I have been an investor in, and a customer of, Nexo for some time now. Naturally, I have done my best to conduct due diligence on the company. Here, I’ll explain why I found Nexo an attractive investment and why I eventually decided to head for the exit.

Nexo is a crypto lender, operating as a traditional centralized company rather than as a collection of smart contracts like its competitors in DeFi. Currently, the major players in the CeFi sector are Nexo, Celsius Network, BlockFi, and Crypto.com. Smaller contenders include Ledn from Canada and Russian-Estonian CoinLoan.

The Nexo token entitles the holder to a dividend equal to 30% of the company’s profits, which makes it ostensibly similar to a share in a company. Additionally, it has some utility functions, which include a lower interest rate on loans and a higher one on deposits. My main interest in studying the company, however, is to estimate the future dividend stream.

The inspiration for my approach comes from the book The Zulu Principle (1992) by the late investing guru Jim Slater. Slater’s wife read an article about the Zulu people in Reader’s Digest. This made her an expert compared to her husband. Had she then borrowed every book on the topic from the local library, she could have become the leading expert in the county. Had she then been invited to a Zulu kraal and spent some time reading about the history of the Zulus at Johannesburg University, she would have become one of the world’s top experts on the topic. In effect, a moderate amount of effort focused on a single target is enough to build a slight edge, and as Slater writes:

It is only necessary to be six inches taller than the other people in a room to see above everyone’s heads.

Accordingly, I’ve tried to look at every possible source for information.

A Look at the Blockchain

There is an obvious starting point for analysis: a lot of Nexo’s business is recorded on a public ledger.

Looking at transactions in and out of Nexo’s public wallets reveals some interesting tidbits. For example, Nexo has been active in DeFi platforms from time to time, most notably in late June, when it took part in yield mining on Compound for six days with a very significant amount of capital, earning over a thousand COMP tokens, which were promptly sold for ETH on Uniswap.

However, total transaction volumes are possibly the most informative detail available. The community-run Nexo Statistics site tracks stablecoin transfers from known Nexo wallets on the blockchain to gain visibility into the growth of the company’s business. Based solely on transfers on the blockchain, it is not possible to estimate loans paid out in fiat currencies, nor is it even possible to distinguish taking out a loan from making a withdrawal. Thus, the statistics only give a general idea of the trends in Nexo’s business.

For whatever reason, the site’s proprietor likes to present the data in a cumulative format, which makes trends hard to fathom. I have taken the liberty of reordering the data to make it easier on the eye. Here’s a chart of recorded transfers grouped by month:

There is obviously a rising trend here. That fits in well with the public statements of Nexo representatives, mainly CEO Antoni Trenchev. Putting the two together, it seems plausible that the company’s loan issuance has grown fourfold or more year on year.

If the token price has merely doubled while the size of the business has quadrupled, that would mean valuation (on volume-based metrics) is significantly lower. Seeing that, adjusted for growth, Nexo may be the cheapest fintech on the planet piqued my interest. However, deeper due diligence on the company proved rather difficult.

Nexo has never published financial statements, even unaudited ones. The loan and deposit contracts available on the company’s website are between the user and “any holding company, subsidiary or entity belonging to the Nexo group of companies”, while governing law is defined as “the substantive law of Nexo jurisdiction”. In other words, you are entering a contract with an altogether unspecified party.

Surely the company could shed some light on its murky structure?

Correspondence

I decided to ask directly. Here’s the initial email I sent to Nexo:

Greetings,

I am a holder of a modest amount of Nexo tokens and considering investing more. However, there are some basic due diligence questions I cannot find an answer to, listed below. I’ve also been in contact with a number of other investors with similar questions. If you can either answer them, or forward my question to the right person, or give me such person’s contact information, I would be grateful.

1. In the recent announcement of Nexo’s cooperation with Chainlink, it was mentioned that the company has assets under management of over $600 million. My understanding is that this figure includes crypto held as collateral for issued loans. Can you confirm this? Furthermore, can you confirm whether this figure includes customers’ fiat and stablecoin deposits?
2. My understanding is that fiat deposits (in Europe at least) are sent to Nexo Services OU in Estonia, which issues e-money tokens to Nexo AG, so that the latter does not directly interface with the fiat deposit. In return, loans are issued in these tokens by Nexo AG and Nexo Services OU in turn converts them to fiat on the customer’s behalf. Can you confirm my understanding is correct?
3. Are the Swiss and Estonian companies fully owned, either directly or indirectly, by the Cayman-based Nexo Capital Inc., or are there minority interests?
4. Do you intend to publish financial statements, whether audited or not, of the parent company?

Thank you in advance for your reply.

I will assume any answer from you is on the record and can be shared with the investment community, unless you clearly specify otherwise.

Nexo’s first response was a request that I correspond with them from my registered email address, because:

…a lot of the information you are inquiring about has been deemed confidential or sensitive by our higher management, and we would be more inclined discussing it with you through your registered email address. Due to the nature of the requested information, we would be more comfortable addressing it with active customers of ours.

Accordingly, I sent the questions again from the right address as requested, so that they could confirm I was indeed a customer. After some delays (apparently the issue was escalated all the way up to higher management), I finally received this information:

We are reaching out to you with regards to your inquiries.

