Paying with gold, blockchain-style

gold

Hopping on the “digital gold” trend (with possibly two blockchain-based gold exchanges coming on line this year) and the “initial coin offering” (ICO) trend, last week Dubai-based OneGram announced that it was planning to offer a digital coin backed by physical gold.

The aim is to raise $500m in capital through a digital token offering. If achieved, it would be the largest amount raised to date via an initial coin sale.

It has a good chance, and not just for the prevailing winds – ICO sales have been enjoying a surge in investor demand, and the unusual structure and potentially attractive fundamentals of this one could pique interest.

What makes this ICO especially interesting is that it is the first digital token to comply with the rules of Islamic finance. Last November, a clarification of Sharia law qualified digital gold assets as approved investment vehicles as long as they were backed by physical gold.

The potential market is huge: on top of the usual pool of investors, for the first time a digital token will be accessible to Muslims. A recent survey by the Pew Research Institute estimates that there are 1.6 billion Muslims in the world, and total Islamic finance assets reach around $2 trillion.

The plan is to issue 12.44 million tokens, called OneGramCoins. Each will be backed by one gram of gold, and the token price will mirror the gold price. At current market levels, that should bring in over $550 million.

According to founder Ibrahim Mohammed, 50% of the offering has been already been committed. The public sale will start on May 21 and run until September 22 (unless, of course, it sells out sooner, as several other recent token sales have done).

An interesting twist is the objective of creating a payments solution around the token. The company is creating a merchant service program which will make it easy for retailers to accept OneGramCoins (as well as bitcoin and perhaps a couple of other top cryptocurrencies).

Ironically, this seems like a fusion of the old and the new: a modern technology allows customers to return to the ancient tradition of paying for things with gold.

Could Brexit encourage blockchain development?

by Rob Bye via Stocksnap
by Rob Bye via Stocksnap

The FT reported yesterday on the intensifying staring match between the EU and the UK over financial services.

London has for some time been in danger of losing its position as the world’s clearing center for euro-denominated derivatives. The city’s clearing houses handle up to three-quarters of the global euro-denominated derivatives market.

The European Central Bank (ECB) has long argued that oversight of euro clearing services would be easier if they were relocated to within the Eurozone, and in 2011 issued a policy reflecting this. The UK took the case to the European Court, which eventually sided with the UK. The reason given was not because geographical restrictions would discriminate against some member states (the UK’s main argument), but because the ECB’s role is to supervise payment systems, not securities settlement. The ECB still alleges that settlement oversight is essential for payment system stability.

Now that Britain will soon no longer be an EU member, the battle lines are shifting. The European Commission (EC) is preparing legislation for June that will impose geographical restrictions on euro-based clearing. An interesting twist is that the EC is not waiting until Brexit becomes a reality.

The policy, due for publication tomorrow, moves to extend the ECB’s role to include supervision of clearing houses if they provide “critical capital market functions” (such as derivatives swaps). If this goes ahead, it will mean that either the activity needs to relocate, or the UK has to allow ECB supervision on British territory (which it’s unlikely to be happy with).

If the activity has to relocate, the fallout will be considerable, and the impact could be felt around the world. Euro-denominated derivatives clearing accounts for about one third of the global interest rate swaps market.

It’s probable that some clearing houses will prefer to wind down than move (CME Group recently decided to pull out of London due to lack of profitability). The larger ones may find that they lose clients. Either would be enough to contract medium-term liquidity in the market.

Short-term, the potential problem is more serious. Clearing houses reduce liquidity risk in financial markets by standing between two traders in a transaction. They also increase transparency by being in a position to publish the price at which a trade executed.

Disrupt those functions, or even temporarily interrupt them, and you increase systemic risk. You also increase the cost of clearing, as economies of scale are reduced.

