GDPR, blockchain and the technological arms race

A “blockchain killer” in the house? The press, who never knowingly misses an opportunity for drama, is making much of the upcoming clash between blockchains and EU regulators over the new data rules (GDPR), due to activate just over a month from now.

On the one hand, the right of all EU citizens to insist that their data is removed does mean that blockchains can no longer be immutable (in other words, they can no longer be blockchains).

But on the other hand, most of the private blockchains that enterprises are building on are not actually blockchains – they’re distributed ledgers, and they can be mutable. Those that are building on cryptographic systems based on chains of blocks, yup, that might be more of an issue.

Which is a drawback, since there are compelling use cases for public ledgers, and the technological development going on behind the scenes will – if allowed to continue – fuel further use cases and functionalities.

Although the work would most likely go ahead anyway. On the public, decentralized blockchains – they’re not “owned” by anyone. So just who is the European Union going to fine?

Apps that are run by a centralized organization might be easier to target – but there’s not a lot of clarity over control of the data. In a cloud server, for instance, if the company that put the data in there doesn’t eliminate the information, Amazon or Microsoft could step in to do so. In a public, distributed database where no particular entity has control over what goes in, who would the authorities insist take it out?

What’s more, switching geographical base is getting easier, with other jurisdictions clamouring for the talent and investment. All a clampdown would achieve is an exodus from Europe, and a missed opportunity to participate in greater efficiencies and new collaborations.

This highlights the futility of the GDPR legislation, and how it hands technological supremacy to other geographical areas of influence. It not only further entrenches the power of existing silos at the expense of smaller businesses (due to the considerable compliance costs, which the larger companies should have no problem absorbing); it also inhibits innovation in new data structures that actually have the power to better distribute processes and utility (and I’m not just talking about blockchain).

race

(gif via Tenor)

At the same time, it could spur research into new ways of handling online information, including the possibility of sovereign identity. Rather than just an interesting concept with potentially empowering consequences, new identity management could become an economic imperative.

The goal is becoming increasingly important, given that Europe is falling behind. A think tank (with the aspirational name JEDI, for Joint European Disruption Initiative) has called the region to task for being too slow and thinking too small in its technological development. Misguided initiatives that ineffectually value privacy over progress, and punitive tax measures that will have the net effect of reducing collections, further entrench the disadvantage.

As recent headlines (North Korean hackers, Chinese takeovers and belligerent National Security Advisors, to name just a few) highlight, technology is an increasingly powerful tool in the race to economic (and military) supremacy. Barriers to development – however well-intentioned – could end up deciding the winner. Even leaving aside military outcomes, economic growth for all becomes a matter of survival as deepening inequality shakes political establishments to their core.

So, it’s probable that GDPR will back down, and allow blockchain development – on both public and private ledgers – to continue. That would be good news, on many levels. We have no way of knowing where the impact of research and pilots will be most felt, but we can be certain that the progress will be felt in areas well beyond the bounds of the crypto sector.

Rather than European data privacy laws squelching blockchains, it may be that blockchains squelch GDPR.

 

Blockchain speed bumps

by Alex Iby for StockSnap
by Alex Iby for StockSnap

Sigh, thought so.

The DTCC (the US post-trade giant) hosted a fintech symposium earlier this week, in which blockchain technology was one of the main points of discussion. According to CoinDesk’s report, the atmosphere – as evidenced by the event’s keynotes and panels – could be described as “reserved enthusiasm”, “hopeful realism”, or perhaps even “putting on a brave face”.

Several of the speakers pointed out the complexity of the systems currently in place, the limitations of blockchain technology, the risk inherent in public blockchains and the colossal task of getting regulators around the world to agree on a constructive way to protect users.

One intriguing detail revealed is that the unveiling of the DTCC’s new platform will be delayed. The original press release promised a launch in early 2018. CEO Michael Bodson let drop in a LinkedIn post last December that it would be late 2018. Now it’s looking like it will be in 2019, at least a year late. This is where the sigh comes in, because it will probably end up being even later than that.

I wrote about the scope and advantages of the DTCC project a few months ago, but to recap: the decision to go with a blockchain-powered platform was based largely on the need for 1) transparency – where all participants could share the “golden copy”, the main database from which others draw their information; and 2) efficiency – reducing settlement times, and streamlining administration with smart contracts. The use-case makes sense.

