Setting up a Stock Exchange

[RHorning]

The thought came across my mind that there is a niche to be filled for some kind of securities exchange that might be dedicated to transactions involving Bitcoins.  This may be something perhaps that is premature or perhaps legally too encumbering.  Basically I want to float the idea and see where perhaps those on this forum might even see a way for this to begin.

The role of a stock exchange, so far as I see it and how it would certainly work for Bitcoins, is a way to concentrate wealth in such a way that a useful enterprise might be started.  Not everybody has access to huge mining farms to collect coins, they may have started later and not have coins, and certainly the number of things with which you can spend the bitcoins on is more limited and sort of chaotic.

There would certainly be some sort of programming which would need to be done in terms of setting up this exchange, but I see most of the issues dealing with an exchange to be more political than technical.  Rules would have to be established for what qualifies as a security, how those "securities" are organized and recognized by the community at large, and how such an organization could be set up.

So far as bitcoins are concerned, electronic securities are essentially the same thing as a bitcoin and would likely have similar hashing algorithms for authentication.  Much of the "trading floor" may even be possible to be done with peer-to-peer clients and "seats" on the "trading floor" would likely be much more direct.

I am worried a little bit so far as the legal implications of doing something like this are concerned.  I came across this page via the SEC website which goes into some of the current laws that at least a "nationally registered exchange" must follow.  Then again, if it is a peer to peer network thing with (at the moment) very low volume in terms of dollar value traded it might just fly under the radar until we can afford some more competent legal counsel to make the whole thing "legit"... or perhaps inspire somebody else to build a more "legal" exchange if it is necessary.  In this regard, I'm more of a damn the torpedoes kind of guy as long as everybody knows that this is all experimental using an experimental currency which may all fall apart anyway.  The law in this case would be a good guideline, however, in terms of what rules we ought to consider for establishing this exchange and we might as well follow the law so far as making that an ultimate goal.

The NYSE started as a bunch of merchants gathering underneath a tree that happened to be next to the city wall on the edge of New Amsterdam (hence "Wall Street").  A Bitcoin security exchange can certainly have as humble of a beginning.  There certainly are enough enterprises of various kinds using bitcoins that perhaps some way for people to invest in those ideas could be organized with the idea to create an investment mechanism for Bitcoin-related enterprises.

Yes, I'm trying to be serious here, and it is something I would like to get organized.  Other than the legal issues, I don't see any significant show stoppers but I'd like some feedback on the idea.

[grondilu]

I've just posted a topic with more or less the same concern.

Indeed the issue is much more political than technical.  It would, indeed, be illegal in almost all countries.

Still, I don't care if it is illegal.  This should exist, and I hope it will.

But such a black equity market would have to be extremely cautious, in order not to get caught.

Transactions should be negociated via encrypted communications, but even in that case there is the risk the network gets infiltrated by a government agent.

Therefore, it is tricky.

[slush]

Guys, nice idea, but you are playing with fire.

Bitcoin itself is on the edge of black market. You can still talk about it as 'digital commodity'. But stock exchange for bitcoin will be definitely against AML rules of ALL countries .

[RHorning]

In terms of the legality, if the entire exchange was set up through a peer to peer network, I think it would be insanely difficult to get law enforcement to stop the activity on the market.  For example, if I got arrested for setting up this market and my computers get confiscated, it wouldn't stop the exchange and for that matter it wouldn't even cause a hiccup in the market.  Indeed one of the more interesting aspects and perhaps side effects is that securities could be exchanged in this fashion in almost complete anonymity.  That by itself might scare some governments into action as it is a unique kind of beast that has never existed before other than being another hydra coming from the internet.

One of the things that I'm sort of bashing my head against is how to organize an IPO using this exchange.  Somehow there needs to be a mechanism where an individual can come up with a proposal for an idea, lay out a "business plan" for how money will be used, and to set up a system to then "sell" shares in that idea.  The "real world" way of doing an IPO is so utterly corrupt that it turns my stomach thinking about all of the people who "pad" the price of shares in a company on the current major exchanges.  If a company has in the bank more than 50% of the "market cap" value of its shares an hour after the IPO, I consider that to be a very lean and efficient IPO.  In other words, it need to be done almost by definition as something different from how the major exchanges get that job done.

