What is a Productive Asset in Crypto?
What is a productive asset in TradFi? In crypto? Definitions, examples and counterpoints
In the world of crypto ‘memetics’ (a fancy word to explain when a meme or idea infects the collective consciousness), ‘productive assets’ are the newest meme captivating the attention and dollars of Crypto Twitter.
But what is a ‘productive asset’?
Traditional Finance has a standard definition:
“Productive assets are those with the ability to generate profits and cash flow”.
Per Nasdaq, all stocks are productive assets because:
A stock that pays a dividend distributes a cash flow to stock owners
If a stock does not pay dividends and instead invests in growth, this theoretically increases profits
(Maybe Nasdaq is talking their own book here a bit)
More tangible examples of productive assets include farms, real estate, and factories.
You can own a farm, cultivate land, and sell crops.
You can own a home, rent it out for cash flow, and sell it when you’re done.
You can own a factory, produce widgets, sell widgets.
In contrast to productive assets, there are non-productive assets such as gold, art, and fine jewelry. Owners of gold bars hope it will preserve their wealth or perhaps increase over time, but can’t do much of anything with the gold.
Warren Buffett (a lover of productive assets) says the value of productive assets isn’t determined by any currency, but by their capacity to produce goods and services.
Elon musk reminds us:
To sum it up:
Traditional finance defines productive assets as those which entitle the owner to usage and/or cash flow.
Within DeFi the principles are similar, but the applications are different:
@iamDCInvestor has a number of great tweets on the topic, including this one
He defines a productive asset as a crypto token that is economically relevant to the operations of the protocol by absorbing risk and/or earning fees.
I would take this a step further to say that within crypto, there are both weak and strong productive assets.
Weak Productive Assets:
At this point, because of the creation of trading protocols such as Uniswap or long-tail lending platforms like CREAM and Unit Protocol, nearly any asset can be a ‘weak productive asset’.
You can take the shittiest of shitcoin, create a Uniswap pool, and if just a few people trade on it, BAM… you’re earning some fees based on your holdings.
If you can get a platform like CREAM or Unit Protocol to accept your coin, now you can also use it as collateral or lend it out to someone else and BAM… you’re levering up or earning some yield.
Andrew Kang of Mechanism Capital had a tweet in September 2020 calling $UNI a productive asset based on this very principle.
By this definition, Bitcoin, Shitcoin, and everything in between CAN BE a productive asset. Even something like PAX Gold (a tokenized representation of the world’s least productive asset) could be a productive asset since it is probably a good form of collateral.
Strong Productive Assets:
A ‘strong productive asset’ is one that is core to the functioning of and/or economic activity of a protocol and produces a cash flow. In many cases, the asset owners are also entitled to the protocol’s cash flows (via dividends or some deflationary mechanism such as a ‘buy and burn’).
By this definition, a much smaller subset of assets are productive assets. We can quibble a bit about this definition. For example, does the control of a large DAO make an asset productive? Maybe, but not by the definition above.
Let’s walk through some popular examples:
Two assets that @iamDCInvestor highlights:
$AAVE:
From Aave’s website:
“Aave will be secured by a Safety Module (SM), a staking mechanism for AAVE tokens to act as insurance against Shortfall Events. Stakers earn AAVE as Safety Incentives (SI) along with a percentage of protocol fees.”
Now, I could be wrong, but I don’t think Aave is actually paying those fees to stakers yet. I think for now, stakers are only earning Aave incentives (400 Aave/day split across all stakers).
However, if Aave was paying those protocol fees to stakers, it would be a golden productive asset. Stakers would be backstopping the protocol (taking on risk) in exchange for protocol fees. Paid for ‘skin in the game’. Taleb would be proud.
At the moment, Aave is putting these cashflows in its treasury rather than paying it out to stakers or using it to buy-and-burn (more on that here), but the mere fact that is produces this measurable cash flow, makes it productive.
$MKR:
It feels like these days, I can’t go one day on Twitter without seeing a post about Maker’s P/E ratio. See: https://makerburn.com/#/
Maker takes a different approach to being a ‘productive asset’ than $AAVE. Rather than paying protocol participants directly with a fee, it instead uses revenue to buy-and-burn MKR tokens, creating benefit to all MKR holders by making the token deflationary.
Other Thoughts:
1
One thing our authors debated about in our own definition is whether or not buy-and-burns / putting assets in the treasury makes assets productive or not. Where we landed is that simply having the cash flow makes an asset productive and what the protocol decides to do with it afterwards is kind of moot point (as long as it is approved by governance and for the best of the community). For example, MakerDAO uses its cash flow to burn MKR tokens, Aave will eventually use its cash flow to pay stakers and for now sends its fees to a treasury.
The downside of anything other than paying stakers is that this often rewards passive token holders to the same degree that they reward active token holders (often, stakers who take on real risk).
2
As we were getting ready to publish, @hasufl put out a short tweet thread arguing against the idea of protocols paying out dividends
As a general rule of startups, Hasu is correct. It would be VERY odd (even a red flag) if a 1 or 2-year old tech startup was paying a dividend to its shareholders.
That said, there are two areas where this gets tougher in practice for DeFi protocols. As @edadoun points out in the replies, crypto is not often full of people with long-time horizons. $1 in the hand of a staker today is worth more than $1 in the treasury if they don’t plan to hold the protocol token for a long time.
Perhaps a comparison is how Jeff Bezos ran Amazon for so long ‘without profits’ and he certainly never paid a dividend. Bezos (as arguably the greatest CEO of all time) was able to do this because he won the trust of the public markets and was right a lot more often than he was wrong in terms of reinvesting would-be-profits (AWS, own logistics network, Prime Video, Alexa, etc.).
I think it would be very possible for the most established protocols (who have won the trust of their communities) to do this. MakerDAO comes to mind as an example where their community seems to be one of the most long-term oriented. If on the other hand, you’re running a protocol with a very mercenary community (‘wEn mOOn’), this longer time horizon investment seems much more difficult.
The other thing that makes this more difficult for DeFi is the difference in voting power between traditional tech companies and DeFi protocols. If you’re Bezos running Amazon or e.g., Tony Xu running Doordash, even though you only own ~10% of the company’s shares, you probably own a super majority of the company’s voting shares (see: dual-class stock). While the idea of the ‘benevolent dictator’ can exist in DeFi, it would scare most communities if the project’s founder used their power to vote for a long-term decision like reinvesting in growth when the community wanted buy-and-burns or dividends.
Thanks for reading,
@0xSuperTruper