DeFi

How innovation and debt are correlated

Bradley Woolf

Debt as an instrument of innovation

When you think of innovation, I would assume that you think about the outcome- the disruption, the industries that change, the wealth that is made, the lives that are changed. What does not enter mainstream conversation is how that innovation was funded. Sure, we see a lot of small businesses raising large sums of money from Venture Capital. But, oftentimes, these fundraising efforts are subsidizing the cost of product market fit for the business.


What about the financing of an innovation with a high CAPEX? What if the innovator is in the software space, realizes the value of the innovation, and doesn't want to give away the upside of his technology? What options are available for a medium-sized firm that is reinvesting all of its free cash flow into R&D to reduce their future operations by 100x?

Enter the market of corporate financing.

The beautiful thing about debt is it allows someone to front-run the cost of risk by betting their innovation will achieve higher returns than the interest paid on the initial borrowings. This fosters an environment of urgency, since if you fail and can't pay back the debt, your credit is screwed and so is your product.

Balance

Debt financing, like any risk, has to be balanced with growth. High levels of debt servicing decreases your free cash flow, disallowing reinvestment into the R&D for that specific asset. If you aren't able to finance it within a shorter time frame, you had better have other sources of income- preferably a cash cow. Amazon can subsidize its risks because AWS is a straight cash cow monster.

Unless managed well, "rises in the cost of capital for innovation-intensive firms predict declines in subsequent productivity and economic growth." What this means is, because of the cost of capital (higher interest rates), the firm obviously faces a smaller window of success. In addition, the interest rates grow when government debt increases- something we are experiencing in record levels now.

Can DeFi help?

Yes, for collateralized borrowings, assuming that they are leveraging an asset that is expected to increase over time. A true testament of belief would be collateralizing against their own stock ownership, which may be considered irresponsible.

Yes, if stablecoins that denominate debt values can be disassociated to federal debt levels that increase the cost of capital, making decentralized debt cheaper.

Yes, when small villages with an internet connection and some Ether can borrow against it to fund the development of a new piece of proprietary software.

"While debt hampers innovationby incumbents due to debt overhang, it also stimulates entry."

Bullish AF.

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