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Putting a Blockchain Wrapper on the Financial System
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Putting a Blockchain Wrapper on the Financial System


Here’s how a depositary receipt works:

  1. I buy a bunch of shares of a company.
  2. I put them in a box.
  3. I sell shares of the box to you.
  4. Typically I sell one share of the box for each share of the company that I have put into the box, or at least some integer multiple.
  5. Now you have a share of the box that is almost like a share of the company.

It’s fine! It’s useful. For instance an American depositary receipt typically consists of me buying shares of a foreign company, putting them in a box, and then selling shares of the box in America. The box shares can (sometimes) be listed on a U.S. stock exchange, which is convenient for American investors, who can trade the shares while they are awake, pay dollars for them, etc. It smoothes away some frictions, knits global financial markets together more closely, it’s a thing, whatever.

Anyway blockchain blockchain blockchain, a million blockchains:

A digital exchange opening next week will enable investors to trade in companies including Apple Inc., Facebook Inc. and Tesla Inc. outside of the U.S. even when the stock markets are closed.

DX.Exchange, which has offices in Estonia and Israel, will offer digital tokens based on share of 10 Nasdaq-listed companies with plans to expand to the New York Stock Exchange as well as in Tokyo and Hong Kong. Each digital security is backed by one regular share and holders will be entitled to the same cash dividends, even though the companies themselves aren’t involved.

The exchange’s virtual stock offering will provide a test of investor appetite for products that seek to improve upon mainstream financial markets by using technology from the world of cryptocurrencies. DX will offer digital stocks, or tokens, based on actual shares bought and held by partner MPS MarketPlace Securities Ltd. The tokens will be based on the Ethereum network, with the amount corresponding to demand on the DX exchange.

Digital stocks could hold advantages over traditional shares because they can be traded even when exchanges are closed, and traders can choose to buy fractions of a share. They could also give foreign investors the ability to buy and sell U.S. shares they might otherwise struggle to access.

Blockchain! I am not particularly impressed by the stated justifications here: Stocks are already digital, and I am pretty sure that European investors could already find a way to buy Tesla stock, and 24/7 trading is not especially useful unless people are actually there to trade. There are also some legal issues; DX.Exchange claims that it will not be subject to U.S. regulation “because DX doesn’t operate there,” but I feel like some goofy American will end up buying some Tesla quasi-shares on the blockchain and get everyone in trouble.

There is another standard set of crypto-y justifications that don’t even get mentioned here because they are clearly irrelevant. This is not decentralized trustless immutable permissionless censorship-proof blah blah blah: The tokens live on the blockchain, but they have value because they represent actual shares that live in a brokerage account. You have to trust the broker not to steal them, you have to trust its security procedures to prevent hacking, you have to trust its decision-making processes in case of disputes, and you have to trust the legal regimes in the countries where it operates. This is very much a regulated centralized trusted intermediary holding your shares for you, with an overlay of blockchain.

Still, you know: It’s fine! It’s useful. It’s a thing. The way I think about this is that these tokens are effectively depositary receipts on Tesla shares, only they are not, like, European depositary receipts but blockchain depositary receipts. They let people trade Tesla shares, not in Europe, but in the Invisible Republic of Crypto.

This strikes me as a very useful thing, conditional on already thinking that crypto is a useful thing. If I live in America and want to buy stock in BP PLC, I could probably find a way to buy its ordinary shares in London, but buying its American depositary receipts is more convenient and fits in better with the rest of my financial life. Similarly, if I lived in the Invisible Republic of Crypto, I could probably buy Tesla stock — I bet a lot of Cryptonians do! — but buying its blockchain depositary receipts might be more appealing. If a large chunk of my net worth was in Bitcoins, and if I lived my financial life primarily in the crypto system, and I read some articles about how great Tesla is and wanted to buy Tesla stock, it would be annoying for me to have to take money out of crypto, turn it into dollars, and then give it to a broker. There would be many points of interaction with the traditional financial system: I’d have to go through anti-money-laundering/know-your-customer procedures to turn my Bitcoins into dollars, and there’d be more procedures to open a brokerage account, and every transaction would take three days and be done through the sorts of traditional third-party financial intermediaries that I moved to the Republic of Crypto to avoid. But if I could just go to my usual crypto exchange and trade Bitcoins directly for Tesla shares — Tesla BDRs I mean — and get back those shares immediately, on the blockchain, with my own private key, then that would be nice. Nice for the hypothetical me who lives in the Republic of Crypto, I mean, and who is already used to using crypto exchanges and private keys and so forth. Not for the actual me who finds all of this a bit exhausting. But my impression is that a lot of Cryptonians find bank accounts and brokerage firms pretty exhausting!

I think of this the way I think of stablecoins. The basic point of a stablecoin is that (1) the U.S. dollar is very useful as a store of value and a unit of account, even for people who are committed to crypto, but (2) the dollar is not a particularly useful instrument to pay for things in the crypto ecosystem. I can’t just send you dollars over the blockchain; if I want to send you dollars, we have to leave the blockchain and go to our traditional banks and send wires or write checks or otherwise rely on non-crypto mechanisms. These mechanisms are fine — imperfect, but currently better than crypto mechanisms anyway — for buying a sandwich, but they are bad for some crypto purposes. If we have a smart contract that will send money from me to you upon the occurrence of some specified event, that smart contract might have a tough time accessing my traditional bank account to send you the money. What we want is programmable, crypto-native, blockchain-y money that also has the value of a U.S. dollar.

And so people have invented stablecoins, which are just dollars, but on the blockchain. And while there are some decentralized trustless immutable-code-type algorithmic implementations of stablecoins — which seem sketchy! — there are also more popular and more straightforward implementations that are just, I get a bunch of dollars, and I put them in a box, and I issue shares (tokens) in the box, and each token corresponds to one dollar. I have just put a blockchain wrapper around a box of dollars. This smoothes away some frictions and knits the crypto financial markets more closely together with the dollar ones.

But this concept is broadly extensible: You can take anything from the traditional financial system, put it in a box, and issue crypto-tokens against it, moving the thing from the traditional system to the blockchain. Often, when you do this, you accompany it with bold claims that you have somehow revolutionized and democratized the thing: Finally, regular people will be able to buy real estate, or … dollars! … or … Tesla shares!

Those claims are often silly, but I am not sure that they are essential. The essential thing is that you find something useful, or at least appealing, about the crypto ecosystem; this can be philosophical (decentralization, immutable code, non-discretionary monetary policy, etc.) or practical (easier to buy drugs, etc.). Once you decide that the crypto ecosystem is good, then extensions that bring the rest of finance into that system are also good, even if they are not particularly interesting — or even particularly crypto-y — on their own. A stablecoin, or a Telsa blockchain depositary receipt, is not censorship-resistant, is not controlled by immutable code, relies on trust in a centralized intermediary, and generally is not going to revolutionize the financial system. But it is useful in the crypto system: You can transfer it on the blockchain, or trade it easily for Bitcoins, or write smart contracts that make use of it. And if crypto is going to revolutionize the financial system, then giving it useful add-ons — like dollars, or Tesla shares — can’t hurt.

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