Can the Token Economy prevent the next global recession?
The year is 2008. Subprime mortgages have just started a chain reaction that would send shockwaves through the global economy, creating the worst recession in history.
It would claim some scalps, and force Western governments to intervene — pumping trillions of dollars into the economy to prevent banking systems around the world from total collapse.
“September and October of 2008 was the worst financial crisis in global history, including the Great Depression”
- Ben Bernanke, Former head of the Federal Reserve.
Chain Reaction
Before the financial crisis, the U.S credit system had total debt liabilities of around $53 trillion. Bank liquidity at the time was approximately $350 billion. A ratio of 150:1 debt-to-cash. Such a high amount of system-wide leverage meant the world was not prepared for the extreme procyclicality that followed.
First, Lehmann Brothers (who specialised in securitising sub-prime debt) announced bankruptcy.
Then HBOS, the UK’s biggest mortgage seller, looked as if it would become the first UK victim of the crisis.
AIG, the world’s largest insurance company — had just made the considerably non-prescient move of insuring leveraged debt (that 150:1 must seem a significant ratio when you’re having to pay out against it!) just as the financial system hung in the balance.
£90 billion in value was lost from the FTSE100 in a single day as the crisis escalated.
The UK announced a £50 billion bank bail-out, whilst the the ‘Troubled Asset Relief Programme’ bought up $700 billion of endangered assets from Wall Street. The IMF announced a further $200 billion to lend to governments around the world.
“[International banks are]…global in life, but national in death”
- Mervyn King, former Governor of the Bank of England.
As defaults occur, fears of further insolvency throughout the macro-economy lead to a constriction in cash reserves and short-term markets, resulting in less liquidity. Consumers and businesses tighten the purse-strings and place greater significance on retaining cash deposits to ensure they can pay their obligations. Velocity slows — not enough cash is circulating to continue paying debts, and more defaults occur. An uncontrollable deleveraging spiral occurs, and the markets tumble.
2008 and 2019
The current stock market bull run is the longest recorded in history. Those familiar with markets will recognise that all markets have cycles, and with the average market cycle lasting five and a half years, we are long overdue a downturn.
Clouds were gathering in 2008 long before the deck of cards tumbled. Gold prices and other ‘safe haven’ assets were surging from 2006 onwards, the bond market yield curve had inverted two years prior and house prices started to fall.
In 2019, gold prices (and Bitcoin) are up as investors seek safe assets, historically seen as inversely correlated to the dollar. Household debt in the US is higher than peak-2008 levels. The yield curve has just inverted, which has preceded every recession in the past 50 years.
This doesn’t necessarily mean a recession is imminent — but it is largely unavoidable as markets naturally ebb and flow.
Blockchain and the ‘Token Economy’
Is it possible to mitigate against the coming recession? Perhaps.
I believe the potential benefits and efficiencies proffered by DLT are likely to be substantial, creating and allowing access to entirely new or illiquid markets, streamlining financial productivity and making the concept of wealth more globally inclusive.
Tokens are programmable proof of investment, ownership or equity. They are trivial to create, and the data is secured on-ledger through the magic of Merkle Trees and notarisation. The possibilities are limitless in a turing-complete environment.
Efficiency and cost savings
Blockchain will optimise global financial infrastructure allowing institutions to collude with regards to data transfer & sharing. Rather than a sequential back-and-forth between institutions, models are agreed upon and data reconciled as part of the transaction itself.
According to a study by Santander, DLT may help reduce banks infrastructure costs by between US$15–20 billion per annum by 2022
Rather than disparate, siloed legacy systems, we will agree industry standards and create systems built upon a single protocol, with trust at it’s core. No more proprietary legacy integrations or protocol layers needed when these can be built into the infrastructure itself.
Standard settlement and payment times are currently at best, T+2. DLT can reduce this to sub-second, significantly reducing counterparty risk and removing the need for expensive risk assessment software.
Financial market cut-offs will cease to exist, and assets may be productive for the economy 24/7.
The cost of administrative processes can be shared between parties and reconciliation practices may eventually become entirely obviated with parties relying on the ledger as a single source of truth.
Collective Fractional Ownership
Collective fractional ownership of tokenised assets will provide financial inclusion to poorer demographics and societies and in turn close the world’s “wealth gap”.
Consider housing. Prohibitive deposit demands and steadily increasing market prices mean that a large swathe of the younger generation are simply unable to invest in property. Wage growth cannot keep up.
Now consider if a property was tokenised into 100 transferable tokens. The owner of the property benefits from a highly liquid market with which to raise equity. The investment market benefits from much lower barriers to entry (you may invest in a £300,000 property for as little as £3,000).
This not only allows inclusion to more investors, but allows for extreme diversification of portfolios (Modern portfolio theory) and therefore safer investment strategy.
Perhaps the owner of the token could also be paid interest through the rent of the property, proportional to their ownership. Perhaps they could effortlessly and autonomously re-invest these returns — compound investment becomes effortless.
Don’t have a spare $110 million? Don’t despair — tokenise.
Rather than the status quo of asset prices increasing and outpacing wealth accumulation for the masses — making the barrier to entry for investment higher and making the rich, richer — we may tokenise assets and make investment fairer and more accessible to all, reducing the wealth gap.
Tokenisation allows the creation of more balanced portfolios and has a knock-on effect of stabilising the macro-economy.
Macro-Market Efficiencies
Data privacy techniques will usher in a new age of ‘big data’ and provide efficiencies to macro-markets.
Generally, retail investment data is proprietary and cannot be shared for reasons of GDPR and other such directives. If this data could be anonymised and sold to the wider market — or calculations were able to use the data without actually exposing it (Secure Enclaves, Zero-knowledge Proofs, etc) — then the markets would likely see a net increase in productivity.
Regulation becomes less onerous as regulators are able to be present within the DLT environment and analyse real-time transactions.
Economic sanctions against nations and malevolent institutions become easier to enforce.
Breaches of guidelines and directives deemed harmful to the economy (subprime loans, anyone?) can be assessed and prevented as they occur, limiting damage and apportioning blame with lucidity never before seen.
As the Token Economy builds in conjunction with the emergence of Artificial Intelligence, Neural Networks and Machine Learning, shared data can be iterated in real-time to expose inefficiencies, limit destructive behaviour, guide fiscal policy and enforce standards.
To Conclude
I expect Tokenisation to usher in a new era of financial prosperity akin to the industrial revolution (The Ledger Revolution? perhaps something more pithy…), but it will take time and combined effort to succeed.
From addressing unfairness in the incumbent system whilst ensuring the economy is at peak productivity, to encouraging collusion between competing entities for net benefit of all, tokenisation holds incredible promise.
Standards must be written. Interoperability will be key. Consortia will become the norm. Tokens are Blockchain’s killer application.
