Spencer Dinwiddie & Contract Tokenization: The Next Generation of Finance

“The spirit of a people, its cultural level, its social structure, the deeds its policy may prepare—all this and more is written in its fiscal history, stripped of all phrases. He who knows how to listen to its message here discerns the thunder of world history more clearly than anywhere else.”

– Joseph Schumpeter

Are you not entertained?

Pick any historical period and you will see that most forms of marginalization has been built on economic systems that establish and sustain asymmetric distribution of capital and profits. Spencer Dinwiddie’s goal of tokenizing his NBA contract foreshadows a monumental shift in how money and power are distributed by leveraging the power of blockchain technology. I start with a brief introduction of how legacy power structures have been formed and present why us in the blockchain community believe so strongly in the technology.

The Roman gladiator era demonstrated the ability of emperors and powerful aristocrats to sustain their wealth via manipulation and exploitation of common day citizens. By expending slave and prisoner lives for entertainment, these powerful forces leveraged their vast resources to simultaneously create fear in breaking the law and satisfy the subconscious bloodlust of the masses. Society was not only entertained but became obsessed – so much so that the sweat of gladiators was believed by some to be powerful aphrodisiacs. Control of public entertainment (and underlying propaganda) allowed those in power to influence the masses into accepting and then desiring the image of the gladiator, reinforcing a tyrannical grasp on the Roman population.

The economic system underpinning the gladiators allowed the elite to (i) finance the construction of arenas via taxation and war and (ii) popularize a distraction to the cruel and anti-democratic principles they had set in motion. Essentially, assets from the working class were stolen and re-appropriated to maximize gains of the elite; ultimately culminating in the demise of the middle class, increased animosity amongst the starving population, a constant state of war, and the demise of the most powerful state the world had ever seen. Sound familiar?

History has been defined by people trying to optimize government and social institutions in order to maximize happiness. Humanity’s institutional relationships have changed quite substantially since the Romans. Subsequent government structures were built by the elite in all flavors – monarchy, theocracy, dictatorship, etc. Ultimately, the ability to maintain dominance was bolstered by principles of instilling fear of breaking rules while providing the bare minimum societal benefits to prevent rebellion.

The French Revolution was a watershed moment where the culmination of extreme poverty, war, massive government budget deficits, and uncontrolled spending mobilized the French population to push for radical reform. This period of enlightenment was grounded in creating momentum for democratic institutions to take hold; the movement espoused key tenets reflected even today in the US Constitution’s Bill of Rights. Technology was at the heart of the rebellion. Improvements in printing and records retention contributed to the reduction in the cost of production and allowed French citizens to better store, organize, and disseminate information. The spirit of the revolution also manifested a renewed interest in science, technology, and philosophy. The French government, fearing the rebellion, eventually began to require the registration of printing presses and filter their own propaganda through their media network. Ultimately, the revolution also paved way for Napoleon to take control as communication technologies were coopted and gave power to those that could wield it the best. As Malcom X said:

“If you’re not careful, the newspapers will have you hating the people who are being oppressed and loving the people who are doing the oppressing.”

The cycle of a paternalism continues even today despite each new advancement in communications technology (the postal system, telegraph, telephone, etc.) as the elite were able to exploit the tech to maintain control. However, for the first time, blockchain technology allows people to be their own banks and gain trust in trading with partners around the world in a seamless fashion. While these industries are still in their infancy, the hesitance of the NBA to approve SD8, the US government’s reluctance to accept Bitcoin, and trillions of dollars in negative interest rates all prove that we are doing something right. All these events are part of the same underlying story – people are becoming more powerful and that scares legacy power structures that have been engrained in society for generations. Not only can we now call bullshit easier, we have the power to do something about it.

“Basket Ball and Dance”

The Black Fives era was rife with all-black basketball teams; most notably, the New York Rens and their 83%-win rate over a 25-year period (including an 88-game win streak)! Since introduction of basketball to African Americans in the early 1900s, the sport served as a microcosm of the struggle for equal rights and to redeem a culture that for generations had been coopted and destroyed. The games, however, manifested a community ethos to social change. Organizing and promoting Black Fives basketball among all American communities was a battle focused on challenging the identification of the African American as depicted by the mainstream media.

