Robust Finance (RF)

RF

A new financial system is already being built by prudent investors.

Robust finance (RF) both describes the structure of the new financial system and the investment approach of prudent investors building it one asset at a time.

RF requires no government, no legislation, no centralised planning.  Its driving force is the desire for capital to seek the best risk adjusted return.  The system is based on autonomy and self-reliance.  Its spread comes from investors building genuinely diversified portfolios from truly independent assets.

RF Assets – Independent Value and Allowed to Fail
 

RF is built from assets that are allowed to fail.  The ability to fail along with independence of value are their two essential features.  Because the value of assets are independent of each other, failure of one does not jeopardise the value of other components, the integrity of the portfolio or the system as a whole.

The antithesis of assets of independent value is the derivative, an asset whose value depends upon another.  Their second antithesis is leverage, an asset whose independence is compromised by debt.

Designed like the Internet
 

RF follows the proven principles of distributed network design we see in the Internet.

  • The Internet is the perfect example of the distributed network design.  Independent servers route information to the required destination.  If one server fails the information is simply rerouted.  In RF assets of independent value make up a portfolio.  If one asset fails through loss of liquidity, the flow of value in and between portfolios simply takes another route.  There is a loss of value from the failed asset but it is never catastrophic.
     
  • The Internet is built upon the embarrassingly simple TCP/IP protocol.  People thought TCP/IP would restrict the development of Internet functionality.  This was incorrect.  Today all the sophistication of the web still rests on this basic functionality.  RF is built upon the underlying principle that all financial value, like language, is a human construct.  Assets are developed when people decide to give them value.  When people no longer have the need for, or no longer believe in the value of an asset that value disappears.  RF is therefore based on the realisation that financial value is a creative process.
     
  • The internet is not owned by anyone.  Nor is its ability to scale dependent upon any authority.  It simply grows, or diminishes as people add or take away content and servers.  In the same way RF is not dependent upon government or any other institutions.  Assets are added or removed by investors as they seek to optimise the performance of their portfolios.
     
  • It is not possible to bailout the Internet because there is nothing to bailout.  The system is built so that servers are expected to fail.  When they do content finds a new route or they are replaced.  RF assets are also allowed to fail. Because failure is fundamental to the robust nature of the system there is again nothing to bailout.  The loss of value of any particular asset is simply business as usual.

New Asset Development Follows Proven Venture Capital Model
 

The Venture Capital business model  demonstrates the success of the RF design.

  • Like RF the venture capital industry is built on the ability of assets to fail.  On average 40% of startup companies will go under.  Yet over the last 20 years venture capital has outperformed all other asset classes.  The industry demonstrates just how successful the initially illiquid/allowedto-fail business model is.
     
  • The venture capital business model shows how to build new assets.  In particular, VCs:
    • Understand diversification builds robustness by never investing in just one start-up
    • Have patience by appreciating a new asset is initially illiquid and it takes time to take the asset to a liquidity event
    • Actively engage in growing their assets through participating in new capital rounds, promoting the business as well as assisting in strategy and hiring new talent.
       
  • In the same way the prudent investor can launch and grow new RF assets through:
    • Investing in more than one such asset
    • Appreciate illiquid assets take time to build liquidity.
    • Actively promote the asset by publically declaring a holding, communicating benefits to other investors, and undertake other confidence building activities.

Distributed Ledger (Blockchain) Fastracks New Asset Development
 

The distributed ledger (blockchain) has greatly enhanced the ability of investors to build new RF assets.

  • The distributed ledger removes the need for a centralised authority to confirm ownership of an asset.
     
  • As RF assets are those of independent value, the distributed ledger also becomes the repository of value for digital assets.  Counterparty risk is removed.
     
  • Digital assets are traded on multiple exchanges.  This removes dependence upon a single centralised exchange for price discovery.
  • If decentralised exchanges such as the Waves Exchange (https://waves.exchange/) are used risk of asset theft is mitigated.
     
  • Distributed ledgers are designed so that investors can own a full node thus ensuring ongoing proof of ownership.

Self-Managed Investments (SMIs)
 

The development of new assets enables the spread of RF.  This is essential as there are at present not enough assets of independent value to go around.  For example it is suggested physical gold accounts for just 0.58% of global assets. Self-Managed Investments (SMIs) are an example of a new asset class designed for this purpose.

  • A form of digital hedge fund, SMIs enable investment into long/short trading strategies with none of the systemic and counterparty risks of a traditional hedge fund.
     
  • SMIs are digital tokens whose ownership is secured on a distributed ledger.
     
  • In their startup phase SMIs are capital efficient by discounting the price of tokens.  Like the seed round of the VC model this provides early investors with the greatest upside potential for least capital outlay.
     
  • SMI tokens are generally capped.  This prevents loss of value through inflation and increases demand through fear of missing out.
     
  • The first SMI is a long/short Bitcoin strategy called Bitcoin Enhanced. https://bitcoinenhanced.io/
     
  • Because they have no fees SMIs offer a better return profile than the traditional 2 + 20 hedge fund fee structure.
     

How to Distinguish a RF asset

There are four criteria that distinguish an RF asset:

1 Outside the fiat system

2 Non-collateralised

3 Limited supply (or supply pegged to demand)

4 Little or no debt.

 

Some Current RF assets


Gold
Independent value
Physically held
Paid in full

Property
Independent value
Owned outright

Bitcoin
Non-collateralised
Ownership secured on distributed ledger

Land
Owned outright

Bitcoin Enhanced
Non-collateralised
Ownership secured on distributed ledger

Equities
Owned outright
Strong cashflow
Low debt

Corporate bonds
Owned outright
From companies who are RF due to high cashflow and low debt

Government bonds
Owned outright
High revenue to debt ratio (https://www.kenton-dau.com/government-revenue-to-debt-ratio.html)

 

Some Non RF assets
 

Fiat Currency
Value ultimately determined by government printing press (inflation/hyperinflation)

Equities other than RF
Independence compromised by debt

Bonds other than RF
Independence compromised by debt

Private Equity
Independence compromised by debt

Infrastructure
Independence compromised by debt

A Diversified Portfolio


With RF the prudent investor is re-creating the diversified portfolio of the past.  Stand-alone assets of independent value make up the portfolio so that the loss of any asset does not jeopardise the value of the whole.  The main difference between RF and the past is the creative element.  The prudent investor now realises that they are no longer limited to assets whose value has already been established.  Following the venture capital model, the asset universe can be expanded to meet demand for new products.  As long as independence of value and the ability to fail are maintained RF provides the method by which a robust financial system grows one investment at a time.

Resources

 

Gold the Final Standard by Nathan Lewis
A good account of the history of money and the demise of every fiat experiment since money began in the 7th century B.C.

https://newworldeconomics.com/gold-the-final-standard/

 

Self Managed Investments (SMIs)
Brochure and the series of Medium articles that describe their development.

https://www.kenton-dau.com/self-managed-investments-smis.html

 

Bitcoin Enhanced
The first SMI.

https://bitcoinenhanced.io/

 

More Information
 

Branton Kenton-Dau
branton@kenton-dau.com