But blockchain is complicated. Securities markets are complicated, particularly derivatives. And project planning is complicated, especially when you’re dealing with new territory and uncertain infrastructure.

The DTCC’s project is far from the only one that has suffered setbacks. Going through the slew of announced banking blockchain projects from the past year, the number of missed deadlines is overwhelming. Many projects start out with high hopes and effusive press releases, only to get quietly shelved as the obstacles prove to be expensive.

Often it’s because limitations of the technology are discovered as building progresses. The technology is young, after all. The DTCC platform was originally to be based on ethereum (not even four years old), with Solidity as the smart contract language. Yet the team soon discovered that the DTCC application needed something more sophisticated than Solidity would allow. While the firm has not (to my knowledge) specified what the new solution would look like, it is an investor in Digital Asset Holdings, which has developed a new smart contract language.

Sometimes setbacks originate where regulation and applicability meet, an area fraught with uncertainty. Getting the authorities to sign off on something that hasn’t been built yet is a challenge. Beyond that you also have the need to agree on regulatory reporting requirements.

Technology changes are extremely difficult, and delays are common. The risk is that the longer the delay, the more complicated the project gets as additional requirements are inserted by regulators or stakeholders, and as technology moves on. With delays come additional costs, and there may come a point when the change is no longer a good business idea. The infamous upgrade of the London Stock Exchange system in the 1980s accumulated a delay of over 10 years – in the end, it was scrapped after sinking over £70 million (£140 million in today’s money). Could the same thing happen here?

I hope not. The work being done is important, and points to a new financial system that has the potential to solve current roadblocks and cost barriers. We can’t underestimate the knowledge contributed to the blockchain sector, even if the work ends up being private (although the DTCC’s technology partner Axoni has said that it plans to open source the project once completed).

The main lesson is to not get giddy with excitement over big pronouncements – they are far from a victory. They are, however, a validation of an idea, and a commitment to further the sector’s development. We also need to be able to take setbacks in our stride, lower our expectations and not point to delays as evidence that we are now in the “disappointment” phase of the hype cycle. Even if the high-flyers end up pivoting, the amount of focus and progress in the sector shows that others will be willing to pick up the mantle and try a different, perhaps more modest approach.

Given the strong amount of work still going on, and the constructive tone of high-level conversations – such as those at the DTCC event – we can take the delays as breathing space, and settle back to watch hard-won progress slowly emerge. Better late than never.

Twitter tantrums and bitcoin brawls

What is it with Twitter and bitcoin?

source: Giphy
source: Giphy

CoinDesk published today a dissection of the latest flare-up of hostilities between bitcoin’s different factions. It makes compelling reading, and reveals the complex web of interests behind tweeters, promoters, bots and Twitter’s administration.

“…when it comes to cryptocurrency, it can be tricky to distinguish moderation from censorship.”

Yet beneath the short fuses bubbles a tension that speaks to a deeper characteristic of cryptocurrencies: the complicated mess that is consensus.

By that I mean agreement on issues both big and small. When strongly held beliefs are challenged, history shows that humans tend to man the barricades. The weapons at our disposal these days are barbs and blocks, downvotes and unfollows. We dig trenches in the battlefields of social media, and fire away, with only our reputations and tempers to lose.

Most of us just observe, sometimes taking silent sides, sometimes just feeling grateful that we don’t care that much, often oblivious to what the map is telling us.

Leaving aside the scams for now (we’ll get to them in a minute), the Twitter battles are a public example of the force of disagreement. While good-natured debate is often a feature of Twitter controversy, the distance from which verbal weapons can be fired empowers many to throw restraint and diplomacy out the window – especially with a subject like cryptocurrencies that speaks to utopian dreams and political hopes. And the intransigence of all sides is racking up the volume to such high levels that the Twitter administration is thinking about stepping in.

You see the irony? A protocol that automates consensus generates discord. A technology that is about not needing to trust your counterparty is rife with mistrust.

But that precisely is the beauty of bitcoin and its peers. It lays bare our human nature, and then shows us the solution. Or rather, it offers us a function, and then shows us how much we need it. Very clever.

With bitcoin, we don’t need to agree – the algorithm will figure out what the consensus is, and implement that. Whether or not we agree is irrelevant. If we don’t like how the algorithm does that, we can take the code and make a new version. We won’t have the ecosystem that the original one has, but the choice is ours: to pay the price of participating in a broader “society”, or to branch out on our own and forgo the support and access to a broader market. Blockchain technology makes sure that shouting and shadow attacks don’t impede progress or the working of the system.

