Digital Assets and the Potential Perversion To Come

Upon wrapping up arguably the largest of annual blockchain conference weeks (Consensus), I find myself eyeing a familiar pattern unfolding around the still brewing technology. Within the cacophony of pitches and business ideas surrounding “blockchain” (I hesitate to still use the term, because of it’s overuse), there is an ever increasing offering of services provided by, or intended for, traditional finance and consulting incumbents. The edgy libertarian founders and new, incredible creative programming talent are at risk of seeing their technology morphed into something entirely different, at least for now. Maybe this is how nature intends it, or maybe the true social promise/power of this technology will show it’s true head as mainnets begin to go up. Nevertheless, the old incumbents are not pioneers in the space. They will be quick to try and apply this newfangled tech to their systems and extract value wherever possible. There is no stopping that if there is margin to be had. Some crypto market forecasters have hailed 2018 as the year of the security token and the arrival [finally] of institutions to the market. Be careful what you wish for.

The pattern of early pioneers and social movements losing control of the direction of their technology/voice is nothing new (computers, cell phones, and rap are fun recent case studies). Adoption isn’t good nor bad, it just comes in the form we, as people, can digest, namely following what the next person does (ex: texting is really cool, cheap and useful when a friend has it; and rap has come a long way from Tipper Gore). Converging technologies and cost curves often come into play, but many major economic movements, and certainly those with great social impact, such as those which lie in cryptographic ledger incentive systems, may likely be the same. It’s why no one can say with absolute certainty where this technology will be in 12–24 months, at least honestly. This brings us back to institutions.

Institutional grade investors are not like normal investors. We’ll come back to what types of investments they make in a moment, but, stay with me. Their needs are very specific. They are fiduciaries and investors (ref: current regulatory and custody friction points). When it comes time to invest or “manage” their portfolios, they look to “best execution.” There are costs associated with executing depending upon the security: liquidity/price, compliance/legal/settlement, fees (brokers/trustees etc.), and of course the big one: time. This is actually a legal requirement (see earlier fiduciary note). Enter digital ledgers and programmable securities. The idea of being able to trade (and settle!) within moments should be a wish come true to any trading desk and portfolio manager. The idea of being able to potentially eliminate other time lags/fees of compliance/legal aspects (KYC/AML) and fees from certain parties, like trustees, is more gravy. Add to that the possibility to trade liquid markets 24/7 without having to have a local office, and you can see why there is excitement over digital securities. They are coming, and traditional finance is gearing up to deploy across their systems, just not in the way we all had hoped for (buying tokens so everyone gets mad rich).

This is a good time to come back to how institutions invest. There are institutional funds who trade in everything across asset classes. These already exist and digital assets won’t change these markets, just how they execute and operate. Ethereum created a new way to fund early stage venture companies. Let me repeat that: a way to fund early stage venture companies “aka startups.” Venture stage investing, while in the single digit billions, and on fire with blockchain capital, is dwarfed by the other segments for investing. It’s an asset class. US corporate debt issuance alone for last year, another asset class, was just inside of $1.7 trillion. That’s just bonds; not loans, stocks, int’l securities, derivatives, nor…you get the picture. The gravy meat and potatoes here for traditional incumbents (banks/advisors) is in crafting digital securities for the trillions in securities outside venture investing. But what about crypto? Well, many of the “tokens” offer a “new way” to invest (read: scary to institutions). Hopefully with mainnets going up, this model will start to prove out showing tokenomics work, at least as currently designed and to justify some valuations. If so, and institutions can model out economics, then maybe there’s a shot they play. Most tokens need to carry some sort of security (aka security tokens), or they simply won’t go there. This is the main reason that the vast majority of what is labeled institutional capital (we’ll call it institutional-light capital) has fallen into the LLC or private equity of the most popular projects and not in the tokens. Why? They want security and to be an owner of something, and when things go awry (remember fiduciaries?), have a claim. Note, every single security in existence has a claim on something as protection (see the US bankruptcy system and just go through a cycle before you get hot and bothered about issuing tokens in Malta because you can). Just saying. Back to institutions.

Just like normal people, institutions like company (the portfolio managers are people after all) . They typically like to invest alongside someone else. So, until their buddies start doing deals for the same investments they are used to, just in digital form, or their service providers (banks/advisors) start offering the security packages, this could be slow. The networks also need to be up and running with such low latency that no trade issues arise, especially for liquid markets. It’s just not worth the time to invest if the hassle of settlement gets in the way (friction). Obviously, custody of digital assets must be in place as well, but that is underway.

The wave of digital securities is coming, and in size over time, but not in the way the space has been hoping for, perhaps. Institutions don’t yet know that their futures lie in digital securities. And why should they care? After all, it’s a part of doing business that may be more cost effective, but it doesn’t change their main business: sound fiduciary management and analysis over their respective assets.

I delight in these new ways of programmable exchange/value. I think they are revolutionary and that we are in the early days of witnessing their true impact on economies and societies as an empowering technology, particularly as they converge with IoT, AI, the declining energy cost curve, et al. And, indeed, there is still time to see how new token models may change the way in which we govern business transactions, and where and how we distribute the wealth from these new micro economies. In the meantime, however, don’t sleep on Wall Street taking the reigns on this technology for an immediate and proven use case, much to the chagrin of it’s pioneering brotherhood. Stay tuned…