Another aspect of the IPO is also setting up the "standards" for letting somebody organize a security.  In this aspect, perhaps there really shouldn't be much of a barrier, but I'm willing to hear from others on this.  The SEC acts as a huge gatekeeper for such actions and getting an IPO on the NYSE takes a team of lawyers and passing a whole bunch of reviews about the company involved... even if it turns out that the company is full of a bunch of people who are going to disappear with the money and run the company into the ground afterward.  Indeed any sort of "gatekeeper" on letting somebody set up a security on this exchange seems to be almost futile unless you have a central server that can be shut down, confiscated by law enforcement, and therefore putting that gatekeeping role into the hands of a single person or small group that may or may not include the original team putting the exchange together.

There would be rules to this exchange, but to me it would have to be something that can be put into software, which is certainly going to be an interesting governance model.  I certainly don't know of any security exchange that has been governed strictly by mathematical principles alone or in this case a networking protocol.  There are certainly other "virtual" exchanges, but you almost always get back to a major gatekeeper on the idea in every case.

If the danger is using the terms "exchange", "securities", and "IPO", perhaps we ought to get away from those terms, but I think there is also power of words and that these terms mean something real.  I'd rather not run from potential legal threats by trying to be a marketing genius and inventing new terms when these terms fill the niche.  If there is a new terms that can apply, let's use them, but it ought to be for completely new ideas unlike the conversion of "used" cars to "pre-owned" cars.

Guys, nice idea, but you are playing with fire.

Bitcoin itself is on the edge of black market. You can still talk about it as 'digital commodity'. But stock exchange for bitcoin will be definitely against AML rules of ALL countries .

Yeah it is playing with fire.  I am fully aware of that.  It strikes right at the heart of what a corporation even is and sort of flips the bird at the very notion of government after a fashion, at least for commercial law is concerned.  An exchange made in the fashion I'm proposing sort of throws out the conventional notion of a state-chartered corporation, even though such an organization certainly could use this exchange to raise funds.  That goes back to my gatekeeper argument above.... which might make this particularly interesting for government regulators wanting to get their claws into this concept.

[grondilu]

I personnaly own several hundreds lines of european stocks.

I could sell them for bitcoins.  Basically this will mean that I will agree to convert all dividends into bitcoins and to tranfer them to my buyer.

Only problem is taxation.  Because I'll have to declare those dividends as my personnal income.  So it's not that easy but hopefully I won't pay any income tax anyway...

[grondilu]

There is also the problem of the vote right.  But this is easy, since when I receive a convocation for a general assembly, I am always given the possibility to be represented by someone else.

So I could easily give the name of my buyer if he wants to attend the assembly and use his vote right.

[Timo Y]

If the whole thing is based on "insecurities" rather than securities it may just stay inside the confines of the grey market.

Make it an informal, honor-based exchange, without binding contracts, and you no longer meet the legal definition of a security (which always requires some sort of contract). Make it a bit like crowdfunding websites such as Kickstarter except that the giving goes both ways. Tit for tat. Use webs of trust to keep the "insecurities" as private and confidential as possible. Nobody but the parties involved need to know about them.

You could also follow the example of Wikileaks and go supranational, cherry-picking from the legislations that suit your business model most. There is no reason this website must be under the jurisdiction of any one particular country. Bitcoin itself is already supranational.

[Anonymous]

Why not just model it after bitcoin itself ?

Create a sharemarket block chain that verifies trades meaning you dont have a central authority to raid. You could then transfer a share by a client  to an address someone else owns and they would transfer you bitcoins in return...or use an escrow to manage the trade.

You could  pay dividends to the last address the share went to. As long as you never published your shares address how would they find you or know who owns it?

Any lost shares would increase the value of the remaining shares.  

An open auction system could handle buying and selling of shares.

