When you start to take a deep look at how the capital markets system actually works, you quickly come to realize that the system the capital markets operate on, is an archaic legacy system.
The Settlement System
Think for example, about how we settle securities transactions. If you buy a publicly-traded stock through a broker, how does the ownership of the stock transfer over to you? The settlement of that stock actually takes some days. This is why when companies are issuing dividends, they have a record date and execution date.
Cede & Company
But that’s just half of it. If you buy a stock, say one which is listed on the NYSE, you don’t actually own it. I first heard of this from Patrick Byrne, Overstock.com’s quirky founder. When I heard it, I thought he was exaggerating or just misunderstanding something.
But if you look it up, you’ll find that Cede technically owns substantially all of the publicly issued stock in the United States. Investors do not hold direct property rights in the securities they hold, but rather have contractual rights that are part of a chain of contractual rights involving Cede. If you still don’t believe this, there are actually plenty of legal cases where this system has caused major conflicts and confusion.
A Feature, Not a Bug
It is important to understand that this is not some sort of a conspiracy theory about men in dark rooms trying to use their power to advantage themselves. The current clearing and settlement system is built to suit the needs of a paper-based reality. Derek Edward Schloss explains this pretty well in an article called Security Tokens and The Digital Wrapper:
DTC’s system of share ownership was likely born of good intentions, although today it just looks like an expensive and inefficient upgrade of a slow, centralized, paper-based framework. As a result, our present-day public markets run on a system where we don’t actually own anything, controlled by multiple rent-seeking intermediaries at each stage, with sometimes wildly inaccurate share management and relatively slow settlement times across the board.
When the Transaction is the Settlement
If securities, such as stocks, are tokenized on a blockchain system, in theory, the transaction is the settlement. There are other advantages as well. Today it is hard for the issuer of a security to communicate directly with the shareholders. Voting, as described in the Bloomberg article that I link to above, can be quite tricky.
There are many exciting projects out there, that aim to improve those processes and would allow the issuers of securities to interact and share information with the owners of those securities. Ravencoin would be one of them.
Adoption of Security Tokens
So far, there the disruption of the current clearing and settlement system doesn’t seem to be there yet. Which is very understandable. The capital markets are huge and the barriers to entry are enormous. Not only is the regulatory scrutiny as high as it gets, but any incumbent system will also have huge network effects.
In his book, The Hard Thing About Hard Things, Ben Horowitz describes the internet landscape facing Netscape, before it came out with the first web browser:
At the time most people believed only scientists and researchers would use the Internet. The Internet was thought to be too arcane, insecure, and slow to meet real business needs. Even after the introduction of Mosaic, the world’s first browser, almost nobody thought the Internet would be significant beyond the scientific community – least of all the most important technology industry leaders, who were busy building proprietary alternatives.
In the case of Security Tokens, at least the industry leaders seem to be very aware and already participating in clearing and settlement 2.0.
More Thoughts on Crypto
- Bitozi Crypto Compendium
- Will there ever be more than 21 million Bitcoin?
- The Economics of Cryptocurrency Mining
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How to Value Stuff 