A stereotype of 1980s greed is Michael Milken. Known as the “Junk Bond King”, Milken created a means for startup companies to reliable raise capital. The term “junk bond” was due to the fact that the companies involved were yet to establish a credit rating.

According to the Gentlemen’s Journal, “Milken developed a unique ability to sense changes in the financial world that others were too lazy or unimaginative to detect.” Specifically, he pioneered using bond funding to finance strategic acquisitions. A legacy tarnished by his 1989 indictment for securities fraud.

Instead of one entity such as a bank assuming 100% of loan default risk, corporations, and governments issue bonds. These contracts spread the risk over many investors. In return, the company issuing them is obligated to pay back the principal with interest — making regular payments to investors.

Sometimes corporations default. Leaving investors with worthless paper. However, much of the time bonds prove to be a stable asset within an investor’s portfolio — providing a source of reliable income.

Angels are private investors that fund new companies with relatively small loans. These loans are either paid back at the next round of funding or convert to stock. The purpose is to help a company go from zero to an initial round of venture funding.

Venture Capital is a group of investors that raise funds to invest in growing companies. This is the main avenue a new business has to fund its self. Google, Facebook, and Amazon all began as small upstarts in a venture capital portfolio.

This model of investing assumes the majority of investments will at best break even. Relying instead on the handful that breakout into global stardom. Those few more than pay for the losing majority.

As a CEO for a startup, much of my time was spent in front of would-be investors. At first individual angels then larger venture capital firms. The reason I and so many others spend so much time on raising capital this way is there are no real alternatives.

Sure, a startup could issue bonds but who would buy them? Those bonds listed on an exchange are from large companies with proven credit ratings. Instead, a new business would have to sell them one by one to accredited investors. The same investors who would rather lock companies into a venture deal.

It was not that “junk bonds” were bad in the same way mortgage-backed securities were not wrong. What occurred in both cases was the hype surrounding them drove demand beyond supply. Thus the new supply became less and less viable as sound investments.

Decentralized Finance (DeFi) is a movement of permissionless financial applications on the Etherum network. According to Etherum, “Smart contracts are a type of Ethereum account. This means they have a balance and they can send transactions over the network.” Instead of being controlled by a person, they execute transactions based on programmed rules.

Smart Contracts can act like bonds. Allowing investors to pay for them and automatically make payments back to the investor according to the terms of the program. This means a small company could issue bonds like the Milken days with much less risk of a payment default.

In theory, a startup could raise funds from hundreds or even thousands of unnamed investors without spending time on numerous pitch events. Instead, multiple investors benefit from periodic interest payments while the new company launches its product. Taking control from the few venture capital partners and placing it into the hands of the many DeFi users.

When trying to go from zero to a global powerhouse many startups rely on acquiring other companies. As CEO myself, I tried to acquire a related company but could not make the cash flow work. Instead, it sold to a liquidator that just wanted its patents.

However, if a new company sold bonds it would be much easier to generate the funds that make strategic acquisitions much sooner in the process. Meaning, an inexperienced team could buy a proven set of leaders and an established market within the first few years of existence.

Today, it takes a few rounds of venture money before acquisitions are realistic. When they do occur, acquisitions almost always make the buying company more valuable. Increasing the cash flow, revenue, assets, and intellectual capital of the new entity. Making it more likely the bond payments can continue.

Several companies are currently working to launch DeFi bond products. The stumbling block is not the technology but the legal implications. Based on the country and how regulators view bond-like Smart Contracts, it may be available soon or never.

Regardless, DeFi is an exciting evolution in finance that promises to take power from the few and place it in the hands of the many. To learn more, visit https://toddmoses.com/.

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Source: https://toddmoses.medium.com/the-defi-bond-market-a4918651835f?source=rss——-8—————–cryptocurrency