Some clearing houses are looking into blockchain applications as a way to reduce costs and enhance liquidity. In 2015 a group including settlement giants CME Group, Euroclear and LCH.Clearnet formed a working body to discuss how the technology might be used to settle transactions. The Depository Trust & Clearing Corporation (DTCC) in the US is specifically looking at credit derivatives settlement.

And notable blockchain startups such as Setl, Digital Asset, Clearmatics, Symbiont and others are also working on protocols to either help or replace traditional clearing houses.

So, there is movement to seek greater efficiencies in settlement, reduce dependence on clearing houses and reinforce transparency. But it’s happening slowly.

Understandably so. Blockchain technology is still new and relatively untested in financial applications. And systemic market infrastructure is not something you play around with.

However, the clock is ticking. And heavy investment in new systems that perpetuate current inefficiencies and are not future-proof will end up adding even more pressure to financial services firms’ already squeezed margins.

I’ve written before how financial shifts due to pending regulation end up spurring research on new uses.

Now we can add political pressure to the list motivating factors.

PSD2 and the blockchain

by Diego Hernandez via Stocksnap
by Diego Hernandez via Stocksnap

Europe has some surprisingly progressive ideas about retail banking.

In 2018, the new payments directive (PSD2) comes into force. This will change not only how we see banking, but also how we treat data.

A bit of background: the Payments Services Directive was adopted in 2007 to create the Single Euro Payments Area (SEPA), aimed at simplifying and modernizing the rules and guidelines for money transfers within the European Union.

An update (PSD2) was passed by the European Parliament in 2015, with the goal of further promoting innovation while enhancing consumer protection.

That may sound good for the consumer and the fintech sector, but it makes banks’ current situation even more tenuous. The sector is already pummeled by low interest rates, increasing KYC/AML costs and flourishing competition. Now, it has to invest in further compliance, and watch while its main competitive advantage is eaten away.

What main competitive advantage? Access to your information.

After 2018, when PSD2 comes into effect, banks have to share your data with third parties.

For end users, this streamlines payments and lowers costs. For innovative businesses, it gives them instant access to a significant resource: specific and detailed information about potential clients.

Retailers will be able to ask you for permission to access your bank account – the payment will be directly between your bank and the retailer. No intermediaries. Investment services will have access to your financial history and be able to offer more tailored advice. Payment portals will be able to compete for the lowest fees and creatively combine financial and social functions. Aggregators will be able to display all your financial information in one place, regardless of how many banks you work with.

Just think how attractive all that data is for service providers.

(There’s some other stuff in there as well, such as tighter control on credit card charges, greater protection for non-EU payments, unconditional refunds on direct debits… all good news for the consumer, not so much for the banks.)

What does that mean for blockchain development?

Basically, PSD2 is about the sharing of sensitive data with a network. Right now, the law envisions the transfers being handled through Application Programming Interface (APIs), code that gives third parties access.

On a blockchain, the distribution could be handled in an open, seamless and secure manner. Banks, clients, retailers and fintech services could all use the same system to share information. Access would be limited to network participants (who would have to jump through some hoops to join), transparency would ensure good behavior, and decentralized storage would enhance security.

This has to be preferable to a system in which banks (reluctantly) cede the information to any approved entity. Or a system littered with targeted APIs with limited interoperability. Or one in which the information is stored in centralized (hackable) silos.

Furthermore, a blockchain-based system would have lower operating costs than a distributed database, since less verification will be needed each time the data crosses over to another platform.

Lower operating costs will be crucial, given the tightening squeeze on banks’ profit margins.

While banks are currently preparing for this seismic change on their current systems, the appeal of a blockchain alternative is likely to encourage even more research and pilots than are already going on. Incorporation of a decentralized, transparent solution may shift from being a nice-to-have, when-we’re-absolutely-sure option to an increasingly pressing imperative. While blockchain technology is still new and has many hurdles to overcome (not least, regulatory), and while the cost of implementation is likely to be substantial, the need to adapt to a new financial paradigm could well be the catalyst that the sector has been waiting for.

