August 23, 2022

Two loans, working punks, and Canadian clarity

Welcome to the Block & Mortar newsletter! Every week, we bring you the top stories and our analysis on where business meets web3: blockchain, cryptocurrencies, NFTs, and metaverse. Brought to you by Scott Robbin and Q McCallum.

Tokenize This ™ follow-ups

We've gotten some very positive feedback from our recent Tokenize This™ segment and, as promised, we plan to do more.  Would you like us to explore your business model through a web3 lens, and share it in a future segment?  Reach out and let us know!

A tale of two loans

A while back, we described taking out a loan as placing a bet on your ability to repay it later. One point we left out is that your lender is placing that same bet.  They believe in you – sort of –  but they could also use some extra assurance.  So they ask you to secure that loan by providing some collateral that they can claim if you go into default.

(Compare that to unsecured loans like revolving credit cards, and you see why those interest rates are much higher compared to a mortgage.  For an unsecured loan, a lender only has your word, so the higher interest rate is their compensation for taking that extra risk.)

We've seen people taking out loans to buy crypto. And we've seen cryptocurrency tokens used as collateral for mortgages. But now that we're seeing NFTs used as collateral, it's time for A Tale of Two Loans:

The first loan is a mortgage, so the house itself serves as the collateral: if you stop paying, the bank can reclaim the house as their property.  The thing is, the banks are in the business of issuing loans, not owning and maintaining houses. So they usually try to work with you to modify payment terms or whatever.  This slow, methodical process takes place over months and it involves lots of letters and phone calls.  Repossessing – foreclosing on – the home is a last resort.

The second loan takes place on a cryptocurrency exchange and your NFTs serve as collateral.  (Some NFTs cost more than houses, so this isn't completely unrealistic.)  Should you go into default, the lender – well, its code, written into the smart contract – automatically and instantaneously liquidates the loan.  No phone calls, no letters, no deal-making to adjust the loan's terms.  You lose your NFT collateral in the blink of an eye.

Some people are living that second scenario as their loans from crypto lending service BendDAO are coming due.  Borrowers put up their Bored Ape Yacht Club (BAYC) NFTs as collateral, and BendDAO lets them take out loans based on a percentage of the floor price (that of lowest-priced item in the entire BAYC collection).  That percentage – the loan-to-value ratio, or LTV – is roughly 40%.  So if the cheapest Bored Ape is currently $100,000, you could borrow up to $40,000 through BendDAO.

And since the entire crypto market is going through a rough time right now, those ape JPEGs are worth a lot less.  That $40,000 you borrowed has gone from "hey this is OK" to "you need to pony up more collateral or pay off a portion of the loan, pronto.

We've mentioned before that cryptocurrency and NFTs can be a person's intro to variable-priced assets.  That was a useful shorthand, but not completely true, because most asset values fluctuate over time.  The distinction is in how quickly and how dramatically those valuations change. Your home's value, for example, may take years to shift due to changes in the surrounding area and maybe even the wider macroeconomic climate.  An NFT's value, by comparison, can swing overnight. 

So what's the lesson here?  From our view, the lesson is not "don't use ape JPEGs as collateral."  An asset is an asset, so that's not the problem. The lesson is "be mindful of how you choose collateral."  Especially in a world where that asset can be reclaimed, in an instant, without any way to negotiate.

(Bonus lesson: "if you've taken out a loan to buy that BAYC NFT, maybe don't use that same NFT as collateral for a different loan."  Chaining loans like that just compounds your stress.)

Blockchain: star pupil of the emerging tech world

If you've been following the Big Data data science machine learning AI space as long as we have, you've probably noticed two things:

  1. It's been on a good run since, what, 2009?  All of that excitement really drove corporate adoption.
  2. A couple of years ago, companies started to acknowledge that their AI adoption wasn't going quite according to plan.  

If you read between the lines, those companies hadn't developed a strong understanding of what AI really was and how it would work.  They got caught up in the success stories of item #1, didn't do their homework, and found themselves in the pit of item #2.

And blockchain, always the star pupil of the emerging tech world, has managed to reach that state …. in less than half the time.  

Several large, well-known companies in the insurance space – including Allianz, Swiss Re, and Generali – formed The Blockchain Insurance Industry Initiative (B3i consortium) to help port insurance services to blockchain technology.  And last week, after five years, B3i threw in the towel.

What went wrong?  According to Swiss Re Group CEO Christian Mumenthaler:

“We would need an end-to-end view. It would need all insurance companies to basically create smart contracts at the beginning, at the origin.”

[...]

The problem, he noted, is that all insurers would have to switch their IT systems to be able to create smart contracts.

Deloitte fintech specialist Julien Maldonato has a slightly different take.  He has seen a common thread each time companies have tried to apply blockchain to insurance (translated from a source piece): "

You can't establish a web3 system while doing web2, using a decentralized system with the intent to centralize everything [ … such as] creating your own database, your own certification system, and so on.  That doesn't work because it's too expensive to develop and it doesn't meet the need of knowing how to make a service faster and more secure.

