How we can make Financial Engineering great again?
When I say the phrase “Financial Engineering”, usually what comes to the mind of people is usually 2008. With CDOs, Credit Swaps and Debt bonds. All these different contracts are a product of the field of financial engineering.
Just like software engineering is about building different software applications. Financial Engineering is about building different financial instruments and asset classes.
Historically, Financial Engineering has done more harm for society, than good. Partly, because they’re usually exclusively available to the ultra-wealthy due to strict capital requirements. And also because they usually include complex legal structures around financial regulation.
The concept of a subprime mortgage or a Credit Default Obligation (CDO) which caused the great recession of 2008 was a product of financial engineers who wanted to build a profitable bond, built out of a bunch of mortgages.
To give you some context, there’s approximately $1,000,000,000,000,000 USD in notional value in derivatives, and $253,000,000,000,000 USD in global debt. More than most humans can fathom.
Although, we have this negative perception of financial engineering. There’s been some major innovation in this field especially with regards to blockchain and cryptocurrency entering this field.
How synthetic tokens can make financial engineering great again?
The main reason people why financial engineering and these synthetic assets brought us down in 2008. This is because of the lack of transparency of what was within these assets and the fact that they were available only for a small subset of the population with a high level of capital available.
Up to 2008, people were buying these complex financial structures like Subprime mortgages not knowing what exactly was even in these assets. But a technology built off the basis of transparency could change this. Blockchain.
Right now if I as a Canadian want to hold a short or long position on an asset like a Brazilian government bond unless I have a net worth of billions of dollars. I have no method of holding a position on that asset unless I have tens of millions of dollars ready to invest. This exacerbates inequality within society, allowing only a few at the top to participate in certain financial activities.
But now with synthetics tokens, since they’re built off of blockchain and have the option of fractional ownership. They’re transparent in nature, solving this major problem.
What is UMA and how you can build a synthetic token?
Now there’s a new product called UMA (Universal Market Access) and this allows people from any part of the world to create any synthetic pegged to the market via something called Oracles. You can engineer your token’s price to an outside price feed such as an API. Then, the creator would need to put some money towards the contract to collateralize the contract and would need outside investors to put money towards the contract.
UMA basically gives every person with internet access and a bit of money, the ability to become a financial engineer. And the sky’s the limit.
One of the greatest applications I see for this today, is having the token’s price pegged to the John Hopkins API regarding COVID-19 cases. You can then possibly create a separate token for a different regionality or community. Through UMA, you could peg the value of the token inversely to the number of COVID-19 cases.
Hence, allowing people in different communities to receive an economic incentive towards keeping people at home and socially distanced.
This is still an idea and working through a lot of the backend tech, logistics and economics behind this, but conceptually this would be a neat project.