This essay contributed materially to the realizations behind Salutary. It was originally published on Twitter here and Substack here.

Why did investors stop demanding dividends from stocks? The answer reveals a truth about how markets mature, and why DeFi's current obsession with 'yield' is both predictable and temporary. 

DeFi needs more respect for our financial forefathers; many of our problems, discoveries, etc. are not new, they're reruns with better special effects. Crypto is said to be “speedrunning financial history”, yet it inexplicably refuses to look to history for solutions to questions that have already been litigated. Wheels do not need to be reinvented, only streamlined. It chooses to fixate on daily news, rather than study how certain problems were solved decades ago.

"Speedrunning" means we can glean historical wisdom from lessons that have already been learned. Let’s predict crypto’s future and clarify its present, by looking to the past.

Terms:

• DeFi: decentralized finance, the infrastructure that crypto runs on. It encompasses blockchains and applications that exist natively atop them. It's finance on a decentralized database.

• Crypto: The digital assets that exist on blockchains, transactable within DeFi. I will use “crypto” and “DeFi” interchangeably.

• TradFi: traditional finance, finance on a centralized database.

1600s-1900s: What Does the Stock Do?

2020s: What Does the Token Do?

There’s an instance of said speedrunning happening right now: the insistence that a “fee switch” is required to make a token valuable. Also known as "staking", “utility”, and sometimes expressed as“if the token doesn’t have yield, what does it do?”

TradFi has a name for “fee switches”, they're called dividends. Back in the day, they didn’t care much for abstract notions of equity, they wanted cold hard cash for holding stock. Right now, DeFi is of a similar mindset. Parallels.

• 1600s-1900s: “If it doesn’t pay dividends, what does the stock do?”

• 2020s: “If it doesn’t let you stake for yield, what does the token do?”

Let’s review historical examples of what TradFi already experienced, and what DeFi will eventually make peace with.

Dividends and Costly Signaling

Our TradFi ancestors used to share many of the sentiments DeFi presently does - stocks with no dividends were once considered unacceptable! They demanded ‘real yield’ (a cut of earnings) to justify investment. And now only 50% of the Nasdaq pays a dividend… how did we get here?

The instinct to tie the value of an abstract, intangible concept to something recurring and concrete is logical. There are a lot of scams out there, and proof of profitability via payouts is a solid heuristic for knowing you're transacting with a legitimate business. In the old days if you could pay dividends you were seen as a credible company; just as now if you can return yield to tokenholders, you’re a credible DeFi operation. Dividends previously were a form of costly signaling for business viability, whereas today they communicate steady earnings expectations (management tends to set a dividend rate they feel confident they can sustain).

However, this heuristic now carries inverted utility for growth investing.

In modern finance, if you’re paying a dividend that means you don’t have sufficient growth opportunities to invest in, so you return money to shareholders. Whereas if you’re expanding, you deploy profits back into the business. Investors don't prioritize dividends anymore; in fact, they actively want management to keep their earnings and reinvest it. They seek capital gains, not yield.

Humans prefer tangible proof that abstract claims aren't vapor, and a dividend check in 1750 was the financial equivalent of a pulse check: proof of life in an era when companies with little regulation could disappear faster than ships in the Bermuda Triangle. Today's yield farmers demanding big APY in an industry that also has little regulation are spiritual descendants of Dutch investors who said "show me the money". Both groups are asking the same question: 'How do I know this isn't a mirage?'.

How did our financial ancestors navigate this equity evolution?

A Brief History of Stocks and Dividends

The first instance of an IPO and publicly tradable stock came in 1602 from the Dutch East India Company, ticker VOC for Vereenigde Oost-Indische Compagnie.

The impetus for stock issuance provides insight into business models and investor expectations from that era. VOC needed big chunks of capital for specific reasons: to finance voyages for its massive spice trade. VOC issued stock and bonds to fund highly uncertain expeditions, which could either pay out a great deal, or nothing at all. If the voyage was successful then everyone made money, if not, then nothing.

Capital markets used to view stocks essentially as junk bonds in this way: all the focus was on yield, not notions of equity.

Stocks paid a dividend that was greater than debt yields, however it was junior in the payout waterfall. Higher risk, higher reward: just like a junk bond.

Here’s an example payout structure, in order of priority:

• 1st: Bondholders receive interest payments (e.g. 4%)

• 2nd: Preferred shareholders paid next. More than bonds, but less than common stock (e.g. 6%)

• 3rd: If there’s remaining profit, then common stock gets paid. This dividend was the most uncertain, but also the largest (e.g. 10%).

Fun fact: VOC sometimes paid dividends in actual spices like pepper, nutmeg, and cloves. Nothing says 'return on investment' quite like receiving a sack of oregano in the mail. 

Important: Past companies issued equity for specific endeavors that required a large amount of money at once. For example: we’re going on a voyage, we’re building a factory, a railroad, etc.. Expansion was achieved in chunks, not increments.

This is not how growth works today.

Investors gradually became more and more okay with companies paying out less of their retained earnings and keeping the net income for themselves. This has to do with incremental reinvestment in the business becoming more feasible, making those earnings more valuable and useful to the company in smaller amounts. Technological developments like electricity then and cloud computing now meant every dollar a company retained could potentially be used productively.

Technology transformed retained earnings from dead weight into scaling fuel. When you can deploy capital in $10,000 increments rather than $10 million chunks, suddenly every dollar becomes more valuable, rather than spare change rattling in corporate coffers that you might as well return to shareholders.

