Forget Bitcoin: blockchain could mean universal access to cash

 

 

Dr Katrin Tinn explains how the technology behind Bitcoin could make it easier to access funds

 

Bitcoin may succeed or fail as a global currency, but the underlying blockchain technology has, on its own, much broader potential applications: both startups and incumbents in the financial services industry are exploring its potential in speeding up transactions and slashing operating costs. It is seen by some as having as much revolutionary potential as the internet.

 

In a new research paper, Blockchain and the Future of Optimal Financing Contracts, I explore the impact of so-called smart contracts – contracts that automatically execute predetermined actions when predetermined conditions are met – and show that, under optimally designed contracts, external financing would be as cheap as internal funds, and more accessible to agents with no proof of cash flow or collateral assets (a common bugbear for entrepreneurs raising money).

 

One of the biggest hurdles entrepreneurs face is financing their projects. Launching a firm is an inherently risky and difficult endeavour, and anything that makes that more challenging is unwelcome. Conversely, technology that eases the pain of growth will be coveted. Blockchain potentially widens the pool of people who can raise finance. In theory, anyone anywhere in the world could access cash – or at least have the chance to.

 

We are living in a world where entrepreneurs are able to analyse data faster and faster: the potential of blockchain to provide reliable and up-to-date transactions data will probably amplify that trend. Traditional assets lack the flexibility to react to entrepreneurs’ changing incentives as new information arrives: when, as now, incentives can change at a faster and faster rate, this lack of flexibility becomes increasingly costly. A key feature of smart contracts on the blockchain is that they can benefit from time-stamped transaction records, and react to the arrival of new transactions data in a predetermined but flexible manner.

 

High early sales can be either an indication that a product is gaining popularity among its target consumers, or an indication that the target market is becoming exhausted. A smart contract, which takes the form of a dynamically adjusting profit-sharing rule, benefits from incorporating this information and making financing ultimately cheaper.

 

Simple equity contracts are less than perfect because the share of sales revenues the entrepreneur retains is fixed – and it needs to be high enough to keep the entrepreneur incentivised even in the worst-case scenario. This makes access to financing more difficult as the contract does not benefit from the fact an entrepreneur would be ex-ante willing to give up a bigger share in the best case scenario to access financing more easily and cheaply.

 

Equity is still noticeably less expensive than debt contracts, and gives the entrepreneur an incentive to quit early following initial bad luck: there is little reason for them to continue to put their best efforts into selling a product if nearly all revenue they make goes to the financier. This undesirable feature of debt becomes a bigger obstacle in an environment where you can learn from sales data ever more quickly, i.e. the sooner an entrepreneur can ‘see’ they’re not making as much money as they would like, the sooner their efforts will slip.

 

With better sales data, faster processes and wider access to capital, the blockchain could encourage the creation of new types of flexible profit-sharing contracts. These are better positioned to handle the increased capabilities in data analysis, and the trend towards more short-term engagements and the so-called ‘gig economy’.

 

The full version of this article can be found on IB Knowledge.