So, what the Twitter crypto battles are really showing is how useful blockchain technology can be. It gets around the barrier of “consensus paralysis” by removing the human component.

The vast number of crypto scams on Twitter holds a different irony: that a technology based on the automation of trust is attracting those that rely on trust to steal. Blockchain technology says “I don’t know who you are, but I don’t need to in order to trade with you”. Scam artists say “trust that I am who I say I am and send me xxx”. And that the two concepts can uneasily co-exist in the same sector speaks to its sheer size and attraction.

Is Twitter a catalyst for the discord and the scams? No – if Twitter didn’t exist, the battles would be (and are) raged elsewhere – Reddit is aflame with fiery argument. I don’t use Facebook, but I imagine that that has its fair share of vitriol, also. And Twitter doesn’t affect human nature as much as it does display it.

Meanwhile, the premise of bitcoin and the possibility of blockchain reveal the underlying convictions and prejudices… and point to a way to minimize their impact on operations and progress.

So, let the Twitter wars rage (but stop the scams). Cryptocurrency doesn’t “belong” to any one faction. And as Twitter users, we can choose who we follow, who we listen to and who we ignore. There will never be a human-based consensus. But as the sector is showing us, at an operating level, there doesn’t need to be.

Lessons learned: Taurus and the ASX blockchain integration

image by Tamarcus Brown via StockSnap
image by Tamarcus Brown via StockSnap

London, 1993. A big decision was about to be made, that would send ripple effects across Europe and forward through time, acting as a warning against ambition and consensus.

For the past 10 years, the London Stock Exchange had been working on a significant upgrade of its securities settlement system. With paper-based systems groaning under the 1980s boom in share ownership, pressure was building not only from nimbler competitors but also from the regulators across the Channel. If London wanted to maintain its role as the continent’s money centre, it needed to upgrade.

The new system was called Taurus, and its goal was to remove as much physical documentation from the system as possible. It also planned a move to rolling settlement, reducing the payment period for equities from three weeks to three days.

Yet things were not going well. The first sign was the rhythm of missed deadlines.

From the outset, the project was complicated. It aimed to include as many sector stakeholders as possible, in spite of conflicting interests. Institutional investors wanted a fast, reliable service, while private investors wanted lower costs. Also, the existing registrars (dominated by large banks) were given a say in the development of a centralized registry, even though it would undermine their business model. Well into the development cycle, they torpedoed the idea.

What went wrong?

In the haste to get development off the ground, the project allegedly started without a clear roadmap. And delays gave more time for the various stakeholders to add requirements.

Even with clear and stable stewardship, that scale of development would have been tough. Yet the project management structure was not clearly defined, and the lack of centralized control meant that interlocking pieces were being developed out of sync, with sections of the process at different testing stages, while other functions had not yet been designed.

Also, given the long lead time (which ended up being more than double the initial estimate), the system – if launched – would already have been behind the competition from day one.

The final straw came when an investigation in 1993 revealed that completion would take another two to three years, at double the cost-to-date.

The decision was taken to scrap the whole project. The exchange’s investment of over £70 million (over £140 million in today’s money) was lost. The London Stock Exchange handed over responsibility for the development of a new stock trading system to the Bank of England, and its CEO resigned.

It wasn’t just the colossal waste of money and the damage to its reputation that made many fear for the exchange’s future. Hundreds of brokers had based their systems development on the assumption that Taurus would be the main platform, and thousands of employees had been trained. The total cost to London’s financial centre was estimated to be in the hundreds of millions of pounds.

Of course, it’s easy to see in hindsight where things went wrong. And it’s easy to believe that today, big systemic projects would be managed with different principles.

While that may be the case, the fate of Taurus serves to highlight the colossal complexity of introducing a new systemic platform. Throw in a technology that has yet to be tested “in the field”, and you have a potential powder keg of risk.

All change

I’m talking about the decision of Australia’s primary securities exchange, ASX, to upgrade its clearing and settlement platform to one based on distributed ledger technology.

Announced late last year, the news sent waves of excitement through the blockchain sector – it would be one of the first major public-facing applications of the technology, which many have touted as having the potential to decentralize finance.

Introduced with bitcoin, the blockchain offers a way of sharing data that removes the need for validation from a central authority. The elimination of redundancies and the speed with which information can be transmitted and acted on present significant cost reductions, especially intriguing in an era of diminishing margins and increasing competition in the financial sector.

