The Most Profitable Company I know

QUICK FACTS

Trading Symbols: DEFI

Share Price Today: $1.30 (now $1.44)

Shares Outstanding: 359 million

Market Capitalization: $466 million

Net Debt: $18 million*

Enterprise Value: $484 million

*Cash on hand, does not include potential cash from warrant issuance

POSITIVES

– Crypto looks to be in the early innings of a new bull run

– DeFi business model is directly tied to growing interest in crypto

– DeFi’s biggest asset is Solana, which has been big winner in the last 6

months

NEGATIVES

– Relies on counterparties to custody crypto and to lend to

– Yields on staking and lending crypto are likely to moderate over time

– AUM is going to rise and fall with crypto prices

IT’S ABOUT THE JOURNEY

This company has a unique business model that to me can have real legs–I like that, but only if crypto prices hold up.

They have a growing suite of ETPs–Exchange Trade Products that trade in Europe (essentially the same as an ETN in North America). So DEFI is listed in Canada, but the ETPs only trade in Europe.

The difference is–in Europe you are allowed to “stake” your crypto and create a (relatively lucrative!!) income stream that you are not allowed to do in North

America. DEFI thinks they can generate an income stream of 8-9% of AUM–Assets Under Management. And their AUM is soaring now in this crypto run(because they can offer yield/income)

It also has a very seasoned crypto management team, led by Olivier Roussy Newton–I like that too.

BUT–I can boil down the opportunity with DeFi Technologies (DEFI –CBOE) to this: if crypto markets do well, I have an opportunity to make moneyon DeFi. Quite possibly a lot of money.

But DeFi almost certainly has to be traded with crypto prices. Those of you who were subscribers back in 2020-2021 will remember Voyager Digital. We made A LOT of money on Voyager. It’s one of those rare times where we were fortunate enough to get in just days before the stock took off.

We bought Voyager Digital in December 2020 at $1.81. The stock proceeded to go CRAZY. We sold 1/3 of my position less than a moth later for $5 (more than a 2-bagger in that time). Believe it or not, that was my biggest mistake!

We continued to pare back over the next few months and the stock went higher and higher – we sold stock at $28.50 – 15x what we had bought it for – all in less than a year.

This story is essentially why I’m taking a position in DeFi. Look, DeFi may work out and may not – in the long run. A lot will depend on crypto and management not doing anything dumb (which is what happened with Voyager).

That is no guarantee. Remember, Voyager Digital filed for bankruptcy in July 2022, only a year after I was selling it at $28. The stock was a 30-bagger and a big zero in 12 months!

 You can make a fortune on these crypto plays. You can lose it just as fast. You have to be nimble, and you have to be skeptical.

That said, it looks like we are at the beginning of another crypto bull run, which means a stock like DeFi could have a long way to go.

The good news is that DeFi has hitched itself to the right wagon. The company is tied at the hip to Solana (it is likely about half of their assets under management, though I can’t be 100% sure). DeFi participates directly in the growth of the Solana network AND any the increase in the Solana token price its Solana exchange traded product (ETP).

Through other ETPs it manages, DeFi also is tied to Bitcoin, Ethereum, and a whole basket of smaller coins. You never know, any one of these smaller coins could be the next big thing.

As crypto goes mainstream and tokens take off, DeFi’s assets under management (AUM) grows and with it so does profits. All this spells

LEVERAGE to crypto. As long as crypto goes up, so will DeFi. Just don’t fall in love with the stock. It may be a real business, but its a crypto

business, which means we can’t be sure how long it will last. Much like Voyager, I will be looking to take profits as they come.

EXCHANGE TRADED PRODUCTS

AND OTHER PEOPLE’S MONEY

Warren Buffet got rich by using other people’s money (from his insurance business) and investing it, reaping the for profits himself. It is not that different than DeFi, which has figured out how to make money off the crypto assets it manages for others.

DeFi operates exchange traded products (ETPs) through their subsidiary Valour, which they acquired in 2021. They have over 20 ETPs listed, mostlyon European exchanges: Börse Frankfurt/XETRA, Euronext Amsterdam, Euronext Paris, and Nordic Growth Market.

