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Glass Boxes: Bitcoin Investments and Real-Time Transparency

This is an incredibly exciting time to be alive. Before our eyes, we’re witnessing the evolution of a technology that’s simultaneously empowering, liberating, and disruptive. The decentralized blockchain is already beginning to shake the world; with each passing month, cryptocurrencies are gaining wider adoption as programmers and entrepreneurs create, innovate, and explore new possibilities.

Yet this is only the beginning. It’s not just the currency that’s evolving – it’s the platform. Bitcoin will soon be supplemented by tools and protocols such as Open Transactions, Ethereum, and Mastercoin that enable smart contracts, digital assets, and the creation of any financial instrument imaginable – from stock to options to bonds and beyond.

In light of these upcoming advances, let’s take a look at one area that stands to be utterly revolutionized as the next level of development takes hold.

DO YOU TRUST ME?

Imagine you’re a forward-thinking entrepreneur with a small, successful business. You’d like to expand your startup, but lack the necessary funds. Rather than turn to a bank for a loan, you’d prefer to offer digital shares in your company.

If you try to do this today, you’ll run into two nasty obstacles.

  • A lack of trust and transparency. The nascent Bitcoin investment market can be summed up in two words: Caveat Emptor. From currency miners to online casinos to nebulously-described Bitcoin funds, there’s no shortage of ways to invest your hard-earned BTC. Unfortunately, there are also endless tales of losing investments and outright scams. As an entrepreneur, it may be difficult to prove to skeptical investors that you are legitimate, with an actual revenue-generating business.
  • The logistical limitations of the Bitcoin protocol. Bitcoin, on its own, doesn’t lend itself to the creation and trading of securities like stocks and options. Websites and services have stepped in to meet this need; however, this places the onus of trust on a third party. The ideal solution would have trust baked into the equation; neither the business nor its investors should have to worry whether a particular exchange or service is trustworthy. Much like Bitcoin itself, shares in a company ought to use a decentralized network to provide built-in trust.

The good news is that smart contracts and digital assets will soon provide an elegant solution to the second problem. But while the rise of “Bitcoin 2.0” offers a better way to issue and trade shares, investors will still be eager to manage risk; they’ll want to know which companies are legitimate and have a successful business model. In short, they’ll need more information.

BLACK BOX, GLASS BOX

Private companies operate in a black box. With no outside investors, they maintain full confidentiality over their financials; there’s no incentive to do otherwise. Today’s publicly traded companies provide a deeper level of insight, issuing quarterly reports on their performance. These backward-looking, after-the-fact results show investors where the company was, but not necessarily where it’s going. (In his recent piece on Triple Entry Accounting, Jason Tyra showed how that method could improve trust in financial statements.)

The advent of the decentralized public ledger has paved the way for a new approach to the disclosure of financial results – a system that can be used to build trust and credibility.

Real-Time Transparency (RTT) stems from the simple notion that information wants to be free. In this system, key financial results – such as incoming revenue – are monitored in real-time via specific public addresses enshrined in blockchain’s public ledger. RTT is the antithesis to the Black Box; it opens the windows and lets investors peer inside.

There are major incentives for companies to use this approach. The ability to instantaneously track key financial results would give investors more timely and accurate information on a company’s performance. Trust levels are increased, and the business owner stands a better chance of gaining investors. And as we’ll see, RTT also opens the door to novel ways of rewarding those investors.

REAL-TIME IN REAL LIFE

RTT provides a way to see how a company is performing at any given moment. It’s as simple as using the Blockchain to monitor certain key metrics. Let’s use one metric – incoming revenue – as an example. A business owner looking to attract investors could do the following:

  • Designate one Bitcoin address as the destination for all incoming sales.
  • Using the blockchain, this address would be easily tracked by investors. It could also be verified; investors could make a test purchase, for instance, and verify that those funds actually went from their address into the revenue address.
  • Investors (and potential investors) would be empowered with timely and relevant information on which to make their decision. Is the company actually bringing in money? How many sales have been made over the past month? Do these figures approximate the projections made by the business?

Want to provide even deeper insight into your organization’s performance? Simply leverage the blockchain by confining all business expenses to BTC, rather than dollars. State, in advance, all your fixed expenses – from servers to salaries to utilities. Investors could then verify that the stated expenses are indeed being transferred to the service provider, who also maintains a public address. This would allow potential investors to more accurately vet the company; if they think the expenses are too high, they might steer clear.

RTT, however, does pose a few challenges of its own:

How do buyers maintain their privacy?

If a company’s revenue address is public, this naturally means that anyone would be able to see the source of incoming sales. This could present a problem in cases where buyers didn’t want their Bitcoin address linked to the company’s revenue address. Fortunately, tools such as the forthcoming Dark Wallet will soon give buyers the privacy they crave. These tools could even be offered at the point-of-sale by the company itself.

How do businesses maintain strategic secrecy?

The interesting thing about RTT is that transparency isn’t binary; it can be offered on a sliding scale. Companies that don’t want to reveal any information to competitors might opt to reveal no financial results, knowing that this might limit their appeal to investors. Businesses looking to foster greater trust would have a stronger incentive to “open the kimono” and reveal revenue, fixed expenses, and other key financials via the blockchain.

MEET THE CONDITIONAL DIVIDEND

Most investors are familiar with the concept of a quarterly dividend, where a company rewards its investors with a pre-determined amount – say, 25 cents/share – as a way to share profits and incentivize ownership.

RTT opens the door to a tantalizing possibility: the creation of a conditional dividend, which is paid out if a certain revenue target is exceeded within a designated timeframe. Shareholders, for example, might be rewarded an extra 200 MBTC/share if incoming revenue passed 100 BTC for a particular month. This conditional dividend would be safely programmed into the dividend’s smart contract, and paid out immediately in the event the revenue target was exceeded. Rather than trust the company to report the revenue figure accurately, shareholders could monitor progress toward the dividend target in real-time.

Another benefit of RTT would be fewer nasty surprises for shareholders. Currently stocks can experience violent price swings when unexpected news, such as a weaker-than-expected earnings report, hits the market. Similarly, shares can gap higher and skyrocket if a company surprises to the upside. Price action would likely be smoother as these developments are factored in real time, rather than all at once via a quarterly earnings announcement.

SCRATCHING THE SURFACE

If you were an entrepreneur who owned a successful or promising business, what would be the best way to attract investors? As we’ve seen, it’s all about fostering trust. RTT offers an easy and effective way to do just that.

The applications of the transparent approach aren’t limited to businesses; they could be applied to non-profits, or even crowdsourcing efforts. Down the road, RTT may also be a natural fit with Decentralized Autonomous Corporations(DAC’s) – businesses that are pre-programmed with business models and mission statements.

A flourishing market for smart contracts and crypto-investments isn’t far behind. We can reasonably assume that within a year or two – or perhaps much sooner – there will be an easy and secure way to invest in companies. It’s safe to say that within that market, open and transparent organizations will stand a better chance of gaining investors’ funds and support.

The future is on its way, and you can see right through it.

Photo via Rob Deutscher and licensed under Creative Commons CC-BY-2.0

Kent Barton

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