Funding for creating teams and organizing games were often sponsored by cultural organizations such as churches and social clubs (e.g., the Y). Games were opportunities for activists, musicians, poets, and religious leaders to assimilate. It was a place everyone could come together to share ideas for improving their communities and to dance the night away. Coming together was a necessary endeavor to continue the fight against a bigoted system hell bent on keeping their boots firmly planted on the neck of emancipation movements. Basketball was a tool for minorities to fight cultural imperialism by reclaiming their identity, and it worked.

As the Black Fives games became increasingly popular, the NBA *reluctantly* allowed African Americans to play in the NBA. Over the next 7 decades, the NBA was morphed into an institution that is now trying to remove the term “Owner” given negative historical connotations. Hundreds of millions of dollars are now paid to black athletes in the form of sponsorships and salary. A good piece of that capital has been successfully filtered back to local communities through both investments by the NBA and coaches/players. NBA Cares promotes the well being of local communities across the country and soon, around the world.

Still, substantial work needs to be done. While ~70% of NBA players are identified as African American, MJ was finally named the first black majority team owner in 2004. The NBA, despite the claims of its positive effects on urban development resulting from the construction of basketball arenas, has not been able to foster statistically significant growth in these cities. In fact, the construction of sports arenas has shown to have a negative economic impact. How, with all the development and capital flowing to an economy, does that happen? Discretionary income as a percentage of income is somewhat constant over time (many would argue that this ratio is decreasing for certain populations); therefore, spending in these zip codes is just redistributed more to arena owners rather than local businesses. When teams and owners use public financing or receive favorable tax incentives, the problem is then accelerated as the taxpayers become financially responsible for construction and maintenance of the stadium, as well as the painful debt service that will last decades. The profit motives are then juxtaposed against necessary local government services such as schools, libraries, parks, etc. in the short term with the promise of improved economics (which doesn’t occur). Furthermore, development of the surrounding businesses are often national chains rather than local businesses. Sure, that means more jobs (potentially), but the massive profits are asymmetrically allocated to just a few large corporations and sucked out of the local economy.


“The contemporary tendency in our society is to base our distribution on scarcity, which has vanished, and to compress our abundance into the overfed mouths of the middle and upper classes until they gag with superfluity. If democracy is to have breadth of meaning, it is necessary to adjust this inequity. It is not only moral, but it is also intelligent. We are wasting and degrading human life by clinging to archaic thinking.”

-Martin Luther King Jr.

The beginning of a monumental shift in the power structure of contract negotiations started with ‘The Decision’. Although widely mocked as an arrogant display of LeBron, the next generation of superstars benefited from the sudden transition of power from teams to players (also important to note that, even if he was arrogant, he backed it up). With the new collective bargaining agreement in place, players now enjoy more earnings potential and flexibility than ever before. Rather than deemed as assets ‘owned’ by a team, players are reshaping the equation and ‘renting’ their talents to the highest bidder or best opportunity at hand.

Further, leaders like LeBron and Spencer are today crafting ecosystems to ensure player’s voices are heard and finances are taken care of (about 60% of NBA players declare bankruptcy 5 years after retirement). The focus is shifting away from just earning a high salary to maximizing the value of one’s talents and career. This new generation of athlete entrepreneurs born in impoverished urban centers across the US over a century ago speaks to the tremendous success of grassroots movements and dedicated leaders pushing relentlessly through some of the darkest times in our country’s history.

As LeBron did for disrupting the relationship between ‘owners’ and players, Dinwiddie’s SD8 token will alter the relationship between ‘owners’, players and fans. Bringing liquidity to contracts enables players to invest better, plan, and more easily repay fans for their loyalty. Leveraging blockchain technology builds transparency into the process and minimizes rent-seeking in today’s outdated financial system. Finally, a key advantage of the SD8 securitization is the uncorrelated returns (relative to the general market). Placing faith in the talents of players is an attractive hedge against the macroeconomic background of our unsustainable central banking system. The uncorrelated nature of the SD8s will perpetuate demand for and continue to shift power in favor of the players, reversing the age-old wisdom that ‘owners’ create value for the NBA.

