In the traditional sense, capital efficiency is the ratio that compares the spending of a company on their growing revenue and how much they are receiving in return in the way of profits. This means that if a company is earning $1 for every $1 spent, then it has a 1:1 ratio. The higher the ratio, the more capital efficient a company is and the greater the profit.
Ensuring capital efficiency can help companies look more closely at their processes to see if there are expenses that can be cut without reducing the quality of their operations. For startups, capital efficiency is an important factor to consider. Namely because if a company is spending too much relative to their growth, they may find it hard to fundraise.
In crypto, capital efficiency is considered more effective when using digital assets than fiat because it is usually cheaper to maintain, utilize, process, and send than fiat money, particularly when considering the cost of scaling and security on a long-term and a global scale.
Whether in the form of fiat or crypto, one of the key challenges with ensuring an efficient capital ratio is always requiring a 1:1 backing of an asset. Stablecoins, like Tether, often face challenges where the more capital that goes into the assets from token buyers, the more collateral backing the asset needs. This would be considered capital inefficient.
Innovations coming from blockchain-based finance are changing the way we maintain and improve capital efficiency. Stablecoins that are backed in two ways: collaterally-backed and algorithmically modified, don’t require full collateral backing, like Tether, because only a certain percentage of its supply is required to be collaterally backed. This means the asset requires fewer dollars to act as collateral, so that money can be put to more efficient use. For example, if a $1 peg can be maintained with only 85% of it backed by fiat stablecoins, you can be 15% more capital efficient.
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