After discussing the matter with our higher management, we can confirm that at the time of writing this Medium article, we had ±600 million USD worth of customer assets in our custody. However, the rest of the information requested concerning the functionality of our company and the legal entities that form the Nexo Group is considered a business secret and will not be disclosed publically. Thank you for your understanding. Let us know if there is anything else we can assist you with.

Nexo’s answers have some important implications for investors.

Assets and Loan Book

The only question that received a definite answer was about customer assets, which were confirmed to be in the region of $600 million at the time. Let’s use $620m as an estimate, since the figure was stated to be “over” $600m.

All loans issued by Nexo are secured by collateral. Each asset has a different maximum LTV. If the customer assets were entirely made up of BTC, then at a maximum LTV of 52.7%, the $620m asset base could support at most a loan book of $327m.

The true loan book must be smaller than the theoretical maximum for several reasons. First, at this level, all loans would hover at the edge of margin calls, which is rather unrealistic. Second, most assets have an allowable LTV lower than BTC. Finally, some customers use Nexo as a deposit facility to earn interest on their assets (including yours truly). Those assets are included in the total number of customer assets but do not support any outstanding loans.

If we make the rather optimistic assumptions that total loan book is around $300 million and that all customers pay the standard 11.9% interest without using Nexo tokens for discount, we get an annual run rate of interest under $36 million. Keeping in mind that Nexo has experienced rapid growth, the loan book must have been significantly smaller than this for most of the last twelve months. Slightly offsetting this is the fact that there is a minimum loan period of one month, so even very short loans incur interest for that period.

Here’s a recent infographic with an estimate of the upcoming dividend by Nexo Statistics:

The baseline (middle) estimate is a total dividend of $14.5 million. Keeping in mind that the dividend is 30% of profit, that would imply total profit of around $48 million. Clearly, Nexo cannot pay interest to depositors, salaries to its about one hundred employees, and all other business costs from gross interest income of $36m and arrive at anything like that figure, no matter how much yield farming they do on the side. That would suggest that the dividend expectations being bandied about in the community are too high.

Anyway, toning down expectations of the next dividend is not a reason for me to sell, as the company’s valuation remains attractive even with a lower dividend estimate.

Licenses

What exactly is Nexo? It is easy to find three well-documented entitities in the group:

• Nexo Capital Inc., based in the Cayman Islands, which issued the tokens and pays the dividend;
• Nexo AG, incorporated in Switzerland
• Nexo Services OÜ, located in Estonia

A quick Google search easily unearths an online review that outright calls Nexo a scam because of its inadequate licensing. The author correctly points out that Nexo Services OÜ does not have a license to issue loans. It does have a license to issue e-money tokens, however. The system I outlined in question 2 is one way the company may have been set up to operate legally within these restrictions.

In fact, the licensing regime doesn’t have a significant impact on my investment thesis. The question gave Nexo an opportunity to address such public grievances and to assure investors that they are legit. They failed to take that opportunity, but for the time being, they seem to be doing a roaring trade, so there are enough customers who don’t care about such things.

Corporate Structure

The last issue is a big one. Token holders receive 30% of Nexo’s net profit. But again, what exactly is Nexo? If you go through all public documents about the Nexo token, you will that the legal entity is never identified. We can surmise that we are dealing with Nexo Capital Inc. since its board of directors signs the dividend payment decisions (hence we can call it the “parent company”). However, management has declined to release any financial information about the parent company, or to confirm what part of the other Nexo companies it owns.

How can one make a rational decision to invest in an entity without any knowledge of cash flows, or even of what part of the “Nexo group” one is really investing in? Not only could I not justify additional investment, I decided to sell most of my modest cache of tokens, leaving only a token amount.

This is not to say that one will lose money by investing in Nexo tokens. They may turn out to be a great investment. Then again, if you bet on red at the roulette table, red may indeed come up. That is, alas, something that cannot be predicted with any reasonable approach.

Who Made Who?

People learning about limited companies for the first time sometimes ask the question: Why do companies have shareholders, when it seems they provide no clear benefit to the company? Of course, this question is backwards. A company exists for the benefit of its shareholders, not the other way around. As for holders of security tokens like the Nexo token, the relationship is not quite as clearly defined.

It seems Nexo’s culture of opacity is symptomatic of their attitude towards investors. The team that brought us Nexo previously built consumer lender Credissimo from the ground up. The company IPOed in 2014, but the founders bought the company back and delisted it the next year. Someone purporting to be from the company explains the decision:

However, we later realized that listing on the stock exchange and being a public company was too burdensome and expensive without much advantages, so we bought out the public shareholders and we took Credissimo back to private.

This statement may not be genuinely from the team, but it does fit their actions. Remember, Nexo asked me to verify I am a “customer” before addressing any questions. That is a silly thing for them to say; token holders are not mere customers. If they are entitled to a profit share, they can reasonably ask to ascertain how that profit is generated.

Nexo’s disinterest in addressing such questions suggests that it may have been a mistake for them to issue a security token in the first place. They could have instead opted for a utility token like many of their competitors. Then, as long as they deliver the promised utility, they’d have no great obligation to explain themselves. A company that wishes to remain less transparent than the vaults under the Vatican should never have issued securities of any kind to the general public.

Perhaps, as Nexo’s business matures, its culture will experience a parallel movement towards transparency. That will be an interesting development to see, but it is one I intend to watch from the sidelines, at least for now.

• cefi