Decentralized Stock Tokens

With the Fort Canning Update, that went live in December 2021, DeFiChain introduced stock tokens. Since then, you can invest into stocks (such as Apple or Alphabet), ETFs (such as the MSCI World), commodities, and other assets in a decentralized way.

In this post, I want to go into the details of what decentralized stock tokens are, how you can get them and what sets them apart from “normal” stocks.

In my previous posts, you can find some more details about how they are traded, how their (DEX) price is determined and how this price relates to the price of the underlying asset.

A few words about nomenclature:

For the sake of brevity, I call all of those new decentralized assets (in the XXX-DUSD pools) stock tokens — even though strictly speaking some of them don’t represent stocks (but ETFs, precious medals, commodities, etc.).

I also call them dTokens at times, which is not completely unambiguous either since dBTC, dETH, etc. may also be called dTokens, but I usually call them crypto tokens instead to avoid confusion.

What are decentralized stock tokens?

From a technical point of view (most probably also from a legal or tax point of view, but I am no expert on those topics), decentralized stock tokens are just crypto assets. However, there are additional mechanisms that try to ensure that the prices of those stock tokens loosely follow the prices of the underlying assets they represent.

It is important to understand though that they are not backed by “real” stocks and they do not exactly mirror the price of the asset. Those points are important to ensure that they are not viewed as securities (which would prevent centralized exchanges from ever listing them).

How can I get decentralized stocks?

I will go more into strategies for using decentralized stocks in future posts; here I only want to briefly touch on how they come into existence and how you can get them.

There are a few ways how decentralized stock tokens can be bought or created (minted).

• Mint from a vault: People can collateralize vaults with DFI, DUSD and other crypto tokens and then mint stock tokens.
  In that case, the loan needs to be paid back in the same token: If you mint one TSLA, you have to pay back one TSLA (plus interest). So if you mint them, you should make them available to the ecosystem by adding them to the liquidity pool or by selling them. Minting and hodling does not make sense. (You would only lose money because of the interest, but you would not benefit from a rising price.)
  Those stock tokens are burnt when the loan is payed back.
• Via future swaps: About once a week (at the future swap block), one can buy stock tokens with DUSD via a future swap. (See this post for more information about future swaps.)
  In this case, the stock tokens are created and the DUSD are burnt. If you buy them via a future swap, you have a long position on that asset and benefit from price appreciation.
• Buy on the DEX: Finally, you can buy stock tokens on the DEX. (See this post for more information about the DeFiChain DEX.)
  In this case, you buy stocks tokens that someone else has created and added to the liquidity pool. You add DUSD to the pool and take out stock tokens. Nothing is created or burnt in that case. You will have a long position on the asset and benefit from rising prices.

What are the differences between decentralized stocks and “real” stocks?

I am going to discuss some of the main differences that set decentralized stocks apart from “normal” stocks. I avoid sorting them into pros and cons since I feel that many points may be seen as both an advantage and a disadvantage and it is highly subjective which aspect is more important to you.

They are decentralized

With decentralized assets, you don’t need a broker as a custodian. You own the keys to your portfolio yourself. This means that no one can take them away from you, but this also means that you alone are responsible for keeping your private keys safe. If you lose your keys, you lose your funds. There is no support who can reset your passcode or anything of that kind.

Also, for “normal” assets (stocks, certificates, etc.), there are sometimes rules that prevent certain people from investing — depending on the risk classification of the asset. With decentralized stocks there are no such rules. There are no bank and no BaFin to “protect” you from investments that are not suitable for you. Instead you are free to make your own choices, but you should be aware of the risks.

In summary: Decentralization is great, but it may not be for everybody!

However, there are companies (such as Cake DeFi) that act as custodial wallets and make DeFi easily accessible for those who do not want to get into all the technical details and the hassle of being responsible for their own wallet and their own keys.

They are more widely available

Via decentralized stocks, you can get exposure to assets in which you cannot invest directly.

Some assets are not available to everyone. For example, most German banks don’t offer the ARKK ETF and hence it is difficult (but not impossible if you are willing to look for the right broker) to invest into this directly for German investors. Since ARKK is listed on DeFiChain, you can easily buy the stock there.

