Tokens – Lowering the Barriers to Innovation

I was getting my daily hit of Matt Levine’s excellent Money Stuff this morning (subscribe here!). In my favourite blockchain blockchain blockchain section he noted:

But a popular pattern in the crypto/token/blockchain world is that someone will come along and be like “finally, through tokenization, we have invented a way to slice _________ into bits and let people trade the bits.” I always find this a bit confusing. Whatever _________ is, it is safe to say that before the invention of tokenization there was already a way to slice it into bits and let people trade the bits. Slicing things into tradeable bits has been a very hot area of finance for a very long time, and people got pretty good at it. Real estate is a popular target for tokenization, for instance, and I am confused because real estate securitization—not so much mortgage-backed securities but real estate investment trusts—is a thing that has existed for a long time.

https://www.bloomberg.com/opinion/articles/2019-01-30/if-you-want-to-invest-in-pot-buy-pot

I agree with this! We’ve had securitisation before blockchains and tokens. You can chop up the title to a painting and sell it to investors in 1% slices already without blockchains or tokens.

I also agree with the “But do people want it?” line of thinking:

But it is also quite possible that the answer is, like, “no one ever traded $100 slices of individual buildings because that is not a particularly appealing investment for anyone.” If that was the problem, then blockchain will not solve it.

But I think there is perhaps another reason why chopping up something into bits and selling them off individually and allowing them to be traded hasn’t affected buildings and art and whatever other assets and cashflows down to the $100 level. That is because it has been either complex, time consuming, and expensive for the issuer (initial set-up costs and costs of maintaining the registry), or not trusted by the investor (“Psst, wanna buy $100 worth of this bridge? I’ll record your holdings in my Excel sheet.”).

Issuers

As a potential issuer, you may be an art or real estate aficionado so you probably don’t know how to do securitise the asset. So you pay someone wearing an expensive suit a lot of money to help you. The barrier to entry is high and the cost of innovation is high. They have the contacts, the know-how, the processes, the loopholes and can advise on the choices. The process takes weeks or months, with fees to all manner of parties. It’s a complex and opaque process. People don’t try new stuff because the risk/reward isn’t worth it.

Investors

And as a potential investor, you may not trust the issuer unless they go through the above process. If the issuer says “Oh don’t worry, give us money and we’ll put your name on an Excel spreadsheet” you may not trust that the Excel spreadsheet will be robust, or that you’ll be able to easily sell your slice to someone else.

At the most basic level, to set up a list of people who are going to spend money on something (whether that thing is a financial security or not), and to have that list be robust enough and trustworthy enough, with the controls in place to be able to have validated changes automatically being made to it 24×7 is hard and expensive.

The bar is high. If you want to try something new it’s expensive and takes a lot of time and effort. If you have a new idea, it’s costly to try out.

Blockchains

Now, consider this blog post “How to list your own token on Ethereum in 20 minutes“. If you follow the basic instructions, you get a list with various controls in place (creation of tokens, transfer of tokens, no double spending, etc) and almost anyone can do it in 20 minutes.

The bar is much lower.

I personally did this, live, one morning about a year ago in front of a class at Hyper Island. We made Hyper Island Coin, and it’s still there, on Ethereum’s public blockchain (and any forks etc that have happened in the past year).

There are of course legal and regulatory costs if you want to create a list of token holders, if the tokens behave like a financial security. Note: We didn’t do anything with Hyper Island Coin. We didn’t promote it as an investment, nor does it confer any rights, and it’s not traded on an exchange etc.

But the point is, it’s there, you can interact with it, and it’s transferrable. In a few minutes we created a list with the standard ERC20 constraints and interactions, and people know how to engage with that list.

Blockchains have lowered the barriers to innovation for creating new lists of owners of things, whether the things are financial securities or not. The trustworthiness and robustness of these lists depends on what blockchain you choose to use, and is subject to debate. (Quick shill: I, along with my colleagues at R3, think that Corda is the most suitable platform for tokenised financial securities)

But for sure, tokens on blockchains are easier and cheaper to create than a stock ticker on a traditional financial exchange, and they are better than a row in an Excel spreadsheet. This reminds me of Clayton Christensen’s disruptive innovation thesis where something a bit crap but cheap and good enough gradually eats into a market.

Go and innovate!

PS If you enjoyed this post, you may also enjoy my book The Basics of Bitcoins and Blockchains. Just saying.