Why is selling risk the good business model?

Why Selling Risk is a Profitable Business Model

Source: FutureMoney

These days, watching SBF’s trial, I have many insights. No matter how talented you are, financial risks can still crush you.

We all think that as long as a stock keeps rising, there will be liquidity. This is actually wrong. Liquidity can disappear in an instant, and prices can plummet.

During the 2008 financial crisis, the London Interbank Offered Rate (Libor) couldn’t be quoted for a whole morning due to market panic. This shows that when assets lack liquidity, price information also stops.

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In such times, a few hours can determine a lifetime.

A similar situation occurred with FTX. FTT (its token) quickly broke through the psychological price level, causing prices to plummet. Looking back, frantically trading during the first few hours was the right decision. Those few hours of effort were much more important than what followed. However, the market’s liquidity was too fragile, and it couldn’t save the situation.

FTX had a significant amount of AUM and collateral before the explosion, but it didn’t have enough cash to repay its debts. The Total Value Locked (TVL) of Web3 protocols lags behind liquidity, so we can’t conclude that high TVL equals high liquidity.

Some people might say, what about market makers? In the financial markets, there are no friends. Market makers are the first to withdraw when needed.

Risk is what business people hate the most. Liquidity risk is probably the most detested by financial practitioners. However, some people use bearing liquidity risk to create an illusion of grandeur and support their business empires.

Asset management institutions buy risks; it’s their profession. As long as prices rise, everyone’s happy. When prices drop more than 50%, clients start to panic. If there are some bad assets on top of that, it might lead to insolvency.

How are bad assets generated? There are countless reasons. Salespeople neglect risk control for performance, and human ability to recognize liquidity risk is limited. Financial asset complexification and other factors contribute as well. SBF may have already done his best in his own way; the only mistake was choosing the wrong path.

Relying on buying risks to support a business model is questionable. A better business model should involve selling risks and earning cash.

Take Facebook as a comparison. Its business doesn’t require buying risks to make a profit; it only needs to collect fees from advertisers. During a financial crisis, it can simply earn slightly less from advertising fees. It only faces operational risks, not the liquidity risks of financial assets.

The significance of DeFi lies in innovating the asset management industry, allowing users to bear their own risks. Protocols only earn transaction fees and advertising fees while facing operational risks, not liquidity risks.

Top-tier enterprises and market makers are the ones who sell risks. Those heavily leveraged by funds are merely lucky gamblers who borrowed money.

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