Tokenization of talent and skill can accelerate the process of democratization through replication of the SD8 process for various industries. The concept could help lift both the future computer scientist that lacks the ability to afford a laptop and the local artist that can’t afford a new easel. Blockchain technology empowers people to tokenize their talents and seamlessly raise capital from around the world and contribute more positively to society. The world’s trend towards a gig economy will likely further decentralize talent away from larger organizations as people are learning how to leverage their unique talents to make a living on their own. These increasingly positive trends point to a social system that can be deconstructed and rebuilt by and for the people. The next generation of civil rights leaders will no longer be labeled rebels and hosed in the streets; they are respected thought leaders with a global voice.

“Every individual… neither intends to promote the public interest, nor knows how much he is promoting it… he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.”

-Adam Smith


Black Fives Foundation. “The Black Fives Era in Perspective.” https://www.blackfives.org/about/

Bowen, Fred. “In its early years, NBA blocked black players.” February 15, 2017. The Washington Post. https://www.washingtonpost.com/lifestyle/kidspost/in-nbas-early-years-black-players-werent-welcome/2017/02/15/664aa92e-f1fc-11e6-b9c9-e83fce42fb61_story.html

Brangan, Mallory. “Why do taxpayer’s pay billions for football stadiums.” January 31, 2019. Vox. https://www.vox.com/2019/1/31/18204471/football-stadiums-cost-taxpayers-billions

Brooking, Doug. “The Role of the Press during the Revolutionary Period.” https://pdfs.semanticscholar.org/2254/bf9e4058d4ee789a90ed771f791fbda6e87e.pdf

De, Nikhilesh. “Spencer Dinwiddie Could Decentralize Pro Sports – If Accredited Investors Want In”. September 28, 2019. https://www.coindesk.com/spencer-dinwiddie-could-decentralize-pro-sports-if-accredited-investors-want-in

Feinstein, Brad. “Blockchain in Sports: Fractionalized Fan Ownership and Athlete Crowdfunding.” July 9, 2019. https://media.consensys.net/blockchain-in-sports-fractionalized-fan-ownership-and-athlete-crowdfunding-4aa246886f9

Istrate, Emilia and Harris, Jonathan. “The Future of Work: The Rise of the Gig Economy.” November 2017. National Counties. https://www.naco.org/featured-resources/future-work-rise-gig-economy

MIT Technology Review. “An NBA star plans to turn his contract into tokens and sell them.” January 10, 2020. https://www.technologyreview.com/f/615034/an-nba-star-plans-to-turn-his-contract-into-digital-tokens-and-sell-them/

Neuharth-Keusch, AJ. “NBA teams ‘moving away’ from using ‘owner,’ says commissioner Adam Silver.” June 24, 2019. USA Today. https://www.usatoday.com/story/sports/nba/2019/06/24/nba-commissioner-adam-silver-teams-moving-away-using-owner/1545041001/

NPR Code Switch. “Before the NBA Was Integrated, We Had the Black Fives.” March 15, 2014. https://www.npr.org/sections/codeswitch/2014/03/15/290117181/before-the-nba-was-integrated-we-had-the-black-fives

PBS News Hour. “Why should public money be used to build sports stadiums.” July 13, 2016. https://www.pbs.org/newshour/nation/public-money-used-build-sports-stadiums

Propheter, Geoffrey. “Are Basketball Arenas Catalyst of Economic Development.” Journal of Urban Affairs. November 30, 2016. https://www.tandfonline.com/doi/abs/10.1111/j.1467-9906.2011.00597.x?journalCode=ujua20

Sage, George H. “Sport and Social Resistance.” February 15, 2007. The Blackwell Encyclopedia of Sociology. https://onlinelibrary.wiley.com/doi/abs/10.1002/9781405165518.wbeoss238

Sprung, Shlomo. “Spender Dinwiddie Discusses Digital Tokenization Plan, Happening Against the NBAs Wishes.” October 17, 2019. Forbes. https://www.forbes.com/sites/shlomosprung/2019/10/17/spencer-dinwiddie-discusses-digital-tokenization-plan-happening-against-the-nbas-wishes/#63bf5f466dc0

Streeter, Kurt. “Is Slavery’s Legacy in the Power Dynamics of Sports?” August 16, 2019. The New York Times. https://www.nytimes.com/2019/08/16/sports/basketball/slavery-anniversary-basketball-owners.html

Teicher, Jordan. “America’s Black Basketball Pioneers.” April 17, 2014. Slate. https://slate.com/culture/2014/04/the-new-york-historical-societys-exhibit-the-black-fives-highlights-early-black-basketball-stars-photos.html

