Category: Risk

Introduction

We have a series on risk that won’t write itself, so I guess that’s what I’m here for. Smart readers can guess today’s entrant (because it’s in the title): Shutdown risk. What’s that? Well, (a) duh, and (b) the risk that a bank, FinTech, credit card issuer, or other counterparty throws its virtual hands up in the air and says “that’s a nah from me son.”

Shutdowns as a Spectrum

Shutdowns come in many forms, much like your crazy ex’s promises. A few examples:

• The Gentle Backoff: When you say jail to a churner, the first thing they’ll think of isn’t metal bars and locks, but rather AmEx Pop-Up Jail, which prevents you from getting future sign-up bonuses.
  
• The Not-so-gentle Backoff: Small to medium sized credit unions are great at this, generally something like “if you don’t stop refunding those travel redemptions the week after you book them, we’re going to close your account”.
  
• The Cold, Calculated Axe: Banks famously don’t care about feelings, and the good ones have a risk algorithm or two that, when alarms, leads to immediate shutdown. The really good ones will send you a polite letter telling you to pound sand and kick rocks while you’re at it too.
  
• The Random Wildcards: Gift card sites, obscure portal aggregators, and fly-by-night buying groups don’t have compliance departments, instead they have automated ban-hammers. Breathe on them sideways when the wrong Toby analyst is looking and your account is locked instantly, often taking your pending payouts, rewards, and maybe your money with it.

Some shutdowns obviously sting more than others.

Managing Shutdown Risk

I know, I know, no one likes to be managed. So do the managing yourself:

• Earn and Burn: Points sitting in an account aren’t assets, they’re unbacked IOUs
  
• Learn about an Institution’s Triggers: Some issuers that rhyme with schminkrony hate cycling for example, while other FinTechs hate when you taek them as nothing but a hub, while others hate it when you chase their deposit accounts; know the pitfalls so you can dodge ’em
  
• Isolate Your Real Accounts: Is your mortgage payment coming out of the same account that you’re depositing buyer’s group checks into? Well, cut it out. Would P2 be eternally mad if you lost your Kohl’s card? Maybe be careful with Capital One
  
• Consider horizontal scaling: A dozen accounts for your friends and family each spending $50,000 a month is a lot less likely to ring alarms at a FinTech compared to spending $600,000 a month in a single account

As a corollary, perhaps develop a thick skin.

Coping

Remember: If you haven’t been shutdown by an institution, you haven’t gone hard enough yet.

Happy Thursday friends!

Next time: Managing digestive risk.

Introduction

A few weeks ago in a drunken rage (reportedly), we talked about a series on risk in manufactured spend, because apparently sending $173,000 worth of gift cards to a guy named “Rob” that you met on Telegram deserves slightly more analysis than “he seems cool and stuff”.

Enter counterparty risk: the possibility that the person, company, or robotic-AI-cow on the other side of your transaction doesn’t do what they’re supposed to do. In manufactured spend that can mean:

• A buyer doesn’t pay in part, or in full
• A merchandise reseller “never received” your inventory
• A liquidation partner’s accounts are frozen
• Someone who paid you with a credit card disputes a transaction after
• A company freezes withdrawals
• Rob moves to Argentina, which I hear is popular right now

Each of these actually happens in the real world, though fortunately are somewhat rare. Need to beat a dead horse though? See The Plastic Merchant.

Reputation

The manufactured spend community has a surprisingly effective decentralized credit-rating system and we gave it a super unique, fancy name: reputation.

When people you trust have successfully exchanged millions of dollars with someone else (let’s call them a counterparty), that’s what we call in the business “useful information”. It’s certainly better than dealing with DefinitelyLegitBuyer420 whose references consist of his Canadian girlfriend and another Telegram account that was created Tuesday.

Unfortunately though, reputation tells you about past behavior, not future solvency. A reseller that successfully paid you $100,000 last month may still be unable to pay you $100,000 next month. Businesses fail, bank accounts get frozen, employees steal, payment processors shut accounts, fraud happens, and occasionally otherwise honest people decide that your money would look better in their couch.

I guess tl;dr: Reputation reduces counterparty risk, but reputable parties still can go pear shaped.

Exposure

Setting aside reputation, let’s take a hard body stance and reframe counterparty risk directly as exposure: Suppose that you’ve got a scheme with a broker where you’re paid back two Fridays after the broker receives your goods. Every week, you send the broker $20,000 in merchandise, and every two Fridays later, you get that back.

After seeing this work well for months, you decide to triple your volume, and a couple of weeks later, the broker delays payment from Friday until Monday because reasons. Well, congratulations, your 2*$20,000 counterparty risk quietly became 3*$20,000, and if you keep going, maybe it becomes 4*$20,000.

At that point, you need to decide, “Am I comfortable with making a bigger unsecured six-figure loan to Steve from discord?” Because that’s exactly what’s actually happening. This also leads to the now common refrain from whales in manufactured spend.

“Never float more than you can afford to lose.”

Controlling Risk

Ok, so what do we do about it? Simple friends, we manage it:

1. Commit to an exposure limit: Decide how much money you’re willing to have outstanding with a counterparty, and reevaluate that periodically, knowing that you could lose it all
2. Watch settlement time: A buyer paying reliably every two days is a different risk from the same buyer paying every two weeks, Faster settlement means less exposure over time, and speed bumps appear more quickly
3. Scale slowly: A successful $2,000 transaction proves that someone can successfully complete … a $2,000 transaction. It doesn’t prove that they can successfully complete a $200,000 transaction #themoreyouknow
4. Diversify: The likelihood of multiple brokers failing at the same time is quite a bit smaller than a single broker failing (duh)
5. Look for speed bumps and react: Tuesday payments become Wednesday payments, then Friday payments, then bank issues, then supposed hospital stays, then something about being part of the next mission around the moon. Signs usually exist, watch for them
6. KYC (sorry): A real name, business entity, address, phone number, mutual contacts, and some idea of how the operation actually works are all more useful than a Telegram avatar of a Lamborghini with a beer can in the driver’s seat

Finally, note that good counterparties generally communicate when something goes sideways. “ACH got held, here’s what happened, here’s the documentation, and here’s when I expect it to clear” is very different from silence followed by “sorry bro been busy”.

tl;dr

Counterparty risk can be managed, but let’s repeat the most important point because it’s easy to forget when the money is flowing:

“Never float more than you can afford to lose.”

Happy Thursday!

On the other hand, maybe Rob had a totally valid reason to go to Argentina on short notice, looks legit.