Im not sure how the shares would be issued though .

[grondilu]

Why not just model it after bitcoin itself ?

Create a sharemarket block chain that verifies trades meaning you dont have a central authority to raid. You could then transfer a share by a client  to an address someone else owns and they would transfer you bitcoins in return...or use an escrow to manage the trade.

You could  pay dividends to the last address the share went to. As long as you never published your shares address how would they find you or know who owns it?

Any lost shares would increase the value of the remaining shares. 

An open auction system could handle buying and selling of shares.

Yeah I've been thinking about that for a long time, but finally I concluded that it is not appropriate.

1.  this means you will have a different block chain for each stock.  With CPU power used for each of these chains.  Doesn't look good ;
2.  You need to trust someone anyway : the person who is holding the "real" stocks, or ultimately the enterprise.  Therefore there is no point using a decentralised network.

[Anonymous]

Why not just model it after bitcoin itself ?

Create a sharemarket block chain that verifies trades meaning you dont have a central authority to raid. You could then transfer a share by a client  to an address someone else owns and they would transfer you bitcoins in return...or use an escrow to manage the trade.

You could  pay dividends to the last address the share went to. As long as you never published your shares address how would they find you or know who owns it?

Any lost shares would increase the value of the remaining shares. 

An open auction system could handle buying and selling of shares.

Yeah I've been thinking about that for a long time, but finally I concluded that it is not appropriate.

1.  this means you will have a different block chain for each stock.  With CPU power used for each of these chains.  Doesn't look good ;
2.  You need to trust someone anyway : the person who is holding the "real" stocks, or ultimately the enterprise.  Therefore there is no point using a decentralised network.

Not necessarily.

I was looking at opentsa (open timestamp) http://www.opentsa.org/#introduction  .You could always verify a share using the issuing companies timestamp server then trade it without counterparty risk.

[RHorning]

Why not just model it after bitcoin itself ?

Create a sharemarket block chain that verifies trades meaning you dont have a central authority to raid. You could then transfer a share by a client  to an address someone else owns and they would transfer you bitcoins in return...or use an escrow to manage the trade.

You could  pay dividends to the last address the share went to. As long as you never published your shares address how would they find you or know who owns it?

Any lost shares would increase the value of the remaining shares.  

An open auction system could handle buying and selling of shares.

Yeah I've been thinking about that for a long time, but finally I concluded that it is not appropriate.

1.  this means you will have a different block chain for each stock.  With CPU power used for each of these chains.  Doesn't look good ;
2.  You need to trust someone anyway : the person who is holding the "real" stocks, or ultimately the enterprise.  Therefore there is no point using a decentralised network.

The block chain would be to process the transactions in the market, where the "miners" would receive the transactions fees.  As far as I can see, there would be only one huge chain just like with Bitcoins, which would deal with the CPU issue.  Perhaps you could get CPU power to overwrite the chain, but it would have to take out the market as a whole.  Creating a generic transferable "transactions" in Bitcoins that could be used by miners of bitcoin-related concepts might have to be added to the main Bitcoin protocol, but it is at least technically possible.

Individual issues would be more like addresses in Bitcoins, although some mechanism might be put in place in terms of allowing additional "public offerings" to expand the number of shares.  Yes, it is a bit more complex than Bitcoins itself, but I think it could work and wouldn't require separate chains.  In this sense, for a distributed system you could set up some sort of protocol where actions impacting each "security" could be decided by some sort of "majority vote" based upon shares owned.  For example, if some group wanted to expand the number of shares available, there might be some protocol in the system to allow individual "shares" to vote on expanding the number of shares available.

Keep in mind that when an IPO would happen, the number of shares would be fixed, so there is no need to keep mining or expanding the number of shares outstanding.  All that is needed is to simply to keep track of the transaction of those shares.  So in this sense the IPO is a single event that certainly could be organized in some fashion.  I would dare say that in this case, transactions (including the IPO) would have to be tied to regular Bitcoins addresses.

