Real World Assets - When a commercial bank partners with MakerDAO for 100 million DAI

it's True - a Philly bank partnered with MakerDAO for 100 million DAI

DeFiPhilly was fortunate to land a great speaker at their meetups on September 26, 2022 - Dan Krewsom from Huntingdon Valley Bank (HVB).  What makes Dan a great speaker is that he is the orchestrator of the MakerDAO and Huntingdon Valley Bank deal - the partnership where MakerDOA made 100 million DAI available to Huntingdon Valley Bank to specifically increase and enhance their business offerings.  Firstly, this is an amazing announcement and experiment - a bank borrowing money from a protocol.  Simply bonkers today.  But maybe not bonkers in the near future.  We’ll dive into why we think this is only the beginning for businesses working with protocols.  But first, here are the deets of the deal that helps us understand why it’s possible businesses will work with protocol’s in the future.  

The deets of the deal:

This deal isn’t the same as creating a vault through the Oasis app, and posting $ETH as collateral.  Instead, HVB is entering a Master Purchase Agreement with a Delaware Trust who’s beneficiary is the MakerDAO protocol (a protocol being listed as a Trust beneficiary is also bonkers).   When HVB wants to access any of the 100 million DAI, they summon the MakerDAO overlords to buy interest in HVB loans (the real world asset).  In return, HVB gets access to the 100 million DAI to use for their business.  This summary is definitely confusing for anyone not intimately involved with commercial lending (which I am not).  My own grounding required multiple readings of MIP6, and some email exchanges with Dan Krewsom for a dummied down summary.

Not to be a downer, but why do the deal?  

According to Krewsom, the deal took 9 months from start to finish.  The deal required the involvement of many regulators, many lawyers, many accountants, and so many other professional heads that I couldn’t help but wonder “why even bother?”  Sure, it’s an amazing testament for a decentralized protocol, tying real world assets to a digital, immutable ledger.  But what’s the value proposition for a publicly traded bank?  MIP6 is over 45 pages of legalese documentation, which is all HVB trying to convince Maker to grant them access to this 100 million DAI.  So what’s the angle?

As stated on Page 5 of MIP6:

the proposed relationship with MakerDAO will be strategic for HVBank insofar as it will allow the Bank to maintain and grow relationships with customers by expanding its effective lending limit. Loans to new and to repeat borrowers will comply with the same credit requirements. 

What I learned was that HVB has a lending limit of about $7 million (meaning the loans they issue are not allowed to exceed that amount).  But sometimes their clients need larger loans.  HVB has an interest in maintaining a working relationship with that client.  To bypass this lending limit, what they do traditionally is work with other small banks to increase the total money to be lent to a client.  So in the relationship between HVB and MakerDAO, Maker is acting like a small bank.  When HVB’s clients are requesting more money than what HVB can offer, HVB taps into its partnership with MakerDAO, and uses them as a 2nd lender for their clients.

Just from a surface level perspective, this is a great way for a small bank to be more self-sufficient.  When one of your premiere clients requests a large loan that you can’t service, then that bank is probably treading carefully introducing a new bank into the relationship.  Replacing that small bank with an unassuming protocol adds a powerful tool for small banks (and probably small businesses) in the future.  

Where does this go in the future?

After listening to Krewsom’s interview, I couldn’t help but wonder if HVB is forging the way for future protocol-business relationships?  My own question for Krewsom was “does this become an industry standard for future business-protocol relationships?”  And Krewsom’s answer was simple: “yes.”  

According to Krewsom, other banks are closely watching how this unfolds.  If HVB proves that this new relationship is viable, then what small (or large) bank wouldn’t want to work closely with Maker to mint DAI using real world assets?  And if you read through the long-winder MIP6, one nugget of info states:

While the facility will be structured with the intention of having the ability to onboard multiple banks, it is currently only intended to be used for HVB

So onboarding other banks is already in the forethought of both HVB and the MakerDAO.  

But why stop with banks?  Every business generally needs a loan.  And with the federal reserve raising rates, Maker is looking very attractive for anyone needing a bump in cash.  Sure, future regulation could limit who deals with the protocol.  But even that’s still a ground-breaking regulation - protocols getting the same treatment as corporations.  We’ve already seen protocols getting sanctioned by OFAC, now we’re seeing protocols becoming a beneficiary of a Trust.  Where will protocols go next?  Either way, their decentralized, immutable ledger is wedging itself deeper into the fabric and policies of society.  