We could be on the verge of a shift in blockchain interest. Already high among banks, it could jump up a notch to imperative.

 

Does JP Morgan’s exit hint at changes at blockchain consortium R3?

red-exit-sign (1)

CoinDesk reported earlier this week that JP Morgan has officially exited R3.

This is not a surprise – last year when Goldman Sachs and Banco Santander left the banking consortium, rumours abounded that JP Morgan would stay out of the funding deal that R3 was trying to put together. Disagreement with the structure of the financing was one reason cited for the exit of the two large financial firms.

Speaking of the funding deal, you know, the one that David Rutter assured us would be completed in Q1 and would be biggest ever in the sector…

“We will be closing the largest round in the industry, with the largest number of market participants, now, in the first quarter.” (from CoinDesk, January 11, 2017)

Where is it? The first quarter has come and gone, and still no news. And then we hear that JP Morgan are leaving.

R3’s reaction is disconcerting. Managing Director Charley Cooper gave the following comment to CoinDesk:

“JP Morgan parted ways with R3 to pursue a very distinct technology path which is at odds with what the global financial services industry, represented by our 80-plus members, have chosen.” (from CoinDesk, April 27, 2017)

So, the “global financial services industry” (as represented by a mere 80 firms) has chosen a certain technology path? Do the tens of thousands of financial firms not in R3 know this?

And are they really comfortable with choosing only one path this early in the game? They are so sure that R3’s solution is the correct one? Whether they are or not, it’s R3’s assumption that they should throw all in with their solution that makes me splutter.

JP Morgan’s leaving is quite a big deal – it was a founding member.

Back when Goldman Sachs (also a founding member) and Santander left, my hypothesis was that they were backing away from consortia in general. Consortia are especially useful when investigating a marginal activity. When it becomes key, and when businesses feel that they know enough, it makes more sense to “go it alone” for competitive advantage.

JP Morgan, however, is active in both Hyperledger and the Enterprise Ethereum Alliance, and has contributed code to each. It’s not rejecting consortia as a concept. (Also, Santander since then has joined the Enterprise Ethereum Alliance as a founding member.)

So, it does sound like there were issues with R3 in particular. And it sounds like R3’s funding round isn’t going as smoothly as hoped.

Blockchain data storage

database

One relatively overlooked application of the blockchain is that of data storage. This is odd, given that the technology is all about data: moving it, sharing it and keeping it whole. So why the lapse of coverage?

It may just be my blinkers – data storage is not the most sexy of functions. But, having dug into it a bit over the past few days, I’m realizing how varied and important the solutions are. It’s not just the need for safe and reliable data to value just about anything we do… It’s also the increasing role that data plays in our lives. If data is the new oil, and the big data enthusiasts proclaim, then we really need to think seriously about how we handle and store it.

Here’s a brief overview of the main blockchain innovators in the data storage space:

The group that has been at it the longest is Scotland-based Maidsafe. It has been working on decentralized computing for over 10 years now, and it doesn’t rely on a blockchain for data storage (it has built a distributed alternative which, to my non-expert ears, sounds a lot less streamlined). It does, however, rely on a native cryptocurrency for incentives – MaidSafeCoin is now the 10th largest in terms of market cap. Users contribute unused computing capacity in exchange for the native cryptocurrency, which can be sold or used to pay for network services.

Instead of information being uploaded to a central server, it is broken up, encrypted and stored on random computers across the network – several times each, to ensure availability. Data is moved around the network as computers are turned on and off and as demand ebbs and flows from certain areas, to improve access, speed and security (information is difficult to hack if you don’t know where it’s going to be).

Maidsafe aims to do more than offer distributed storage – it wants to establish a “decentralized internet”, in which surveillance and data theft are impossible.

