BitMex Founder: What new financial products will DAO unlock?

Author: BitMex Founder, Arthur Hayes

Compiled by: Block unicorn

The Road to the Return of Wind Turbines

Look around------every object interacting with you began with someone's imagination. This idea then infected others, persuading them to part with their material or financial capital to create it. The more organized, popular, and well-funded an idea is, the easier it is to realize.

The goods and services enjoyed by society depend on the ability to organize and deploy capital in specific places. The ways in which various cities and nation-states utilized maritime navigation to expand their economies perfectly illustrate the importance of organization.

Like most American high school students my age, we spent a lot of time in history class documenting the various ways European countries colonized parts of the Americas, Africa, and Asia. The novelty of exotic continents and trade routes was "discovered" by brave individuals seeking wealth. Today's curriculum might focus more on the various odious ways nations expanded their empires (and they should)------but when I was in school 20 years ago, history class wasn't that sobering.

During the Ming Dynasty------a century earlier than the European Age of Exploration------a Chinese naval captain named Zheng He landed at various points along the African coast with impressive large ships. His vessels featured waterproof hulls, magnetic compasses, and fresh citrus fruits to combat the scourge of scurvy.

Unfortunately, due to financial strains from Zhang Qian's voyages and other internal economic issues, the emperor at the time unilaterally ended China's maritime voyages. Shipyards were sealed, and China's economic engine entered a long stagnation that wasn't broken until Deng Xiaoping's southern tour in 1992.

Centuries after Zheng He's death, a cold, damp, dark little island called England became a global empire thanks to its powerful navy. (It also helped that England didn't have to frequently defend its land borders, allowing them to pick battles to keep the European continent divided------but I digress.)

The technologies adopted among various European and even Chinese sailors were not the determining factor in which nation-state floated the most impressive ships. Instead, it was the way maritime financing was conducted. What truly made the British (and the Dutch) so successful was their pioneering of the limited liability corporation.

A corporation is a fictional concept that allows strangers to agree on a set of codified principles under which they can pool capital and limit risk. When one party violates the spirit of the agreement, the legal system supporting the corporate charter ensures that everyone believes in this illusion by legitimizing sometimes violent state reprisals. The emergence of corporations allowed a diverse array of people------both wealthy and non-wealthy------to participate in the expansion of global trade. Citizens of European nations collectively agreed that paper notes, also known as "stonks," could be used to represent partial ownership of these fictional entities, thus creating the first stonk market and enabling investors to speculate on the future success of a given company.

A system that includes as many people as possible pursuing dreams is more likely to succeed because it can raise more capital. Another approach------at least as it relates to maritime activities at the time, monarchs (like Spain) or emperors (like China) unilaterally decided which voyages to undertake and retained most of the profits------could not compete effectively. After our Lord Satoshi Nakamoto led the revival, we no longer think of corporate entities as decentralized------but half a millennium ago, a company funded by different individuals was the original decentralized organization. It is well-known that decentralized, inclusive systems are more successful than centralized monopolistic systems in many tasks.

The conclusion is that a fictional entity called a corporation allows a group of people to appropriately leverage risk opportunities and create immense wealth for shareholders and their homeland. This new framework for organizing people and capital allows for the full utilization of maritime globalized trade.

So, what will be the new shared narrative that unites billions of people to create and develop various metaverses in the near future? It is decentralized autonomous organizations, or DAOs.

The focus of this article is to illustrate how DAOs can introduce new, independent financial markets that exist only within their respective Metaverses. The end-to-end use of cryptocurrencies transmitted via public blockchains will unlock amazing financial products that will help effectively allocate risk and capital within the metaverse. The result will be a powerful civilization that exists solely on silicon-driven thinking machines, let us pray.

DAO Triple Entry Accounting

In my junior year, I foolishly applied for an advanced accounting course. Like many universities, students can sample many courses in the first two weeks. Only after the first two weeks of the semester do you need to decide on your final course load.

The professor began describing the various skills we would learn to uncover inconsistencies and fraud in financial statements. After a semester abroad, forensic accounting didn't sound appealing. I dropped the course.

