Equity Evolution or Revolution

Introduction

Gain insights into how security tokens are the next logical progression in the context of financial innovation beginning with the early clay loan tablets of ancient Babylon.

Understanding Financial Evolution

There are powerful arguments that humanity’s development can be attributed to the financial innovations which allow us to transport value across time, mitigate the risk of future uncertainty, and even standardize the meaning of “value.” Together, these three concepts are known as the time value of money, conditional claims, and negotiability. Without these dimensions of financial innovation, we would never have holstered the risk to sail across oceans, liberated ourselves from base serfdom, or even purchased houses for our families.

 

We take a look at the financial innovations that got us here, and look forward to determine why the next great financial innovation, the security token, follows this distinguished parade of financial innovation. We borrow heavily the seminal work of Yale Professors:

 

Three Layers of Financial Innovation.

Time Value of Money

The understanding that the value of a fixed amount of currency now is greater than that same value of currency in the future underpins the entire discipline of finance. In fact, the assertion is so fundamental that from 1200AD – 1700AD, the Roman Catholic Church banned the practice of transferring wealth in the present with the obligation of returning greater wealth in the future.

 

French theologian William of Auxerre, first medieval author develop a systematic treatise on free will and strong opponent against the censorship of Aristotle, asserted following about loans: The issuer acts contrary to natural law, for he ‘sells time, which is common to all creatures.”

Conditional Claims 

To create the foundations of many of today’s advanced financial instruments, a layer of conditions must be laid atop the time value of money. This layer allows financial actors to engage in bets on future outcomes, and thus in a sense control for the future or at least reduce the amount of uncertainty in it. This principle underlies everything from options contracts on stocks and bonds to insurance policies.

Negotiability

For liquidity to exist on any exchange, the ability to sell a contract to another party is necessary. This ability is known as negotiability. According to Goetzmann and Rouwenhorst, “the power of such a market is that it simultaneously allows thousands, perhaps even millions of anonymous investors each day to rebalance their holdings of financial claims to suit the need for savings versus short-term cash use, as well as allowing them to speculate on or hedge against future events”.

 

The process of creating such a market is known as securitization, the goal of which is to encourage liquidity through greater participation from an investor public.

Timeline of Financial Evolution

4000 – 3000 BC

Clay Tablet Records, & Loans

Mesopotamia

The foundation of modern finance (and even blockchain) is the ability to keep accurate records that all parties to a transaction can trust. Cuneiform characters on clay tablets found in ancient Mesopotamia is some of the earliest evidence of systematic record keeping from agricultural cycles to loan amounts and interest rates. Clearly, accounting is as old as civilization itself.

4000 – 3000 BC
619 BC

Coinage

Greece

Coins were a major financial innovation because they promoted the concept of negotiability and were minted by the state. Though merchants in this era were known to have traded with bars of precious metals, each had to be individually weighed upon every transaction to prove its value. The negotiability of coins on the other hand, provided a level of standardization that drastically increased the speed of transacting.

619 BC
332 BC

Property Rights, Land, Claims, Banks

Ptolemaic Egypt

The royal banks of ancient Egypt are thought to have evolved from a combination of “state and temple treasuries and granaries, and private money-lenders.” They became a centerpiece of the Egyptian economy as the venue for tax collection, and as financial service provider for retail clients. The ability to manage deposits, withdrawals, transfers, and loans demonstrates the ability to maintain financial ledgers and take advantage of the time value of money.

332 BC
207 BC – 202 AD

The Silk Road

China

An early example of a globalizing economy, the success of The Silk Road demonstrates the importance of financial innovation in supporting trade across dissimilar goods, acutely contrasting cultures, and unique business practices.

207 BC – 202 AD
100 BCE

The Corporation & Equity Markets

Rome

Thought of as the earliest instances of the corporation, the societas publicanorum featured organized management structures that bid for and executed public projects in ancient Rome. Shareholders in these organizations were typically from the land-owning class.

100 BCE
618 AD

Paper Fiat Currency

China

Originally developed in the Tang dynasty, paper money proved to be far more portable than metal coins. This would prove to be a significant advantage as merchants along The Silk Road could replace the dead weight of coins with additional products, increasing their yields from every trading excursion. The Song dynasty saw the institutionalization of this paper money as the government officially licensed specific pawn shops to issue paper money in return for coins. Ultimately, the Song government reserved the right to issue paper money for itself in the 12th century.

618 AD
1250 – 1650 AD

Government Bonds & Foreign Exchange

Italy

Government bonds in Renaissance Italy marked the beginning of usury in the Christian world. By forcing citizens to enact loans to the government for financing public works, the religious establishment avoided strict definitions of usury which require loaning by free will. This allowed the Christian establishment to implement effective loans without violating canonical principles, paving the way for more effective uses of the time value of money. Citizens would be paid back an interest on the loans they were forced to extend. Often, this was preferable to taxes as citizens had the ability to transact these loans on the secondary market, highlighting the importance of negotiability.