Offset Industrial Energy with Bitcoin Mining

Subsidize American Manufacturing with Bitcoin Mining

The year is 2022 and energy is simultaneously becoming more scarce and more in demand.  America is hellbent on onshoring manufacturing.  But our energy costs are mooning.  And we're seeing industrial businesses shut the doors due to unsustainable energy prices.  This is why bitcoin mining is revealing itself to be a budding industrial tool that could convert into critical infrastructure to onshore manufacturing, and ultimately subsidize all of our manufacturing.

Industrial plants are shutting down due to electrical costs.  As stated by Bloomsburg, Century Aluminum and Alcoa are the largest aluminum producers in America, and they are being strong armed by energy prices to shut down significant sizes of their production.  The article assumes that high energy prices are forcing the shutdowns.  However, it could also be questioned if demand is lagging.  But if it is a demand problem, that too could be a result of inflated prices seen by both consumers and manufacturers.

And inflated prices are only the beginning.  The EIA is estimating natural gas prices to nearly double in price.  And a significant amount of electricity is created from natural gas.  These price rises are first hitting energy intensive business first (aluminum smelting), but will bleed out to remaining manufacturing.  

This will be a major monkey wrench in our country's adjustment to strengthen our domestic supply chains.  Because the pandemic revealed how insecure our supply chain is.  So we must progress with more homeland manufacturing, regardless of the rising expenses.  So what's the solution?  Continue to depend on overseas manufacturing?  Or raise our consumption costs due to increased manufacturing costs?  The best solution is to find a way to offset these energy expenses.  One creative solution is shaving peak demand with solar and batteries.  Clever, but the upfront cost can easily exceed millions of dollars of construction, which would take years to recoup the investment.  At this precise moment (and hopefully I rattle enough minds to grow a chanting bandwagon), I am the only one pitching that these industries should be mining bitcoin to offset energy prices.  

Bitcoin Mining Subsidy - American Manufacturing

Commercial and industrial facilities are unique in that they have 2 major line items on their energy bills - they get charged for their consumption (KWh) AND their peak demand (KW).  Residents are not familiar with peak demand because they don't typically require enough electricity to run their homes to jeopardize the grid's stability.

Commercial and industrial plants do draw SIGNIFICANT energy.  This means that power providers have to be ready at a moment's notice to provide peak demand for these monstrous energy consumers.  Here's a graph that can be found on this document from  the US Department of Energy:

In this example, this plant's peak demand (max load) is 340 KW.  That means, at any given moment, the power provider has to have 340 KW of capacity available for this plant.  Because of this max capacity, this plant gets billed for 340 KW of capacity.  But if you look closer, they are only using max capacity for about 20 minutes throughout a 24 hour day.  So they're basically getting billed for energy they are not even using!  All the green in the graph below is inexpensive, industrial-rate energy they aren't using, but they're still getting billed for:

I went into more detail on the economics in a previous article.  But it's clear this unused capacity can be used to mine bitcoin.  Industrial plants have privileged electrical pricing, and get some of the biggest discounted electricity rates in the country.  which can then be used to offset rising electricity costs.  

It should be noted that this is not a perfect fit for every facility.  The right facility will have high peak demand costs, and low consumption costs.  And the difficulty of bitcoin mining also has to be fulfilling to make this work.

Beyond the economic engineering, there's also the physical engineering.  Heat emission, sound reduction, storage, IT set up, power connection are all components that these plants need to figure out.  But these plants are already equipped with the infrastructure and man-power to hook this up!  I've been in over 100 different manufacturing plants, and each one has engineers, IT pros, HVAC specialists, and electricians on staff.  Every plant already has a team in place to work out these important details.  

With this forecast, I see a strong future where bitcoin mining becomes an industrial tool for EVERY commercial and industrial building, which will offset electrical costs,  AND subsidize American manufacturing to give us back our control on our supply chains.

Should Industrial Plants Mine Bitcoin to Offset Peak Demand Costs?

Thesis:

Bitcoin mining can be an industrial resource for industrial plants to offset their Peak Demand charges on their electric bills.  Peak Demand charges can account for 30-70% of an industrial plant’s bill.  Peak Demand charges are determined by the maximum amount of energy consumption in a given 15 minute duration.  These plants do not demand this maximum amount of consumption during a 24 hour period, meaning they can turn on additional equipment without incurring more Peak Demand fees.  Bitcoin miners could be this equipment to offset Peak Demand fees.