Thomas, Vince. “Basketball’s Forgotten (Black) History.” March 10, 2010. The Root. https://www.theroot.com/basketballs-forgotten-black-history-1790878850

Tisdale, Julie. “Publicly Funded Stadiums.” https://www.johnlocke.org/policy-position/publicly-funded-stadiums/

Torre, Pablo. “How (and Why) Athletes Go Broke.” March 23, 2019. Vault. https://www.si.com/vault/2009/03/23/105789480/how-and-why-athletes-go-broke

Winck, Ben. “The NBA is reviewing Brooklyn Nets player Spencer Dinwiddie’s revised plan to turn his contract into a digital investment vehicle.” January 14, 2020. https://markets.businessinsider.com/news/stocks/nba-reviewing-spencer-dinwiddie-plan-brooklyn-nets-contract-crypto-token-2020-1-1028816903

Zimbalist, Andrew and Noll, Roger. “Sports, Jobs & Taxes: Are New Stadiums Worth the Cost?” June 1, 1997. The Brookings Institute. https://www.brookings.edu/articles/sports-jobs-taxes-are-new-stadiums-worth-the-cost/

Pricing Loans on Cryptocurrency Assets

The early stage of the cryptocurrency lending market has dramatically changed in the short time since the birth of the industry. These changes were driven by a combination of digital asset volatility, increased competition, an influx of financial products, and correlation to traditional market events. Investors and lenders are still struggling to find equilibrium pricing on interest rates against the backdrop of high price volatility and reduced demand during the protracted cryptocurrency bear market. Below, we review traditional loan pricing fundamentals and extrapolate what lessons can be applied to this dynamic, emerging asset class.

Loan Fundamentals Review1


Loans are typically priced as a percentage of par value (per $1,000 in most cases). Discounts reflect percentages less than 100% and premiums reflect percentages greater than 100%. Discounts to par indicate that the buyer of the security requires some level of return when they are repaid their principal balance. For example, a buyer of a loan may pay 99% of par ($990) to get $1,000 at some point in the future when they are repaid by the borrower. This specific structure would reflect a return of 1% ($1,000 / $990 – 1) over that period. If the yield of 1% is generally attractive for this type of loan, it would be considered the yield to maturity; i.e., the expected rate of return. If the rate is too low, lenders will not underwrite the loan. If the rate is too high, competition will quickly bring prices down.

The yield to maturity (YTM) is considered the ‘discount rate’ for loans. Generally speaking, the lower the YTM, the lower the risk. The ‘risk free rate’ represents a theoretical return with zero credit risk. In the US, US Treasury rates are typically used as a proxy2. The difference in the YTM for other assets (assuming securities other than Treasuries have greater than 0 risk) above the risk-free rate is considered the credit spread (i.e., credit spread = YTM – risk free rate). 

Coupon Rate

Often confused with the YTM, the stated coupon rate is the interest income paid to the lender by the borrower. The payment can be made in multiple forms:

  • Cash – Reflected as a periodic payment paid as a percentage of the total principal value (i.e., the loan amount) to the lender. For example, an 8% coupon rate on a loan of $1,000 would reflect an $80 payment.
  • Payment-in-Kind – The payment is instead reflected as compounded interest and paid lump-sum on exit. In the example above, the $80 would equal $1,080 total balance due to the investor. These structures typically demand a premium to a cash payment structure given they are utilized by issuers with imminent cash flow needs.
  • Interest Only – Only interest is paid to the lender until the entire principal balance is paid at exit (referred to as a bullet payment).
  • Principal + Interest – Each payment to the lender includes a portion of interest and a portion of the lent capital. This reduces the burden of paying a lump-sum payment at exit. This structure is typical with real estate mortgages.
  • Variable versus Fixed – Interest rates can fluctuate (floating-rate securities are typically used to hedge inflation risk) or be paid in the form of a fixed amount. Historically, the interest rate on these loans are expressed as a rate on top of a floating instrument (e.g., LIBOR, TIPs, etc.).
  • Hybrid – Each of these instruments above may be combined for exotic instruments to fit various needs.

Origination Fees

Fees paid to the lender (or the originator of the deal, I will keep it simple for this post and assume they are the same) for work performed to consummate the deal. The funds go to pay the lender for time spent preparing documents, marketing the loan, covering expenses for legal and accounting, etc. In complex deals, the origination fees are greater.

