Tokenisation of financial assets provides a new transaction layer on top of the nation state stack layers of governance, regulation, and financial infrastructure. These layers underpin our financial and economic systems, and the implications of this technology will be felt all the way down.
The Nation State Stack
Paul McCartney once said that when he came up with the tune for Yesterday, he wandered round for a month wondering where he had stolen it from. I have been using the term "nation state stack" quite a lot in discussions as a way of explaining "The System" - governance that supports financial institutions and is rooted in national structures. I feel the same way Macca did. I think I may have heard someone use the term on a podcast, or read it somewhere, or perhaps it's just so obvious that it's there. Either way, it's a handy thinking model. My definition of the nation state stack is from the perspective of financial systems, but if you think about the stack, it applies to all sorts of areas. Our current financial system is often referred to by crypto folk as TradFi, which suggests it has been around for ever ("Trad., arr. McCartney"). It has not. Systems of all kinds evolve continuously, and finance is no different.
(Oh crap. I've just compared myself to Paul McCartney in the opening paragraph. Oh well. Onwards.)
In the current system, we use banks for our day to day financial needs. The banks use technical infrastructure - banking systems and other financial market infrastructure like SWIFT and credit card rails - to move money around. We generally trust banks with all this because we know they are regulated. Those banking regulations sit on top of a broader set of company law, which in turn relies on a socio-legal system that has evolved over centuries. That system sits, in turn, on the ability of the state to enforce its laws: the "monopoly on violence". This system is entrenched, well tested, and pretty robust. Applying a new technology on top of this stack is an evolutionary improvement: this is what stablecoins and tokenisation do.
Stablecoins, RLNs and Shearing Layers
Stablecoins (fiat / HQLA backed ones) are crypto tokens that represent a claim on an asset in the existing system. They are thus referencing the nation state stack, using the existing system as a foundation to build on. I have written before about this concept when talking about the future of blockchains. The idea of a "Regulated Liability Network" is basically the same - blockchains are just another technology, and so another way of recording and transacting a financial asset, or "regulated liability". What we are changing is the top level of the stack: upgrading some of the existing technology, but continuing to reference the lower levels. The lower down you go in the stack, the harder it is to change, which is a common pattern, sometimes referred to as "Shearing Layers".
The concept of Shearing Layers was coined by architect Frank Duffy. In a building, the fixtures & fittings may change fairly often, internal walls less often, the physical structure lasts decades and the plot is pretty permanent. It is much harder to change something lower down the stack; harder in terms of making the change, the costs involved, the impact of inter-connected changes, and so on. The relative permanence of the bottom layers makes it possible to change the upper layers. If you've ever restored anything complex - a house or a car for example - then you have experienced this. It is considerably easier to repaint than rebuild; or to roll out a payments app than to rewrite central bank policy.
Unpacking the Nation State Stack
This concept applies to the nation state stack too - there is an increasing permanence, or longevity, as you go down the stack. See also the Lindy effect: the longer something has been around, the longer it is likely to stay around. We can use these models to assess the potential changes that are being driven by blockchains. Taking it from the top:
The likelihood of a better technology being applied to financial instruments is a racing certainty. Tokenisation provides new profitable business cases that are impossible with any other technology. Financial institutions and fintech disruptors will therefore adopt this technology as soon as they come to terms with that fact. We can see it happening with stablecoins; it will happen with other liquid assets like funds bonds and equities, and then with alternatives, and then with everything else. Anyone not working in this direction is in denial.
At the layer of financial regulations, changes are made fairly infrequently, and are slow to implement. To the extent that regulatory change is necessary to enable a change in the technology layer, it will happen, but more slowly. The process of changing regulations takes longer for a whole lot of obvious reasons, but it is similarly inevitable. You can see consensus emerging globally on how this will happen, whether it's guidance from global standard setting bodies, or the Brussels Effect of the European MiCA regulations. Again, this is in process.