After a murky ICO in 2014, Maidsafe’s second funding round was a £1.3m equity crowdfunding October 2016 (lower than the target of £1.75m). The alpha network was released in August of 2016, and has encouraged an ecosystem of apps includes data storage, email, forums and video conferencing, with more to come. One drawback to this project is the long development time. It’s an ambitious goal, true, but over 10 years’ buildup – especially with distributed technology evolving as fast as it is – runs the risk of being obsolete before it starts. Not to mention the risk that other, more agile competitors that started later with a different tech base can overtake on the inside…

Such as Sia, for example. Rather than try to rebuild the internet from scratch, Sia is starting with data storage. Like Maidsafe, it aims to harness unused computer space to offer a low-cost, decentralized alternative to Amazon’s S3 and the like.

To that end the Boston-based company built a proprietary blockchain that uses smart contracts to handle the payment from the user to the space contributor. Payments are made in the native cryptocurrency Siacoin, currently 40th in terms of market cap.

As with Maidsafe, information is split up, encrypted and distributed, retrievable only with the user’s key.

After an initial crowdfunded round of $500,000 in early 2014, the first beta prototype was launched in 2015, with version 1.0 following in June 2016. Sia’s parent company raised a further $750,000 in September 2016, from VCs Raptor Group and Procyon Ventures.

Storj, based in the US, is another startup going after the enterprise storage market. It started out on the bitcoin blockchain (with transactions occurring off-chain), although it recently announced its intention to migrate to ethereum.

As with Sia, participants receive a native cryptocurrency (in this case, Storjcoin, currently #35 in the market capitalization rankings) in exchange for offering their storage capacity. After an initial ICO in June 2014 of almost $500,000, Storj raised a further $3m in February of this year from angel investors, making it the best-funded startup in the data storage space.

Testing of the network began in 2014, continued through 2015 and in April 2016, Storj launched in beta and was added to Microsoft Azure.

A spectacularly ambitious project comes from the BigChainDB stable: its public network IPDB, which stands for Inter-Planetary Database (next stop = the universe!). The project aims to be the database for the “emerging decentralized world computer” (possibly that of Maidsafe, but more likely to be that of Golem, a project focused on harnessing unused computing power rather than storage space).

Rather than try to turn a blockchain into a database, BigChainDB approaches the problem from the other direction – by adding blockchain functionality onto database technology (this may sound like trying to fit a round peg into a square hole, and I’m not a database technician so no expertise here, but it could lead to a more adaptable and flexible solution).

The Germany-based startup has managed to raise £5m so far, including €3m in a Series A last September from Earlybird Venture Capital, Anthemis Group, Digital Currency Group and innogy SE, among others.

The barriers to these becoming mainstream are 1) regulation, and 2) reliability.

If data is sensitive (and it often is), then someone is going to want to regulate it. “Sharing” is simply not possible with certain types (health, fiscal, etc.), and even if encryption and protection assure that only those who should access it can, the chance that others could gain access is enough for regulators and potential clients to hesitate, or even downright object.

It’s a bit like the decision between keeping your gold spread around the world (where it is more vulnerable, but on a piecemeal scale), or in a vault 600m deep in a mountainside (where it’s harder to get to, but if the bad guys do…).

The reliability issue is also going to be a concern for the important stuff (like identity, finance and government documents). Even with layers of redundancies, is it enough? Sure, distributed risk is preferable in that system failure is less likely. But what about responsibility? If the distributed system fails, no-one takes the blame, but also no-one makes up the loss.

However, the idea is interesting, and could well be where the internet is heading. Once the technology has advanced further and speed and distribution issues are ironed out, could it replace our current siloed format of storing data, with ownership, rights and other fundamental concepts in the murky area of this-is-not-what-we-meant-by-equal-access? Will the benefits and redistribution of wealth offset the humongous costs of changing the way the current system works?

Time (sorry, I mean the market) will tell.

