Business Plan№ 3 December 2017
Money makes money
The role and importance of the financial sector for the global economy is evergrowing. If the world’s leading countries officially recognise innovations such as cryptocurrencies, blockchain and smart contracts, it could indicate the beginning of a new era.
In the beginning, financing became possible due to the deregulation of financial activities. At the end of World War II, the Marshall Plan helped accumulate a significant amount of dollars outside the USA. This led to competition for foreign currency deposits, with borrowed funds lent to companies that exported goods to America. In the late 1970s, the amount of offshore dollars in circulation rose to $385 billion; by the mid-1980s, it exceeded $1.6 trillion.
In Britain, it was Margaret Thatcher’s government that significantly influenced the internationalisation of financial services. Following a large-scale antitrust investigation in 1986, the UK abolished fixed interest rates on securities, and lifted the ban on merging the roles of brokers and financial advisers. Finally, foreign banks were given the green light to own firms that traded on the London Stock Exchange.
Around the same time, the USA went through similarly notorious reforms. In 1971, President Nixon refused to peg the dollar to gold, which resulted in a recession, accompanied by increased inflation. In these conditions, bank depositors began to transfer their funds to mutual, venture capital and hedge funds, which promised more income. The stock market attracted more attention because of pension reforms, resulting in pension savings also being placed in securities.
In the struggle for customers, banks lobbied for a revision of the Glass-Steagall Act, which prohibited mixing credit and deposit operations with investment banking. Moreover, the deregulation did not stop there.
The strengthening of the role of banks and other financial intermediaries has led to significant changes in the structure of the largest corporations, according to Susan Bergen, Professor at the Massachusetts University of Technology. The pressure on a company’s management to show short-term profits has forced businesses to rely more heavily on outsourcing their industrial production. However, after the global financial crisis in 2008, the pace of globalisation has slowed significantly and many companies have put their foreign units up for sale. The Fourth Industrial Revolution also played an important role in transforming international production chains. Due to high automation levels, production costs in developed countries have reduced.
Anyone can participate in the mining of cryptocurrencies. This involves participating in the maintenance of a distributed platform by downloading your own equipment
Removing Payment Barriers
Banks, whose innovations ultimately led to a significant economic downturn, faced a sharp increase in regulatory pressure. The need for additional capital, the cost of improving risk management processes, and the complexity of reporting formats has led to a substantial increase in costs. This has led to the emergence of a new class of technology companies that, without relying on credit, interest and market risks, can make payments, advise investors, buy and sell securities, and connect potential borrowers and creditors.
Cryptocurrencies have a chance to become one of the cornerstones of the new global financial system
The changes penetrated the economy even further. In October 2008, a then-unknown man named Satoshi Nakamoto published a research paper entitled Bitcoin: A Peer-to-Peer Electronic Cash System. It described a secure electronic payment system with its own currency. The authors managed to solve the problem of trust in an environment where participants do not know if they can trust each other. At the same time, in a so-called blockchain – a distributed database with information about all transactions – users do not need any identification except their digital signature. The owner of a specific signature is unknown, but the operations in all wallets are transparent.
The anonymity, or rather, the lack of a direct connection between a particular person and one or more Bitcoin wallets, prompted abuse of the system. However, existing businesses saw blockchain as an opportunity to reduce costs by saving on the services of an intermediary, whose role had suddenly become redundant.
In september, Raiffeisen Bank, MegaFon and the National settlement Depository implemented the country’s first deal to place bonds using blockchain. They issued 500 million roubles with a circulation period of approximately three months. The structure of the issue is made up of discounted commercial bonds, which are registered by the National settlement Depository and are placed by private subscription without collateral or an issue prospectus, and with easy disclosure. Circulation on the secondary market does not provide for exchange trades. Such securities allow companies to quickly attract short-term liquidity from qualified investors. The issue used a fully decentralised platform, with the issuer, the central depository, and the investor having direct access to it. The solution provides the necessary confidentiality, but at the same time makes the process of placement, circulation and accounting of bonds as transparent and simple as possible. Using cryptographic protection and verification allows users to conduct all transactions electronically.
Blockchain spawned yet another phenomenon – the Ethereum platform, where the idea of smart contracts, proposed in the 1990s by the American scientist Nick Szabo, was finally realised. Unlike Bitcoin, which allows users to initiate direct and unconditional transactions, smart contracts perform transactions, automatically monitoring compliance with certain conditions.