Think of it like this:  Somebody "creates" a new "security" where they define the parameters of the security, mainly how many shares that are outstanding but there could be more things put in with that.  It would also have associated with all of those shares some sort of Btcoins address.  At that point they own 100% of all of the "shares" in that security.  The BTC address certainly could be "owned" by a group but that would be up to how that group itself is organized and has nothing to do with the exchange of securities in this case and maintaining that address with its associated wallet is not the concern of this exchange.

When they want to "IPO", they "advertise" their business plan (perhaps a link to a website or even prospectus is included with the generation of the shares originally) and then can offer some or perhaps all of the shares onto the market.  How the market is set up can vary and there are different auction systems which could be used here (perhaps simultaneously too!), but the point is that they would be made available for purchase at a known price per share that would then in turn "transfer" ownership of those shares as a transaction + fees for processing the transaction (for the miners who are collecting the transactions and putting them into the main chain).  Since Bitcoins are involved here, the share would then be transferred to a new BTC address and that person would then "own" those shares, and the share price would be transferred to the original owner of that share, in Bitcoins.  All of the protections of Bitcoins would make sure double spending of those coins would not happen and perhaps the Bitcoin transaction would have to be "confirmed" by a miner before it is included into the share transaction chain.

Really, this is all pretty simple and not all that more complex than Bitcoins itself.  I do think this ought to be a completely separate chain from the main Bitcoins chain, and likely have separate miners involved, but there certainly would be a whole bunch of synergy between this market and the overall Bitcoins trading economy.  As long as the whole transaction chain is completely accounted for, the value of and ownership of those shares would be as solid as a bitcoin itself.   Any attack on that share would be an attack on the whole concept of bitcoins.

This gets back to my point that I don't think there even can be a gatekeeper in terms of stopping somebody from issuing a "security" on this exchange.  If somebody says that their business plan is to take all of the Bitcoins and spend them in Las Vegas after converting them to dollars hoping to beat the casinos, that is something for the individual investor to consider for themselves.  A "share" is as valuable as the person standing behind it, so you could use this for social causes (Let's donate to the EFF!) or for many other things as well.  The purpose of this is to set up a mechanism to concentrate Bitcoins for some social good, and for most purposes would be to make a profit for those investors.  In this case, it would be up to the market to decide if an individual business plan is worth further investment or if it is a waste of money.

The only real issue I can think of here is some way to keep spam attacks from happening, where somebody creates a security that is essentially worthless and sends transactions between a couple of addresses repeatedly with essentially bogus transactions.  I'm hoping here that a transaction fee would stop that from occurring, as it would essentially be a direct donation to the miners.  If you can't sell a security for more than the transaction fee, it becomes worthless and is effectively de-listed from the exchange.

[grondilu]

I'm sorry but I keep thinking it does make sense to keep a centralised model for equities.

Equities are issued by a precise entity : the concerned entreprise.  Therefore it does make sense thazt this enterprise is responsible of issuing and managing its shares.  Using a decentralzed model such as bitcoin would make the system more colmplex with very few benefit.

[RHorning]

I'm sorry but I keep thinking it does make sense to keep a centralised model for equities.

Equities are issued by a precise entity : the concerned entreprise.  Therefore it does make sense thazt this enterprise is responsible of issuing and managing its shares.  Using a decentralzed model such as bitcoin would make the system more colmplex with very few benefit.

Yes, you could set up a simple server using a client/server model at a fixed location.  That would give a physical location for an attack on the system, however, which may be good or bad depending on how you felt about it.  That would also require you to conform to the laws of that particular location as well.  Other problems would happen as well, but that is just the beginning.

I think the problem is more of legal enforcement.  How do you get somebody who has received a whole bunch of money from an exchange of this nature, through an IPO, that they will do what they claim that they will do?  The judicial system is indeed the teeth that normally back up the purchase of a security as you take "ownership" of the assets of a company when you typically buy a share.  It is a separate issue from the exchange itself but it is tied into the concept of a "share" and what that means.