Their ETPs include several altcoins, carbon neutral Bitcoin and Ethereum products, and an inverse Bitcoin product.

Source: DeFi Investor Presentation

 Valour ETPs boast very low management fees. In the case of their Bitcoin and Ethereum products, the fees are zero.

These low fees get $’s in the door and let DeFi generate revenue through another channel.

DeFi makes money by lending or staking their crypto AUM from their ETPs in return for yield.

It all comes down to how crypto works – in particular how crypto networks are validated. DeFi stakes their crypto assets on a network and in return collects fees from the network that generates yield. They also lend their crypto in the traditional way, again collecting interest on the loan.

Through these two methods, DeFi is able to make a tidy return on the assets they hold via their ETP. They guided to 7.2% yield on the Q1 call.

To grow revenue. DeFi needs to grow assets. Which until recently, was a tough task. Valour’s AUM bounced around the bottom as crypto prices suffered the last couple years.

Source: DeFi Investor Presentation

 That has changed this year. Valour’s AUM has skyrocketed since January:

Jan: C$530.9M

Feb:C$590M

Mar:C$838M

May: C$748M

A big part of that growth can be attributed to one token. While all crypto has done well, some have done very well, and one has been a 10-bagger in the last 6 months. Solana.

STAKING A CLAIM ON SOLANA

Solana is by far DeFi’s largest ETP and therefore the crypto they hold the most of. At the end of Q1 Solana made up $430M of a total of $874M of AUM.

Source: DeFi Q1 MD&A

 Solana is a blockchain network. It does much the same thing as Ethereum does – acting as a base layer for transactions to take place. Other apps, smart contracts, decentralized finance platforms (where “DeFi” comes from), or non-fungible tokens (NFTs), are built on top of Solana.

Solana makes transactions happen faster and cost less. It is often called the “Ethereum killer” because it promises to be faster and cheaper than Ethereum. The network is designed to, at least theoretically, process over 700,000 transactions per second.

The Solana token, which is what DeFi holds for its ETPs, is used as currency on Solana. Fees on the network are paid in Solana. Rewards for validating the network are paid in Solana.

These fees and rewards are where DeFi makes their yield.

Every blockchain network relies on some sort of validation model to make sure the transactions on the network are legitimate. Solana does this by combining two methods of validation: proof of stake (PoS) and proof of history (PoH).

PoS is what matters to DeFi.

PoS depends on validators staking tokens on the Solana network in return for a “vote” of what blocks of transactions are added to the network. Think of them as the policemen/accountants of the network.

In return for validating transactions, the validators get paid. They get a slice of each transaction fee as well a reward of newly minted Solana tokens (Solana is adding about 5.4% more tokens in 2024 – they call this their inflation rate).

The overall reward rate (fees + inflation) varies depending on usage and demand. It was 5.5% the last time I checked. This reward is essentially a yield for being a validator.

As of the end of Q1 DeFi had C$332M staked on the Solana network.

That seems like a lot, but it isn’t. According to Coinbase, 287.3M Solana are staked right now, which works out to almost C$68B!

DeFi’s “take” from staking is straightforward. C$332M of Solana staked at a 5.5% rate is about C$18M of revenue per year.

A CRYPTO LENDER

Defi’s staking operations are primarily with Solana and a little bit with Cardano. These are the staked assets as of the end of Q1:

Source: DeFi Q1 MD&A

DeFi’s staked assets are all held in self-custody. This means they hold the Solana (and to a small extent the Cardano) in their own crypto wallet and put it up against the network in return for their rewards

Source: DeFi Q1 MD&A

 The rest of their assets are held at counterparties, where they are loaned out at rates from 2.4% to 9.7%.

Source: DeFi MD&A

The amount loaned out changes a lot – while it was only $130M at the end of March it was $270M at the end of December, even though DeFi’s AUM was smaller.

VENTURE PORTFOLIO AND AMINA BANK

There are two other lines of business that are worth a mention.

First, DeFi owns a venture portfolio of C$41M valuation at end of Q124.

Source: DeFi Investor Presentation

 Of the $41M portfolio, most of the portfolio (90%) is concentrated into a single company: Amina Bank.

