The dilemma between building isolated products versus network ecosystems is one of the living frictions in the security token ecosystem. In the past, I’ve written in detail about this idea but lately I’ve come across some fresh ideas in this area that involve the subject of programmability. The fundamental thesis I would like to explore is related to the relationship between programmability and decentralization in security tokens. More specifically, I believe that “if programmability becomes a relevant capability of crypto-securities, the space will inevitably gravitate towards more decentralized network models”( for the purists out there, noticed that I used the terms more decentralized and not decentralized 😉 ).
The idea of programmability being the ultimate decentralization vector in security tokens has its root in three fundamental premises:
i. The current value distribution models in security tokens are broken and not sustainable to create a meaningful ecosystem.
ii. Network effects are needed to expand the value proposition of security tokens into a relevant financial vehicle.
iii. Programmability is the ultimate enabler of network effects for security tokens.
Let’s explore these ideas in more detail. We can start by understanding how value is distrusted in the current wave of the security token market.
The Value Accumulation Model in Security Tokens
The current DNA of the security token ecosystem is based on isolated issuance platforms and a handful of marketplaces that enable the trading of these assets. In this dynamic, financial value is initially accumulated by the token issuance platforms and eventually transferred into the marketplaces. The fact that security token protocols fundamentally rely on centralized parties and not in decentralized networks, indirectly implies that no value is accumulated in the protocol in the long term. As a result, the value creation model ends with the exchanges and doesn’t permeate into other parts of the ecosystem. Sure, miners and other infrastructure elements of the Ethereum network could ultimate benefit from security token transfers but that’s the opposite effect of what we are looking for. In a robust tech ecosystem, value should fluctuate up the chain with different levels of abstractions not downwards to the infrastructure level.
Why is this a big deal? Well, an ecosystem in which value is essentially accumulated by two constituents is fairly vulnerable and unlikely to create long-term value.
The Products vs. Networks Friction
Network effects are the obvious answer to expand the value distribution in the security token ecosystem. However, in a market completely based on isolated products, the creation of network effects is near impossible. An ecosystem without network effects is largely vulnerable to incumbents that can completely swing the value chain. In the past, I’ve outlined four fundamental risks to the centralized nature of the security token market:
· The Fragmentation Risk: Building crypto-securities is relatively simple from a technology standpoint which means that we are likely to see many token issuance platforms that achieve relevant in specific jurisdictions and industries. Without a network for those players to interoperate, the security token ecosystem might become increasingly fragmented to the point of not being very useful.
· The Leader Influence Risk: In a centralized security token model, some of the early market leaders can achieve asymmetrical levels of influence compared to the rest of the ecosystem. In that case, those companies can dictate the rules that move the market to their benefit.
· The Whale Risk: It doesn’t matter how successful a security token platform is in the short term, its unlikely to be comparable to a Goldman Sachs, Fidelity or J.P Morgan. In a centralized ecosystem, it only takes one of those big financial players to enter the space to become the dominant market force and, essentially, roll back to the previous mess we are trying to move away from.
· The Forkless Risk: Forks are ugly but are one of the factors that help to enforce the balance in crypto-networks. A centralized security token models prevents any forking mechanisms making it vulnerable to the influence of market leaders.
If we believe that the security token market requires network effects then we need certain level of transition from isolated products into network models. This argument is probably nothing new but, at least in my case, was missing a key element.
The Flawed Theory of Generalized Mining in Security Tokens
The idea of creating a network ecosystem of entities like validators, data providers or other personas that participate in security token transfers has been discussed before. All those ideas have their root in the concept of generalized mining that looks to extend the creation of value in a crypto-network from infrastructure miners to domain-specific knowledge workers that contribute to different aspects of a transaction.
The idea of generalized mining might make sense conceptually but I think is fundamentally flawed when applied to security tokens. At first glance, the main missing argument in the generalized mining theory is that the security token ecosystem is lacking an incentive model to foster the creation of network participants. Without a transferable unit of value, it is difficult to envision a thriving network ecosystem at least in principle. However, we should consider that the tech industry is full of examples of platforms with great network effects without a tangible incentive mechanism. Would it be possible to create a viable network model for security tokens without an underlying currency? That question bring us to the last point of my thesis.
Programmability as the Ultimate Decentralization Element
I firmly believe that programmability is the most important contribution of security tokens to the financial ecosystem, but I’ve never thought about it in the context of network effects. The idea sort of crystalized reading a recent post from Union Square Ventures(USV) that explains the evolution of distributed computing models. In the USV thesis, tech ecosystems are initially dominated by centralized providers until the developer experience improves to a point that developer-network effect take over.
Applying a similar reasoning to the security token space, we can think that as crypto-securities become more programmable, they will influence the creation of more DApps which, in turn, will naturally create network effects in the ecosystem. To be even more specific, the incorporation of all the elements we discussed before such as validators, regulators, legal entities in security token models require acceptable levels of programmability.
Network effects are necessary for the long-term viability of the security token industry. I believe programmability is the key factor that will introduce meaningful network models in crypto-securities. While centralized models are driving the first wave of innovation in security tokens it is likely that programmability will shift the pendulum towards more decentralized, network-based models.