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Blockchain Cheshire Cat

March 25, 2017

One of the criticisms (which is sometimes valid) about blockchain is that it is media hype that’s useless for most things in finance.  One funny thing is that even when that is true, just thinking about blockchain and coins turns out to be useful.

So within the next month we will be beginning trading of convertible notes on the alt-coin exchange http://www.spacebtc.com/  There is a small company, which I’ll call Company K, that is raising USD 500k in convertible notes for an IoT project.  So our first effort was to use blockchain and do coin based fund raising.  The idea was that the company would issue coins that represent the convertible notes, and then they would be able to trade these notes on SpaceBTC.  So we were looking to see how to use blockchain and coin-based tokens, and it turned out to be complicated and messy.  Also most people that look at this see a regulatory nightmare from hell, and run away from that.

What I ended up doing was to draw this big diagram with a lot of boxes and arrows.  They I removed all of the boxes and arrows, and we ended up with something that is crazy simple.

When I talked with the exchange, I realized that the hard part in issuing and trading tokens was the deposit and withdrawal parts.  You have to write special code to handle each different type of coin.  It turns out that when you trade coins on the exchange, you have to write no new code at all.

Once I looked at that, I realized that in order to trade notes, you don’t even have to deal with coins.  If someone wants to trade notes from Company K on SpaceBTC, then can call up Company K, and Company K changes the registration of those notes on their internal ledger, and notifies SpaceBTC.  If someone wants to move notes off of SpaceBTC, they do the opposite process.  All of the stuff with blockchain and distributed ledgers turns out to be unnecessary.  You just do everything view e-mail.  Also since everyone is going through Company K, you get rid of all of the regulatory issues since Company K will vet the investors, before the get on SpaceBTC.  Also you get rid of the cybersecurity issues.  The actual “ground truth” of who owns what is the ledger that is held by Company K.  If you hack the exchange, you get nothing.

It turns out that even though the final design doesn’t involve blockchain and coins, blockchain and coins turns out the essential for this to happen.  If you didn’t have blockchain and coins, you wouldn’t have the exchange in the first place.  Once you have an exchange that processes blockchain and coins, you can use that exchange to process notes that don’t have anything to do with blockchain and coins.

Also once we have 10000 companies, then it becomes more efficient to have everyone put everything into a distributed ledger, but if you have one company or even ten companies, it becomes more efficient to do everything by hand.  However, doing everything by hand allows you to bootstrap the system so that you get enough volume to deal with a large number of companies.

Speaking of regulation, here is what I’ve learned

  • Minimize the number of regulators that you have to deal with.  In my case, I have to deal with HK regulators, maybe US or Mainland Chinese.  What I’m doing may or may not be wildly illegal in Japan or the EU, but since I’m not planning to do business there, I’m not concerned about that.
  • Regulatory arbitrage is your friend.  The only time I have to start worrying about regulation is if I just can’t do something easily in Hong Kong, at which point I start looking for things outside of Hong Kong.  For example, one could make an argument that SpaceBTC would require a type 7 Automated Trading System license if it was operating in HK.  So that’s why it’s not operating in HK.
  • Create products and not services.  One problem with providing legal services is that you start talking with the lawyer, he tells you how complicated everything is, and then you decide it’s not worth the trouble.  In order to reduce legal costs, it’s necessary to “mass produce” a system.  You find something that “just works” and once it “just works” it becomes boilerplate and then you just photocopy all of the documents.  DragonLaw is doing this with the standard business documentation.  It’s not clear how this would work with the standard business model of law firms, but that is something they have to worry about.
  • Assume it can be done.  One technique is that I use is to start off assuming that what I’m trying to do can be done, and then come up with time and money estimates.  For example, suppose I need to do something that requires a Hong Kong banking license.  At that point instead of giving up, I just pencil in that it will cost me USD 25 million and three years to start a Hong Kong bank.  So I could end up with something that as a first pass costs USD 100 million and take five years.  At that point, I stare at the diagram, and then try to figure out what is the most expensive part and then remove boxes and look at cheaper alternatives.  For example, can I replace this with a bank in the Caribbean which will cost USD 3 million and take one year?
  • Be careful about Gucci hand bags.  It turns out that a lot of things in banking and finance are like Gucci hand bags.  Just extremely expensive, but it impresses people at a party.  At that point, I have to look at the situation and ask myself whether my goal is to impress people at a party (which turns out to be necessary), or whether I can make do with a burlap sack.
  • Stay hungry.  One thing that I’ve figured out is that money is like food.  People want to get money, but consuming too much money is like consuming too much food.  It’s really bad for you, and you really wonder about all of these projects that try to save money by throwing tens of millions of dollars at it.  There’s a careful balance between starving and eating too much.  Unfortunately, I’ve ended up closer to the starving side of the equation, but as long as I can get just enough money to stay alive and healthy, I think I’ll get more done than people that have too much money.
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