Joseph Lubin, CEO of Consensys, is waving his own red flag on the use of leverage in crypto treasury management. He's not alone in his concern. The crypto market is extremely volatile by nature. This volatility, further compounded by the challenges in navigating the decentralized finance (DeFi) landscape, can pose significant hazards for companies handling their own digital assets. Miles O’Connor will look at leveraging risk in crypto treasury management, especially for smaller firms. He’ll provide practical, real-world solutions that you can use today to avoid putting your assets at risk.

His warning couldn’t be more timely, as the web between crypto and the traditional financial system becomes even more tangled. That interconnectedness increases the risk that crypto’s built-in volatility could set off a chain reaction that leads to wider economic consequences. Crypto companies are under the gun to seek yields greater than even the king of cryptos, Bitcoin itself. This urgency frequently pushes them to make dangerous choices. This is turning into a precarious ecosystem where companies can soon find themselves at risk of what Lubin describes as “capital erosion.” When many crypto firms collapsed in 2022, this alarming incident serves as a wake-up call to remind us that the far-reaching ramifications of such a development can result in people losing their hard-earned savings.

The Perils of Leverage in Crypto Treasury Management

Leverage, broadly defined, is the practice of using debt capital to amplify your returns. And remember, while leverage makes it possible to experience dramatic profits, it magnifies losses. In the precarious landscape of crypto, this often leads to catastrophe. Now picture a microcap firm with its own borrowed money putting money into the next great altcoin. If that altcoin suddenly drops 50 percent in value, that company has lost its initial investment. It needs to pay back the money it has borrowed, putting it on an increasingly insecure path toward insolvency.

In fact, as we’ll see below, the incorporation of crypto into the broader financial system threatens to harm everyday people too. Middle- and working-class Americans are significantly over-invested in crypto, both directly and through investment vehicles. This trend puts them at risk of a new level of volatility in the crypto market. The risk of retirement savings being wiped out, as was seen in 2022, is no small matter.

Safer Shores: Alternative Strategies for Crypto Treasury Management

So, what else can companies do to safely and effectively manage their crypto treasuries? The trick really is to focus on building that long-term stability and growth instead of quick hit short-term fixes. Here are some actionable tips:

  • Diversification is Key: Don't put all your eggs in one basket. Spreading your investments across different cryptocurrencies and asset classes can help mitigate risk.
  • Understand Your Risk Tolerance: Before making any investment decisions, assess your company's risk tolerance. How much loss can you realistically withstand?
  • Due Diligence is Non-Negotiable: Thoroughly research any cryptocurrency or DeFi protocol before investing. Understand the underlying technology, the team behind it, and the potential risks involved.
  • Secure Custody: Choose a reputable custodian to store your crypto assets. Look for custodians with robust security measures and insurance coverage.

Good treasury management and ensuring equity in all their financial practices are critical for keeping cities financially healthy. This includes daily and weekly activities, such as:

  • Holding Bitcoin as a Reserve Asset: Following MicroStrategy's lead, companies can allocate a small percentage (e.g., 1%) of their assets to Bitcoin as a long-term store of value.
  • Exploring Alternative Assets: Diversifying into other alternative assets, such as stablecoins or tokenized commodities, can provide stability and inflation protection.
  • Careful Use of Options: Strategies like box spreads can offer risk-free returns similar to treasury bills, but with potential tax advantages.

The Daily Grind: Treasury Management Activities

All treasury management processes—including collections, disbursements, fraud prevention, filing requirements and more—need to be done every single day by a set time. To further enhance security, require dual control for all ACH and wire transfers.

Getting a clearer picture of your company’s risk tolerance will help inform investment decisions. There are various tools and methods available to assess risk tolerance, including:

  • Reconciling cash and following up on dated in-transit items
  • Merchant services payments tie-outs (for retailers)
  • Credit card reconciliations
  • Drawing on or paying down the line of credit
  • Submitting vendor payments that are due upon receipt of invoice
  • Recording all vendor invoices received
  • Apply cash from customers in AR
  • Updating the working capital dashboard

In fact, researchers have determined that psychometric tests often reveal the most valuable information regarding propensity for risk taking behavior. Innovative software tools like DataPoints bring a new approach to risk assessment. They give precedence to narrative and dialogue, centering the client’s lived experience and interpretation as the most important text in the room.

  • Drawing or paying down the line of credit if not done daily
  • Accurately and completely processing payroll
  • Submitting vendor payments that have terms
  • Completing the weekly cash flow forecast

Advisors can use various methods to assess risk tolerance, such as:

Assessing Risk Tolerance: A Deeper Dive

Lubin is correct to warn about the dangers of too much leverage. First, we just need to accept the fact that sometimes controlled leverage is a force for good. For instance, a startup could take on leverage to fund a wise acquisition of their technology or scale out their business with additional offices or staff. Before you use leverage, make sure you understand both the risks and the reward potential. Learn the company’s capacity for loss.

  • Psychometric Tests: These tests measure risk tolerance based on past behavior and stated preferences. An example question might be: "What amount of risk do you feel you have taken with past financial decisions?"
  • Econometric Tests: These tests measure risk tolerance based on preferences for different probabilistic trade-offs. An example question might be: "Suppose you can invest $100, and there is a 50% chance you could receive $207 and a 50% chance you'd receive nothing."

To avoid costly mistakes when managing a crypto treasury, focus on safety and diversification. Never lose your sense of the danger at stake. To find success amid crypto’s tumultuous environment, companies must continue to adopt trailblazing practices. By proactively determining their levels of risk tolerance, they can best protect the long-term fiscal wellbeing of their residents.

Advisors can also use various methods to assess risk tolerance, such as:

  1. Asking about the investment time horizon.
  2. Exploring past behaviors and experiences.
  3. Discussing different scenarios and probabilistic trade-offs.

A Balanced Perspective: Controlled Leverage

While Lubin rightly warns against excessive leverage, it's important to acknowledge that controlled leverage can be beneficial in certain situations. For example, a company might use leverage to finance a strategic acquisition or expand its operations. However, it's crucial to carefully assess the risks and rewards before using leverage, and to have a clear understanding of how much loss the company can withstand.

Ultimately, the key to successful crypto treasury management is to prioritize caution, diversification, and a deep understanding of the risks involved. By embracing innovative strategies and carefully assessing risk tolerance, companies can navigate the complexities of the crypto market and ensure their long-term financial stability.