Castles in the Air

by Markus Spiske via Stocksnap
by Markus Spiske via Stocksnap

Reuters reported today that Fidelity Investments Inc has joined IC3. This is intriguing, on many levels.

IC3 (Initiative for CryptoCurrencies & Contracts) was set up by faculty members of Cornell University, Cornell Tech, UC Berkeley, UIUC and the Technion-Israel Institute of Technology, and is based at the Jacobs Technion-Cornell Institute in New York. It has a “partners program” to encourage interaction with the business community, through which enterprises can pay an annual fee and participate in the development of new ideas and prototypes.

According to IC3’s website, partners can participate in monthly webinars, receive regular updates on and early previews of IC3 projects, access faculty and students (which could be used for recruiting purposes), and send up to two visiting researchers or embedded developers. The cost is $150,000 a year (or $450,000 for a higher-level partnership with even more access), a lot more expensive than Hyperledger’s $50,000 (or $250,000 for premium).

Fidelity joins Chain, Intel, IBM and Digital Asset, making it the first non-tech partner. According to Reuters, Fidelity wants to study how blockchain technology could make financial systems more secure and efficient.

So why not join a finance consortium? Why not sign up with Ripple, R3, Hyperledger or the Enterprise Ethereum Alliance?

While even academics acknowledge that a technology with no practical applications is not exactly useful, IC3’s approach seems to be blatantly “science first”. On its website it claims to “meets the blockchain community’s urgent need for world-class expertise in computer science” – notice that business models are not mentioned. Hyperledger, on the other hand, is also based on computer science, but seems to place the business applications front and center.

The motivation behind the choice of a consortium that takes a more scientific approach raises questions about Fidelity’s goals and strategy.

It’s important to note that Fidelity Labs will join as partner, not Fidelity Investments. Fidelity Labs was created in 1998 as the innovation arm of the financial corporation, and currently has over 100 patents to its name. This is just one indication that the multinational conglomerate has been investing heavily in technology for decades. Back in 1965 Fidelity Investments was one of the first investment firms to install a mainframe, and Fidelity Labs currently owns two of the first NVIDIA DGX-1 “artificial intelligence” computers.

But that doesn’t deter from the bigger question of “why IC3?”.

Perhaps Fidelity is looking to escape what they see as an overcrowded space in “mainstream” consortiums. Perhaps it feels that the higher fees and focus on research give IC3 a certain cachet. Perhaps it has a specific idea that aligns with a project already underway in IC3.

Or perhaps it is the beginning of a shift in priorities: business cases are interesting, but without academic proofs, you’re building castles in the air.

Surprising diversification

steel cut

Yesterday one of China’s largest P2P lenders announced a surprising move into blockchain technology.

I say surprising, because on the surface it does not seem to have much to do with marketplace loans.

The report, sourced from a Chinese newspaper, claims that the project’s goal is use its ability to store and secure data on a blockchain platform to develop a supply chain tool for enterprise businesses.

Apparently it will start by integrating the service with a steel trading platform.

You can see why I’m scratching my head, right?

Creditease does have a long history of diversified investments, that does not show any sign of letting up. In this year alone, it launched a second venture fund focused on Israeli technology, and invested in the funding rounds of three US fintech companies.

Diversification makes sense in a sector being hit by additional regulatory pressure, market scandals and looming international competition.

But a blockchain platform for supply chain management for enterprises?

I wrote recently on the impact that blockchain innovation could have on the massive marketplace lending sector in China. It is, I believe, poised to take off with the introduction of new technologies and relationships, which in turn can open up new markets.

But steel trading??

If anyone can see where this strategy is going, please let me know.

Are blockchains and distributed ledgers the same thing? Sort of.

I had the privilege to give a seminar yesterday on bitcoin and the blockchain, to an engaged group of professionals with lively debate and challenging questions. One member of the audience asked a particularly intelligent question: what is the difference between a distributed ledger and a blockchain?

