This project aims to build a proof of concept of distributing and holding stock exchange values across different owners through the help of Ethereum smart contracts.
To simplify explanations and discussions, we will only speak about company shares that are bought and sold through a stock exchange classic principle but the concept aims to enlarge to any buyable product.
A central organisation (Cent) buys shares of XYZ on a stock exchange and wants to be able to distribute the ownership of these units to others. It can be a full share but also a part of it (fractional-share).
People can then buy those fractional-shares in a decentralized way.
We want here to demonstrate that this is feasible using Ethereum decentralized virtual machine.
- Smart contracts
- Token creation, distribution and exchange
- Proof of ownership provided by the underlying blockchain of Ethereum
- Wallets to old tokens
Ethereum is based on Ether which as a market cap of around 20B$ (3/6/2017). Usage of the peer network and the "computer" requires that each transaction is backed up by a fee that will transfer Ethers from one account to multiple miners to thank them for having settled and verified the transaction. At the moment Ethereum works on the base of a PoW (Proof of Work) but this might change in the near future to a Proof of Stake. See a comparison here
Meaning that each transaction happening on the networks induces a fee that someone needs to pay for.
Stock markets are subject to volatility either is the Ethereum network. This problem needs to be addressed in order for the Buyer or the Seller to pay the right price for fractional-share trading.
Holding fractional shares represents a risk because it might create illiquidity. Indeed, when trading on the stock market there might already be some liquidity issues because there is not enough orders in the order book to enable a trader to successfully execute an order. This problem might get even greater with fractional shares and an early market creation. The critical mass needs to be met on this secondary market to enable efficient trading of assets.
When trading on regulated market bid-offer spread provides liquidity. This aspect might or not need to be taken into account. Even though, at large scale, creation of fractional-shares might be a solution to avoid bid-offer spread and provide higher liquidity.
The fact of creating a secondary market-place might create an additional volatility on the available securities.
Legal side needs certainly to be inspected carefully. From a basic understanding, if this system is used in a way that it creates a separate value it might fall under strict regulation, if it's used to create trust and a decentralised ownership it might be easier. Therefore value might need to be tight to the value on the stock market, demand created, needs to be followed by Cent.
Therefore, I do not recommend, neither do I take responsibility for the use of this project. Make your researches and make sure you can do it.
As seen, the goal is to create (via Ethereum) fractional-shares of stock quoted shares of a company. The idea is that Cent serves as a deal-maker for the secondary market. Therefore, we need to be sure that Cent will respect the secondary market by binding shares ownership to the blockchain and that it cannot be undone unless units want to be sold.
In order to respect that engagement, the idea would be to create a legal regular contract that would be stored in the blockchain that everyone can access in case there would be an issue. Those shares would need to be non lent neither borrowed and hence be hold on a bullet-proof custody account. In order to create trust, it might be worth that a non profit organization ruled by Blockchain voting is in place. This non-profit would have responsibility to create legal binding contracts and take all reasonable steps in order to insure that Cent is respecting the contracts they signed off. An insurance contract on default might be worth to be put in place. This insurance contract would create pressure on Cent to not make default as they would have necessary power to recover any damage as a straight profit in turn of paying the asset price and mandating another Cent to re-bind on the existing contract.
In order to create a Cent. A company must apply to the non profit by signing off necessary standard contracts. Once done, the company would be submitted to a vote by the non-profit for approval.
The way this binding system is made should also enable individuals to value their rights if they feel the non-profit is failing on them.
Cent's are hard to create and imply a market-barrier. Chained default is possible but is still hard to create. The non-profit needs to police the Cent's which would involve money lost because the non-profit would need money to work and this money would need to come from market players.
An alternative way would be that anyone could be a Cent but that each Cent puts a collateral as a warranty to the ownership, incentivising Cent's to not fail on their engagements. This collateral would need to be higher than the value of the asset otherwise, when the value of the asset rises, there would be no incentive anymore of keeping the asset. A threshold should be in place that would auto-engage higher collateral when asset value increases. If Cent cannot put a higher collateral, a third market would have to be put in place to exchange those contracts when someone is about default it.
To incentivize Cent's to be created, they would need to receive a premium and make money by just doing this job otherwise there is no point of becoming a Cent.
Once a Cent has made more money than what the underlying asset costs it could default it just by reducing the profit made without anyone noticing it and create a bad chain reaction at some point.
Cent's could also pretend they own the asset and just engage a collateral without ever having the underlying asset which would mean that blockchain owners do not own the asset but just a right on the collateral thus offer and demand on this secondary market would not have any impact on asset price and flaw the whole purpose of the project.
Corporate actions need to be reflected on the secondary market as well.
- Cash dividends
- Stock dividends
- Splits
- Symbol change
These events being public, it is rather easy to reflect them on owners but some problems might rise as well.
Indeed, stock dividends and splits might produce more/less shares associated with cash. The reason for that is that company usually prefer avoiding ending up with fractional shares. Hence, users might surprisingly receive cash as well even though it was not a dividend. How to prove the right of the user on getting a part of this cash as the only one ending up with the information is Cent?
Corporate actions do happen always when the markets are closed, therefore the price of the asset is not moving at that point, even though it has moved, there is always a fixed price when the corporate action happens. Therefore this price can be known and flaws can be excluded.
A solution needs to be found to force the contracts to respect that. Meaning a source needs to give the information and the source data needs to be bulletproof otherwise the contract will not be correct and actions would be taken without right because of the nature of the program not being able to revert when an error happened. Errors can not happen. Hence, it would be the responsibility of the non-profit to grant corporate actions data introduction into the contracts. Again this could be done through a vote and event automated per contract by using multiple sources and maybe even some humans when sources aren't agreeing on something. It would be fair to take also into account the opinion of Cent but the casting vote would need to end up being in the hands of the non-profit to avoid conflict of interest. Meaning if every party agrees (Data sources and Cent) the non-profit does not need to be taken into account. When unanimity is not met, then the non-profit has to cast vote the data introduction.
So when an event happens (no matter which). Multiple data sources need to try introducing the event in the blockchain to cause a reaction. Cent needs to provide the same information. If consensus is not met, multiple voters of the non-profit would need to give their version of the story, if 2/3 agrees, Cent needs to execute as the non-profit casted the vote.
Up to Cent to go after them if they think there really is something wrong, this can be done off blockchain without impacting traders.
Cent is a company that just wants to delegate ownership and to enable people to own fractional-shares with the help of the blockchain. Having this approach in place, enables users to need less trust in Cent, helps reducing the risk of being hacked, loosing track of ownership and reducing costs faced in IT infrastructure.
By having those safe harbours in place, Cent can offer a better service and excel at costs.
- Placing legal contracts of ownership in the blockchain (public records)
- Use of a custody account to ensure shares are not borrowed or lent
- Group trade users to have better deals
- Respecting market will
- Enable inter user share exchange to remove stock-markets and broker fees
A wants to buy XYZ shares.
XYZ:BR, is a Buy right on XYZ
