Preliminaries & Some Motivation

Business as usual?

Finance is very "expensive" 

Why worry about the distant future?

Let's look at some former industry leaders

Paid-for vs. valued 

• Keyboard
• Security
• Being businessy
• Cool and cutting edge
• Being Canadian
• Independence from desk

What did they pay for?

What do people value?

• Mobile email

• Safe-keeping of assets
• payments services

Example: Blackberry and a generic consumer bank

Major Lesson: Platforms provide value

What replaced Blackberry? The App-Phone - a PLATFORM

Financial Infrastructure

What our financial infrastructure looks like

What would the most efficient financial infrastructure look like?

Is this a distant future?

Option 1: centralized solution/private platform such as WeChatPay

\(\Rightarrow\) a single common resource

• easy value management
• straightforward transfers & ownership accounting
• new types of contracts and usage of assets
• \(\ldots\)

Counterpoint: Blockchain = common but decentralized resource

Who will provide the next gen banking platform?

The past (and the present?)

The present and near future

3-5 years in the future

5-10 years in the future

Past, Present, and Future: Who will provide the next gen of banking?

The Business of Trading in a Decentralized World

Trading Infrastructure

Illustration of infrastructure fragmentation by example: equity trading

Text

Application: decentralized trading with automated market makers (AMM)

• Liquidity providers share the risks
• Pricing function ("exchange rate") hard-coded, based on the contract token balance

Liquidity Pool

How does this look in practice?

What does it take to make this work in practice?

average annual saving: $2.4 million

Source: "Learning from DeFi: Would Automated Market Makers Improve Equity Trading?" working paper, Malinova & Park 2023

Possible transaction cost savings if AMM applied to equity trading: \(\approx\) 30%

Source of savings: 

• better risk sharing among liquidity providers
• better use of capital

Blockchain-based Businesses?

1. Self-custody of assets
2. Open-access financial infrastructure
3. Value management layer = common resource
4. Platform approach to commerce

What makes blockchain-based finance different from TradFi?

Platform economics is tricky:

• What's the product?
• How do you get it started?
• How do you get people to contribute?
• How do you earn money?

Business Challenges

• protocol tokens to provide incentives?
   
• which side to incentivize?
   
• where does token value come from? (no intermediation rents)

What value do these tokens have?

1. Functionality:
   • fee levels for AMMs
   • decision to deploy on other chains
   • key threshold values for lending
2. Monetary value
   • implicit claims on "protocol" income
   • implicit claim on reserve pools

Economics of financing instruments

Lots of academic research on tokens!

• Tokens as financing tools:

  • tokens as revenue claims lead to under-investment relative to equity

  • token retention by the entrepreneur as a tool to signal quality

  • developer incentives for continuous development

  • importance of future monetary policy

  • Chod and Lyandres (2021), Gan, Tsoukalas, and Netessine (2021a), Davydiuk, Gupta, and Rosen (2023),  Canidio (2018), Catalini and Gans (2018)

  • Malinova and Park (2023):
    • poorly designed tokens lead to under- or over-investment but optimally designed token is superior to equity re: moral hazard problems 

Lots of academic research on tokens!

• Tokens for platforms:

  • network effects, overcome coordination failures, accelerate adoption

  • transfer of governance rights from platform to users

  • speculators early on, users later

  • pre-sale allows for more surplus extraction for the entrepreneur, more projects to be financed

• Li and Mann (2018), Bakos and Halaburda (2019), Sockin and Xiong (2023), Cong, Li, and Wang (2021) and Cong, Li, and Wang (2022) (asset-pricing based), Prat, Danos, and Marcassa (2023), Chod, Trichakis, and Yang (2022), Shakhnov and Zaccaria (2021),
  Lee and Parlour (2022), Goldstein, Gupta, and Sverchkov (2022).

Tokens: summing up

• Lots of things to like about tokens
   
• Don't neatly fit into known financial instrument classes/compliance frameworks
   
• token can have many purposes/functionalities - which one reigns supreme?
  • ​Take ETH
    • ​payment = money?
    • staking = income generating?
  • (when) are they securities/investment contracts?

• • evolving use: when do they stop being investment contracts?
     

• Finance-related disclosures \(\to\)  may not ask the right questions
   
• Easy to re-use capital \(\to\) system-wide leverage concerns
   
• Side note: protocols seek other income sources & additional functions (UniSwapX order routing?)

Bringing TradFi to DeFi:
Asset Tokenization or
"The Creation of Asset-Linked Tokens"

Tokenization of stocks is nothing new: American Depository Receipts

foreign investor/
issuer

domestic bank with foreign representation 

ADR issuing bank handles

• shareholder communications
• dividend payments
• other recording-keeping

deposits shares

detailed review: Malinova and Park (2023) "Tokenized Stocks for Trading and Capital Raising" available on SSRN https://papers.ssrn.com/abstract=4365241

Blockchain Tokenization has many options

existing investor/
issuer

Use Case #1 for Tokenized Assets: Stablecoins

What do central bankers think about stablecoins?

BIS Survey of Central Banks (2021):

Advanced economies:

80%+: high potential or some potential for single-currency backed

Source: On-chain Foreign Exchange and Cross-border Payments by Austin Adams, Mary-Catherine Lader, Gordon Liao, David Puth, Xin Wan (2023) [team from UniSwap Labs]

Further Thoughts

The Development is Ongoing