The socio-legal layer consists of a mixture of laws and social practices and behaviour. The best example of a change in non financial law that I can think of here is the English & Welsh law definition of property. There is a proposal from the Law Commission - via a super comprehensive documentation of the issue - to change the law to recognise digital assets as a third form of property. In a social sense, adoption of new financial technology should be largely invisible to its users; the new products and services it enables will follow their own adoption curves like anything else.
At the bottom is the nation state itself. These feel permanent, but I only have to open my high school geography book to see how the maps have changed, especially in Eastern Europe. History is now. The concept of the nation state as a way of organising the world seems pretty stable though, even if the states themselves evolve over time. Effecting change at this level is a slow and difficult process because if you change the bottom of the stack, you unfreeze everything above it. There are hard things like national borders, but there are deep structural things that you take for granted until they start to shift.
Bitcoin as a new stack
The reason that Bitcoin is so revolutionary, so appealing, so clever and so scary is that it changes the entire stack from a financial perspective. Bitcoin was deliberately created to be independent of the existing system. There are some parallels with the internet and information. If you grew up pre internet, then your access to information was broadly restricted to your local education, literature, media and so on. Now you have access to everything. The way that we organise and consume information is still in turbulence because we are coming to terms with the implications of global access, social media, computers in our pockets and all that good stuff. In a hundred years time, historians, social scientists and anthropologists will study how this change played out, but as someone may once have said, "it's too early to tell".
What the internet is doing to information, bitcoin and crypto is doing to money. The bitcoin stack builds on a community of miners, cryptography, and the internet. More philosophically, it comes from a global libertarian perspective that is totally different to the nation state view of the world. This is why many governments, and Bretton Woods institutions like the IMF, are so wary of it. Changing the whole stack changes everything, remember, and that takes a long time to play out. Bitcoin is not just a new technology, it is a new financial system.
We are still living through the impact of freeing information via the internet. As for the impacts of bitcoin and crypto on The System, nation states, institutions and all that, what does that look like? I think it's fair to say that it's too early to tell.
Separating crypto from tokenisation
In understanding the landscape of blockchain driven change, it's vital to separate crypto from tokenisation. By "crypto" I mean things that are global by default and don't rely on existing regulations or nation states; bitcoin is the cleanest example. By tokenisation, I mean the application of the technology on top of the nation state stack. Tokenisation, to me, looks inevitable at this point. We will have a tokenised financial system, whether it's in 2 years or 20, and it will be constructed by a mixture of disruptors and those incumbents who adapt intelligently.
Incumbent financial services players tend to confuse themselves in two main ways. The first is to conflate crypto with tokenisation. This makes it harder for them to think about the implications of a new technology, because they can't see past the potential problems with a new world built on that tech. It's like worrying about self driving cars because one day they might fly. The second confusion that institutions submit themselves to comes from not understanding the stack. They worry about regulatory change, when technology change comes first. South African regulations illustrate how this can play out. The current regulations do not distinguish between different tokens - they treat USDC and meme coins the same. This is clearly wrong, and it will change, but the technology will change first.
Looking ahead
The impacts of technology, at the top of the stack, will eventually have implications much lower down. We have seen this already with information and the internet, the Arab Spring being a good non-US example. Separating tokenisation and crypto is absolutely the right thing to do, but we should also recognise the longer term implications of tokenisation more deeply in the stack. As an example, tokenisation of dollars makes them available to anyone, anywhere, in a way that was not possible before. This makes currency an individual choice, taking it away from the nation state.
For institutions public and private, there are manifold implications of all this. Nation states are lower down the stack, so their evolution, while potentially profound, is probably further off. For financial institutions higher up the stack, this technology has the potential to change industry dynamics in the near future. The time to engage is now. These businesses - banks, payment providers, asset managers, insurers - need to position themselves for the inevitability of tokenisation, or risk being left behind.