Origination fees can be paid in multiple forms. They can be paid up front, as a portion of the notional balance (e.g., original issue discounts), or built into some exit fee (usually as a multiple of the amount).

A portion of the interest is paid to a servicer. A servicer performs administrative duties (such as recordkeeping, recording the ledger, etc.) related to the loan. More complex instruments generally require a greater fee. Larger banks may have deals where a lender teams up with a servicer and structures as a revenue-share or a JV model. 

Prepayment Penalty

A penalty imposed by the lender in case there an is voluntary early prepayment of a loan. The fees are assessed on exit; for example, a 1% prepayment fee would mean the lender would need to return 101% of the principal balance if paid before the stated maturity. Exit fees can also be assessed, where a premium or discount is reflected in the final payment. The purpose of these structures is to protect the lender against early repayments, which negatively impacts their ability to find a replacement borrower at the same (or greater) interest rate.

Credit Ratings

A financial scoring system for issuers that provide standardization for risk analysis. S&P’s rating system, for example, goes from AAA down to C. Indices can be measures for loans with the same credit rating to get an average yield. Some of these indices can be observed on the St. Louis FRED system with daily reported yields and spreads3. The ratings typically reflect the probability of issuer default, although more recent models with the advent of P2P alternative lending may reflect a greater breadth of data points (although it is questionable as to which data sets contain statistically significant data with meaningful predictive power).

The intent of credit ratings is to standardize risk and allow for comparability. Typically, both the issuer and the actual loan receive a credit rating. No blockchain-based loan (nor issuer) currently has a credit rating associated with it.

Primary versus Secondary Markets

Primary markets involve the issuance of new securities to investors. Secondary markets involve the purchase and sale of securities after the borrower has sold its shares in primary markets. Secondary markets may reflect updated prices as the YTM changes based on a company’s credit rating over time, macroeconomic changes (such as a liquidity crunch), or demand for a particular issue. Primary market dealers may receive favorable pricing (up to a 50% discount in many cases) for providing liquidity.

Loan-to-Value Ratio

The Loan-to-Value ratio is expressed as the ration of the loan’s principal amount to the value of the firm or asset. For example, a company that takes out a loan of $500 and is worth $1,000 has an LTV of 50.0%. The inverse of the LTV (1 / 50% = 2x) represents the asset coverage ratio.

As the LTV increases, it becomes riskier for the lender and they may compensate by increasing the interest rate or adjusting the loan structure to acquire a greater rate of return.    

Loan Risk

There are four primary risk factors to consider as a lender:

  1. Interest Rate Risk – Loan prices are inversely related to market yields (the coupon rate certainly plays a part in determining price, but the coupon rate is distinct from a YTM). The impact of a shift in rate of return expectations are measured by factors such as duration and convexity (which estimate the magnitude of the change given a change in interest rate expectations). Also, when interest rates decline, lenders worry about the impact of prepayments on their portfolio.
  2. Inflation Risk – The risk that the interest you earn as a lender is less valuable considering future inflation. This risk factor helps us understand why a rate of return is expected even on ‘risk free assets’ such as T-Bills.
  3. Market Risk – Represents the systematic risk of the loan market (e.g., a liquidity crunch).
  4. Credit Risk – An asset specific measure, standardized risk buckets are estimated by credit rating agencies. This factor is more commonly referred to as default risk.   

In order to deal with the risk factors above, derivative contracts have become popular. These contracts are either embedded within loan structures (e.g., calls/puts) or traded in the form of OTC products (e.g., interest rate swaps or forward contracts). Borrowers utilize these contracts to either create more predictable cash flows (e.g., swapping floating for fixed payments) or speculating on future rates (e.g., swapping fixed for floating payments).  

Loan Valuation Methods

Loan valuation techniques are primarily based on cash flow analysis. Given that the structure of the cash flows is predetermined based on the credit agreement (as opposed to estimated in an equity valuation), modeling the cash flows is a relatively straightforward exercise. The key input used to value these loans is the discount rate (i.e., the yield to maturity). The YTM can be extrapolated based on the factors explained above; however, the general build-up to a discount rate will look like (not intended to be drawn to scale) the image below. Like the capital asset pricing model used to calculate the cost of equity, the cost of debt is built using the risk-free rate as the base. On top of that, layers of risk are added based on various, mutually-exclusive risk factors. In the chart below, the YTM is comprised of the risk-free rate, a premium for expected inflation, and an asset-specific risk factor. The combination of the tenor and the asset-specific risk is the ‘credit spread’.