It’s not yet clear whether the technology that ASX will use (developed with blockchain startup Digital Asset) will technically be a blockchain, in which information is stored in blocks that are irrevocably linked to previous blocks, ensuring data integrity. The official press release referred to “digital ledgers”, and while the two terms are often used interchangeably, some distributed ledgers don’t rely on linked blocks to share and verify inputs and outputs. However, since the boundaries of the new technology are being blurred as the concept evolves, the announcement was treated as a triumph by blockchain sector participants – official, public validation of the potential benefits.

Be careful

And yet, it is by no means the windfall that the headlines proclaimed.

First, it isn’t happening anytime soon. At the end of March, the ASX will reveal a potential live date for the new platform – it will most likely be years away. We won’t get a clear indication of the expected timing until the end of June.

And, as we saw with Taurus, in complex undertakings, deadlines are often extended. Hopefully the new system will be revealed within a much shorter timeframe than the failed British attempt’s estimated 13 years…

If it gets revealed at all. The ASX platform does need to be replaced – known as CHESS, it is 25 years old and is struggling to keep up with newer and nimbler competitors. But the decision to build on top of a relatively untested technology with uncertain scaling and bottlenecks is a brave one. And few development projects progress without setbacks.

It’s fair to assume that the planning will be meticulous and thorough. But will it manage to avoid the pitfalls of overwhelming systemic change?

Learning from the mistakes of Taurus will help. But the leap forward in technology with this development adds a new layer of complexity.

A large part of the problem will be managing expectations. While “blockchain” has been hailed as “the next industrial revolution”, we are not going to see a new decentralized stock exchange emerge before our eyes. As far as the public is concerned, things will continue pretty much the way they are.

For the financial and technology sectors, though, it is a big deal. If all goes well, back office costs will be reduced, new efficiencies will be explored and distributed ledger technologists will learn much from the real-world rollout.

The true change, however, will come years down the road, as other exchanges around the world take a look at their own clearing and settlement processes, as regulators encourage compatibility and connectivity, and as frictionless cross-border trading finally begins to look like a possibility.

But first, the ASX system needs to be successfully launched. And, as we’ve seen, it’s nowhere near as easy as it sounds. While the decision to migrate a country’s main securities settlement and clearing platform to a distributed ledger is good news for the blockchain sector, it is too soon to celebrate.

The envelope, please… Blockchain and shareholder voting

Who knew that shareholder voting could be so… suspenseful?

If you missed the news, Proctor & Gamble has been locked in a bitter battle with shareholder activist Nelson Peltz, who wants a seat on the board. This led to the biggest shareholder battle to date, with over 2.5 billion votes (for 2.5 billion issued shares) in play. Robocalls, social media ads and a flood of mailings… the tactics got fierce.

suspense

At stake is the structure of the consumer goods conglomerate. Peltz – CEO of asset management firm Trian Partners – wants a seat on the board, and to break P&G up into three distinct units, to streamline operations and add flexibility. P&G says that the recent restructuring is already showing positive results, and changing the composition of the board would bring unnecessary disruption.

At the annual general shareholders’ meeting, P&G announced that Peltz’ bid had been defeated. Shareholders had voted to not give him a seat on the board, by a margin of 6.15 million votes, which sounds like a lot but when taken in context of the overall number of outstanding shares, was only 0.2%. A statistician would argue that is well within the margin of error.

And she would be right. Yesterday the FT reported that a recount by an independent expert found that the margin was only 43,000, in favour of Mr. Peltz. Effectively, a dead heat. The final, definitive results are not yet in. But Mr. Peltz could well get his board seat.

Why the lack of clarity in the outcome?

As you have most likely seen with national elections, counting votes is cumbersome, and largely manual. Even today, there is no definitive way to ensure that votes are not double-counted or falsely filed. One of the main problems is collecting all the votes, which are still mainly submitted on paper, either at a company’s annual general meeting, or sent in via physical mail (although some firms allow online voting). Another is making sure that the count is not manipulated. This requires rigorous identity verification, and a decentralized process of tally.

A separate issue is identifying who has the right to vote – with shares held at central depositories and “ownership” represented by a type of cession of rights, this is often not as clear as it should be.

Could blockchain technology, with its security and automation, help? Several large proxy voting managers believe so.