Forensic accounting became a thing because double-entry bookkeeping has a fatal flaw. The fatal flaw is that by looking at a set of management accounts, we implicitly assume that all payments flow to the correct party and that the relevant company actually owns the value of the assets recorded on the books. To authentically verify the information provided, we must inquire with third parties whether certain payments were made (banks) or whether the company owns the title to an asset (government property office).

By definition, a DAO exists only in digital format on a public blockchain. This means that its assets, liabilities, and shareholders' equity (issued governance tokens) are completely transparent, and anyone with an internet connection can publicly verify them. Furthermore, the flow of funds between the DAO and any of its counterparties is also publicly recorded on the blockchain.

Imagine a Metaverse called PalmByte and a commercial landlord named TrumpDAO. TrumpDAO builds the largest and worst virtual buildings and residences and rents them out to virtual characters within PalmByte, all of which are golden.

To get started, TrumpDAO issues TRUMP tokens in exchange for ETH. Suppose TrumpDAO raises 1,000 ETH and issues 1,000 TRUMP tokens. The reporting currency for TrumpDAO is ETH.

Balance Sheet

Assets:

1,000 Ether

Liabilities + Shareholders' Equity:

1,000 TRUMP worth 1,000 ETH

To build the most humid structures in PalmByte, TrumpDAO hires Tadao Ando as the digital architect. Who knew TrumpDAO had such good taste…… Tadao Ando charges 100 ETH. The remaining 900 ETH is used to purchase land within PalmByte. The output of this expenditure is 100 virtual buildings.

Balance Sheet

Assets:

• 1,000 ETH [Tadao Ando fees + virtual land purchase]

• 100 buildings

Liabilities + Shareholders' Equity:

1,000 TRUMP worth 1,000 ETH

TrumpDAO is able to rent all 100 properties at an annual rent of 1 ETH per unit.

Year 1 Income Statement

Revenue:

100 ETH in rental income (100 units * 1 ETH per unit rent)

Operating Expenses:

100 ETH fee to Tadao Ando

Net Profit:

0 Ether

Every data input for creating this balance sheet and income statement for TrumpDAO can be publicly verified on the Ethereum blockchain. This is crucial because now TrumpDAO needs financing to expand.

TRUMP token holders have the right to decide how to raise additional funds to purchase more land, which will then be used to increase rental income. They can dilute themselves by issuing more TRUMP tokens in exchange for ETH, or they can attempt to tap into the fixed income market of the metaverse.

The cost of capital for landlords like TRUMP is currently 5% per year. Token holders decide to issue bonds, hoping that other avatars in PalmByte can invest. The face value of the bonds is 1,000 ETH.

Imagine you are an ETH-rich avatar in PalmByte looking to earn ETH returns. Clearly, you want to lend to the DAO, whose business will allow them to repay you. As a savvy metaverse investor, you can review TrumpDAO's documentation. Some clever development teams have created a handy tool that quickly verifies the accuracy of any DAO's financial statements by comparing the accounting statements written to the blockchain with all input records. This service is almost redundant because you cannot lie with triple-entry accounting. To attract avatars to pay for the service, this accounting dAPP also performs simple financial ratio analysis.

The output is TrumpDAO's solvency. You learn that their return on capital is 10%, while the offered bond coupon is 5%. The dAPP also checks ZillowDAO to understand the current market value of the units owned by TrumpDAO. If TrumpDAO defaults, you want to assess the recovery risk. The PalmByte real estate market is booming------all these new Dorkers are moving across the wafer for better tax treatment and driving up prices.

You do well on the DOGEBONK pump and decide to cancel the entire TrumpDAO bond issuance.

New Balance Sheet

Assets:

1,000 ETH (raised by selling TrumpDAOBonds)

100 buildings worth 1,000 ETH [900 ETH purchase cost + 100 ETH improvement cost due to Tadao Ando's fees].

Liabilities + Shareholders' Equity:

1,000 TrumpDAOBonds worth 1,000 ETH

1,000 TrumpTokens worth 1,000 ETH

In this brief example, the following actions occurred that can be verified by the public blockchain:

1. The DAO saw an opportunity to develop virtual land.

2. The DAO issued tokens in exchange for ETH.

3. The DAO used ETH to pay the architect and purchase virtual land, then created 100 units for rent.

4. The DAO earned rental income.

5. The DAO issued bonds to fund additional development.

The DAO uses the transaction records of its actions from the Ethereum blockchain to programmatically and automatically create financial statements. This allows third-party avatars to confidently take on some credit risk to earn their ETH returns.