The rates of return for bonds by credit rating are posted daily on the St. Louis Federal Reserve database3. In more private transactions, information on comparable yields are typically harder to acquire given investors benefit from the information asymmetry. However, some companies – such as SPP Capital – post average rates for recent transactions4. Either way, increasing yields (referred to as ‘widening’) point to lower credit quality and decreasing yields (referred to as ‘tightening’) point to improving credit quality.

The YTM deciphered for each asset represents an array of risk factors; however, the primary concern for any lender is default risk – i.e., 100% loss of capital.

Extrapolation to Blockchain-Based Loans

The initial model for blockchain-based loans has been focused on providing liquidity for popular cryptocurrency assets such as Bitcoin, Ether, and Litecoin. This conversation will focus on loan products targeted at these assets; however, I note the expansive universe of securitized assets will soon hit the industry. In determining an appropriate yield for blockchain-based loans, it is important consider a few factors:

First, this is a completely new industry. Granted that Bitcoin has been around for more than 10 years, the initial retail ‘splash’ happened late 2017. A true understand of market risk (from the standpoint of traditional financial theories) has not been developed.

Today’s popular blockchain-based loans are effectively margin loans, the same as those you would have access to in a typical brokerage account5. Interest rates are developed based on consideration of trading liquidity (which is exponentially deeper than cryptocurrency markets), algorithmic / high-frequency trading with sophisticated electronic networks, operating expense margins, and an appropriate margin to the cost of servicing the loan. Given that price volatilities today on crypto assets are 3-4x broad equity indices, the need for a lender to have high-quality OTC and exchange relationships with sophisticated trading functions are a priori.

Another consideration involves estimating supply & demand for various security structures, a process typically known as price discovery (i.e., the notorious invisible hand of the market). The market has evolved so quickly that APRs have declined from greater than 20% at the top of the market to below 10% within a year. This decline is the result of greater competition in the space, low interest rate pricing strategies, and further development of portfolio surveillance and monitoring systems. At some point in the future, capital pricing may begin to reflect equilibrium. Until then, pricing competition between firms may reflect hyper competitive behavior as the market continues to discover itself.

There is also a focus on ‘paying down’ points at origination. In real estate mortgage loan structures, the borrower usually has the option to pay an additional amount to reduce the interest rate on their loan. On average, paying the lender approximately 1.0% of the notional balance of the loan will reduce the interest rate by 0.25%. For crypto loans, there are different methods for a borrower to reduce their interest rate such as the traditional ‘paying down’ points method, membership / token purchase staking, or through increasing AUM on a company’s platform. 

The lack of a securitization and secondary trading market contributes to a slower growth profile of blockchain-based loans. Traditional unsecured credit markets were previously disrupted by a slew of new fintech P2P lending models that could still quickly sell their loans given they had the same look and feel of traditional bank loans. Currently, no market exists for lenders to quickly sell / securitize blockchain-based loans, forcing them to be conservative with underwriting and in developing their risk models. Despite being 100% secured and ~2x collateralized, loans against these cryptos are sold at a premium given the nascent stage of the industry.   

The intent of many cryptocurrency advocates is to reduce reliance on traditional central banking influenced economic models. Given the lack of a central authority influencing the cost of the largest cryptocurrencies (although one could argue that the exchanges, operating costs of miners, and primary markets are currently influencing prices for their benefit6), debates about the concept of a ‘risk free rate’ are now emerging. As the market evolves, it will be critical to observe correlations in traditional interest rates with those in emerging cryptocurrency assets.

Finally, the lack of custody and asset insurance solutions has been discussed in depth since inception of blockchain-based loans. Given the lack of these products, potentially billions of dollars are currently on the sidelines7. Moreover, effective custody solutions are just now beginning to emerge, but it will be years before institutional investors begin to see blockchain-based financial products as a common piece of their investment portfolio. Security audits can and should be mission critical items to review during due diligence.

Final Words

Margin loans are quite risky. If underlying assets fall, it could lead to an uncomfortable situation for the borrower as they either need to come up with the money to add LTV cushion, sell assets, or get liquidated – all at a magnified loss given the interest paid on the loan. The future of blockchain-based loans will depend on a decline in price volatility and maturation of institutional investment administration products.     