Whether you take Mumenthaler's view or Muldanato's, it sounds more like the insurance industry heavyweights behind B3i got ahead of themselves. Especially when you consider that "enterprise blockchain" success stories have been rather limited to date.  (That's not just because of the challenges of integrating blockchain technology into an existing business.  Also consider what it takes to achieve interoperability between multiple companies.)

So we think the take-home lesson is that it's great to be excited and see the potential for a new technology … but you also need to develop an understanding of how it works, and how to weave it into your business operations before moving forward.

Putting those punks to work

A couple of weeks back, our segment If you love JPEGs, set them free covered some high-profile NFT artists releasing their work under the wide-ranging CC0 license.

In a slightly different vein, this week Yuga Labs (home of the Bored Ape Yacht Club) announced the IP agreement for the popular CryptoPunks and Meebits collections:

CryptoPunk and Meebits holders have been waiting for this announcement since Yuga Labs first bought the collections from Larva Labs in March. The agreement confers full commercialisation rights to create projects and products based on a holder’s NFTs, putting them on par with the IP rights enjoyed by the Bored Ape Yacht Club’s holders, some of whom have already used the IP in projects.

In other words: people who have purchased CryptoPunks and Meebits NFTs now have the opportunity to put those assets to work.  (Technically, there are some wrinkles with US law as far as transfer of a copyright license … but we'll leave that one to the legal scholars out there.)  How soon till these JPEGs pay for themselves?  Will we get a CryptoPunks band that, to be ironic, performs music that is definitely not punk rock? And will we see a spike in phishing scams that target those collections?  

(No, we're not thinking of Seth Green's BAYC-NFT-turned-sitcom-star getting kidnapped a while back.  Why do you ask?)

Canada crypto clarity

Some people enjoy the current Wild West side of crypto, but longtime readers will know how much your Block & Mortar editors would prefer some rules. We strongly believe that regulatory clarity will lead to wider adoption.  And while we certainly don't claim that Any Regulation Is Good Regulation – rules should make sense, after all – we also know that Lack of Regulation Leads To Surprise Crackdowns, And That Hinders Adoption.

(What, "recent TornadoCash issues?"  No, we couldn't possibly be talking about that.)

We're pleased to see that Canada has recently defined some rules on cryptocurrency purchases:

Nine provinces in Canada have decided to limit the amount of crypto you can buy in a year. The provinces have set an annual limit of $30,000 as the maximum amount of crypto that can be brought. However, there are four notable exceptions for cryptocurrencies under this rule. 

Bitcoin, Ethereum, Litecoin, and Bitcoin Cash are exempted from this regulation. As a result, those four tokens will not be counted in your annual limit.

On the one hand, it's easy to cast aspersions on how the provinces are handling this. People generally don't like restrictions.  Doubly so since the idea of a government limiting your purchases runs contrary to the crypto ethos.  Fair. 

On the other hand, the two major cryptocurrencies – Bitcoin and Ethereum – do not fall under this rule, so it sounds like you're free to buy as much of those as you can afford.  We read this as Canada nudging people to the more well-known parts of the crypto ecosystem, which may limit citizens' exposure to certain kinds of crypto scams.

Taking a long view, remember that we're in the very early days of crypto regulation.  Governments are still figuring out what's the best long-term approach. It's similar to smartphones: over time, feature sets have converged and devices are largely similar. Manufacturers figured out that "powerful cameras," "on-screen keyboards," and "plenty of storage space for cat photos" were the must-haves. We expect to see the same with crypto regulation. 

Who will wind up as the iPhone (the clear trendsetter) and who will be the Blackberry (good for the start but eventually fell off the radar)?  Time will tell.

Well, Since You Asked …

We've referenced the notion of a "hardware wallet" in several newsletters.  (Usually in the Scam O'Clock ™ segments, but who's counting?)  Having recently added a definition of that term to our glossary of web3 terms, some sharp-eyed subscribers have asked: "this sounds great, but how do you actually use one?"

It just so happens that we're writing a short wallet tutorial right now.  And we'll share it with you in next week's newsletter.  Stay tuned!

Hell is … someone else's kitchen

We recently saw an announcement that Gordon Ramsay is setting up his Hell's Kitchen concept in The Sandbox's metaverse.

We have only seen the tweet, which includes a teaser video clip. 

We intentionally did not seek out additional resources. You see, we have a view of what this game could be, and we want to hold on to that view.  No need to let the truth get in the way of that, right?  We can then imagine the fun Ramsay had while recording the sound bites.

Just let us have this one, OK?

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Note: We’d like to thank Shane Glynn for reviewing early newsletter drafts. Any mistakes that remain are ours.