Digital dividends are blockchain-asset dividends issued legally and 1:1 to shareholders of a public company. They have the potential to reconcile sloppy accounting and force a reconciliation with naked short sellers. How?
A bit of background. In 2015, I worked for t0 (now tZero) where I learned quite a bit about the National Market System (NMS). This was in preparation to build a platform for digital settlement. This came in several parts. One part was working out the details for a digital parallel equity. This began on a platform called Counterparty which was a pre-cursor to what is now Ravencoin. It used the UTXOs (unspent transaction outputs) to track stocks, bonds, etc. I helped build the tech that issued the first blockchain bond, and later the first digital crypto security with OSTKP.
We also built a platform that would take the slop out of short-selling and force one-to-one borrowing, or at least document it in a very public way. The platform required a blockchain entry when borrowing hard-to-borrow stocks. This system, once fully utilized, would prevent over-borrowing (double-dipping) when short selling. It was stopped.
Background: If you don’t understand short-selling, it’s pretty simple. Borrow stock, sell it right away, keep the cash, and then return the stock later by buying it back with the cash. If the stock goes down in price after you sold, you win. If the stock goes up, you lose. Until you return the shares, you have unlimited exposure as you still need to buy and return the stock. Why would you short stock? Because you think it is priced too high and you think it will go down. You can make money betting against the company.
Is short selling illegal? No! So what’s the problem? Naked short selling provides a way to manipulate the market. What is naked short selling (it sounds sexy)? It isn’t sexy. It’s selling shares that aren’t really borrowed, or are double, or triple borrowed. If it seems ridiculous to sell shares that don’t really exist, then you’re starting to grasp the problem. And, if you think about the market implications of having more shares floating around than were issued, then you’ll realize that the extra shares and selling pressure will push the price down. Combine that with the fact that it is easier to tear something down than build it up, and you have a recipe for disaster.
Reg SHO was supposed to prevent naked short selling. I don’t think it has. Surprisingly, and despite Reg SHO, the SEC says that “naked short selling is not necessarily a violation of the federal securities laws or the Commission’s rules.” This means effectively that additional shares can be created. With supply vs. demand determining the price, it seems absurd to this engineer’s mind to allow this at all. And, as a guy who thinks in terms of systems, it immediately triggers thoughts of ways this can be gamed, manipulated, and abused. When the person doing the short benefits and is financially incentivized to have additional supply driving the price down, why wouldn’t they borrow more, and what prevents them from borrowing more than exists. The answer was supposed to be Reg SHO, but it is a super sloppy system.
Let’s start with how naked short selling can happen in the NMS. Stocks and cash don’t settle for two days, and the records of all shares owned are never fully synchronized and settled. This, combined with the separation of brokers, a loose trust system, and no blockchain, it allows for creation of shares that were never issued. Watch this video for a more in-depth explanation. If forced into instant settlement, the errors would be instantly obvious, but this doesn’t happen. So what would happen if you just stopped trading in its tracks, and counted up the shares? It happened when Dole Foods went private, and there were too many shares by about 33%.
The NMS is unlike crypto-based assets which are settled every minute on Ravencoin. Ravencoin has a mempool which is list of unsettled transaction and during one minute, someone could create thousands of spends of the same coins (or assets), but by the time those transactions are added to the chain, only one of those transactions will be allowed. The other transactions will be purged as an attempted double-spend. Every minute the system is in-sync, fully settled, and can be audited.
So what can a digital dividend do to reconcile excess NMS shares with legit shares? The concept here isn’t to stop the market and count. The concept is to issue a digital dividend that can be claimed by all share-holders. If there are more claims than issued shares, it exposes the sloppy accounting. If naked short selling has occurred or additional shares created, the illegal naked short selling is exposed because the share borrowers owe the dividend to the share holders and can’t fulfill their obligation because the digital dividend shares are 1:1 with only known issued shares. Does the system like being called to account? NO. Beyond the risk it poses to those enabling the naked short selling, it also calls into question the integrity of the market system.
A platform like Ravencoin allows the creation of a uniquely named quantity of digital assets that can be minted at exactly a 1 to 1 ratio with the legally issued shares. These can be given to the legit holders of the shares as a dividend. There shouldn’t be a mismatch. If there is, then the sloppy accounting has been detected. Ravencoin is like a CPA and a computer had a baby. It can track everything down to the 1/100,000,000 of a unit and there’s never a remainder or rounding error because it uses integer math in the bowels of the code. It does not sleep, it does not make mistakes, and it does not double-book. Ravencoin assets can be audited in real-time to ensure integrity of the digital issuance.
So, where is this useful? In stocks where potential naked short selling may be happening. We’ve recently had a few of these stocks that reached meme status because of the potential for a short squeeze. If you’re reading this, you probably already know which ones.
It’s time for this game to stop.