Industrial Plants - American Manufacturing

I'm not an electrician or engineer. But I'm pro-bitcoin and consider bitcoin mining to be its greatest utility.

I’ve spent the past 8 years of my career as a contractor working in industrial manufacturing plants.  I’ve been in food manufacturing plants, pharmaceutical manufacturing plants, waste processing plants, corrugation packaging manufacturing plants, and many more.  Everyone of these plants operates the same business model - anticipate future demand from previous years, and create enough of their commodities to fulfill that anticipated demand.  

This production cycle creates a very volatile energy-consumption profile for every plant.  Imagine a food manufacturing plant with 6 production lines to fulfill their different products. Sometimes, this food plant will need to run at maximum capacity (all 6 lines) to fulfill holiday demand.  After the holiday, some of those production lines can sit idle while maintenance contractors (my experience) inspect the equipment and building during these scheduled shut downs.  

Here’s the kicker for their electric bill - whether this food production plant is running all 6 lines, or only 3 lines, they are still getting billed for the same Peak Demand costs.  WTF?  WTF indeed if you’re first learning about industrial power consumption.  But it actually makes sense from the electric company’s perspective.  

Here’s a graph of a typical/theoretical industrial facility from the Department of Energy (pg. 8)

What you see are 3 load types: base load, avg load, and Max Load.  Max load is how we determine a plant's Peak Demand Costs.  This particular plant has a max load at 340 KW.  This means that in order for the utility provider to properly serve this industrial manufacturing plant the necessary amount of electricity to operate, it needs to offer a capacity of 340 KW of power at any given moment.  This means the utility company needs to have 340 KW of equipment and infrastructure and energy on standby, just for this moment, which is why this cost is a large part of this plant’s energy bill.

But let’s take a closer look.  Only for about 15 minutes does this plant actually need 340 KW of capacity.  The areas highlighted in green in the same graph below, shows all of the demand capacity this plant is getting invoiced for.  But they aren’t using the capacity!  They’re leaving power capacity on the table that they could be using to produce and manufacture some other commodity.  The gap in capacity usage is so large, that there’s 10 straight hours (7PM - 5AM) of 200 KW not being utilized.

How can an industrial plant offset these peak demand charges?  Bitcoin mining?  Maybe…

Every manufacturing plant does the same thing: convert electricity into a commodity.  And that’s no different than bitcoin mining.  So can these industrial manufacturing facilities, who already have electrical engineers and system controllers, use this excess, unused capacity to mine bitcoin to help offset these Peak Demand charges?  

Maybe…

Every industrial & commercial facility gets invoiced for both Peak Demand (measured in KW), and Energy Consumption (measured in KWh).  As residential energy consumers, we’re more than familiar with the energy consumption portion (KWh).  This typically costs us $0.10 per KWh, give or take, depending where we live.  But residential people don’t get charged for the Peak Demand.  Only commercial and industrial facilities get charged for this.  And Peak Demand can cost anywhere between $5 to $50 per KW, or even more.  Here is a geographical chart created by the National Renewable Energy lab in 2017

So for the theoretical plant above, if 340 KW is their Peak Demand, and their peak demand is $15 per KW, they’re getting charged for 340 KW x $15 = $5100 per month IN ADDITION TO THE ENERGY CONSUMPTION (KWh).

So, to find out if it’s worth a facility to crank up extra equipment to max out that capacity, we have to know if the value produced by that extra equipment (bitcoin) is greater than the additional cost of energy consumption (KWh).   This really is no different than any other bitcoin mining operation.  The key difference is that industrial plants may be able to take advantage of lower KWh rates, as long as their extra consumption doesn’t raise the Peak Demand.

Let’s look at some numbers…

In April 2022, the avg KWh price for an industrial plant in Pennsylvania is $0.0754.

Let’s say the KW cost for Peak Demand in this whatever area in Pennsylvania is $15 per KW. 

This means the total monthly bill for this plant is:

210 KW avg x 24 hrs x 30 days x $0.0754 = $11,400

340 KW Peak Demand x $15                 = $5,100

Total = $16,500

Now, let's see what happens when we add some bitcoin miners into this mix.  The goal is that we’re utilizing the capacity that we’re already being invoiced for, to produce additional commodities.

