The Stubborn Risk of Liquidity

For thousands of years, certain aspects of the way human societies buy, sell, and trade goods have remained relatively constant, including those of centralized authorities and the concept of tokenization.

Tokens bestowed with redemptionable value have existed since kings began minting coins with their faces welded on the front. Those coins — like the ones circulated today by the Federal Reserve — are tradable and possess value for one reason: because a centralized, issuing authority says so. The tokens themselves don’t have any value. They’re but derivative instruments. Yet we continue using them every day.

Why? Because we’re able to redeem them for some quantity of things which are intrinsically valuable.

The same is true of stocks and investment funds traded on an exchange. An Exchange Traded Fund (ETF) — to add another layer to the example — is effectively a token that represents ownership in the 500 stocks on the S&P 500.

Indeed, humans trade goods today in accordance with the same foundational concepts that existed back in Ancient Rome.

Some people, however, are predicting that the rise of digital currency and of decentralized ledgers is going to change all that.

Those people would, in short, be wrong.

While it is true that we no longer have to rely on a bank or exchange to validate or conduct transactions — we can just trade directly with another person on a peer-to-peer ledger — the objects we’re trading — no matter if they’re Bitcoins or stocks or pieces of copper — must still be liquid. There must still be a buyer willing to accept our digital tokens in exchange for a good of intrinsic value, as is the case currently with something like cash, a highly liquid asset.

Furthermore, the enablement of liquidity — by way of a new, decentralized trading environment, for example, or the generation of a decentralized digital token — doesn’t itself create liquidity.

A marketplace is a marketplace regardless of its structure or fabric.

In other words, the problem of liquidity doesn’t go away just because we’ve developed a new technology that enables an easier and more convenient means of transacting. In fact, the need for its existence only becomes more pronounced. Buyers and sellers must still value what their counterparts possess enough to take the risk of trading for it.

Now, it’s correct that the decentralized mechanism of digital currency creates the potential for liquidity in a way that has not heretofore been possible. In the past, we had to rely on banks and exchanges for such enablement. Today, with the blockchain, we don’t need to rely on those things at all.

But in order for individuals and companies to intelligently engage in commerce in a way where they’re effectively managing their risk, liquidity must still occur.

And that never happens magically; it happens as a function of asset aggregation and tradability.

I can go out right now and create my own exchange and try selling people my digital tokens. But my tokens will still need to function as traditional derivative instruments. They’ll need to be redeemable for something of intrinsic value.

And, yes, I’ll still need buyers.

The bottom line is this: even though our digital fabric is changing, the risk and importance of liquidity still remains.

This, ultimately, is a fact that Bitcoin zealots of today must reckon with.

Digital objects on a decentralized ledger are but tokens in our pocket. And they’ll remain useless unless certain timeless marketplace conditions continue to exist.