Written By: Juan Hernandez
Those of us in the FinTech and blockchain industries often get caught up in the pure technology innovation that distributed ledger can bring. I’m certainly guilty of that myself, given my computer science background. I tend to marvel at the sheer elegance and simplicity of blockchain and am thrilled by all the potential applications of the technology.
Even when I take a step back, and look at the business use cases, it is still too myopic in scope. Yes, blockchain can disrupt the stock and bond markets, and most forms of institutional capital can be remodeled with the introduction of this disruptive force. But if that’s all those using blockchain are trying to accomplish, then we are all failing broader society as a whole.
The earliest iteration of Openfinance began shortly after the passing of the Jumpstart Our Business Startups (JOBS) Act in 2012. In summary, the JOBS Act opened up private markets to a broader audience. Many heralded this legislative action as a watershed moment for the democratization of finance.
Our fundamental belief was that wealth creation should be available to all, not just the elite few, and we saw tremendous potential within the JOBS Act and the impending “crowdfunding” boom set to hit the market. We asked ourselves: “How do we make this accessible to everyone?” and set about to build the infrastructure needed to help the industry grow.
Crowdfunding as a movement did take effect in the US, UK, Europe, South America and many other regions, but it never quite grew to the level that many anticipated. The industry encountered several barriers that caused a faltering of the movement: operational inefficiencies, muted public awareness and lack of institutional support.
What we can learn about building trust from Mexico’s Tandas
The concept of “crowdfunding” in and of itself is not new. The act of individuals banding together to help each other financially has existed for centuries in many cultures worldwide.
For example, there is a tradition amongst small Mexican villages of informal loan clubs called tandas. Groups of community members gather together and pool their funds, and offer it as a loan to fellow villagers. My parents grew up in rural Mexico, and like many immigrants, they brought this tradition with them when they arrived in the United States.
A tanda can be managed in a variety of ways. Here’s one example:
Ten members of the community (relatives, friends and acquaintances) get together to form a group, and each member agrees to give $100 every two weeks to the organizer of the group. The group gives one member the whole pot at the end of the month: $2,000. The next month, the pot goes to another member of the group. This goes on for 10 months until every member receives the pot.
Each member pays $2,000 into the group. Each member receives $2,000 from the group.
If someone were to receive the $2,000 early on in the rotation, it would act as a no-interest loan, which could be used for a big-ticket purchase or to pay medical bills. For members who receive the pot later on in the rotation, the tanda acts as a savings account for that individual.
The structure of a tanda varies per instance, but typically it is formed within tight-knit communities, since the core foundation of the group is based on members trusting each other to make the required payments.
If a member misses a payment, the consequences are letting down close friends and family, a public penalty of shame that serves as a harsher punishment than a default notice from a bank. Your social collateral effectively serves as your trustworthiness factor to the group (and to the broader community).
While there are many benefits to these informal rotating savings and credit associations (ROSCA), the tandas are not without risk. An unscrupulous member of the group could receive the pot early and never return to the group. The leader of the group could also disappear with the entire pot. Members of the group may not be able to keep up with the recurring payments into the pot. There are inherent issues with tandas of transparency, organization, localization, money collection and distribution methods. Despite this, studies have shown that these problems within tandas rarely occur.
As someone whose family has personally taken part in tandas, I have seen firsthand how this process can work and how it fosters economic opportunity and empowerment for participants in the community.
A tanda is illustrative of the fact that, even in an environment where there is a lack of institutional support (due to opportunity cost, regulation, or operational expense), capital markets can still organically develop, be they in the form of a combined peer-to-peer banking and peer-to-peer lending model like a tanda, or other forms as supported by the local infrastructure.
Ultimately, big or small, capital markets come down to TRUST: a fragile construct of the social fabric that makes up a community at large.
Democratizing capital markets with “trustless” blockchain
I believe blockchain technology can be used to build trusted capital markets infrastructure that could one day be utilized even at the micro level of tandas.
Capital markets shouldn’t only be accessible to traditional institutional participants, but to everyone worldwide. A local villager should be able to tap into their local/regional capital market with the same level of confidence that an American investor places in their Vanguard fund.
Let’s move a step up the ladder from a tanda. A small business, say a local bakery, needs a new oven for its shop. The total cost may amount to $5,000. This might be too small for a traditional loan from the bank (or too much paperwork). Instead of relying on the bank however, the business can ask its local customers to chip in for the oven, and in turn the customers can receive a piece of the revenue of the business (revenue share). This is now possible after the JOBS Act. Unfortunately, it’s not a very efficient model, as some groups have already tried to do this during the crowdfunding boom, and ultimately found that it was not a scalable business model for a centralized platform to perform. As a result, these types of small business owners have been unable to tap into these private capital markets effectively.
Let’s move another step up the ladder. A local real estate developer, who wants to build condos or single-family homes in an up-and-coming neighborhood, may have a hard time securing financing from a traditional lender at attractive rates. Now, thanks to the JOBS Act, the developer can turn to the local residents to help raise the capital needed for the project. The developer gains access to new source of capital (at a potentially lower cost) and the local residents have a way to participate directly in the economic benefits of the project. This is already happening today, but much like the tandas, there are issues of transparency, organization, localization, money collection and distribution methods.
Moving even further up the ladder, the benefits of tapping into these “distributed” capital markets become more evident. From individuals and small businesses all the way up to emerging fund managers and institutional asset managers, all can gain equal access to new sources of capital, lower cost of capital and broader distribution.
But now, blockchain technology can remedy some of the shortcomings in these original crowdfunding methods. The inherent “trustless” nature of blockchain enables the removal of redundant centralized dependencies that bring forward operational efficiencies and create a more streamlined flow that enables more dynamic capital markets, along with a driving factor of additional trust and transparency.
As a point of clarification, when I talk about blockchain being “trustless”, I don’t mean untrustworthy. Instead, I mean a system whereby participants don’t have to depend on the intentions of other participants; instead, they can be assured that the system will function in the same manner regardless of the intentions of others, thus enabling transparent and immutable interactions in a peer-to-peer basis with other system participants.
We’re likely not going to see tandas reliably conducted on-chain anytime soon. It’s going to take time for the benefits of blockchain to work their way down to that micro level. There is a lot of infrastructure that needs to be built out first – infrastructure that has never been built before, in a distributed and “trustless” fashion. We’re working on some of that infrastructure at Openfinance.
While much of today’s work is starting within the realm of structured capital markets, I believe that the technology being built now will ultimately work its way downstream and benefit a broader audience of underserved communities and populations. And, this technology will enable the creation of trusted capital markets that can be accessed by everyone in a fair, orderly and efficient way that protects both investors and issuers alike.
Today, we face a once-in-a-generation opportunity to reimagine and modernize capital markets as we know them. Wealth creation should be available to EVERYONE, regardless of economic background, not just the elite few. Many of us in this space are hard at work building toward this brave new world, where everyone can enjoy the same levels of access, transparency, and efficiency to empower their own financial future.
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