Last year, Russia’s National Settlement Depository announced that it has tested a blockchain-based voting system. The Abu Dhabi Stock Exchange unveiled a blockchain-based voting service that allows shareholders to both participate in and observe the process. And Nasdaq ran an e-voting trial, which recorded stock ownership on a blockchain platform, and issued digital voting right assets and tokens.

Earlier this year, Broadridge – the world’s largest provider of proxy voting infrastructure – revealed that it is building a blockchain platform on ethereum to streamline the sharing of information between custodians. A pilot run was successfully executed (in parallel with voting using traditional software) with JP Morgan, Northern Trust and Banco Santander.

Around the same time, financial services company TMX group (operator of the Toronto and Montreal stock exchanges, among others) revealed that it had completed a proxy shareholder voting prototype built on Hyperledger

And just last week, a group of central securities depositories (CSDs) announced progress on a distributed ledger proxy voting platform. Swift is among the institutions participating, to assist in ensuring compliance with international financial messaging standards (which would open up the platform to uses other than voting).

Timelines on any of the above projects going into the production are at the moment vague. Will any of them even happen? With shareholder voting generally an in-network activity (with limited, if any, need for participation from outside organizations), why use blockchain at all? Why not just go for a robust, efficient database?

Because of the vulnerabilities of centralization, which in many cases doesn’t matter – but when it comes to voting, that’s a different story. First of all, even a distributed database can be hacked and manipulated. Second, shareholders need to be certain that the vote was fair, and that the company in question has not tried to influence the tally. If they are granted real-time transparency into the voting process are more likely to trust the system, and therefore more likely to vote.

Plus, as shareholder voting becomes even more important, propelled by improvements in the technology (reduction of friction) and increased activism, audits of processes by external parties are going to become even more of a regular feature. An access node would facilitate that, as well as reduce the costs.

And finally, proxy polls are not cheap. According to FactSet Research Systems Inc., a “typical” proxy battle costs about $1 million, mainly from printing, mailing and legal fees. For context, the P&G battle is expected to cost the company over $35 million (small change compared to its Q2 income of $2.2 billion, but still…).

And even with that expenditure, it might not win. Final results are yet to come, so the battle isn’t over yet.

But the drama and nail-biting suspense sheds light on the urgent need to reform shareholder voting technology. Current platforms are, in general, inefficient. And electronic voting systems run by any one organization, even audited ones, will always have a cloud of doubt over the controlling interests. The transparency and security of distributed ledger systems could offer a more robust, lasting and scalable solution. Widespread use is still a long way off, though, and they’re unlikely to be practical until the murky issue of stock registration is solved.

While perhaps not the decentralize-the-organizations disruption that blockchain technology originally promised, it would be a step towards a more democratic governance, enabling shareholders to participate in corporate decisions more frequently and with less upheaval. It could end up giving shareholder activists more firepower and motivation, even perhaps going as far as to change what we understand by “shareholder capitalism”. Or capitalism overall, for that matter.

And when it comes to letting the market decide, it must be galling for the P&G board to see the positive price reaction to the news that they might not get their way. If the close outcome of the voting doesn’t send the board a strong message (in other words, when almost half of your shareholders side with your most vocal critic, you’re doing something wrong), perhaps the voice of the market will.

Blockchain will not keep food fresh

by Ryan McGuire via StockSnap
by Ryan McGuire via StockSnap

This type of blockchain article – from Quartz, no less (they usually do better) – is not only annoying (hype, anyone?) but also detrimental to development.

For starters, the headline – “Supermarkets are now using blockchain to keep food fresh” – is misleading. No, supermarkets are not using blockchain to keep food fresh. One supermarket chain (Walmart) has trialled the concept, and a broader group is uniting to explore functionalities of a platform built by IBM.

Also, promising that blockchain technology can keep food fresh is heightening expectations unreasonably. Shippers and supermarkets keep food fresh. This particular project is focused on detecting the origins of food contamination. Not the same thing.

Furthermore, of the founding members of the group, only two are supermarkets (Walmart and Kroger). The others (Golden State Foods, Dole, Unilever, Nestle, Tyson Foods, McLane Company and McCormick) are distributors, meat processors or manufacturers.

And, while the technology exists, claiming that it will be implemented is a stretch. A lot of buy-in will be needed for it to make a difference. Network effects will give an advantage to the first mover, but will not necessarily give it victory over others that emerge. Can there be more than one platform fulfilling the same function? If so, some degree of interoperability will be necessary to avoid silos of information – not a simple task. And if not, is that not the ultimate centralization?

