How 'Hard Money' Can Make a Cannabis Firm Competitive for the Long Run

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Keynesian economics is dead. Yes, I mean the economist John Maynard Keynes, the once-famous and infamous economist who has inspired the model of the western world’s monetary and fiscal policies since the end of World War II.

What does Keynesian economics, or the idea that money should be managed by the government, wherein the economy is driven by mostly aggregate demand, and that people will buy more when they have more nominal money in their pocket, have to do with cannabis? Well, cannabis, like any other industry, is facilitated by money. And the money being invested into the cannabis industry meant to protect cannabis companies from the eventual consolidation of the industry is based solely on 75 years of “easy” money policy. The result being that larger firms with access to easy money will pick off weaker, smaller firms who cannot compete with multistate operators or large tobacco, alcohol, and pharma corporations when federal legalization arrives. The only defense for smaller cannabis firms is to fortify their balance sheets with “hard” money.

What do I mean by “easy” and “hard” money? First, money has three main characteristics. One, it is a store of value. This means that what an amount of currency buys today should buy, at a minimum, the same goods in the future. Two, it is a medium of exchange, meaning you can easily use it in a marketplace that accepts it in exchange for goods or services. Three, it is a unit of account, which allows for the calculation of profits, losses, and balances.

One example of “easy” money is the fiat or paper and coin currency issued by central banks and made legal tender by governments around the world. It is “easy” because money can be printed at will and there is no cap as to its issuance. On the other hand, “hard” money is not easy to produce and there is a cap, or at least a very low level of issuance regardless of the economic demand for it. Gold is an example of a historical hard currency.

To put it into econo-speak, “hard” money creation is inelastic to any price or demand signals. (In that regard, gold is an imperfect example as an increase in demand (leading to a price increase) would eventually lead to more gold-mining activity (increase in supply) to meet that demand and capitalize on the price increase.)

The Problem With “Easy” Money

When the government prints fiat money, it dramatically reduces that currency’s usefulness as a store of value. Who hasn’t heard their parents or grandparents say, “When I was a kid, you could go to the movies for 25 cents?” Now, movies cost $10 or more. The quarter obviously didn’t keep its store of value.

When money is printed, it floods the capital markets after winding its way through consumers’ hands and is eventually lent out to or invested in larger firms, or it ends up as banks’ reserves held at the Federal Reserve.

When the level of money rises, asset values increase, but the actual level of wealth created (store of value) is non-existent. In fact, as money is printed, it devalues the current outstanding stock of money. As a result, it takes more money to buy any asset, including cannabis companies.

Over time, large companies get access to the capital spigot that small companies don’t. For example, a public company with decent earnings can easily issue stock to raise equity capital, issue debt at competitive lower rates, and can get bank loans that small companies can’t access.

But, there is a potential route for small companies to access capital: hard money.  

Our firm has researched whether there are legal cannabis companies accepting hard money in the form of digital currency (also known as digital assets or digital money, or, in the vernacular, “crypto”), and discussed it with bankers who bank cannabis, and it appears there are too many impediments at this time to make it possible. In summary, we found:

  • Because cryptocurrencies are kept in pseudonymous wallets on a blockchain, there is no way for a bank to be 100% sure the funds in the wallet came via cannabis sales from a buyer who also has a pseudonymous wallet. (This is changing given increasing levels of payment options from firms such as Cash App or PayPal, which do follow Know Your Customer (KYC) regulations).

  • PayPal currently allows the use of digital currencies for spending and the sending and receiving such assets. Their use of KYC in theory could integrate with a cannabis point-of-sale system. Venmo, a PayPal company, allows the buying and selling, but not for the use of payments. Also, with Venmo you do not have your own wallet, you have an interest in digital currency assets held within Venmo’s wallet.

  • Currently, digital currency assets are classified as a property and therefore subject to taxation at the applicable capital gains or income tax rate when converted to fiat currency or any other property—i.e., spending it on a cup of coffee or an ounce of cannabis. Also, there are some theories that digital currency assets are commodities, or securities; all this will be straightened out with regulations in the coming years.

  • Combined, these restrictions make it impossible to have a bank account and accept digital currencies into a cannabis company.

  • Theoretically, there is a way to run a cannabis company via crypto only, but practicality points to the decision that it is better to get a fiat bank account than try to run a cannabis company exclusively on crypto. A bank account facilitates wires, payroll, etc.

What To Do?

So, how can cannabis companies use hard money digital currencies to fortify themselves for the long run? Ideally a cannabis company would accept digital currencies as a medium of exchange for its product and keep it as an asset on its balance sheet. As we’ve seen, this is not currently practical.

The goal then is to be able to convert earnings from a cannabis business into hard money in order to take advantage of its properties as a good store of value. Converting earnings into hard money property to be held on the balance sheet will allow the digital asset-holding company to retain value as a firewall against a larger firm using their access to cheap capital (“easy money”) to buy the crypto-holding company at a cheap price. The purchaser would in essence need to pay for the digital currency asset, or release it to the owners at closing, allowing the owners to retain those earnings (and any interest earned).

