How capital markets actually work
A primer on how capital gets raised, priced, and traded
This article is adapted from a video essay by Tally CEO & Co-founder, Dennison Bertram. Watch the full video on Youtube.
Before diving into on-chain capital markets, it’s worth grounding ourselves in the basics. What are capital markets, and how do they work?
What capital markets do
Capital markets are the systems through which long-term capital is raised, allocated, priced, and traded. They connect capital providers (investors) with capital seekers (companies, governments, projects).
At a high level, capital markets answer four questions: Who needs capital? Who has capital? At what price will capital move from one to the other? And under what rules and protections?
Capital markets are distinct from money markets, which deal with short-term funding like treasury bills or commercial paper, the instruments companies use to cover expenses over short periods.
Primary and secondary markets
There are two markets to understand here: primary and secondary.
Primary markets are where actual capital formation happens. This is where new capital is created. Examples include initial public offerings, follow-on equity offerings, corporate bond issuances, government bond auctions, and private placements like venture capital, private equity, and private debt. In a primary market, investor money goes directly to the issuer.
Secondary markets are where liquidity and price discovery happen. If you’re thinking about tokens, the ICO would be the primary market, and Uniswap would be the secondary market. In traditional finance, secondary markets include public stock exchanges, bond trading desks, and OTC markets. These markets don’t fund the issuer directly, but the liquidity they provide is essential. Without a secondary market, investors would demand a much higher return in the primary market because they’d have no way to exit their position.
Equity, debt, and hybrids
Equity represents ownership claims on residual cash flows. It’s what you classically think of when you think of owning part of a business. Equity is high-risk, high-return, and generally comes with voting and governance rights. Stockholders get to vote. They have some say in the board and thus some control. Equity instruments include common stock, preferred stock, options, and warrants.
Debt is a contractual obligation to repay principal plus interest. It’s lower risk than equity, mostly because debt holders have seniority in bankruptcy. They get paid first, before shareholders, who might not get anything once the debt is netted out. Debt instruments include corporate bonds, government bonds, loans, notes, and asset-backed securities.
Hybrid and structured instruments combine features of equity and debt, generally engineered to reallocate risk in some way. Examples include convertibles, structured notes, and mezzanine debt.
Who makes it work
Capital markets require infrastructure. Issuers are corporations, governments, and financial vehicles like special purpose vehicles or trusts. Intermediaries include investment banks (for underwriting and distribution), brokers and dealers, asset managers, custodians, and clearing houses. Venues are the exchanges: in traditional finance, these are centralized exchanges like the New York Stock Exchange or NASDAQ, plus OTC networks, whether bilateral or dealer-mediated. Regulators set disclosure rules, enforce market integrity, and protect investors; in the US, that's the SEC.
Capital markets as risk-pricing machines
Capital markets are fundamentally risk-pricing machines. The key principles: higher risk means higher expected return (you see this in crypto, where some tokens have very high rates of return but are extremely risky), time value of money, diversification reducing idiosyncratic risk, and systemic risk that can’t be diversified away.
Pricing inputs include cash flow expectations, discount rates, volatility, and correlation with broader markets. The canonical models here are things like discounted cash flow, capital asset pricing model, yield curves, and credit spreads.
Liquidity and market efficiency
Liquidity is the ability to buy or sell something without moving the price. In crypto, liquidity gets discussed constantly. It depends on depth, breadth, and immediacy.
Highly liquid markets in crypto include ETH to USDC or USDC to USDT. In traditional finance, highly liquid markets include large-cap equities (Tesla is extremely liquid) and sovereign bonds.
Illiquid markets in traditional finance include private equity, venture capital, and real assets. It’s hard to get out of a private company. It’s hard to sell land. In crypto, low-liquidity markets are tokens where small sales move the price enormously.
On market efficiency: in practice, markets are efficient enough to be hard to beat, but inefficiencies do exist. You see this in complex instruments, regulatory gray zones where not everyone who might participate is participating, and especially during stress events.
Capital markets versus banking
It’s useful to compare capital markets with banking. Banks are balance-sheet-based, create credit, are relationship-driven, and are intermediated. Capital markets are market-based, allocate capital rather than create it, are price-driven, and are disintermediating, reaching many different people.
Modern finance increasingly shifts risk from banks to markets.
Why capital markets matter
Systemically, capital markets fund innovation and infrastructure. Most good things we have come from capital markets that funded the innovation to create them.
Capital markets enable risk-sharing across society. Many different investors participate in something like Tesla. They encourage disciplined management through pricing, since the price reflects how people think a company is being operated. They also transmit monetary policy and amplify shocks when things are mispriced or overleveraged. The 2008 and 2020 crises are often called capital market plumbing failures, not just bad assets.
Current structural shifts
Several shifts are happening in capital markets right now: passive investing dominance, private markets overtaking public markets, tokenization and on-chain settlement, regulatory arbitrage between jurisdictions, and AI participation in markets.
The question today is less about whether capital markets allocate capital, and more about who controls the rails.
What’s exciting is how crypto is disintermediating many of these functions and making capital markets more efficient, wider, broader.
One of the ideas Tally was founded on is to drive the cost of capital formation to zero and establish incorporation in software rather than jurisdictions. That's where all of this is going, and it's what we're building toward: the infrastructure for on-chain capital markets that makes everything described above faster, cheaper, and more accessible. More on that soon.
Tally provides token infrastructure for the most successful teams in crypto. We help teams launch, govern, and operate token-based systems at institutional scale. If you’re interested in launching with Tally, schedule a free sales consultation.