The Theory of Marginal Improvements and Security Tokens

A few weeks ago, I spent some time with several extremely bright Wall Street executives discussing the universe of blockchain and security tokens. These group of talented individuals have done a very thorough research and experimentation with digital securities and have developed, let’s say, a pragmatic skepticism about the space in the short term. While they believe in the promise of tokenization as a mechanism for programmatic transfer of ownership, they can’t yet see a clear solutions to many of the financial, technological and regulatory challenges facing digital securities in the short term. From their perspective, the current generation of digital securities don’t offer clear advantages over traditional securities. Before the security token purists get outraged by that statement, please keep in mind that we are talking about a short term perspective from super bright, analytical people who make a living structuring highly sophisticated securities products typically valued in the billions.

To address their concerns, I used one of my favorite economic theories in technology movements: the theory of marginal improvements.

Security tokens are, without a doubt, one of the most promising trends in both the technology and financial markets but one that also faces tremendous technological and regulatory challenges. Many of the promises of security tokens such as liquidity or fractional ownership are simply unpractical in the current regulatory climate.

Digital securities are not yet cheaper to issue or simpler to maintain than traditional securities and, the pace of innovation in a regulated space, is likely to be slow. With a few exceptions, most of the platforms in the digital securities space lack the technological rigor or financial sophistication to make a dent in the larger financial ecosystem. These are simple facts, not criticisms, and ignoring them is clearest sign of delusion that you can find in the security token space.

A possible path to address many of those challenges can be found by analyzing recent technology movements.

Applying The Theory of Marginal Improvements to Digital Securities

Studying the history of technology movements is a great way to understand the present and effectively predict the immediate future and security tokens are not the exception. The challenges facing security tokens are certainly unique but the macro-context certainly isn’t.

Many of the recent transformational technology movements were, at some point, considered worse than their predecessors. This is a phenomenon that I like to call the theory of marginal improvements.

The core principle of the theory of marginal improvements in technology movements states that the first stage of a breakthrough technology trend tends to be worse in almost every aspect compared to the previous tech trend except in a handful of features. Sufficient iteration over those minor improvements eventually unlocks the value of the space.

To illustrate this theory of marginal improvements, let’s use some examples of recent technology movements. In the early days of the smartphone era, you could make the case that smartphones were worse than PCs in almost every aspect [battery life, screen size, apps] but they improved PCs in two tiny areas: camera and GPS.

Those two features unlocked the mobile app economy and created levels of adoption that surpass PCs by several orders of magnitude. In the case of the big data movement, emerging technologies like Hadoop were considered worse than relational databases in almost every aspect but one: they were able to perform scalable computations on large unstructured datasets. That single feature catapulted the entire space to relevance. Similarly, the first generation of cloud infrastructures were considered worse than its on-premise equivalent except in their management and elastic-scalability capabilities which were the two aspects that unlock the entire cloud revolution.

Current technology trends such as blockchain, artificial intelligence or virtual reality are battling their own version of the theory of marginal improvements.

Extrapolating theory of marginal improvements to security tokens, we should accept that security tokens are going to be considered worse than traditional securities in all but a handful of capabilities and we should put relentless focus on those capabilities to unlock the true potential of the space. A corollary of applying the theory of marginal improvements to security tokens tells us that focusing on anything but those few capabilities is likely to result a futile effort in the near future.

But what are the marginal improvements that digital securities provide compared to traditional securities. In my opinion, there are two clear winners:

· Programmability: Ability to embed programmable logic as part of the smart contract of the security.

· Transparency: Leverage blockchain records to enable new levels of compliance and visibility for digital securities.

Recognizing that programmability and transparency represent the key incremental improvements over traditional securities, the next step is to figure out how to maximize their potential in the next generation of security token platforms.

Unlocking the Incremental Improvements of Security Tokens

Programmability and transparency seem to be the key pillars to incentivize the transition from traditional securities to digital securities. Playing out the theory of marginal improvements for digital securities, there are some tactical steps that can be taken in order to maximize the potential of those two areas.

Programmability

Programmability doesn’t happen without programmers so part of the challenge of unlocking the value of programmability its dependent on maximizing the engagement of the developer community. Here are a few tactical steps that might help in that regard:

a) Open Source Distributions: Open sourcing the protocols and infrastructure building blocks of digital securities is essential to foment a developer community in the space.

b) Developer Community: Open sourcing protocols can only go so far. Nurturing a developer community around these protocols is a monumental effort but one that is required to unlock innovation around programmability in the space.

c) Better Tools and Languages: Issuing security tokens shouldn’t require writing smart contracts by hand. Integrations with mainstream languages like JavaScript, domain specific languages or better tooling will simplify the adoption of digital securities within the developer community.

Transparency

Transparency is one of the obvious benefits of digital securities and somehow the value proposition is almost hidden behind the complexity of other aspects of the lifecycle of security tokens. In the context of digital securities, transparency can materialize in many different ways and there are several key tactical maneuvers that can be used to unlocks its potential.

a) Disclosures Toolset: Incentivizing the disclosure of information related to digital securities is one of the maximum expressions of transparency in the space. While we are probably far away from robust disclosure protocols, some basic tooling in this area might be welcomed.

b) Analytics: Every single transaction for security tokens has a record in the blockchain. That simple factor enables levels of analytics that are simply impossible with traditional securities. A robust analytic layer for security tokens is a relatively simple development that can have a profound impact in the space.

c) Post-Issuance Tooling: Robust post-issuance tooling to enable capabilities such as cap table management, dividend distribution, re-issuance of securities is another simple expression of transparency that can help to lower the costs and streamline the adoption of digital securities.

Those are some of the elements that can help to maximize the impact of the incremental areas of improvements of digital securities compared to traditional models. Base on the history of technology markets, a relentless focus on programmability and transparency is likely to pay the biggest dividends for the first generation of security token platforms that finally unlock the true potential of the space.

The Theory of Marginal Improvements and Security Tokens was originally published in Hacker Noon on Medium, where people are continuing the conversation by highlighting and responding to this story.

Publication date: 
06/12/2019 - 04:40