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#28 - Scams, energy, mortgages, and … chicken?

Blockchain for the energy sector

There’s a lot of excitement in the “upper layers” of the web3 cake. Concerts and moon landings are running in metaverse properties. DeFi is abuzz with scams, big profits, and bigger losses. NFTs are gaining traction for event tickets and loyalty programs. It’s too easy to forget that plain old blockchain, the underlying technology that makes so much of this possible, has other uses.

In the same way that code automates business rules and AI models automate decisions, the core thesis of blockchain is to automate trust. People can put their faith in smart contracts to perform actions and the network to verify activity, instead of having to trust a centralized intermediary (such as a payments processor or stock exchange). In turn, this allows marketplaces to crop up pretty much anywhere.

All of this came to mind as we read up on some blockchain activity in the energy sector:

There are a wide range of opportunities for applications of Web3 and blockchain technology to support the urgent energy transition. For example, Shell and a number of other global firms have launched Avelia, a book-and-claim solution to help scale the supply of sustainable aviation fuel. Technology companies such as Toucan, Moss.Earth, and JustCarbon are tokenizing carbon credits, offering clients a simpler way to offset carbon emissions. Peer-to-peer energy trading is becoming a reality thanks to ventures such as Powerledger, Grid+, and LO3 Energy.

This space involves a growing number of providers and consumers, many of whom would want to verify records of activity. Building on blockchains makes a lot of sense for energy companies.

(Many thanks to the subscriber who sent us that article. And if any of you see web3 news we should know about, please let us know.)

It all comes down to risk management

Most cryptocurrency tokens fluctuate in price over time. This is why so much of decentralized finance (DeFi) is a twist on the foreign exchange markets: you buy and sell different types of tokens, and if you’re lucky you turn a profit on the relative price moves.

DeFi markets run 24x7, though, and traders want to close out their positions – convert all of those crypto tokens into cash – so they can go on vacation or, y’know, sleep. “I cash out my Bitcoin on Friday to $100k, I come back on Monday and I still have that $100k in the bank. Even if the crypto markets tank over the weekend, I’m not holding crypto during that time, so I’m fine.”

The catch is that moving cash into and out of the crypto ecosystem takes days, which is too long for this scenario. Stablecoins, special tokens that are meant to stay in lock-step with (“pegged to”) some fiat currency, fill the gap. Someone creates a stablecoin pegged to the US dollar and that token becomes a proxy for the dollar. A proxy that conveniently lives inside the DeFi ecosystem, where transactions can settle in minutes or even seconds.

(This is when you’ll argue that fiat currencies can also fluctuate in price. This is true. But unless you’re holding British Pounds in October 2022, this is hardly a worry.)

Defining a stablecoin should be simple: someone pays you a dollar, you park the dollar in a bank account, and you hand them one token. Or maybe you swap the bank account for fiat-equivalent units, like government bonds. This is a sound strategy, because the fiat money will always be there when someone wants to hand you a token in order to get their cash back.

But apparently it’s too boring for some people? You’ve collected all this fiat currency and it’s just sitting there idle. You get … ideas … and then you join the crowd of people who try to “improve” the already-perfect plan of “just buy some damned fiat currency and park it.”

Hence why DeFi has seen so many stablecoins that aren’t. Like the “algorithmic” stablecoins, which mix math and code to maintain the peg. Those usually end in tears. Very expensive tears. But people keep trying. The Arguably Not Really A Stablecoin That Manages To Remain Stable Long-Term has become a kind of El Dorado in the crypto world.

We recently learned about another Stablecoin With Moving Parts, called HomeCoin. In lieu of treasury bonds or fancy math, HomeCoin backs its tokens with … mortgages. You hand the HomeCoin company a dollar, they use that dollar to buy up a mortgage. That would make HomeCoin a slight twist on a mortgage-backed security (MBS). Most people learned that term around 2008, so they associate it with the mortgage meltdown, and they may look askance at HomeCoin’s approach.

While we’re not here to promote HomeCoin – we still prefer the Backed By Cash Equivalents kinds of stablecoins – hear us out. Outside of 2008, MBSs have proven fairly stable vehicles for diversifying exposure to risk. The lesson from the housing crisis was not so much “mortgages are bad,” but “a single mortgage involves so many participants, each with their own ups and downs, that the wider mortgage space represents a complex adaptive system. And sometimes complex systems hit a snag.” 2008 was the right mix of ingredients that led the system to convulse and, in some places, break.