For example, if somebody decides to use the exchange to get a "loan" for buying a car, they may say in the prospectus that they agree to pay monthly dividends as "payments" for getting the loan.  If they stop paying those dividends, what sort of guarantee is there that the "shareholders" can get anything of value from that person who is given that money?

To me, it would be a form of fraud in a situation like that if you failed to follow through and do what you promised.  The next question would be:  would any court actually enforce any fraud statue; of course after a long and perhaps tedious explanation about what Bitcoins are, what this exchange is, and some of the details about the sale of the shares themselves?  It is entirely possible that a court would throw the whole thing out as an invalid transaction, but then again they might consider this to be a form of a private contract with a formal promise to fulfill the terms of the prospectus.

Shareholder lawsuits are a regular staple of corporate attorneys, so none of this is really all that new.  Usually when it gets real ugly with a lawsuit of this nature, the security on the exchange is delisted or at least its trade halted until a judgment is entered.

I think this is an excellent question, and I don't know how to even begin to address it other than to suggest that we muddle through, and that it is "buyer beware" about the whole thing.  Some people will earn a reputation as being worthy of investment, and it is those people who would be the most likely to be successful with using this tool for raising money.  Just as there are "blue chip" companies who are reliable with regular earnings and perhaps even dividends on a regular basis ("we pay a monthly dividend of 5 BTC each month per share!") such groups would show up and generally not be questioned.  The problem is when the company starts to fall apart, who gets the pieces?

It also gets more back to the principle that you should invest locally first, and learn all you can about your investments before you throw money at it.  When a stock broker calls you up and says "I have a hot tip for you.... buy 3000 shares in this penny stock mining company today!" and that is your only knowledge about that company, you are being a lousy investor.  And yes I've had stock brokers give me such a phone call before.

[kiba]

Using the statist court system to enforce contract is a stupid way of doing things.

It's expensive, uncertain, and slow.

Rather, arbitration services should naturally arose over time. That will become the basis of the bitcoin common law system. Its service will actually be subjected to...market process.

[wumpus]

Equities are issued by a precise entity : the concerned entreprise.  Therefore it does make sense thazt this enterprise is responsible of issuing and managing its shares.  Using a decentralzed model such as bitcoin would make the system more colmplex with very few benefit.

I don't agree that leaving the administration of shares solely to the affected enterprise is a good idea. Especially with trade in shared, there needs to be oversight (either by the public or some trusted third party)

[grondilu]

I don't agree that leaving the administration of shares solely to the affected enterprise is a good idea. Especially with trade in shared, there needs to be oversight (either by the public or some trusted third party)

When you buy a share of a company, you are already supposed to have some confindence into this company.  Otherwise you would just not buy any of its shares.

Therefore there is no point looking for a third trust party.  The trust party IS the company itself.

PS.  By the way :  companies ARE oversight, by shareholders.  During general assembly, they are shown the books of the company, and any shareholder can ask any question he wants, even if he owns only one share.  If shareholders want even more control, they can decide it.  The company is their property, there is almost nothing they can not do.

[wumpus]

When you buy a share of a company, you are already supposed to have some confindence into this company.  Otherwise you would just not buy any of its shares.

Yes you need some confidence. That doesn't mean that you trust them with everything. If they manage the complete administration of their own shares without any oversight, they could just as well assign them all to themselves, or sell them to someone even though they're your property.

It would be like leaving administration of your own bank account to yourself. Sure, if it is backed by a P2P system like bitcoin it works, but otherwise it's asking for problems. You could just as well add a few zeroes.

It isn't for nothing that stock trading is so heavily regulated. There's so many ways to get screwed.

[grondilu]

It isn't for nothing that stock trading is so heavily regulated. There's so many ways to get screwed.

But relying on a regulation authority only moves the problem from one point to an other.

Anyway, a bitcoin-like system is no solution for this, for no cryptographic currency will check the accounts books of the company, nor will it make sure the voting process during the assembly is honnest, and so on...

You can use regulation authorities if you want, but they have to be private and based only on their reputation.  And companies can chose to hire one, or to be their own.

