidence should their ETP protocols ever trade below par...ultimately leading to bankruptcy.
ETPs controlled by DeFi Tech are nothing like the ETFs they compare them to on their website and in public discussions by their leadership. Their ETPs are not backed by collateral, are dependent on DeFi Tech for marking to market, custody, and operational plumbing required to hedge exposures to their investors. Because of this lack of transparency, investors would likely respond with fear to any price below par...which could occur, per say, should DeFi Tech ever be at greater risk of bankruptcy. Such a risk could easily cascade into complete loss of confidence as investors learn of the true risks behind these ETPs and discover that they are holding only a piece of paper entirely dependent on DeFi Tech’s good reputation and existence to retain value. Similar risks apply to their Treasury Services although not to the same extent. is Should DeFi Tech be at risk of bankruptcy the value of these key services would likely plummet and lead to a complete loss in investor confidence. The reason why is that their ETPs are not collateralized, and their documentation is and thus any discount to par would likely spiral into
If DeFi Tech overcomes these obstacles then it is in the realm of possibility of share price appreciation sending the current market cap of $120M to $1-10B company over the next two years.
We will discuss this article along with our weekly update on our Sunday podcast. [UPDATED: Now Monday 6pm EST] We will be sharing a Zoom link to subscribers and Twitter followers at 6pm EST. Recording starts promptly at 7pm.
Thank you for your support!
Investor Relations Page - https://defi.tech/investor-relations
Investor Deck - https://defi.tech/defi-technolgies-deck-12-04.pdf
Consolidated Financial Statements 2020 - https://sec.report/otc/financial-report/288790