Security Tokens and the 90s in Russia

I remember being a little girl in Russia in the ’90s and directly experiencing hyperinflation. Money, experienced as something tangible and valuable by most of you reading this post, revealed itself for what it really is — a resource that the government controls, and occasionally mismanages.

The Russian government printed too much of it, and it devalued right before my eyes. I remember my mom sent me to buy a loaf of bread from a local store. I was standing there, cash in hand, trying to figure out how many notes I needed. The day before, one loaf was an equivalent of 60 cents, today it was $3.40. This was not an immaterial change for my single mother and me.

Cut to now, it’s no wonder that when I hear people say Bitcoin will never replace fiat money because “it’s not real”, but fiat money is somehow “real”, this rings false to me. If you’d ever held a large bundle of worthless cash in your hand, you’d know the feeling.

I find cryptocurrencies fascinating. They touch on key questions of our lives. How does money work? Who controls it? Why do some people have more than others?

Evolution of Cryptocurrencies

Over the past few years, cryptocurrencies have experienced a number of permutations. From Bitcoin to utility tokens to security tokens. Where Bitcoin derives value from being alternative money, and utility tokens derive value from, you guessed it, their utility, security tokens reflect the value of underlying assets.

One of the most common manifestations of a security token is a share in a company. Typically, share ownership is represented by a paper certificate (not so common anymore), a line in a registry somewhere (a spreadsheet) or a token on a blockchain.

Having a token-based ownership certificate makes a lot of things easier, both for the issuer and any investor who purchases it. But of course, the real reason we are seeing the insurgence of security tokens is because the regulators, such as the SEC, are cracking down on projects that have not complied with the existing fundraising regulations. And because successfully drumming up demand for a token sale in the current bear market requires something new, like a security token. So fundamentally what security tokens are is a return to compliant ways of fundraising.

A Security Token does not a good investment make

To be clear, a token sale that complies with the fundraising regulation is not a better investment compared to the one that doesn’t. Fundraising regulations have a lot of issues, from how your level of sophistication as an investor is determined (it’s your net worth, not your investment skill), to how product disclosure statements work (they don’t because people don’t read them). A good investment is one where the right team is solving the right problem, at the right time, regardless of whether the investment itself complies with the capital raising regulations or not.

I’ve been following security tokens closely for the past few months. In the process, I’ve been exposed to some pretty controversial ideas and met some pretty colorful characters. Some claim that security tokens will end poverty as we know it. It’s a nice thought. But poverty has many causes and access to investment opportunities, or lack thereof, is just one of them.

Sure, security tokens make access to investment opportunities easier. But this should not be the end goal. It’s the quality of those opportunities that matter. If you take a bad investment and put a token on top of it, it is still a bad investment. A pessimistic view is that security tokens will give rise to many useless investments that’ll compete for our attention in an already crowded space.

So will security tokens democratize finance and lift millions out of poverty? No, at least not right away. But will they transform how we live? Absolutely. Why? Because there is just so much to tokenize: $217 trillion dollars in real estate, $55 trillion dollars in equities, $6 trillion dollars in gold.

So what are the benefits of security tokens and how can we prepare ourselves for when the security token wave hits in 2019?

Security tokens should help people to start investing earlier.

Starting to invest early, in your 20s, not your 40s, is always a good thing because the earlier you start the longer the miracle of compound interest is at work. So why don’t people do it? Lack of money and fear of the process are cited commonly as reasons for not starting to invest early. And it’s worse for women, who are half as likely to invest as men. I can certainly relate. It took me too long to open my first shares trading account. I remember being intimidated by the process, and not knowing if I had enough money to start.

Blockchain should make it more economical for the issuer to offer smaller bits of investment by standardizing the back office process flows. This “fractionalization” of one large investment into smaller, more affordable, chunks means that we will see a proliferation of investment opportunities where the minimum investment is $10, or the cost of identifying an investor, instead of hundreds or thousands of dollars. These affordable investment opportunities will hopefully nudge more people to start investing earlier.

Security tokens should reduce investment fees by lowering post-trading fees.

Trading in and out of investments is an integral part of investing. Any time your retirement fund trades on your behalf, you pay trading and post-trading fees. Security tokens eliminate the need for post-trading fees. It’s not rocket science — without the post-trading fee, you can expect more money to remain in your investment account.

Post-trading fees are something that stock exchanges have been charging us for ages. When Kate sells a share to Mike at an agreed upon price, the trade is executed immediately, while the actual transfer of the share takes time, up to 2 days in most cases. Someone has to manage this transfer, and that someone gets paid for doing it. With security tokens, this 2 step process of trading, then settling, gets collapsed into a single step. Trade becomes settlement. But just because this process becomes more efficient with security tokens, does not mean investors will get the benefit.

Take ASX for example. ASX is the main Australian stock exchange. It’s been lauded by many in the global blockchain community for being the first stock exchange in the world to embrace blockchain. It’s also rumored that ASX is one of the most profitable exchanges globally, adjusted for size and that a large chunk of its profit is a result of post-trading fees. Whether ASX will pass the savings, which the elimination of post-trading costs will generate, to investors or whether ASX will pocket them, remains to be seen.

How Security Tokens could have saved Russia in the 90s.

The 90s was not a good time in Russia. In addition to hyperinflation, billions of dollars were stolen via botched privatisation of public assets such as factories, mines and farms. Privatisation was fractionalization on steroids, an economic experiment on an unprecedented scale, where everyday citizens received certificates representing a portion of the national infrastructure.

If security tokens existed then, “privatisation” would have been the best use case to demonstrate the attributes of transparency and immutability that we love in blockchain technology. Anyone with access to a blockchain explorer, such as the openly available etherscan, would have been able to verify that a particular factory or a mine site or a farm was fractionalized into a fixed number of fractions, that each fraction was accounted for and, most importantly, that the fractions were fairly distributed among all citizens, as was intended. Instead, because the process was murky, it was abused and the ownership of the country’s assets ended up in the hands of the few, giving rise to the emergence of the oligarchs and some of the worst financial inequality seen anywhere in the world. In fact, you could argue that that theft of public infrastructure was worse for my family and my generation than the hyperinflation that preceded it.

The promise of security tokens is that such episodes in our common economic history will never have to repeat.

If you’d like to learn more about security tokens, I enjoy Stephen McKeon writing and this Security Token Documentary by Flippening.

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