[FreeMoney]

I don't agree that leaving the administration of shares solely to the affected enterprise is a good idea. Especially with trade in shared, there needs to be oversight (either by the public or some trusted third party)

When you buy a share of a company, you are already supposed to have some confindence into this company.  Otherwise you would just not buy any of its shares.

Therefore there is no point looking for a third trust party.  The trust party IS the company itself.

Yeah. I think of the mass of gov regs as a scheme to get people to buy shares of companies they have no faith in anyway.

[RHorning]

It isn't for nothing that stock trading is so heavily regulated. There's so many ways to get screwed.

But relying on a regulation authority only moves the problem from one point to an other.

Anyway, a bitcoin-like system is no solution for this, for no cryptographic currency will check the accounts books of the company, nor will it make sure the voting process during the assembly is honnest, and so on...

You can use regulation authorities if you want, but they have to be private and based only on their reputation.  And companies can chose to hire one, or to be their own.

However there are cryptographic methods of voting and stuff that is "good enough" in terms of overall governance of an organization.  In fact, I've participated with groups that are really organized almost exclusively over the net and seem to be able to build up a relationship of trust in some fashion or another.  I think you are completely correct that it is reputation here that is the key, and those who are disreputable will eventually be driven from business.

In terms of "auditing the books", Bitcoins presents an interesting situation where in there everybody could be performing an audit of some group's finances simultaneously.  While this sort of spoils the anonymity aspect of Bitcoins (and talked about elsewhere), shareholders could insist that every transaction involve the same address for an audit trail.  If there are transactions which happen "off the books", it would be tantamount to embezzlement.  There are still ways to play games with the accounting here, but you could certainly be aware of the vast bulk of the finances of a company and at least know if it is solvent and the kind of places where the money is going to or coming from.  Other accounting systems could develop too, but the fact is with at least the Bitcoin economy itself the entire transaction history of the world is available at your fingertips.  That leads to some interesting areas of speculation, but tracing the money is something that could be done independent of an individual comptroller simply telling you how much money the company has.  Money spent and received through exchange with other currencies would be much harder to trace, but not impossibly so and that gets to an area of trust as well.

Using the statist court system to enforce contract is a stupid way of doing things.

It's expensive, uncertain, and slow.

Rather, arbitration services should naturally arose over time. That will become the basis of the bitcoin common law system. Its service will actually be subjected to...market process.

I agree that the judicial system of a country may not be the best way to deal with all of the issues involved here in terms of enforcing ownership of a company.  Mediation services I think would be perhaps even more prevalent where it isn't a binding resolution but something trying to bring the two parties together to a common understanding.

In terms of the history of judicial systems, much of it is simply finding a "trusted and independent 3rd party" who can resolve the dispute where both parties agree to the final decision.

Undoubtedly there will be some people who will "run home to mama" and get the real world judicial system involved, which is something to at least concern yourself about, but I'm not so hard-ass to suggest that is the only solution to these problem.

I guess I'm thinking historically to the early renaissance-era merchants who organized vast global enterprises with usually nothing more than a shake of a hand and a simple contract operating out of minor countries like Denmark and Holland who had courts that had very little teeth anyway.  17th & 18th Century Holland was indisputably wealthy but most of the merchant ships coming from or going to that country (and elsewhere) were for the most part unarmed.  That was expensive and a waste of their investor's money, and besides it slowed the ships down and required having sailors paid to take care of the cannons and stuff therefore eating into the bottom line.  Did goods get confiscated by some governments?  Yes, and it was the duty of the people running these enterprises to make sure that didn't happen either through clandestine or "legitimate" means.  18th Century privateering certainly made the distinction between piracy and patriotism quite relative as to how your real loyalties were at.

There was a time when most of the corporate regulations didn't exist, yet extensive trade still happened and some people got insanely wealthy.  If anything we are talking about getting back to the roots of these institutions and trying to re-think how they ought to be operating.  This whole thing is so new that we can and ought to be considering the broader picture on these discussions.