Equity, Liquidity, and Volatility

Startup equity is a core concept in business. Everything from a venture capital investment in a software
company to an ownership stake in your cousin’s new restaurant falls into that category. But traditional
startup equity has no liquidity — you don’t invest in a restaurant with the hope of flipping your shares a
month later. No liquidity means no price discovery, either. Your investment is hard to value.

Crypto is different because a token can start trading right away — sometimes even before the function
the token is meant to be used for is live. This feature is enabled by crypto’s underlying infrastructure,
architected for a post-digital world where data roams freely and important tasks are performed by code,
not clerks. This doesn’t mean every project has to issue a token right away, but many do.

Early liquidity has benefits and drawbacks. Before analyzing them, it might help to understand why the
legacy financial system doesn’t offer this option, even to those who may prefer it.

Despite becoming more digital, the architecture of the Wall Street-run system is the same as it was
decades ago. It relies on opaque systems that don’t talk to each other and still require a good deal of
manual processing. Trading may look hyperactive, but back-office settlement is a bottleneck, leading to
access being restricted to the shares of the biggest companies. Regulations also plays a role in this
gatekeeping, but infrastructure is the primary bottleneck. The startup boom of the past decade has led
to the creation of bespoke markets for smaller companies, but they too are limited in scope. Most
companies can’t issue liquid shares, even if they wanted to.

The natively digital design of a blockchain platforms like Ethereum empowers it to handle more assets
by orders of magnitude — hundreds of thousands (and soon to be millions) of tokens that can trade
around the clock. Code automates how tokens are issued, traded and transferred from one owner to the
next. All assets are programmable, improving how different assets (such as a crypto coin and a fiat coin,
which is pegged to traditional currency) interact, reducing errors. Fractional ownership is easily
accommodated, and universal access to the infrastructure is granted to entrepreneurs and investors
alike. If this were the media industry, then Ethereum would be to Wall Street what YouTube was to
cable TV, for better and for worse. Better infrastructure and a lack of gatekeepers results in greater
participation and innovation, but the lack of curation means more garbage, too.

These features enable cheaper to operate and more dynamic markets, and in some cases financial
models that would not exist otherwise, thus why everyone from central banks to Wall Street is exploring
blockchain technology. The added efficiency comes with tradeoffs, however. On the one hand, capital
formation improves, and entrepreneurs can tap a larger pool of potential investors. But an unavoidable
consequence of bringing such enhanced efficiency to the shares of any young project is extreme
volatility.

Most startups fail, and investing in one is making a bet in a race against oblivion. From the
entrepreneur’s point of view, every decision — what kind of food should a new restaurant serve — has
an amplified impact. So do outside developments, like getting a liquor license. From the investor’s point
of view, trying to discount the consequences of these decisions is equally daunting. The distribution of
eventual outcomes for any business is widest at birth, so rational investors have no choice but to
constantly overreact.

If your cousin’s new restaurant had tradable shares, they’d probably be as volatile as crypto. Landing a
liquor license might make them quadruple, while a bad review may make them tank. Given the
uncertainty, external developments would also have an amplified impact. A new restaurant is more
vulnerable to things like dining fads or bad weather than an established one.