Source: DeFi Q1MD&

DeFi holds ~5% of Amina Bank, which is a crypto focused bank. Amina is the first bank licensed in Switzerland to handle digital assets.

When DeFi made their investment in 2021, Amina had $1B of assets versus over $3B today. DeFi said on their call that they mark their Amina position at cost.

A NEW AND HIGHLY PROFITABLE BUSINESS: DeFi ALPHA

We only learned about DeFi Alpha on the Q1 call. Yet the segment was extremely profitable: it earned $40M in the second quarter, which they press released and talked about on their earnings call.

DeFi Alpha is an arbitrage desk – they look for “opportunistic trading strategies”. This is a common strategy in crypto, where exchanges don’t always price assets identically and where a nimble trader can take advantage of discrepancies. In fact, it is the sort of strategy where Sam Bankman-Fried had his early success with FTX.

DeFi’s revenue from Alpha will come from trading profits. That is about all I can say about it, because management gave little in the way of information on what exactly DeFi Alpha will do – “stay tuned”. They were however comfortable in ballparking that DeFi Alpha could do $10M per quarter of operating income.

TRYING TO ADD IT ALL UP

DeFi management was extremely bullish on their Q1 conference call. They gave some impressive guidance/forecasts of where revenue and operating income could go.

Management believes that if Bitcoin hits $100K and Solana hits $225 their AUM would be $1.35B. Their yield on that AUM would be 8-9% through staking and lending. They used 10% to simplify and estimated US$135M of revenue, operating costs at US$10M, and US$40M from their new DeFi Alpha trading desk.

That would give them US$165M of operating income. This isn’t coming from me, this is from DeFi on their call.

There are 359M fully diluted shares so at $1.30 that is $460M market cap. Which puts the stock at “3x profits” as they said on the call, or more exactly, 3x operating income.

These numbers differ from their guidance. For 2024 they are forecasting C$119M of revenue which, using the same $10M costs would give C$109M of operating income. It wasn’t clear from the call whether this included the DeFi Alpha platform or not.

Down the road DeFi is looking to open up their ETP products to the Middle East, Japan and the LSE to drive their AUM higher. Each of these markets could add another $1B of AUM and with it another $100M of revenue (using their 10% yield simplification). They said on the call you could conceivably have $500M of revenue when all the markets are scaled.

DeFi has deferred tax assets of about $49M. Valour, their ETP business, is in Bermuda where there are no taxes.

Management clearly thinks their stock is undervalued. They said it A LOT on the call. Multiple times.

The sell job on the Q1 call was a bit much, to be honest. Russell Starr, their head of Capital Markets and Olivier Roussy Newton were a little over the top at times. They gave a couple different sets of numbers for what to expect in revenue, they threw out even more numbers for the new DeFi Alpha unit, and yet as far as what the platform does they could only say more information was “coming soon”.

They could just be THAT EXCITED about the business. But it still gives me pause.

Nevertheless, as long as crypto is in a bull market it is pointless to second guess this. DeFi is tied to Solana. Solana is already the 5th largest token, with a market cap of $80B. It is up over 700% since October.

Source: CoinMarketCap

 DeFi continues to add new ETPs. They recently announced new ETPs for Internet Computer coin (ICP), Toncoin (TON) and Chainlink (LINK). While I had never heard of any of these coins, they aren’t small, with market caps of

$6B, $23B, and $9B respectively. If any of those take off it will drive their AUM.

DeFi also announced other products, like a yield-bearing Bitcoin ETP and short Bitcoin ETP that give different flavors for investors.

Another catalyst will be multiple listings of the stock. DeFi is looking at listing the stock outside of Canada. The US is one option. They may also look at listing in Europe.

I wanted to make sure I covered the business in its entirety, but it is probably best not to overthink this one. DeFi is a crypto play and as long as crypto does well so will DeFi.

How DeFi fares in the next crypto bear market well…. my crystal ball doesn’t see that far out. My last big winner in crypto was proof to me that the gains in this space can be fleeting.

You buy DeFi with a buyer beware mentality. Which is why it is important not to overstay our welcome. But nothing wrong with collecting some gains while the bull rages on.

I’m long 60,000 shares at $1.03