The innovative systems do not end there. A few years ago in the USA, a global consortium called R3 was created, within which the Corda platform was developed, facilitating the storage, management and synchronisation of responsibilities between financial organisations. Corda’s smart contracts use legitimate legal language. The Digital Asset Platform is yet another interesting development – it is an environment designed for creating financial applications with its own programming language. In it, the philosophy of blockchain and its smart contracts is linked to a secure database, accessible only by authorised users.It is possible that in the coming years the International Organization for Standardization will include a standard for blockchain technologies and its distributed legers. Thus, Satoshi Nakamoto’s invention has the chance to become one of the cornerstones of the new global financial system.
Blockchain also makes the full automation and transparency of crowdfunding possible. Smart contracts have become an ideal means for attracting financing in cryptocurrencies: the computer protocol can accept user applications to purchase a certain number of tokens into its wallet. The process of crowdfunding on the Ethereum is called Initial Coin Offering (ICO, similar to IPO). Purchased tokens can then be resold on electronic platforms, and, more recently, a special standard has been introduced for ICO tokens, compliance with which automatically guarantees the listing on a variety of virtual exchanges. This new way of raising funds is rapidly gaining popularity. This year, blockchain start-ups placed tokens for a larger amount than they received from traditional venture investors.
Typical structure of an initial coin offering
1. Preliminary stage
- Preparation of a whitepaper: a document that describes the technical aspect and business model of a project and other documentation;
- Computer programming, laying the groundwork for the technical component of the project
- Establishing links with potential investors
- Running an advertising campaign
2. Online (no regulation):
- Launch of tokens
- Preparatory sale of a limited quantity of tokens (presale)
- Placement of tokens among investor
- Sale of proceeds in cryptocurrency on the stock exchange
3. Offline (strict regulation: know your client, anti-money laundering):
- Withdraw funds in legal currency from the exchange
Source: Liniya Prava
Types of tokens
1. Product tokens (Filecoin, Tezos). Contains an application feature list/use of a service system
2. Pseudo equity tokens (The DAO).Provision of rights regarding the company, including a right to participate in the allocation of profits and management.
3. Payment method tokens (Ripple(XRP)). Means of payment for goods, work, services.
4. Tokens without any rights (EOS). Certification of participation in fundraising
Source: Liniya Prava
At first, a whitepaper with a description of an idea was enough for the ICO. Today, it requires a competent independent reviewer to certify that the smart contract is programmed appropriately. In addition, nowadays any use of funds from the electronic wallet is often carried out under the watchful eye of an authoritative person. All of this is increasing trust in technology.
The U.S. Securities and Exchange Commission (SEC) decided that, in some cases, tokens can be classified as securities, and the U.S. Commodity Futures Trading is inclined to classify tokens as commodities. Both bodies are working on agreeing their position and it is likely that the norms protecting investors’ rights will soon be introduced.
Weighing Up the Risks
In Russia, blockchain is also getting a lot of attention: during the St. Petersburg International Economic Forum 2017, Vladimir Putin met with Vitalik Buterin, the founder of the Ethereum.
In October, following the meeting, the President instructed the government and the Central Bank to work out the issues of regulating these new financial technologies. According to the documents published on the Kremlin website, this refers to the regulatory framework for ICOs, using a similar approach to IPOs. In addition, the Russian legislation is legalising terminology such as ‘distributed database’, ‘digital L/C’ (digital letter of credit), ‘digital bill of sale’, ‘cryptocurrency’, ‘token’, and ‘smart contract’. These are the issues that the Russian FinTech Association has worked on since 2016. This legalisation will allow the Association’s creation – MasterChain – to become a fully-functioning and legally-certified platform for any cryptocurrency applications.
It is likely that Bitcoin was conceptualised as a response to the global financial crisis, whose tenth anniversary the world will mark next year. It is symbolic that it is now, at a time when business and consumers have become more optimistic again, that governments and central banks are trying to legalise cryptocurrencies, thus opening up new horizons for financial innovation.
A brief history
According to the US Securities Act of 1933, a share includes an investment contract: a transaction or an instrument by which an investor can put in funds, expecting to receive profit in the future.
In 1946, the US Supreme Court heard the case of the Securities and Exchange Commission against W.J. Howey Co. This company owned extensive citrus groves in Florida, half of which it used itself. The other half it sold to third parties without agricultural experience. Many buyers did not even live in Florida. One of the conditions of the sales agreement was the lease of the plots by the new owners to Howey-in-the-Hills Service Inc, which then grew fruit on them.
Having reviewed the conditions of the agreement, the SEC concluded that they were investment contracts, not property transactions. The Supreme Court sided with the regulator and during the court case proposed a special test, which is now used in the US to test if a transaction is an investment contract or not.