How does Fintech Decentralize Capital Markets?
Head of Business Analytics at Stobox, blockchain expert, theoretical physics researcher
In 1899 American economist and sociologist Thorstein Veblen wrote a book called “The Theory of the Leisure Class”. The key takeaway of this study was that for people on top of social hierarchy spending their time on elite consumption - delicious food, rare clothing etc. - instead of working was a way to highlight their belonging to the higher class.
But more recent research shows that in a modern world the way to highlight your social dominance has changed. Paradoxically, now you highlight your belonging to a higher class by working more. How on Earth could this shift happen?
The reason for this is the fact that in the developed world now almost everyone can live as a leisure class, buying iPhones and flying to exotic countries for a vacation. So elite consumption ceased to be a way to show your dominance. The entire society has transitioned into the leisure class. And there is only one force that made this happen - technological revolution.
New technologies increase productivity, democratize access to opportunities and resources, making everyone richer. We are living during the revolution of AI, Distributed Ledger, Internet of Things, Cloud Computing, Robotics, Quantum Technologies and Brain-Computer Interfaces. They are on different stages of adoption: AI and Cloud Computing are already implemented in large-scale enterprise solutions, for example, social media algorithms. Robotics and IoT are on the transition stage from early prototypes to industrial applications. Quantum Technologies and BCIs are in the early stages of development, and we will see an emergence of viable commercial applications in the next decade.
As for Distributed Ledger Technology, I believe it will decentralize capital markets, giving businesses more access to capital and providing investors with new investment opportunities. In this article I will briefly talk about DLT on the level of macroeconomics and explain how it will impact businesses, investors and the society as a whole.
According to the efficient market hypothesis, capital flows to where it can provide the greatest return. It is simple to understand in practice - people tend to choose better investment opportunities, open businesses in countries with better regulation and markets etc. The more productive is the capital, the higher is the economic growth, the faster is the pace of innovation.
But in more advanced theories the flow of capital is not free - it is limited by what economists call “transaction cost”. There are many examples of these. For example, the lack of information does not allow people to choose the best available opportunity. One of the most pressing problems is that investing abroad is often complicated, especially for people in developing countries, who don`t have access to proper infrastructure. This is especially important in the case of the financial crisis in these countries when the local currency may lose more than 99% of its value and local banks collapse. Reducing transaction costs is not only about global economic efficiency but also about people in developing countries securely saving their hard-earned money.
New business models arise as an answer to these inefficiencies. These are intermediaries that facilitate capital flow, taking some fee. For example, financial advisors and portfolio managers professionally gather information about investment opportunities and redirect the flow of capital towards them. Another example of these might be banks. People are looking for a way to invest their money and businesses are looking for capital. Banks collect people's money and give it to businesses, while the spread between deposit and credit interest rates is their fee.
How do technologies reduce transaction cost?
New technologies can remove intermediaries and reduce transaction costs. For example, thanks to the Internet you can invest in Apple from your home, lying on the sofa. In the past, you would have to travel to New York. And by reducing transaction costs, technologies can enhance economic growth and make everyone richer.
What is Distributed Ledger Technology? It is a technology that allows secure storage and updating of data about asset ownership. This may be the ownership of company shares, real estate - any type of assets. When the ownership of an asset is accounted on the DLT it can be easily transferred to any person on the planet that has access to the system and a legal right to own a corresponding asset. That ease of transferring the ownership right strongly facilitates capital flow to any asset and removes the need in some intermediaries.
How does it work in practice? An example of this may be how venture capital funds are becoming a thing of the past. For a startup owner negotiating with every single investor takes a lot of time, so only high-check institutional investors were worth the time spent. Because of that for a private investor investing little sum was impossible, and he had to give his money to the fund that would aggregate the money and negotiate terms with a business owner. For retail investors even this option was absent. Now investors can offer shares in his business directly to the public through DLT platforms. This is called equity crowdfunding and recently many countries have adopted legislation that facilitates attracting capital this way.
This is especially important for startups and small companies. Big corporations already benefit from crowdfunding when they make an IPO. But even a small IPO costs $7.3 million on average, which is not accessible for many businesses. Equity crowdfunding is a lot cheaper in most cases. Offering shares on DLT costs $50-150k.
Another example may be banks. For a long time, they were the only source of credit for most actors except governments and big corporations that could issue bonds. DLT creates a technical solution for P2P lending, for issuing bonds to a wide public. Reducing reliance on intermediary will create better interest rates for both sides.
We often refer to assets accounted on the DLT as “tokenized assets” because the accounting unit is called a token. As from the legal side, it is similar to traditional security, so these tokens are called “security tokens” or “digital securities”.
Another reason why digital securities disintermediate capital markets is the fact that they enable fractional ownership. A tokenized piece of real estate can be represented not by a single token but by hundred million tokens. This makes investing in real estate more accessible. Similarly, fine art can be tokenized, investing in which is currently possible only for super-wealthy.
Digital securities on DLT are the next step in the global reduction of transaction cost by decentralizing capital flow.
What are the practical implications?
The DLT adoption will have practical implications for businesses, investors and society?
For businesses, it means much wider access to capital. It means more funding and giving up less control over the business. It means having a worldwide network of supporters.
For investors, it means access to better investment opportunities and higher returns. Until now investors were offered a false dichotomy between safe investments with low returns, e. g. bank deposits, and very risky investments with very high returns, e. g. ICOs, Ponzi Schemes and others. Although inverse relation between risk and returns will always remain, there are many other opportunities. For example, investments in small and medium enterprises, which are of moderate risks but provide significantly better results than banks. Or investments in early-stage startups which are less risky then ICOs and Ponzi Schemes but can still make x100. Now the space of possible investment opportunities is much wider and now there are fewer intermediaries with high fees.
And lastly, as a society, we will get a faster pace of innovation due to more funding for startups, we will get more people having money for a decent retirement due to the access to better investment opportunities, we will get a higher economic growth due to more efficient capital allocation. Everyone will become richer.
This is the reason I believe that developing blockchain-based solutions for the financial industry, bringing together small and medium enterprises, real estate owners and investment funds with a global community of investors is making the world a better place.
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