My interest in Blockchain is the concept – different organisations and startups – what is being developed, by whom and how it can be used. My version of Blockchain lowdown below – I will try to keep this simple, contextual and will sincerely attempt not to deviate.
If you want to read something on the topic, there is plenty written on Blockchain. FT has a pretty good explanation and the story around Blockchain. A strategist’s guide to Blockchain is another good piece.
Mike Hearn leaves a Bitcoin experiment – joins R3, Jamie Dimon at Davos says Bitcoin “Worthless,” Bullish On Blockchain, Blythe Masters signs a deal with ASX and R3 tests Blockchain based trading system. Right now, at all levels all roads lead to Blockchain.
What was the Blockchain-based trading system test about?
According to the R3 press release the (part that explains what the test was about) text reads –
What does it mean? Out of the 42 financial institutions in the R3CEV consortium, 11 participated in the simulation. Participating banks were able to carry out financial transactions globally amongst each other (privately). The banks exchanged ‘money’ versus ‘assets’ (buy and sell) on a distributed ledger without middlemen or a third-party.
What is a distributed ledger? What is a centralized third-party? You may ask. There is a good piece on bobsguide that explains key elements of distributed ledger.
Centralised third parties – In the past (and the present) financial transactions follow a procedure, a process and include intermediaries. Intermediaries are the third parties. When a trade is placed for a buy or a sell a simple view below shows how the money and assets are exchanged and the intermediaries involved.
This is a simplistic view of the trade-settlement process for listed securities. The process takes 2 or 3 days to complete depending on the market i.e. the country. Every such transaction is carried out in the respective markets and assets are then held at a custodian who values, safekeeps and performs all the necessary reporting and events on the assets.
The basic idea of the R3 conceptual testing is that intermediaries are eliminated and/or an ecosystem is developed using Blockchain and distributed ledgers that enables all these transactions between the stakeholders i.e. peer to peer, institution to institution and the records are all kept online and decentralised with encryption. So far it has been tested and spoken about in private market setups.
UBS has a blockchain lab. NASDAQ already has its private securities transaction via distributed ledger. Goldman has filed a patent application for “Cryptographic Currency For Securities Settlement.” According to Wired, IBM, Intel, and Cisco as well as the London Stock Exchange Group and big-name banks JP Morgan, Wells Fargo, and State Street—have joined forces to create an alternative to the blockchain. Then there is a Linux foundation that unites industry leaders to advance Blockchain technology and a new report by the UK Government Chief Scientific Adviser sets out the future of distributed ledger technology. At the time of writing, Bank of America has filed a slew of patent application and Digital Assets Holdings received a few more backers in Goldman Sachs and IBM to its Blockchain-distributed ledger technology.
There is plenty of action but in what is available to read no one seems to know how blockchain will weave it all together (or so it is said). The idea that this will become a standard across public markets is fast catching up. All the investment dollars indicate it is not being developed to create a private transacting environment. Safe to assume we are going public and global.
Philip Stafford of FT opens his article on ‘Blockchain for banks still at the ‘gluten’ stage’ by saying “Transferring the technology that underpins bitcoin from a power point presentation to a prototype is challenging the world’s largest investment banks”. There are many variables in the Blockchain equation. So far the experiment only seems to be developing for ‘settlement’ and perhaps ‘investment banks’ are the only one’s trying to solve this equation.
There is one piece of news that has had decent coverage and is possibly an indication of change in guard. Digital Asset Holdings (also known as Blythe Masters) signed an investment deal. Most important of all the investment partners is Australia’s primary stock exchange (ASX). This is one of those look no further moments. It is not the amount of money that ASX has invested but it is the idea of an exchange of acting as an enabler. The ASX press release has a message that could not be clearer –
I would be interested to hear the views of two specific entities – asset owners (pension funds, sovereign funds, asset managers, institutions that manage assets) who will become the nodes and securities services providers i.e. custodians, fund administrators (read: the whole suite of back and middle office) – business units in the same big banks who today have a service that caters day-in and day-out not just settlements but a whole herd of regulatory and services-solutions not discussed so far and apparently face obsolescence in the face of blockchain.
Not long before Blockchain – trading – was focused solely on algorithms and software development for fast front-ends and now we suddenly seem to be all focused on instant settlement. There would need to be a sea change in how local market regulations work for every single country for instant settlement to be recognized in the listed markets.
Blockchain as we stand today has ‘instant settlement’ written all over it. Do asset owners who are large financial institutions and have a predominantly buy and hold strategy care about settlement in 3 days, 2 days, 1 day or instant?
A few set of questions (by no means an exhaustive list) that should take this brain buster concept discussion to the next level.
Blockchain. What happens when many blockchain ecosystems come into existence? Would they all have similar methodologies, technology encryption to trade? How are we going to define encryption standards? Establishing communication protocol amongst these different ecosystems? Do we have to have ecosystems by market (country) or it will be at an institutional level?
Regulation and Markets. What is the impact on local market regulation of each country? How does large volume trading take place? How are the markets then regulated and priced? What is the role of national stock exchanges? What level of data is stored and how is regulator apprised?
Banks and Asset owners. How does the cash move (assuming Bitcoin is dead)? If asset owners are nodes and are transacting amongst themselves we assume every financial institution (read: Asset owners) is sitting long cash? What role do banks play? How are the KYC/AML rules conformed? Will there be global uniform standards (poses challenges if a set of nations embargo one country)? Who values the assets and how is the verification (audit) carried out, if we are talking multiple Blockchains?
Custodians. Fund Administrators. What role do Custodians play? Who provides asset servicing i.e. perform corporate actions, income payment, dividend payment, shareholder services? Who does the valuation of each and every asset class in a node? What role do fund administrators play? Is it just settlements that we need? What if I have to cancel a trade (problem if a settlement is instantaneous)? How do asset owners become a node and are able to trade, all we hear right now is banks are trading amongst themselves?
If you started asking blockchain questions-changes in relation to investment banks, route to capital markets, IPOs, Crowdfunding then this list can go on.
There are realization issues. There are manual processes. There are regulatory nuances. There are weaving-interoperability tasks and it is not just about settlements.
In subsequent blogs, I will analyse different concepts that come out of financial – institutions, startups, technology and which concept is trying to solve which part of the value chain. The experiment has just about begun. This is a real challenge.
Featured photo is from https://stocksnap.io