As advancements like cloud computing today (AWS is way cheaper than having to stand up your own servers) and electricity back then occurred, businesses put earnings back into the business and investors were quite alright with it. Whereas the old-school mindset was “we need *large amount of money* for an investment we think will make X% ROI, and we’ll pay you Y% if it does”. If a voyage costs $20M, keeping a fraction of that as retained earnings doesn’t do you much good, so you paid out basically all your net income to entice investment the next time you needed to fundraise. Expansion previously came in waves, whereas now it could be a steady drip.

Here are excerpts from Byrne Hobart that help illustrate:

For the same reason water takes the most direct path downhill, capital eventually flows to its most productive, efficient applications. If you obstruct this flow and your competitor doesn't, you'll be outcompeted. A sort of financial physics is revealed here in terms of what is empirically the most effective way to manage business and what equity cost of capital should be understood as.

Investor Expectations and Returning Capital

A company can do two things with earnings:

• Reinvest the money into the business

• Return it to shareholders

Early-stage VC-backed tech companies — that are rapidly growing — raise money in rounds for multiyear hypergrowth. And these startups are well-known for paying fat dividends…. ha.

Do you know how many startups pay a dividend? Zero. Why? Because their objective is to use that money to 1000x by investing in business expansion. The goal of the game is capital gains.

(I’ve only heard of one previous startup paying dividends: Kickstarter, and they’re pretty weird.)

If investors desire a dividend, they’d buy a tobacco company or bonds. What's more, in TradFi paying a dividend is essentially seen as a sign of failure for a GrowthCo… “Here take your money back, we can’t find enough productive things to do with it.” Empirically, investors now prioritize growth above all else, and would rather management keep the money if they know how to effectively allocate it. The environment for what contemporary businesses require to succeed is much different than VOC times. Earnings have a greater ROI for both shareholder and company by reinvesting them, not paying them out.

Walmart should pay a dividend, Cloudflare should not. Where do DeFi projects sit in this spectrum?

GrowthCo’s do not pay dividends, and they’re the most richly valued stocks. OldCo’s need to entice you with yields, because performance isn’t cutting it anymore. When growth slows, then dividends are what's offered to keep shareholders happy. Businesses, just like people, have seasons to their existence.

Yet the cultural demands of young crypto startups act as if they're going on an elderly spice expedition.

DeFi businesses implementing 'fee switches' as the only way to prove their tokens have value are essentially cosplaying as 19th-century railroad companies. Meanwhile, the tech giants they want to disrupt pay little to no such dividends: advantage, tech companies. We're building the future of finance while demanding the compensation structure of the East India Company.

Financial Natural Law, 100x or 5%: Pick One

Do you buy a hypergrowth company for a 5% yield or a 100x gain? That 100x is achieved only by the company rapidly proliferating; and that's attained by hemorrhaging cash on marketing, product development, talent, and then doubling down on marketing some more. Expect net income to be technically in the red for a long time.

DeFi hunts for 100x gems while also asking “do we also get yield?”; speaking out of both sides of their mouth in the process. You can’t be a long-distance runner and a bodybuilder simultaneously. The growth-vs-dividends dichotomy is tantamount to finance natural law. No reward without risk. No huge gains without volatility. To want 100x and 5% is to seek stability and volatility concurrently. To want reliability and wife-changing returns from one asset. It’s a contradiction. Crypto is finance on a better kind of database; it has not changed axioms of economics and finance by custodying its assets on decentralized databases.

An Evolution of Culture and Regulation

An interesting cultural insight: in the 19th century and earlier, wealth was measured in terms of annual income, not the market value of one's assets. The notion of "net worth" was not yet a thing, at least not in the way we conceptualize it today. What made that change? It was both a cultural and regulatory development, with the latter facilitating the former.

The historical emphasis on income makes a great deal of sense when you consider the cultural and regulatory limitations of that time. It's not that "net worth" wasn't a concept, it's that it took on a different shape based on circumstances.

Standards like primogeniture and entail laws used to forbid, or severely limit, the ability to trade and sell family-owned assets; you legally had to pass it along to your eldest son. As a result, there was little to no liquidity (e.g. exchanges) for market transactions; how can you calculate net worth if nothing is being priced? So what did you measure wealth in? Income, naturally. Because that's all there was to measure.

You can't calculate an asset's DCF if you can neither price nor sell it, you only value what you can: income streams. We slowly evolved away from measuring wealth in annual yields to capital gains as entail laws diminished that enforced norms around asset sales. Capital transactions became more prevalent, trading did too, and the DCF concept was slowly discovered; and the way wealth was measured transformed along with it. Liquidity began to improve, market makers emerged, and markets developed structure. Accordingly, everyone began to emphasize the capital gains, and net worth, part of the equation - less so annual yields.

We see this legacy continue via stock earning payout ratios today. Previously seen as functionally junk debt, stocks are almost entirely valued as capital gains instruments. Every era measures wealth through its own constraints; it simply takes on different shapes, pragmatically, over time.

Now not only do the wealthy conceptualize their net worth in asset prices, even lower classes look to asset-based valuations as the barometer of wealth. Considering I have yet to encounter anyone in crypto who measures their wealth in staking yield, I don’t think it’ll take too long for us to speedrun the dividend emphasis. DeFi is currently in its VOC phase. This too shall pass.

Crypto will slowly discover the meat behind the concept of control; speedrun this discovery most effectively with Salutary.