Capital leverage is a financial strategy that involves using debt to increase the expected return on equity. It is the use of other people's money to acquire or create assets.
The use of capital leverage can be illustrated with an example:
Let’s say that I'm looking to buy a house for $200,000 cash. Instead of paying all $200,000 in cash, I decided to borrow $100k from the bank and fund the remaining $100k with my own money (equity).
If we assume that there are no other costs involved in buying this house (such as closing costs), then this would be considered 100% capital leverage – meaning that all of the return on investment comes from leveraging up my assets so that I can earn more profit than otherwise possible without borrowing money.
How Wealthy People Use Capital Leverage
In the real world, a wealthy individual can take out a loan from a bank and buy up a rental property or investment property.The interest on the loan is tax deductible and each year as long as they pay their monthly payments, they can deduct expenses related to maintaining their investment property like maintenance costs or repair bills.
After some time has passed (usually a few years), if the market value of the property increases above what the wealthy individual paid for it, then they can sell that asset at any time without having to pay back any money to the bank (as long as they continue making those monthly payments).
This creates unlimited upside potential with minimal downside risk since if something were ever to go wrong—like if the tenant moves out unexpectedly—the wealthy individual could simply sell that asset back into an active market via an auction house or even 'Craigslist' for its current market value.
Although, this sort of capital leverage isn't applicable for noobs like myself. However, the strategy itself can be applied on a smaller scale (e.g getting into business, purchasing equipments).
This same concept more or less applies within the crypto/blockchain world. However there are less barriers here compared to traditional finance institutions. This is largely due to lack of regulation surrounding certain aspects such as security tokens.
This could allow smaller investors access similar opportunities that were previously only available through banks & brokerages but the is not clearly defined yet.
There's A Downside
The down side to this strategy is that you have greater risk sacrificing a portion of your ownership interest and control over the asset.If you do not maintain control enough to prevent the asset from being sold or leveraged in other ways, then you can lose money.
In addition, this strategy does not work well with all assets. For example, if an asset has low liquidity (e.g., someone wants to buy a piece of land) or if there is no market for it (e.g., a gold coin), then this strategy cannot be employed successfully with those types of assets.
Capital leverage And Digital Tokens
Capital leverage can be used in a crypto/blockchain world to create new digital tokens that can generate revenue through digital scarcity, then using these tokens to fuel blockchain solutions. It's a three step process; creating digital tokens (1), generate revenue through scarcity (2), fuel blockchain solutions.Digital tokens can be used as collateral and leveraged for crowd investment and capital raise opportunities. This is another example of capital leverage.
One of my favorite examples was Goldmoney (they exited the crypto biz) which uses digital tokens to back physical gold products which generate revenue that pays shareholders dividends in token form. This can then be converted into cash via exchanges.
It's a simple but powerful model that creates value for all three parties involved: the customers get an easy way to own gold and other physical assets; the company builds a useful product by leveraging blockchain technology; and investors receive income from this new asset class in exchange for providing capital at inception.
Unfortunately, they're out of the blockchain game. Maybe they foresaw the instability of the crypto space and decided to liquidate their crypto assets and go baba i.e back to basics. Present examples I can think of are DAOs and crypto lending platforms (beware!).
Conclusion
Capital leverage can be an effective strategy for increasing your wealth and building a sustainable financial health.It is not without risks, however, so you must take these into consideration before embarking on any capital leveraging adventure especially in the digital world. My hope is that the risk will gradually minimize as the crypto world gains more stability (who knows when will that be).
Thanks For Reading!
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