The first step, from what we have figured out, is for all cannabis companies looking to accomplish this to have a parent company. Retaining earnings in digital currencies within a cannabis company is problematic. The company’s current bank will not be comfortable with this for anti-money laundering (AML) reasons and will not be able to confirm the digital currency came directly from cannabis sales. What is on the balance sheet of the parent company is less of a concern for a bank serving cannabis companies. As long as the bank can ensure that the funds being generated from cannabis sales and flowing through the bank are auditable, the banks will not care what happens to the funds when sent out of the cannabis operating company.

Profit, or return of capital, upstreamed to the parent company can be used for any purpose the parent company sees fit. It is at this level that upstreamed funds would be invested into digital currencies. In essence, if the right digital currencies are selected and are held for the long term, then what the parent company creates is a hardened shield of digital property that keeps its value in the face of inflationary pressures.

This store of value also will come in handy when the cannabis company needs capital to fend off acquisitions, compete against bigger firms or become an acquirer of other firms. Even if the parent company sells the cannabis company, it will be able to keep the digital currency assets and convert it to fiat, if desired, as an extra bonus. Diversifying a company’s capital structure is a good in itself.

Hard Money: Not All Are Created Equal

What makes for “hard” money? Anything that is hard to produce and is accepted for exchange by buyers and sellers is a candidate for hard money. There is an asset scarcity model called Stock-to-Flow (S2F) which is used to compare, for example, the current stock of an asset to how much it grows each year. The less it grows, the higher the ratio. For example, if there are 100 units of ABC and in the next year the amount of new ABC created is 2 units, then 100 divided by 2 = 50. Compare this to asset XYZ where there is 100 units and over the next year 10 units are created. Dividing 100 by 10 gives a lower number, 10. The XYZ asset would need five times more annual growth in demand just for its price to stay even. Here is a handy formula: Current stock of an asset (X) divided by annual production (Y), also known as flow. X/Y is the ratio of stock to flow.

Let’s return to gold as an example. The current stock of gold versus the amount produced every year is far apart. Using rounded numbers, let’s say there are 200,000 metric tons of gold above ground (in human hands) and over the next year 2,000 metric tons will be mined and added to the previous number. Dividing the 200,000 by the 2,000 equals 100.

This model applies directly to digital currencies. If new money creation is small, this results in a high S2F ratio. If the new currency produced is high, this results in a low S2F ratio. All fiat currencies have low S2F ratios compared to gold and the better digital currencies. The higher the ratio, the harder the currency, resulting in better store of value characteristics.

Most informed digital asset observers believe that of all the choices for digital currencies, Bitcoin is the hardest money. The characteristics of Bitcoin that lead to this conclusion are that there will only ever be 21 million coins mined; currently there are 18.85 million outstanding (in existence), with the last Bitcoin to be mined in the year 2140. Bitcoin also is considered the most decentralized of all digital currencies because of the large number of nodes (computers running and validating the Bitcoin blockchain) in its network combined with its consensus protocol—resulting in an asset that cannot be manipulated or increased by hackers (i.e., no money printing). Given that these characteristics add to its scarcity value, Bitcoin, with increasing adoption (demand) over time, should increase in value (either requiring more fiat to purchase or allowing a fixed amount of Bitcoin to buy more stuff). Also, given that each Bitcoin is divisible into a 100,000,000 pieces (called Sats), resulting in 2.1 quadrillion Sats at full mining, it is enough “money” to run the world economy. (The moment the total value of Bitcoin matches the total value of the world economy is called “hyperbitcoinization.”)

It is beyond the scope of this article to discuss in depth the economics of the myriad digital currencies in the market, but with a little due diligence on some of the top 50 digital currencies, you will find candidates that have high S2F ratios are being adopted at a rapid rate and solve real-world problems. As a start you will want to go to the currency’s whitepaper to read the real-world application the currency intends to facilitate. Look at the current outstanding number of coins, the estimated number being minted annually, the maximum amount that can ever be issued (or whether there is a maximum), the amount locked up by insiders and release schedules, initial investor and sponsor holdings, and the adoption of the use of the currency’s protocol (fancy name for business model).

For example, if you look at a decentralized finance digital currency like AAVE you will want to know the economic value that is locked up in their system. AAVE is a finance protocol so it makes sense to look at how much economic value it controls like you would with a bank. This is referred to as total value locked (TVL). The higher the value locked, all things being equal, the more demand for the AAVE currency resulting in AAVE’s price going up. Please do your due diligence as the process just described is part of any fundamental analysis of any asset.

Each digital currency asset is unique. It takes good financial analysis skills just to understand the value proposition of each digital currency (aka “tokenomics”). Then you also need to know specific domain expertise to evaluate the protocols. You will run across use cases with names like DEX (decentralized exchange), Oracle, NFTs, DAO (decentralized autonomous organizations), privacy coins, and more. If you are already confused, start by looking at Bitcoin (BTC) and Ethereum (ETH), but note this is not investment advice.

In summary, the goal of crypto in the cannabis space should be to build a financial shield to enhance the survival chances of a cannabis firm. Eventually, payment options for cannabis firms will expand so as to allow them to accept digital currencies and keep them on the balance sheet, but until then, these assets can still play a part in the financial stability and strength of the balance sheets supporting the firm while protecting your business from the continuing debauching of fiat currency.

Source: One


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