Let’s work with Antminer S19 Pro.  This has a wattage of 3250.  Looking at the chart, let’s assume we can run these for 10 hrs every day.  That means:

(3250 W x 10 Hrs per day) / 1000 = 32.5 KWh

So 1 Antminer will consume 32.5 KWh per day.  This is important to know, since we have about 200 KW of wiggle room between our base load and Peak Demand (because we don’t want to increase our Peak Demand with bitcoin miners).  So let’s assume our fictitious plant runs 6 Antminer S19 Pro’s for 10 hrs per day for 30 days:

32.5 KWh x 6 miners x 30 days = 5,850 KWh per month consumption

So our new invoice, if running 6 Antminer S19 Pro’s for 10 hrs per day for 1 month would be:

210 KW avg x 24 hrs x 30 days x $0.0754 = $11,400

340 KW Peak Demand x $15              = $5100

32.5 KWh x 6 miners x 30 days x $0.0754      = $441

                                                                    Total = $16,941

Now, how profitable was our bitcoin mining?  According to this mining calculator, our S19’s will make $8.31 per day (as of 7-7-2022).  If we’re running for 10 hrs per day, that’s about 42% of the day.  So $8.31 x 0.42 = $3.50 per day

$3.50 per day x 30 days x 6 miners = $628

Meh, not too amazing, but it would offset the cost by almost $200.

Although our energy cost to operate our day to day business, plus the cost to run 6 miners for 10 hrs per day is more expensive, we’re earning a new commodity that is worth more than the additional cost of energy consumption.  Which will help offset the Peak Demand charges.  

Of course, this isn’t accounting for the cost for the ASIC miners.  But, commercial and industrial plants are already setting aside defense budgets to mitigate the growing Peak Demand rates.  Which is why so many plants are looking into battery & solar combos, which is significantly more expensive than bitcoin miners.

Let’s check out another example.  How about a brewery based in Pennsylvania?

Let’s use this load profile from a brewery in California, and just use Pennsylvania rates.  Ironically, this chart came from a battery/solar company that’s trying to offset peak demand charges with batteries.  But when looking at the chart, just pay attention to the choppy line, which is where we are getting our KWh and KW numbers.

Based on the chart, this brewery appears to have a daily energy consumption of about 14,720 KWh.  And, it appears this brewery has a peak demand cost of just under 1100 KW.  So, this brewery’s monthly bill would break out to be:

14,720 x 30 days x $0.0754     = $32,297

1100 KW x $15                 = $16,500

        Total = $48,797

Looking at the chart, and seeing where we can juice that demand capacity, let’s assume we can run 12 S19 Pros for 12 hrs per day.  Here’s what we get when we add bitcoin mining to our energy mix:

Additional consumption

(12) S19 Pro for 12 hrs per day = 14,040 KWh x $0.0754   = $1,059

Bitcoin profitability

$4.15 per day x 30 days x 12 miners                   = $1,494

So, if this brewery decided to run (12) S19 Pro antminers for 12 hrs per day, they would add $1,026 to their consumption fees.  BUT they would net 0.0726 BTC @ $21,000/BTC = $1,524.

Observations

Based on this crude, digital-napkin mathamentals, it appears that it is worth industrial and commercial facilities to at least think about running bitcoin miners.  Certainly, the industrial facility needs to have the right energy load profile.  And, the KW rates have to be high enough, with KWh rates low enough for it to make sense.  If you run these scenarios with plants in California, it usually doesn’t make sense.  But it we run these scenarios in places like Georgia, it appears to make a whole lot of sense.  Because Georgia has low KWh consumption rates (comparable to Pennsylvania), but high Peak Demand rates (many locations exceeding $25).

Additionally, we have to be mindful of the variables.  Obviously with bitcoin tanking in price, the profitability won’t be great.  But considering the excellent KWh rates commercial and industrial facilities get, bitcoin mining should be in the discussion for how plants can offset their overhead costs.

External Ramifications and pie-in-the-sky thoughts

• If industries start to mine bitcoin as supplemental income/commodity production, this can help subsidize manufacturing, and onshore more manufacturing back into America (as James McGinniss quasi talks about in his post)

• If industries start to mine bitcoin, this strengthens the bitcoin network’s decentralization.

• If industrial manufacturers start to mine bitcoin, they won’t be under the same pressure to sell bitcoin as pure mining companies, because it won’t be their core business.  They could end up being industrial/corporate hodlers.

• If industrial manufacturers start to hodl bitcoin, they could end up using bitcoin reserves to trade with other manufacturers, filling up bitcoin block space, and transaction fees.

• This isn’t a free lunch, however.  The plants will need to buy the miners and put up capital (the glory of PoW).

• If these plants sign up for Demand-Response programs, they can earn additional cash when prompted to turn off their miners.