1250 – 1650 AD
1550 – 1650 AD

Asset-Backed Securities & Mutual Funds

The Netherlands

As the nexus for futures and options development during the 17th century, Amsterdam made significant contributions along the second dimension of financial innovation: conditional claims. Following an equities market bubble in 1720, there evolved an emphasis on collateral-backed loans. This commodity backed structure became prevalent as a means for mitigating risk, eventually paving the way for asset-backed securities as these loans became standardized.

1550 – 1650 AD
1686 AD – Present

Land Banks, The American Trust, Regulated Investment Companies, NYSE

United States of America

First established in Massachusetts in 1686 AD, the earliest Land Banks did not accept deposits, but issued bills on loans fo borrowers who offered their surplus land as capital. Ultimately, these bills became a circulating currency that was legal tender for both private and public debts . The interests on these loans became an important source of revenue for the colonial governments. Roughly 100 years later, 24 brokers signed the Buttonwood Agreement, which founded the first American securities exchange. Among the first instruments traded on the NYSE were War Bonds from the Revolutionary War. The concept of the Trust arrived in 1882, driven by American oil colossus Standard Oil’s need to consolidate the business interests of its many acquisitions. The subsequent trust agreements gave birth to the first super-corporations, which would eventually be targeted by the anti-trust laws of the late 1890s. As an institution, the Regulated Investment Company followed, being legislated into existence through the Securities Act of 1933. These companies are unique in that their primary business functions is to invest in other companies. Together, the various institutions contributed by the United States led to a breakthrough in market liquidity for various securities instruments.

1686 AD – Present
1971 AD – Present

NASDAQ, Electronic Trading, Diversification

Global

The National Association of Securities Dealers Automated Quotations was initially an automated digital data feed that traders and institutions could subscribe to. Previously, market information was printed on “pink sheets,” which could not keep up in real-time with the latest market data. Ultimately the NASDAQ evolved into a full scale electronic stock market. Its digital infrastructure and up to date data feed ultimately paved the way for today’s high frequency trading phenomenon. Digitalization of the stock markets also allowed for a new level of global connectivity, giving traders and investors to markets all over the world. This also brought about novel opportunities for participants to diversify their risk by expanding their portfolio of tradable and investable products.

1971 AD – Present
2018-2019

Security Tokens

 

Security tokens will bring major evolution in the conditionality and negotiability layers of financial innovation. Most of the critical technological developments discussed here have completely overlooked a major asset class: venture capital and private equity. For those who have not experienced the VC industry, it should be known that handling a capitalization table is often one of the most manual and complex issues, especially when there are various investment instruments in the same funding round. DLT offers to automate these processes, increasing transaction speeds and reducing human error. VC is a classic use case for automation. In addition, security tokens also offer to raise more money for private companies at higher valuations by marrying the shareholder and the consumer. Companies are empowered to offer special deals to those who invest, offering additional incentives that would otherwise not exist.

2018-2019
2025

Tokenization of Everything

#TokenizeEverything

2025

Security Tokens are the Next Step

Time Value of Money

Security tokens allow people to invest very small amounts of money into startups and private companies. Investments into this class of companies are comparatively risky, but are can provide outstanding returns. This risk profile is especially well-suited for an investment strategy that emphasizes small investments over a wide range of companies.

 

Startups and SMEs are some of the fastest growing but least accessible investment opportunities. Opening this segment for greater participation from the investor public provides more opportunities for passive wealth creation and diversification, simultaneously allows small scale companies to better negotiate the valley of death.

Conditional Claims 

For the first time, we can create conditional claims that marry the consumer with the shareholder. Companies can create incentives for investments that are not available at scale in the traditional equity markets. For example, if a beer brewery were to issue tokens through an STO, they can give discounts or access to limited offer brews to customers who hold a certain number of their tokens at any of their bars.

 

Through these methods, security tokens offer to raise more money for private companies at higher valuations by aligning the interests of the shareholder and the customer. Companies that offer valuable and creative consumer benefits to their investors fare a better chance in raising the target amount of money at the desired valuation.

Negotiability 

Traditionally, VC and PE investments are known as some of the most illiquid and thus riskiest, with most investments returning after more than 5.7 years. Security tokens offer to mitigate this risk by creating liquidity for VC/PE investments on a secondary market. This is made possible by distributed ledger technology (DLT) since private companies capitalization (ownership) tables can accurately be recorded on the blockchain to reflect any changes in ownership.

 

For those who have not experienced the VC industry, it should be known that handling a capitalization table is often one of the most manual and complex issues, especially when there are various investment instruments in the same funding round. DLT offers to automate these processes, increasing transaction speeds and reducing human error. VC is a classic use case for automation.

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