Back to HomeCoin, using home loans to back its stablecoin. Mortgages can be fairly steady investments. Not as stable as Mountains Of Fiat Currency Sitting In A Vault – again, excluding the British Pound in October 2022 – but still more stable than a lot of other corners of DeFi.

As with so much of the financial world, it’s not so much about the idea’s thesis, but about where the idea breaks down. HomeCoin’s long-term success will mostly depend on how the company handles risk management. So long as they choose the mortgages wisely, and they don’t experience a lot of correlated loan defaults (say, due to mass layoffs triggered by a recession), then there are only so many ways for it to break.

But if it does break, well … that’s the risk-reward tradeoff.

But what kind of scam is it, exactly?

Where there’s money, there’s crime. That’s probably why crime is so rampant in DeFi, where people lost more than $700 million to scams just this October.

One common DeFi scam is the rug pull. This three-act play is a twist on the classic pump-and-dump:

  1. You issue a new and hype it up to boost its price.

  2. People buy the token, thinking that it’s going to get huge.

  3. You stop hyping it up, run off with the funds, and the price plummets.

(Yes, yes, insert the obligatory joke here that Your Average Tech Startup Is A Rug Pull In Slow Motion …)

“Getting rugged” is almost a rite of passage in DeFi. So much so that a cybersecurity researcher has determined that just about all of the tokens launched on DeFi exchange Uniswap are rug pulls.

There’s been some debate as to whether these are truly rug pulls, or some other kind of scam. But getting nitpicky over the precise type of scam misses the wider point that scams are plentiful and people should be careful. This is especially true in a bull market, where people let their guard down because enthusiasm is high:

[The researcher in question, Bruno] Mazorra also pointed out the paper […] was a non-peer-reviewed version of the report that had been published in a bull market. An updated, peer reviewed version of the study can be found on the Multidisciplinary Digital Publishing Institute. “It was much easier to do rug pulls in the bull market,” he said. “If we redo this paper in the bear market, I think our hypothesis or conjecture will change completely — how a scam would be deployed would be very different.”

And, you see, that’s the thing. Where there’s money, there’s crime. Yes. But where money is scarce, there’s different crime. We expect bear-market crypto scams will be especially nasty. Hold on to your hardware wallets and be careful where you click.

Will you chicken out?

Cat bonds are a pretty interesting concept from the insurance field. The “cat” is short for “catastrophe.” The “bond” part is a way for an insurer to pool money. If catastrophe strikes, the insurance company that issued the bond uses the money to pay out claims. The investors who pay into cat bonds are placing a bet that the catastrophe in question will not take place – in which case they get their money back, plus interest.

Great. So that’s cat bonds.

Compare that to Chicken Bonds, where the “chicken” means … “chicken.” And “bond” also means “bond.” Kind of.

Chicken Bonds are a new concept in DeFi that blends pools of money with NFTs:

Chicken Bonds will not only be more engaging because of those new strategies but will also reward users with unique Dynamic NFTs - these are on-chain generative NFTs that change their visual representation based on the users actions.

What makes these generative NFTs unique is their dynamic nature: the NFT visual will either be an egg (while bonding), a chad chicken (after claiming the bond - “Chickening In”) or a run-away chicken (after canceling the bond - “Chicken Out”). The most chad Chicken Bonders and engaged users in the Liquity ecosystem will get the rarest NFT.

If there’s one idea DeFi has borrowed from the traditional banking sector (TradFi), it’s Accepting Money From One Party To Lend It Out To Another. The balancing act with that game is to make sure that the first group doesn’t want its money back before the second group has repaid you. Hence why so many opportunities in the financial space are designed to lock up deposits for some minimum amount of time.

Chicken Bonds seem to encourage the lock-up more with carrot (flashy NFTs and interest payments) than stick (hefty penalties for early withdrawal), but the result is the same: you park your money somewhere, and someone hopefully pays you extra for the privilege. And even if they don’t, you at least get an NFT. Maybe you can show it off on your fancy TV-turned-NFT-frame.

The wrap-up

This was an issue of Block & Mortar.

Who’s behind Block & Mortar? I'm Q McCallum. I've spent the past two decades in the emerging-tech space. And I'm very interested in web3 use cases.

Credit where it's due. Big thanks to Shane Glynn for reviewing early drafts. Any mistakes that remain are mine.

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