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The world of finance and investments has always been seen as the domain of elites — a place where the wealthy play by different rules than everyone else. But a new wave of decentralized technologies is changing that, giving rise to a more inclusive economy where everyone can participate.
The best-performing funds, for example, require a minimum investment typically in the hundreds of thousands — or even millions — of dollars. This has made it difficult for ordinary investors to get a piece of the action.
To understand one of the biggest promises of Web3, we must first understand how the economics of the internet has changed and how democratic investing has become one of the frameworks that have made DeFi such a viable investment opportunity for the everyday person.
Pre-Web3: The economics of Mr. Market
Mr. Market — the allegorical figure that represents the collective mood swings of the stock market — has been around for centuries. This is an idea made popular by legendary investor and mentor to Warren Buffett, Benjamin Graham.
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In his original form, Mr. Market was a man who would show up at your door every day, offering to buy or sell your shares for a price that represented his current mood. If he was feeling optimistic, he might offer you $100 for a share that you bought for $80 the day before. If he was feeling pessimistic, he might offer you $80 for that same share.
The key point is that his offer price had nothing to do with the underlying value of the company — it was entirely based on his own emotions. Graham used this idea to illustrate that the stock market is driven by irrational exuberance and fear rather than fundamentals.
This might sound like a simple idea, but it’s one that has been lost on many investors over the years. During times of market turmoil, it’s easy to get caught up in the emotion of the moment and make decisions that are not based on rational thought.
The financial crisis of 2007 and 2008 is a perfect example. Many investors sold their stocks at the bottom of the market out of fear, only to see them rebound soon after. If they had held on just a bit longer, they would have made a lot of money.
Of course, it’s not always easy to stay calm when the market is in freefall. That’s why it’s important to have a framework for making investment decisions that take emotions out of the equation.
The elitist hierarchies of current capital markets
The early days of Mr. Market might have propagated a relatively simple idea — provide capital to a company and that company will share its prosperity with you. Those days, grim as it may seem, have taken a turn for the worst.
The capital markets of today no longer work as intended. They have been taken over by a new breed of investor, one that Graham could never have imagined in his wildest dreams. These are the hedge funds, private equity firms, and venture capitalists that have transformed the way companies are funded. And they come with a whole new set of rules.
The first rule is that you must have a lot of money to get into the game. Best-performing funds require minimum investments comprising many zeroes — which ordinary investors simply don’t have.
The second rule is that you must be willing to take on more risk. These firms are not interested in funding companies that are going to plod along and make a modest return. They want companies that have the potential to make them rich — even if it means that there is a good chance they will lose everything.
The third and most destructive rule — you must be able to access the right information and access it fast. This means having a network of sources that can provide you with the latest market intel. It also means being able to quickly analyze that information and make decisions accordingly.
This last rule has had the most damaging effect on capital markets. It has led to a situation where a select few individuals have an unfair advantage over everyone else. They are the ones that always seem to know what’s going to happen next, while the rest of us are left in the dark.
This is not how the capital markets are supposed to work. They are supposed to be a level playing field where everyone has a fair chance of success. But that’s not the reality we live in today.
How Web3 has enabled democratized investing
Now that you understand how the current system works, it’s time to learn about the solution: Web3.
In our previous articles, we have discussed how Web3 works and what it means for the future of the internet. In short, Web3 is a new way of using the internet that is based on decentralization, transparency and security.
These three principles are also at the heart of what makes Web3 the perfect solution for the broken capital markets. Let’s take a look at how each one of them can be used to enable a more democratic form of investing.
Preventing outside dealmaking
The first issue with the current system is that it gives an unfair advantage to those with access to the right information. With Web3 and Web3 economics, this will no longer be a problem. The reason is that all of the data required for making investment decisions will be stored on a public blockchain. This means that everyone will have equal access to the same information.
There will be no more need for exclusive networks of insiders. Whereas today’s big players are able to use their networks to get an edge, everyone will now be able to compete on a level playing field.
Enabling collaborative investing
The second issue with the current system is that it is geared toward those willing to take on excessive risk. This often leads to bad investment decisions that can destroy companies and ruin lives.
With Web3, there will be a new type of investment vehicle known as a Decentralized Autonomous Organization (DAO). This is a decentralized, transparent and secure way of investing based on the collective intelligence of its members.
DAOs will allow investors to pool their resources and make decisions together. This will minimize the risk of any single individual making a bad investment that could ruin the entire group.
Creating incentives for long-term investing
The third issue with the current system is that it rewards short-term thinking. Companies are pressured to generate quick returns, even if that means sacrificing long-term growth. With the economics of Web3, this will no longer be the case. The reason is that tokens will be used to align the interests of investors with the long-term success of the company.
Investors will be able to hold onto their tokens and receive a portion of the profits generated by the company as reflected by token value development. This will create a strong incentive for them to only invest in companies that have a sound long-term strategy.
Innovative income generation for those who lack liquidity
Several DeFi protocols allow lending and borrowing of digital assets in a completely decentralized manner. This opens up new opportunities for those who do not have the liquidity to participate in traditional investing.
With these protocols, individuals can use their digital assets as collateral to take out loans. They can then use these loans to invest in a variety of different assets, including stocks, bonds, and real estate.
Play-to-Earn games, for instance, have enabled investors to lend their NFTs to players in return for a portion of their future winnings. This provides individuals with the liquidity they need to participate in the markets without having to sell their assets.
The bottom line on the inclusive economics of Web3
Web3 has the potential to democratize investing and level the playing field for all participants. By enabling collaborative investing, creating incentives for long-term thinking, and providing innovative income generation opportunities, Web3 can create a more inclusive form of capitalism that works for everyone.
Now that we have briefly touched upon the economics of Web3, in the next part of the series we will do a deep dive into exactly how the economics of Web3 work, including the role of tokens, DAOs, and DeFi protocols. Stay tuned!
Daniel Saito is CEO and cofounder of StrongNode.