Why Tokens Will Lead the Next Wave of Financial Innovation

But that alone does not explain their success.

Essentially, Exchange-Traded Funds (ETFs) are a modern financial tool that makes it simpler for the average investor to access various asset classes and investment strategies that were previously challenging to reach. This encompasses a wide range of options such as municipal bonds, foreign equities, stock options, private credit, among others. By lowering entry barriers and boosting flexibility, ETFs have transformed the way people approach investing.

It’s no wonder that ETFs have thrived. Historically, financial advancements have tended to follow a common pattern: making investments more accessible, reducing complications, and expanding options, often leading to the emergence of entirely new markets. For instance, mutual funds (1924) enabled multiple investors to combine their resources and invest in a diverse collection of securities. The introduction of the Diners Card in 1950 transformed purchasing habits by allowing people to buy goods without cash on hand, thereby fostering a vast consumer credit market. Discount brokerages in 1975 democratized stock trading, making it possible for ordinary investors to participate. Lastly, online banking and brokerage services during the 1990s made financial management more convenient for those with mobility issues or living in remote areas.

Each technology started modestly, gradually making its way into the market over a period of time.

Initially, ETFs were considered specialized investment vehicles that may have appealed to a select group of individual investors engaged in do-it-yourself investing, yet they seemed impractical for financial advisors, professional traders, large institutions, wealthy individuals, and prominent figures on Wall Street.

Initially, Exchange-Traded Funds (ETFs) were primarily designed as index funds; however, a significant shift has occurred in the market, with most new ETF launches now focusing on active strategies rather than passive ones. In fact, according to BlackRock, active ETFs accounted for an impressive 76% of all U.S.-listed ETF launches in the year 2023, and attracted 21% of global ETF investments during the same period. The company forecasts that active ETF assets under management will soar to a staggering $4 trillion by 2030, marking an over four-fold increase from its current value of $900 billion.

The success of the ETF market is an example of Clay Christensen’s Innovator’s Dilemma. When new technology emerges, the incumbents in a market (in this case traditional asset managers, banks and brokerages) are often slow to embrace it, allowing disruptive innovators to get a critical head start. Their position is understandable, says Christensen. In the investing world, small-time DIY investors were initially the least interesting kind of customer. They didn’t have a lot of money to invest, were stingy about fees and therefore could be easily dismissed.

The perspective taken was narrow-minded, as incumbents underestimated the capacity for growth within the Do-It-Yourself segment due to technological advancements such as Exchange Traded Funds (ETFs) and online brokerages. Furthermore, they underestimated the widespread popularity that ETFs could potentially possess.

Christensen argues that you can’t study or evaluate markets that haven’t been established yet. However, Exchange-Traded Funds (ETFs) have brought about a $10 trillion market previously nonexistent, showing how an existing market can be replaced or overtaken by something new, much like how the emerging market has supplanted the old one.

Tokens, like ETFs, have the potential to democratize finance further.

In essence, there’s a lot of misunderstanding surrounding tokens, with tales and misinformation being common. Frequently, all tokens are labeled as “crypto,” such as in the context of “cryptocurrencies.” However, it’s unfortunate that this label is often misleading. The reality is that many, if not most, tokens are not striving to function like traditional currencies – serving as a medium of exchange, store of value, or unit of account. Instead, it’s more accurate to view tokens as vessels for value, much like a standard shipping container can hold anything from computers and car parts to potatoes and canned fruit.

These versatile digital holders, or “tokens,” have the ability to symbolize various forms of worth – stocks, bonds, artwork, intellectual property, etc. – just as a website can be customized to showcase different types of content, such as an online store, social media platform, or government portal. What makes these tokens exceptional is their global accessibility via the internet, eliminating the need for numerous traditional intermediaries. Advanced features like smart contracts enable automated functions that were previously handled by brokers, exchanges, and transfer agents, thereby minimizing friction and costs.

As a researcher delving into the world of tokens, I can’t help but acknowledge that so far, the U.S. dollar has been the pioneering application for these digital assets. These dollar-backed tokens, often referred to as stablecoins, offer users the unique ability to transfer and save value in dollars, which can then be utilized across a vast array of financial services. Examples include trading securities, depositing funds in lending platforms to secure loans, or investing in budding startups.

Similar to Exchange-Traded Funds (ETFs), tokens offer a unique opportunity to establish fresh markets (currently untapped by billions of individuals who don’t participate in financial markets) and enhance the convenience and personalization of financial products (due to their infinite programmability). As traditional banks and competitors grapple with this emerging technology, pioneers will assume a dominant global role. Eventually, incumbents will be compelled to either adopt or collaborate with these innovators shaping the future of finance.

Just as giants like BlackRock, Vanguard, and State Street became dominant players due to Exchange-Traded Funds (ETFs), the upcoming financial titans could arise from the token industry. However, it’s unclear exactly who these newcomers will be. There are potential contenders, but it seems as though anyone could potentially take the lead in this emerging game.

Please be aware that the opinions shared in this article belong solely to the author, and they may not align with the perspectives of CoinDesk, its management, or associated entities.