Blockchains make sense if distributed control is an advantage. Why that is assumed to be the case here is unclear. Could a powerful database not do the trick? IBM could maintain the ledger, make sure that only trusted suppliers participated, and assume that its reputation for reliable development will give it room to grow with the network. A decentralized approach would most likely distribute the responsibility for the input data, ensuring it complies with regulations. But which regulations?

Furthermore, blockchains are only as reliable as the data they hold. What does it matter that data can’t be manipulated once input, if the data is faulty to begin with? Supply chains are notorious for shoddy documentation requirements and practices – changing a culture of record-keeping and processes will take a lot more than a new platform.

I’m not saying that the idea is not feasible. It’s just that it is so much more complex than superficial articles like this imply. And telling the public that they can expect contaminated food to be a thing of the past is misleading. Even worse, it sets the scene for major disappointment.

According to Gartner, blockchain applications for supply chains are on the initial upward slope of the hype cycle. Articles like this lead me to believe that they are almost at the peak. When the trough of disillusionment is upon us, critics will point to how the technology has not fulfilled its promise. Development projects will be shelved, failures will be paraded and attention will move elsewhere. No-one will blame the media that helped fuel unrealistic expectations.

 

Blockchain and capital markets: equity swaps

by Jan Vasek, via StockSnap
by Jan Vasek, via StockSnap

The world of capital markets is littered with terms that sound simple on the surface, but thoroughly confusing once you start poking at them.

Take, for instance, “equity swaps”. Easy, you swap equities with someone else, right?

It turns out that you don’t swap equities. You swap the returns that the other party’s equities give. That way you can diversify your portfolio without having to actually sell underlying holdings. Selling large holdings incurs costs and can move the market, which you probably want to avoid. Or, maybe your fund’s bylaws prohibit you from doing so. Or, maybe you would rather avoid capital gains tax. Other possible advantages include retention of voting rights (you want to retain your holding in a company but would rather have a fixed dividend than a variable one), access to illiquid markets, or being able to legally go around holding restrictions (eg. limitations on foreign funds).

So, let’s imagine you have a holding that pays you a fixed rate, the same payment every year. But you would rather a variable one. Rather than sell your fixed rate security, you enter into a swap with another party that has a holding that pays (for example) the return on the S&P 500 stock index. They are tired of so much volatility and want something more stable (or maybe they have fixed payments coming up and need to lock in those receipts).

So the two of you enter into a swap – you get the other party’s payments from their security, they get yours.

Now, just imagine the complicated and duplicated paperwork that backs up this operation.

Digitisation helps, obviously. Traiana, founded in 2000 to provide pre-trade risk assessment and post-trade solutions, is the market leader in electronic processing of over-the-counter (OTC) swap trades. It connects derivatives exchanges, institutional investors, interdealer brokers and swap execution platforms, channelling trades to clearing houses and providing analytics.

It is owned mainly by the Nex Group (formerly ICAP Ltd.), which at one stage was the world’s largest interdealer broker for OTC trading with daily transaction volume of over $2.3tn. After a tumultuous few years (which included whopping fines from the Commodities Futures Trading Commission in the US and the UK’s Financial Conduct Authority), that division was sold at the end of 2016, and Nex now focuses on market infrastructure.

Traiana counts among its investors such blue-chip firms as Bank of America Merrill Lynch, Barclays, Citigroup, Deutsche Bank, JP Morgan, Nomura, and the Royal Bank of Scotland.

Yet in spite of the presence of a clear market leader, the sector does not have a common infrastructure, leading to costly data reconciliation.

Could equity swaps benefit from blockchain technology? That’s what New York-based startup Axoni is hoping to determine.

Last year it completed a trial involving nine market firms, including Barclays, Credit Suisse, IHS Markit and Capco (a capital markets consultancy owned by FIS), as well as shareholders Citigroup and Thomson Reuters. The project established a blockchain processing network for equity swap trades using Axoni’s proprietary distributed ledger software.

One interesting aspect is the involvement of Traiana competitor IHS Markit in the trial. One of Axoni’s investors is Euclid Opportunities, the investment arm of Traiana’s parent Nex, and the two firms also both have Citigroup and JP Morgan as investors.

Although it worked with IHS Markit in this trial, Axoni has collaborated with Traiana on other projects in the past, such as a securities post-trade prototype in early 2016 and a foreign exchange one currently under development.

