Scams or Not, Crypto Tokens Have History on Their Side

Contract-seal
4 October 2016

Alex Millar is a blogger, podcaster and YouTube publisher with a degree in engineering physics from Queen’s University in Kingston, Ontario, Canada.

In this opinion piece, Millar looks at how cryptographic tokens can be viewed in a long line of historical investment instruments, and why despite the scams, there remains an argument they should be allowed to continue.

Contract with wax seal

Even before the emergence of money, victims of a crop failures often took short-term food loans and paid them back with interest. When money emerged, interest was usually paid in either a fraction or a multiple of 12 to simplify accounting.

The practice of charging interest on loans, called “usury,” has been frequently and widely condemned, regulated or outlawed by authorities beginning with the Buddhist Jatakas texts from 600-400 BC. Critics claim usury exploits the needy, is a form of unearned income, and contributes to inequality.

Basic economics shows that capping the price of anything creates a supply shortage.

Interest is simply the price of borrowing money and capping interest reduces the incentive to lend, thereby creating a shortage of loans. A shortage of loans means that lenders willing to lend on the black market can charge more interest than would be possible in an unregulated market.

In this way, those who attempt to protect borrowers by regulating usury risk doing more harm than good. To make matters worse, disputes in a black market cannot be settled using a public arbiter, which means that those who are wronged often turn to violence or threats of violence.

A window for scammers

In the Middle Ages, contracts emerged that legally skirted anti-usury laws by tying repayment to profit, rather than time. These contracts varied in terms of who profited and who would be held liable for losses. The classic commenda contract rewarded one-quarter of profits to the laboring partner, with three quarters of profits, and all the risk, to the investor.

Many early trade voyages were funded through contracts called societas, which introduced the concept of limited liability, and often divided the equity of a ship into 24 shares, called carati. After the completion of each voyage, the ship and its assets were liquidated, with profits returned to shareholders.

Over time, the complexity of these contracts grew. In 1602, the Dutch East India Company sold shares not in a voyage, but in a fleet of ships that continually traded with Asia. This made accounting more difficult, as amortization of assets had to estimated to calculate profits. To make accounting even more complicated, this new breed of companies had hundreds of shares, each of which could be traded on the free market.

It was impossible for shareholders to check the veracity of large companies’ accounts. However, darkness in knowledge is hidden by the brightness of great profits.

This opened a window of opportunity for scammers. Before its first ship ever left harbor, the South Seas Company used investor funds to open posh offices in the best parts of London. Stock prices initially skyrocketed then crashed when dividends failed to materialize.

The effect of regulation

Over time, regulations have been enacted to protect investors.

However, like laws that cap interest rates, these new regulations often have negative unintended consequences. For example, take accredited investor laws, which make it illegal for low-net-worth individuals to invest in non-established companies.

The effect of these laws is to redirect capital from new ventures to established companies, like The First Hawaiian Bank. Founded in 1858, the bank now has 2,250 employees.

In August, it raised $485m in an IPO. Surely established banks have good reasons to raise funds, but in the absence of accredited investor laws, some of the capital that funds banks would instead fund innovative startups.

Accredited investor laws also give wealthy investors an unfair advantage because a reduced supply of capital for new ventures creates cheaper prices.

A new financial dawn

This article was inspired by Preston Byrne’s article Against Tokens (And Token Crowdsales), in which he argues that crowdsales are illegal and are usually scams. I don’t disagree with either of those statements. However, just because something is illegal, that doesn’t make it wrong or undesirable. At one time, it was illegal for women to vote.

Furthermore, even a company with a thumbs up from the Securities and Exchange Commission isn’t prevented from scamming shareholders, as evidenced by the options backdating scandal at Apple. This is an example of the fence paradox, which illustrates how regulations can often cause greater harm by making people feel safe.

Like the contracts that emerged, in part, to skirt anti-usury laws, cryptocurrency has emerged, in part, to skirt today’s financial regulation. Anyone can now create, sell and trade cryptographic tokens that represent equity (or debt) in a company. Any investor can pay any entrepreneur, and remain anonymous if he wishes.

Of course, there will be scams and failures. And sometimes, there will be successes. Those who succeed will probably not do so with complicated 44-page white papers, they will do so with new, simple and transparent contracts and ideas for creating wealth.

Irrespective of the law, the legal suppression of innovators looking for funds and people looking to invest is ending. This is good news because it means the resource that is money will become more efficiently deployed.

Ancient contract image via Shutterstock