Metaverse Fixed Income Market

This simple example is powerful because there is no need for the trust required in TradFi (traditional finance) systems to create companies, issue equity, conduct business, and issue debt for expansion in the metaverse. The DAO structure is completely transparent, and it is cryptographically impossible for a DAO to distort its behavior because every piece of data generated by the DAO resides on the public blockchain.

The fatal weakness of the crypto fixed income market will be ------at least in the initial stages------the need to use a simulated legal system to enforce digital property rights. For example, lending Bitcoin or other cryptocurrencies to a potato farmer, if the farmer refuses to fulfill the contract, you need to trust the legal system of some nation-state to uphold your property rights. This is not an issue if both investors and lenders reside in the same jurisdiction. However, the promise of crypto finance is that for the first time ever, we can connect the world and pool capital for groups that cannot access TradFi capital due to jurisdictional issues.

Metaverse DAOs raise cryptocurrencies, earn cryptocurrencies, and distribute cryptocurrencies. It is an end-to-end crypto economy where every operation can be publicly verified on the blockchain. Therefore, it is impossible to deceive investors by creating misleading and confusing financial statements. Those who want to assess the health of a DAO only need to query the blockchain, and presto! A complete, honest set of books appears.

The programmatic nature of crypto capital also aids in debt recovery. Programmatic liens can be easily placed on digital assets. Not paying back? After a grace period, ownership can be automatically stripped, assets sold, and net proceeds credited to the lender. The asset recovery process is public, transparent, and devoid of the shocking legal bankruptcy costs found in TradFi. It is absurd that after more than 7 years, claims from Mt. Gox are finally being paid out. If a similar situation occurs in the Metaverse, the bankruptcy and recovery process will happen within a few blocks, measured in minutes.

Once investors understand the potential activities and value of business organizations in DAOs, the true power of the metaverse capital market will become evident. But what is even more interesting are the simple financial products that may emerge after using DAOs to organize capital within the metaverse.

DAO Banks

A purely crypto fractional reserve bank issuing its own currency is now possible. Imagine CountryWideDAO, a bank focused on real estate loans. To fund its equity buffer, it raises ETH and issues governance tokens. Token holders vote to elect members to the loan committee, which creates and modifies automated loan standards.

CountryWideDAO takes the public address of property assets as data input and analyzes the loan amount for that property. It then places a digital lien on the property so that in the event of default, the asset is automatically sold on a decentralized exchange (DEX), with net funds flowing back to the bank.

To expand its deposit base, CountryWideDAO pays ETH interest on deposited funds. Its balance sheet includes property loans against ETH deposit liabilities. The DAO governance committee discloses reserve ratio requirements, token buffers, asset return rates, and other standard banking accounting ratios. Depositors and investors of governance tokens can view the bank's health in real-time.

If the bank violates certain metrics defined by the DAO governance advisors, it will automatically rebalance its accounts by raising interest rates to attract deposits, disposing of property loans, and/or issuing additional tokens to increase shareholders' equity.

In the Metaverse, avatars can organize themselves into bank DAOs with different social goals. These goals can be expressed programmatically through loan standards. These loan standards are completely transparent, so there is no doubt about how the bank DAOs issue loans.

Credit Scoring

Various types of employment opportunities will be available in the metaverse. In the above TrumpDAO example, an architect offers his services in exchange for ETH payments. In this way, avatars can build a publicly verifiable employment history, which in turn establishes a credit score. All payments are public information, so whenever a virtual avatar tries to borrow funds, potential lenders can immediately access their complete financial status.

Various credit scoring dAPPs will use different algorithms to attempt to determine an avatar's creditworthiness. Some models will become standards due to their ability to predict defaults. To obtain credit in the Metaverse, avatars will need to purchase credit score subscriptions from various dAPPs when applying for loans from lenders.