The more important use case for availability, however, are people who do not have access to the traditional financial markets at all. This includes people in some third-world countries as well as digital nomads or, in general, people without a permanent address. On DeFiChain, anyone with an internet connection can get access to the ecosystem and invest in the available assets.

This new target group could play a huge role in the future of decentralized finance.

The fees are extremely low and they trade in arbitrary fractions

One of my favorite things about decentralized stocks is the following: On DeFiChain, if I have 10 DUSD that I want to save, I can just go and buy dAMZN for those 10 DUSD.

There is no reasonable way to do this with “real” stocks. Firstly, when I buy “real” stocks, I can only buy an integral number (I cannot buy half a stock, or one tenth), which means that I cannot invest small amounts into stocks that have a high per-share price. (Savings plans offer some way around this, but they are really inflexible.) With decentralized stocks, I can buy arbitrary fractions of a share.

Secondly, even if the asset has a low per-share price, the trading fees are prohibitive if you only want to invest a small amount. I know that some neo-brokers offer zero trading fees, but they usually have a minimum volume of 250 or even 500 bucks (where a “buck” may mean Euro or USD depending on your preference). Also, they usually have bigger spreads than other brokers.
On DeFiChain, the fees are extremely small. They consist of two parts:

• The transaction fee: Those usually are in the range of 1/1000 cents and hence really negligible even if you only invest 1 DUSD.
• The swap fee (if you buy or sell on the DEX): Those make up a certain percentage of your input. For buying stock tokens with DUSD, they currently are 0.4%. (There’s more about swap fees in this post about the DeFiChain DEX.)

This great flexibility also allows you to quickly swap from one stock to another. At my bank, if I wanted to get out of Apple and into Berkshire, this would probably take multiple days. (The sell and buy orders would be executed immediately, but it usually takes a few days in-between until I get the money into my account.) On DeFiChain, with a composite swap, this takes me just one block. (Note though that I need to pay the swap fees for both pools that are used— first from AAPL to DUSD, then from DUSD to BRK.B — in this case currently 0.8%.)

They are traded 24–7

While the traditional stock exchanges are only open during normal working hours and are closed at nights, weekends and holidays, the blockchain is running around the clock. Thus, you can also buy or sell stock tokens at any time.

For example, you can react immediately if a company has an earnings call after the stock exchange has closed. This does not necessarily mean that — after a company announces great numbers — you can get the decentralized stock for a smaller price than you would get on a traditional exchange since others will also try to get in quickly. Still, I see it as a good thing that the price on the DEX can also take news into account that happen while the NYSE is closed.

There are fewer assets available

Currently, there are only very few assets available when you compare with a “normal” broker. The number is growing though — currently, we add four new tokens every month. Still it is unlikely that the number of available assets will come close to the options your bank offers in the near future.

They are not “normal” stocks

As I’ve mentioned above, decentralized stocks are just crypto tokens and they are not backed by “real” stocks. So you only get price exposure, you do not get dividends are voting rights associated with “real” stocks.

There are more risks than with “normal” stocks

When you invest in stock tokens, you of course have a similar price risk as you would have in the world of traditional finance.

However, crypto assets come with some additional, inherent risks that you need to be aware of. There may be a bug in the code or a flaw in the design (as with Luna), the blockchain might get hacked or the project might go down for some other unforeseeable reason.

There are crazy high rewards compared to traditional finance

For many people this last point is the main or only reason for investing into decentralized stock tokens: You can earn very sizeable rewards when put your tokens to work in liquidity mining.

While this is certainly an amazing advantage, I think it is important to point out that this is not the actual point. Liquidity mining pools do not exist as an end in themselves for producing rewards but rather for providing liquidity to the DEX so that the decentralized ecosystem can function.

We are still in the process of building up the DeFiChain ecosystem! And we have the amazing opportunity to watch it grow and be a part of it. Hence I primarily see the block rewards as a reward for helping DeFiChain grow up.

What are your thoughts on decentralized stock tokens? Do you invest in them and if so, why?