While no exact science exists today, the bright future for the cryptocurrency industry will compel the creation of new financial products to accelerate liquidity in this burgeoning market. We see an array of products built this year on the back of crypto technology, such as interest accounts, derivatives contracts, custody solutions, and the addition of many more types of digital assets on these lending platforms. Reaching equilibrium will require an optimal balance of supply & demand, and I believe we are on a long path to its discovery.

Finally, I leave you with a short comparison of blockchain-based loans and two similar loan structures: auto loans and stock portfolio margin loans.


  1. The overview is not meant to be robust, but see the following article on Investopedia for a great overview: https://www.investopedia.com/university/Loans/
  2. Federal Reserve Selected Interest Rate Data – H.15. https://www.federalreserve.gov/releases/h15/
  3. FRED (Federal Reserve Bank of St. Louis). https://fred.stlouisfed.org/
  4. SPP Capital, see the “Market Update” section on the top right: http://sppcapital.com/
  5. Data aggregation of various margin Loan rates today: https://investorjunkie.com/12389/best-margin-rates/
  6. See the Bitwise report on the difference between reported and actual trading volumes. https://www.bitwiseinvestments.com/
  7. Coinbase Reportedly Secures $20 Billion Hedge Fund Through Its Prime Brokerage Services, July 18, 2018. Coin Telegraph. https://cointelegraph.com/news/coinbase-reportedly-secures-20-billion-hedge-fund-through-its-prime-brokerage-services

Interest Rate Theory – Predicting a Federal Reserve Interest Rate Hike


In this lesson, we will discuss using futures data to predict changes in the federal funds rate. Changes in the federal funds rate have a critical impact on the yield curve, value of bonds, and economic growth. While this discussion will not go into depth for those topics, it will help you understand the relationship between investor expectations and how you can safeguard your portfolio. 

Gathering Information

The first step in predicting interest rate hikes is to gather information about current prices from the Federal Reserve and investor expectations from futures prices on the 30-day federal funds rate. In order to understand why futures are useful, please review the following:

  1. Investopedia Article on Federal Funds Futures
  2. Journal Article on Using Futures to Predict Rate Hikes
  3. Contract specs on the 30-day federal funds rate

Now, let’s start the process of gathering the data to make predictions! We are going to start with acquiring data from the Federal Reserve website. Specifically, we are looking for the current target rate set by the Fed. This is usually in the latest minutes released by the Fed. If we navigate to the FOMC calendar on the Fed’s website:

Find the last FOMC meeting and review the PDF, the header and relevant sections can be seen below:

Here, we can see that the current target federal funds rate is 1-1/14 (meaning 1.25%). The next step is to find the latest futures price on the 30-day federal funds rate futures. We first navigate to the CME group site for the 30-day Federal Funds Rate (the easiest way to do this is to just google that term). 

This page shows the current quotes; however, we want a more stable figure to help us in our analysis. Click on the Settlements to see finalized settlement prices from the prior business day. 

Here, we can see that the last settled price is 98.8425. According to Robertson and Thornton (Click here to access paper), the futures quite can be thought of as the average price for Fed funds in a particular contract month. 

In this case, the implied yield on the federal funds rate can be calculated as 100 – 98.8425 = 1.1575%

The last piece of the puzzle is to note the date of the next FOMC meeting and select the appropriate futures instrument. Above, we have selected the November futures price (although this should usually be determined afterwards). Looking at the FOMC calendar meeting, we observe that the next FOMC meeting is October 31, 2017. Therefore, we selected the futures instrument with the nearest maturity to the next FOMC meeting, and represents the most relevant instrument to gauge investor sentiment. 

Putting it All Together

Using this information we gathered, we can apply Geraty’s formula to determine the probability of an increase in a federal reserve hike (click here to access the article). The other key factor is what the expected rate hike will be. Based on the information above, we see that the implied yield of 1.1575% exceeds the federal funds rate target of 1.25%; therefore, we can determine that investors are not expecting an increase in the federal funds rate. Instead, let’s examine a 25 basis point reduction. 

The formula is presented below, in addition to the application of the inputs gathered above. 

Based on the analysis, there is an 8.0% probability of a reduction in interest rates. From an investor’s perspective, this implies that the federal funds rate is unlikely to change at the next FOMC meeting!