Could there perhaps be industry consolidation further down the line?

While equity swaps are a small part of the global OTC derivatives market, they could be considered the “low hanging fruit” of the sector for capital markets blockchain integration. The processes are complex, and the market is distributed and fragmented. What’s more, changing regulation calls for increased transparency and reporting. Coherence and coordination will benefit all participants, adding liquidity while reducing costs.

A blockchain-based platform would have the additional advantage of scalability, perhaps also including other types of swaps and offering even further efficiencies to market participants.

While blockchain exploration is ongoing in other areas of capital markets, Axoni’s equity swaps test is an interesting snapshot of a concrete use case. Furthermore, it points to how the sector will be restructured: carefully, one application at a time.

(This is the first in a series on the potential impact of blockchain technology on capital markets. Up next: FX.)

Blockchain and student loans: a solution to an urgent problem?

by Davide Cantelli via StockSnap
by Davide Cantelli via StockSnap

The New York Times reported this morning that tens of thousands of people who took out private loans to pay for college may be about to see their debts wiped away.

Why? Because critical paperwork has gone missing.

Judges are throwing out recovery suits brought by loan issuers because they cannot produce the relevant paperwork to prove ownership of the debts. The New York Times did some digging and found that many other collection cases also had incomplete documentation.

This could turn out to be a very big deal. The paper draws parallels between the student loan overhang and the subprime mortgage crisis a decade ago, when billions of dollars in loans were swept away by the courts because of missing or fake records.

Given that student loans have ballooned to account for approximately 7% of GDP, with more than 44 million borrowers owing $1.3tn, the hit to the economy would be sizeable if a chunk of that debt were to “disappear”. Over 10% of these loans are in default.

The default percentage could suddenly rise when word gets out that the debt cancellation only benefits those that don’t meet their obligations, ie. those against whom the lending companies bring suit. Don’t pay your student loan, get sued by the issuer and have your debt cancelled. What could go wrong? (Note: this is so definitely NOT advice, nor is it a good idea.)

That such an important sector of the economy – student lending is the second highest consumer debt category, behind mortgages and ahead of credit card and auto loans – is still dependent on paper documentation is staggering. These “lost” cases at least are shining a spotlight on the urgent need for reform.

The UK government is investigating the potential use of blockchain technology to manage student loans. The advantages include more secure documentation, less administrative overhead, greater oversight and more transparent data.

It sounds like the US could use similar help. True, the cases mentioned by the New York Times are from private lenders, which account for approximately 10% of the overall market. The troubled loans in question total about $5bn. That is still a sizeable hit, though, and the ripple effects could cause other debts to be questioned, future loans to be denied and uncertainty to deepen in a sector already trembling from the default overhang.

That the problem is due to missing documentation highlights the importance of trustworthy records. That a sector struggling to increase the repayment rate has yet to modernize, especially after seeing what faulty records did to the sub-prime mortgage sector ten years ago, is puzzling.

Hopefully the exposure of this vulnerability will trigger a re-design of the loan process. The benefits of using blockchain for the modernization are apparent, and it would provide the most future-proof solution, but other technologies could also help. The important thing is that the shift happens, because for both students and lenders, a lot is at stake.

A small nation steeped in history helps blockchain move forward

san marino

The elusive myth of 5G is getting closer to becoming a reality, and the impact this could have on blockchain development is significant.

According to a report in the FT this morning, the microstate of San Marino will become the first country in the world to test the new broadband service.

Tucked away in the northern part of Italy, San Marino has the smallest population of the Council of Europe and claims to be the oldest still-existing sovereign state in the world, as well as the oldest constitutional republic.

Telecom Italia Mobile has signed an agreement with the government of San Marino to upgrade the 4G system in preparation for state-wide 5G trials starting in 2018. 5G testing is ongoing in other regions such as South Korea, China and the US. However, they tend to be small trials lacking the pressure of real-world use cases. San Marino’s small size makes it the ideal site for first nation-wide test case (although it should be noted that AT&T plans to roll out 5G in test cities such as Austin and Indianapolis, each with approximately 30x the population of San Merino).

As its name implies, 5G is a step above 4G, which is what most developed countries have installed in the cities (with 3G still the main carrier technology in the countryside), with speeds up to 10x faster. 5G promises broader coverage, faster downloads and lower latency.