The opaque and potentially discriminatory practices of TradFi credit scoring agencies will be a thing of the past. In the metaverse, by definition, the most successful credit scoring dAPPs must be completely transparent about their scoring algorithms. And there is no legal compulsion to use one scoring method over another, so only those methods that actually succeed in predicting default rates will have a chance to gain market share.

Credit Card DAOs

Want to buy that sexy Punk PFP but don't have the money? Don't worry------credit card DAOs will meet the demand.

These DAOs will issue a metaverse credit card to you based on your avatar's credit score, allowing you to use cryptocurrency for approved purchases. DAOs can provide instant approval based on credit scores, the concepts involved, and the items being purchased. Credit card DAOs can even adjust the interest charged based on various factors, all of which are publicly verifiable.

Default risk is reduced because DAOs can automatically increase metaverse income to recoup their funds first.

DAOs, similar to banks, will raise funds by offering crypto deposit rates below loan rates. This is exactly how TradFi credit card companies operate; however, in the Metaverse, the default risk will be much lower because all data regarding avatars' financial histories is instantly public and verifiable.

Mortgage DAOs

Metaverse mortgage-backed securities (MBS) become possible. Imagine you want to buy a pimp pad but lack the funds to purchase it. No problem - you can borrow money based on your credit score. Various MBSDAOs will lend money secured by properties at various interest rates. These MBSDAOs will bundle these loans and sell these securitized products.

Fixed Income Lego Blocks

The way each DAO and dAPP programmatically communicates with each other allows for the creation of hyper-specialized financial products. Eliminating information asymmetry between borrowers and lenders------because all interactions are publicly verified------lowers the cost of credit. I could continue discussing different TradFi fixed income tools in various metaverse styles. Whatever you can imagine in TradFi, the metaverse fixed income market can offer products at lower rates to more avatars with honest public information.

Credit Boom

The essence of credit and debt is the ability to time travel energy. Back to the present, future energy production is the magic that drives the global economy. As long as the economic activity created exceeds the actual interest rates, this will always be true.

Given the vast value to be developed in creating human experiences in a whole new world, the ability to borrow against a bright future will spin the wheel of development faster. The absence of accounting fraud and the programmatic nature of asset recovery in the metaverse will improve the quality of borrowers, thereby reducing the risk for lenders.

The metaverse fixed income market will support billions of people and quickly become the largest, most liquid, and most important debt market in the world. The current dominance of the U.S. economic model directly depends on deep and liquid corporate and government debt markets. The U.S. is a country with a population of 350 million------so imagine the scale and quality of the metaverse fixed income market that will serve 3 to 4 billion internet-connected souls and hundreds of thousands of DAOs.

The exponential growth in human living standards after the first industrial revolution was not only a product of technological advancement but also a product of the financial system that created the ability for companies and individuals to invest now to create a better future. Despite its many flaws, TradFi supports the improved living standards we enjoy today and enables governments, companies, and individuals to create a better future through effective capital allocation. It is unfortunate that it has been so absurdly perverted, but Lord Satoshi Nakamoto is here to save us from evil.

Now that we can obtain verifiable, perfect information about all participants in the metaverse economy, the possible financial architectures will unleash a torrent of human creativity and growth, leaving future generations speechless.

All-Inclusive

Due to the DAO structure, every fixed income financial product innovation of TradFi------and more------is possible in the metaverse. The main difference between the metaverse fixed income market and the TradFi market is that the infrastructure will operate publicly.

Every DEX and dAPP will have its own token, allowing users to collaboratively build the financial system they desire. It will not be a closed system where end customers have no ownership, but rather a system that pays consistent economic rents to harness the power of financial engineering. It will not be a system that selectively prohibits certain individuals and businesses from accessing financial services based on appearance, gender, or industry. It will be an inclusive system that generates a larger economic pie for participants to share.

This will not be a system without risks or failures. As a group of computers and humans rewrite the way financial services operate in the virtual world, there will be massive collective errors.

For investors looking to fund builders of a brand new financial system, this is a once-in-a-lifetime opportunity. Many would prefer to be financiers rather than assets transported or financed during the European Age of Exploration. The creation of the metaverse fixed income market provides the opportunity to create the most important financial services for an entirely new realm. In TradFi, raise your fist and repeat after me------"DAO LAY LO MO!"