My immediate response was “there isn’t one, not really – it’s mainly semantics”. But I’ve been brooding all morning – is that correct?

Not really.

Antony Lewis of Bitsonblocks answers the question with clarity and simplicity (hard to come by in this field).

It turns out that all blockchains are distributed ledgers, but not all distributed ledgers are blockchains. Blockchains distribute data to all participants. Distributed ledgers don’t.

He provides a great diagram:

via bitsonblocks.net
via bitsonblocks.net

He also offers some advice:

  • If you want to include all the initiatives going on, use the term “distributed ledgers”.

  • If you mean blockchains, where unrelated transactions are bundled into blocks, which are chained together using hashes and (in most cases) broadcast to all participating entities for batch processing, use “blockchains”.

  • If you like acronyms, use “DLT”: Distributed Ledger Technology

So, my new answer to that question is the same, but with a qualification: “you can use the terms interchangeably, but technically, not all distributed ledgers are blockchains”. Sound good?

Stock exchange technology problems

New-York-Stock-Exchange-Facade1 800

The Wall Street Journal reported this morning that the NYSE’s Arca exchange, which hosts the trading of more than half of the exchange-traded funds (ETFs) listed in the US, suffered a “glitch” at the end of trading yesterday. All live orders were cancelled, and a “backup method” was used to determine settlement prices.

Why is this interesting? In part because of the lack of information. The NYSE is not disclosing details about why the system failed. Either this is because they don’t know (disconcerting in this day of electronic information) or because they’re trying to figure out how to spin it (which could mean that it’s more complicated than just a simple “glitch”).

It’s also interesting given recent progress made in blockchain applications for trading and settlement of securities.

The NYSE is not as deeply invested in blockchain exploration as other exchanges (notably the Australian Stock Exchange, Nasdaq and Deutsche Börse). It is an investor in cryptocurrency exchange Coinbase, although the exchange’s interest in bitcoin seems to be limited to the index it launched in 2015. Nor is it one of the more technologically advanced exchanges. Bats, for example, has a better reputation on that front.

Maybe what happened yesterday will underline the need for a more robust, transparent solution. Maybe this will affect the scope of the resources thrown at the problem. Maybe the end result will be a blockchain platform, or maybe not – either way, we will likely end up with answers to questions we haven’t even asked yet.

 

A business model emerges

Actually, IBM’s business model was never really in doubt (unlike some other players in the sector), but it’s worth looking at anyway, for what it says about consortiums and open-source development.

Just under a year ago, IBM announced plans to develop a suite of blockchain services for enterprise clients. Today it revealed the first commercial applications: IBM Blockchain.

Housed in the IBM BlueMix cloud computing store, it differs from the Hyperledger Fabric codebase mainly in the extra security layers.

There’s the business model: while the underlying code is open source (ie. free), IBM will charge for access to the extra secure version.

It makes sense. The target clients are mainly large enterprises, such as financial institutions or conglomerates. They are not going to want even the slightest hint of a risk that their information might not remain secure, or that the processes may get interrupted. Paying extra for access to a blockchain service with additional security features – that is going to save them a lot of money in operation costs – is likely to seem a winning proposition.

Other businesses, such as Microsoft, Intel, Ripple, Chain and R3, have followed the same pattern. The underlying code is free, and the revenue comes from the development of additional services, from consulting fees and in some cases from the sale of specialized hardware and other security precautions.

Why make the underlying code free? To generate a vibrant developer community. If it’s out there for people to tinker with, tinker they will. And while they’re at it, they’ll find bugs, help to fix them, and probably invent some curious use cases that could lead to grand innovations.

It’s curious to think that we live in a time in which proprietary information is no longer the advantage it once was. In the blockchain world, for now at least, success seems to stem from giving your product away, and then charging for the value-added layers. Freemium meets the blockchain.

Whether that will remain the case when blockchain is no longer a “new” technology remains to be seen.