The ETF-Blockchain Connection: A Parallel Evolution Towards Efficiency
This is number 1 of a multi-part article series. Tune in next Thursday for part 2 where we dive into the democratisation factor that is similar for both ETFs and blockchain.
Not many people know that I have a background in data science and analytics and that prior to getting into blockchain tech and even the new wave of generative AI, I was a run-of-the-mill capital markets analyst. In that time, I got to do a lot of work in the ETF space performing analysis in the media (ausbiz, AFR, other) and even building a well-used (and free) ETF analytics tool, ETFtracker (see below).
So it was to my surprise (positive) that I saw the folks at Bankless do an interview with James Seyffart of Bloomberg to dive into the world of ETFs. The world of crypto has had its various attempts at bringing a spot Bitcoin or Ethereum ETF to mixed success (we have futures ETFs and some spot ones but not in major markets like the US). Here’s the episode
In the episode they draw various comparisons to the underlying tech of ETFs and Blockchain and it was interesting to see the comparisons between the technologies. So here is this first of a multi-part series, where we dive into the comparisons and in this one we start with the efficiency to markets they both bring.
Introduction
In the realm of financial markets, few developments have been as transformative as the advent of Exchange Traded Funds (ETFs) and blockchain technology. Parallels between the two may seem unconventional at first glance, but upon closer inspection, similarities abound, particularly in the context of their disruptive potential and the efficiencies they bring to the world of finance.
The Emergence of ETFs: A Lesson in Efficiency
Exchange Traded Funds (ETFs) emerged in the early 1990s, born out of the financial crisis of the late 1980s. These baskets of securities that trade on an exchange like a single stock offered a solution to some of the efficiency problems that plagued the investment industry. Prior to ETFs, many investment funds were not physically backed, creating potential for over-exposure and contributing to financial instability.
Imagine the world of finance pre-ETFs as a bustling farmers market, where you need to visit different stalls to buy individual fruits and vegetables. If you want a diversified basket, you would need to spend time and energy walking from one stall to another, and the pricing wouldn’t always be transparent or consistent. The creation of ETFs is akin to introducing a grocery store to that farmers market, offering a convenient one-stop shop where you can buy a basket of goods (or securities) with transparent pricing, in one simple transaction.
Blockchain: A Technological Leap for Financial Efficiency
Enter blockchain, the groundbreaking technology that underpins cryptocurrencies. It offers a secure, transparent, and auditable system for transactions, similar to how ETFs offered a more efficient and transparent method for trading diversified baskets of securities. It isn’t just the transparency and security that make blockchain revolutionary. It’s the programmability of smart contracts that can automate processes and embed complex logic into transactions, much like how the creation/redemption mechanism embedded into ETFs allowed for greater market efficiency.
It isn’t just the transparency and security that make blockchain revolutionary. It’s the programmability of smart contracts that can automate processes and embed complex logic into transactions…
Smart contracts can be viewed as the next evolution in the automation of financial transactions. Just as ETFs simplified the process of purchasing a diversified portfolio, smart contracts simplify complex multi-party transactions. Consider the example of a digital escrow service. In the traditional finance world, an escrow service requires a trusted third party to hold funds until certain conditions are met. With smart contracts on a blockchain, the escrow service becomes a piece of programmable code, removing the need for a third party and making the process faster and more efficient.
Another significant advantage of blockchain is its ability to facilitate quick cross-border fund transfers. In the same way that ETFs provided investors with instant exposure to diversified portfolios, blockchain allows for instant global money transfers, breaking the shackles of traditional banking systems and their slower, more costly international wire transfers.
A Future Powered by Innovation
The advent of ETFs was met with criticism and scepticism, much like blockchain technology today. However, ETFs have proven their worth, now managing trillions of dollars globally, and providing investors with a more efficient method of accessing diverse portfolios.
Blockchain technology, while still in its nascent stages, has already demonstrated its transformative potential, with its ability to decentralise trust, ensure transparency, and automate complex transactions. As we advance, it’s possible that blockchain, much like ETFs, will be integral in solving many of the efficiency problems within financial markets and beyond.
So, let us embrace this wave of digital transformation, acknowledging its potential hiccups, but also appreciating its promise for a more efficient, transparent and inclusive financial system. The world of finance has always been shaped by innovative technologies, and the tandem of blockchain and AI represents the next big leap.
Tune in next Thursday for part 2 where we dive into the democratisation factor that is similar for both ETFs and blockchain.
