Markets are Baroque (Let’s Fix Them).
The coming of the crypto stock market.
Picture yourself as a Dutch trader in the late-1600s, standing on the bustling floor of the Amsterdam Stock Exchange. Clad in rich silks & sporting a fashionable wig, you tirelessly call out orders to buy and sell stock in a variety of commodities, such as grain, tulips, horse manure, and most importantly the newly-invented joint-stock corporation. Now, transport yourself to the burgeoning City of London, where insurance policies are traded in a packed, poorly-lit coffeehouse. There is no modern technology; no computers, no phones, no calculators. All your trades are conducted manually, relying solely on your keen mental arithmetic and copious amounts of bitter tasting coffee.
In this world, the very act of capitalism is simple and engaging. Trades are handled in person, and the barrier to entry is low: provided you have cash in your hand and a brain in your head, you can make a deal. In this world, there are few rules (and even fewer scruples). This is an era of capital exchange, where “free markets,” are about as free as you can possibly get. This of course comes with its own issues: few safeguards mean that fraud is more common than in our contemporary world, there are no well meaning financial advisors to stop you from gambling yourself into ruin, and sour business dealings often end in literal duals. But, despite these shortcomings, the groundwork of our modern market system has most certainly been laid.
Return to the present day, and the markets have changed significantly. Various formalization processes have been added one after another, taking us further and further from those loud and dirty marketplaces of old: Brokers, dealers, clearing and settlement houses, forex shops, and exchanges work together to ensure the secure buying, holding, and selling of securities, commodities, and currencies. In the Capital markets we know today, confidence in clean honest trade is high, and examples of market-generated hand-to-hand combat is decidedly low.
However, this formalized structure — albeit a miracle of modern bureaucracy — holds a dark undertone: one of inequality and structural unfairness. Although our current system is undoubtedly safer and more transparent than three centuries ago, in our efforts to create an equitable & clean marketplace, we have inadvertently created a closed loop, with heavily controlled infrastructure & financial companies serving as the only entry points. Trade can only happen on a regulated exchange, the only allowable players are the individuals we have deemed worthy of receiving a license, and securities must be properly registered and regulated before they can ever see the light of day. In this world, access to this club is restricted to close personal friends of the existing members, those who are deemed worthy of admission, and at a minimum, to those who can afford it.
We have in essence created a guild-like environment, where only those who have been a part of the industry can themselves navigate it. Striking deals, starting companies, opening funds; all of these opportunities become much harder in a system quite-literally designed to limit access to only those who can follow its playbook. As a result, the small businesses, local enterprises, cooperatives, and startups that make up the majority of American employers find it nearly impossible to navigate such a minefield, or worse, financially impossible to engage with. These underdogs have never been part of the exclusive club of “Wall Street,” and they can’t expect an invitation anytime soon, and as access to capital is the defining feature of engaging in capitalist enterprise, we cannot be surprised that our economy continues to churn away to the sound of oligopolies, not individuality. Thus, ever smaller grows the competition, as the largest members of the club continue to gobble up their less-capitalized counterparts, reducing our choices as investors & consumers along the way. Indeed, in our efforts to make a system we can be proud of — one opposed to mafia-like codes of conduct — we have created a financial-industry cartel; an industry that not only reduces the competitive landscape it was intended to fuel, but fails to serve the very people it was designed to protect.
In recent years, however, a new player has emerged that has shown the potential to open up the playing field to more players, without sacrificing the transparency & fiduciary rigor so essential to our modern marketplace. It’s not enlightened government regulation, nor a restructure of the American business ethic, but rather the innovation of blockchain technology (BCT). Despite the recent negative publicity — caused mostly by fraudsters not engaging the technology in the way it was designed — BCT has shown us that it has the potential to revive interpersonal free trade (a hallmark of early capitalism) without sacrificing the transparency of modern auditing, nor the financial security of the clearing & settlement process. If anything, it actually improves them.
BCT is inherently trust-less and auditable. It simplifies the buy & sell process by allowing transactions to happen directly between two parties, while maintaining a clean system of record, logging all transactions immutably to the underlying blockchain. Unlike the current system, which requires multiple third-party checks and balances to ensure smooth transition of assets & cash, BCT allows trades to be executed immediately without intervention, transactions settling immediately to the underlying blockchain, which itself acts as a shared system of record. In essence it returns trade to a physical assets exchange at the same coffee table, without losing the convenience of a modern digital marketplaces. As a result, many of the service providers we think of as necessary to manage our current exchange system are simply no longer needed.