While the first two characteristics sound great from a user perspective, the latter is essential for effective deployment of the Internet of Things (IoT). Latency refers to the time elapsed between one node sending a signal and another receiving it. If we are going to have a myriad of gadgets exchanging data, we need to know that the transfer is fast, especially if payments are made or if decisions are based on the information.

Driverless cars, for example. Sensor-based shopping. Smart gadgets reacting quickly (lights turning on, doors opening, alarms alerting).

With sensors in close proximity to the central server, latency is not usually a problem. But with sensors distributed in a wide area, it would be, especially if the connection is to a blockchain.

I’ve written before on how blockchain technology can help the Internet of Things, but since that was a while ago, a brief update: a network of gadgets connected to a central server is more vulnerable than one connected to each other. It’s not only the single point of failure that is the concern – the possible manipulation of data, relatively simple when that data is centralized, is also a significant risk.

On a blockchain, however, gadgets share information with each other. “Smart contracts” can help to execute actions dependent on that information, and verification is carried out by the network itself. The security is much more hack-proof than traditional databases. And regulators can be “looped in” to the network, facilitating compliance and approval.

Blockchain IoT networks can also give rise to new business models, with “things” being owned collectively, and being economically self-sustaining. For example, a driverless car can both earn (by ferrying passengers) and spend (on tolls, parking and maintenance) its own money.

This scenario is not possible, however, without an upgrade in connectivity. 5G could offer that.

Once the new service is rolled out, San Marino perhaps could also become a testing ground for distributed IoT networks, and other latency-sensitive blockchain applications.

So, the nationwide trial is a big step forward not only for mobile networks but also for blockchain. While many experts believe that we won’t see 5G rollout until the end of this decade, we are getting closer. And San Marino, small and steeped in tradition as it may be, could end up helping pushing development of these two key technologies forward.

Blockchain and the puzzle of the Kazakh bond issue

astana kazakhstan

A few weeks ago, CoinDesk published an article about a blockchain project in Kazakhstan. The central bank is testing a blockchain-based mobile app that will allow investors to buy central bank debt directly, without passing through a broker.

I puzzled over this, as I couldn’t figure out why they needed a blockchain for that. One issuer and a wide range of buyers doesn’t need a blockchain. A database could handle that.

Blockchains aren’t designed for vertical systems, with one entity at the top.

The article went on to say that long term, the platform could be used for IPOs.

Ah, there you have it. Other entities could be invited to join the platform and use it for issuing securities, either equities or debt.

So, is Kazakhstan effectively creating a new financial market? The advantages for using blockchain technology for that are relatively obvious (fewer middlemen, faster settlement, lower costs, greater transparency).

But mobile-based?

A while ago the government of Kenya used the M-Pesa mobile money system to issue a bond. That trial was intriguing in that it facilitated financial inclusion by offering citizens with very little money the opportunity to not only earn a return on the little they have, but also to purchase their first saving product. The minimum investment was KSh3,000 (approximately $30), and it was open to all Kenyans with an M-Pesa mobile money account, over half the population.

But, the government didn’t use a blockchain. There was no need to, and not just because they already had an efficient distribution in place. They also didn’t need to because the relationship was one-to-many (issuer to buyers).

Blockchains are good for many-to-many relationships. If the Kazakh project does indeed end up including other issuers, the trial makes sense. But for now, it doesn’t. Blockchain’s potential won’t be tested with one central issuer.

It also doesn’t make sense to combine IPOs with debt issuance – the two have very different mechanisms and regulation. Inviting other issuers to take advantage of the new processes would have efficiencies – but that doesn’t seem to be a main priority.

So, despite the declared expansion intentions, I still found the incongruity puzzling.

Then an “out there” thought occurred to me. Perhaps what the central bank really wants is for the bonds to circulate. On a blockchain platform it would be relatively simple. Holders trade, and the ownership changes, smoothly and without intermediaries. The ease, especially on mobile, could encourage liquidity and boost circulation.

Why would a central bank want its bonds to circulate?

Perhaps so that they could become a type of currency, exchanged in payment for services received from other institutional platform participants – utilities, for instance (electricity bill?), education (a masters’ degree?) or even taxes.

There a blockchain platform starts to make a lot of sense. Regulated institutions would be “invited” to “open an account” to which bonds could be sent. Bondholders could treat their securities as a type of bank account, earning interest when they are still and being accepted in exchange for something else (fiat money or services) when they circulate.

Using central bank debt as money? Well, isn’t that what we’re doing now, with bills and coins?