Keeping in mind there are adjustments to be made to the formula (read the literature I have posted links to!), this is a simple way to gauge investor expectations. This strategy becomes even more powerful when combined with your own interest rate projections, topics we will cover at a later date!

Bond Investing Basics – Setting Your Goals


In this section, we will discuss setting goals for investing in bonds. This section is not designed to give you a primer on bonds given the plethora of sources out there that provide sufficient overviews (I have provided links to some of the better ones below). Instead, we will focus on the key components of choosing an investment that matches your personal goals and strategy.

Background Knowledge

If you do not have a good background in bond investing, I suggest reading through the following sources:

  1. Investopedia – “Bonds”
  2. The Motley Fool – “How to Invest in Bonds: A Step-by-Step Guide”
  3. Project Invested – “What Factors Should You Consider When Investing in Bonds”

Furthermore, if you are not interested in investing in individual bonds (given the time and knowledge commitment required to get there), review some of the differences in investing in bonds and bond funds below (my only specific suggestion is to play close attention to bond fund fees, that could also be a critical factor outside of the actual management of the portfolio):

  1. CNBC – “Bonds vs Bond Funds: What you Need to Know Now”
  2. Fidelity – “Bonds vs Bond Funds”
  3. The Balance – “Investing in Bonds versus Bond Funds”

Setting Goals for Bond Investing

The sheer size of the global bond market (estimated to be over $100 trillion) provides investors with numerous investment options. Some of these investments have traditionally been seen as “safer” than investing in stocks. Some of these investments have funky features (such as call/put options, conversion features, etc.). Some of these investments provide certain tax advantages (e.g., municipal bonds). As part of your investment plan, we will focus today’s discussion on a few items:

  1. Time Horizon
  2. Risk Taking and Risk Management

Time Horizon

Bonds can be structured to have short-term maturities (0-5 years), medium-term maturities (5-10 years), and long-term maturities (10+ years). Different investors may differentiate the categories for maturity length, but this summary should suffice to get the point across.

In the case of figuring out your time horizon, it can be as simple as counting the years until your child goes off to college to as difficult as figuring out how many bonds you will need to provide income through your retirement. A few suggestions:

  1. Be honest and conservative in your assumptions
  2. There are always multiple time horizons for your savings plan, make a plan for each one
  3. Think about potential scenarios where you may need money
  4. Think about inflation over the long run and if it will impact your time horizon assumptions
  5. Your emergency fund is your best friend, time horizons are meaningless if you do not have a reserve in case the market drops really fast

Risk Taking and Risk Management

For individuals entering into retirement, traditional investment theory dictates most of your portfolio should be allocated towards investment grade (discussed below in the risk taking and risk management section) bonds. A rule of thumb often portrayed is to subtract your age from 100 to determine the percentage allocation in your portfolio (e.g., if I am 75, then 75% of my portfolio should be in bonds).

However, as you will often note, real world application of finance theory often falls flat in real world applications. For example, if the size of the portfolio relative to retirement needs is quite large, an investor will often elect to invest more in stocks in order to potentially maximize their estate. In addition, different portfolios may have different goals, such as saving for an expensive purchase (Harley or a boat), children’s education, or an emergency reserve.

Although we will discuss some of the strategies in later posts, here are some of the risk-based items you will need to think through:

  1. Credit Rating / Default risk – What is the rating of the company and where do you expect this to trend in the future or over your time horizon?
  2. Credit Spread relative to comparable credits and market indices – Are you getting a good deal at the price you are paying?
  3. Financial and operating leverage of the company – Can small swings in the company impact your investment?
  4. Industry of the company – What are certain industry drivers and what part of the business cycle is the industry currently experiencing?
  5. Duration / Interest rate risk – How quickly will rates rise (obviously you will need to consider the opposite as well, but our low interest rate environment contributes to this specific discussion)?
  6. Inflation risk – Is nominal or real return more important to you?
  7. Liquidity – Will you be able to sell when you need to?


There are obviously a lot of factors to consider when setting up a strategy. The issue some investors have is that they read online for various bond investing strategies and try to fit their personal situation to fit the strategy. Rather, you should think more about your situation and pick the appropriate strategies to meet your goals. This will also allow you to make the right sacrifices, correctly set your risk parameters, and focus your attention on specific details you will need to succeed.