This shift is incredibly impactful, even though society has yet to fully comprehend its potential. Traditionally, executing trades has required multiple processors to ensure success. Transactions are centrally handled at a stock exchange, clearing and settlement houses ensure complete trade execution, underwriters insure the process from end to end, and banks take custody of our assets. However, under a BCT system, parties can directly carry out these processes one to one, reducing or even eliminating the need for brokers, dealers, clearing houses, and investment institutions: Transactions can now take place via decentralized Automated Market Maker (AMM) protocols, clearing and settlement is executed directly against the blockchain itself, underwriters are rendered unnecessary as liquidity is handled algorithmically, and custody of assets is assigned to the individual user’s crypto wallet. It is a complete reworking of the exchange process, reducing a complex double-entry bookkeeping system to a few simple (albeit mathematically intense) lines of code.
And that isn’t the only change. The trust-less and open transactions ledger of blockchain eliminates the need for all manner of third party validation usually required by security-issuing companies and organizations, removing complex record-keeping and insurance practices that date back from the birth of capitalism itself. Now, companies issuing dividends or bond payments need only to refer to the chain to determine ownership and payment details, investors no longer need to wait for quarterly reports to understand a company’s ownership or financial structure, and the trade of a security can take place directly: no middlemen required. The blockchain provides immediate and comprehensive details & execution capability in a network that we can all share and validate. Even today, when this technology is young, anyone with an internet connection can open up Etherscan and look at the thousands of Ethereum-based transactions that have taken place in the past several years. You can check the balance of wallets, inspect the equity structure of decentralized organizations, and audit transactions, all without any high-impact technology or special access permissions. In essence, the gates of information have just been unlocked.
To many, moving towards a BCT-based system may seem like an obvious choice: fewer third-party record keeping, lower friction fees, and more direct communication between assets and investors all sounds positive. However, implementing this change will not be an overnight process. To fully utilize this technology, regulatory frameworks must shift — particularly in the United States — to allow for direct-to-consumer securities sales and investor-to-investor secondary market transactions. Additionally, companies themselves need to recognize the benefits of this shift and be open to not only tokenizing their share structures, but accepting more transparent business practices that may at first feel uncomfortable.
Additionally, blockchain technology is only truly effective when all transactions, ownership records, and fees are processed by the chain itself. Any component that is not “on chain” can create significant difficulties as off-chain assets must be reconciled with on-chain records. For instance, if the title to a house is held off-chain but linked to an on-chain token (like an NFT), it could potentially have two mortgages levied against it, one on the physical title and one on the NFT. This could result in large fraud potential, making it necessary for blockchain technology to be implemented in its entirety to eliminate this kind of illicit behavior.
All of these changes require a type of foresight rarely displayed by the American ruling classes, and as a result, until there is widespread adoption of this technology, the financial industry’s transition to a BCT methodology will understandably be slow. Certainly, we may eventually see the old guard embrace this technology as a systemic improvement, but if history is anything to go by, it will come long after younger companies have gotten their first, and a number of lawsuits have set the standards of the newest “new age.”
Despite these hurdles, we technologists can remain positive. Blockchain technology is a natural progression of a capitalist system that has been developing consistently since its inception. Although it may take years to fully realize the potential of a fully-decentralized ownership structure, when the technology & regulatory frameworks are fully in place to allow for such a shift, it will only be natural that companies will look to issue securities to investors on their own terms, and investors likewise will want to trade in a market built for them, by them. We are at the edge of the end of an era, where capital markets controlled by a small group of sanctioned players are about to give way to a new era of capitalism where spinning up a new company could take a matter of minutes, where investors can constantly audit their investment’s financial situation, and where company management is inexplicably tied to their company stakeholders. Though I doubt we’ll ever see a world where business is as intimate as the coffeehouses of 17th century Europe, it is at least exciting to know that we are moving towards an era where the heart of innovative capitalism beats just that little bit freer; one in which the Old Boys Club — although not totally vanished — is at least no longer required.