Initially published on Tuesday 15 March 2016

Initiatives to industrialise distributed ledger technologies have to walk before they can run

Imagine if filling your car with petrol automatically triggered a payment to match the amount of fuel you had pumped. You do not need to walk up to the attendant, choose cash or card payment then check that the charge and your payment were for the correct amount.
In 2016 the results of several real-world initiatives will begin to emerge bringing that level of efficiency into wholesale finance using blockchain, the transaction system for bitcoin (see box 'Under the engine of blockchain').

"You are able to embed the information that evidences title to a financial instrument," said Blythe Masters, CEO of blockchain investment firm Digital Asset Holdings, speaking at the Singularity University's Exponential Finance event on 2 June 2015. "This means the entire lifecycle of a trade, including its execution, the netting of multiple trades against each other, reconciliation of who did what with whom, and whether they agree, can occur at the trade entry level. That's much earlier in the stack of process than what you are accustomed to seeing in mainstream financial infrastructure."

However blockchain does have its challenges. Building the blocks - which contain all of the records of past transactions and thereby validating if one person has the reserves to make a transaction - can be slow. Reading them can also be slow. This limits the number of transactions that can be processed each second. As they accumulate to form the nominative blockchains, those chains not only grow unwieldy to process they require more memory to store. Where processing bitcoin transactions pays the processor in bitcoins, a distributed ledger system using other currencies will need to consider how processing is paid for, if at all. These are a few of the hurdles that an 'industrialised' distributed ledger needs to address.

"A collaborative approach is essential to this industrialisation," says Charley Cooper, managing director at R3, a digital ledger firm founded by David Rutter, former chief executive officer of Electronic Broking at ICAP. R3 has taken the consensus approach to developing technology by bringing 25 banks together in the Digital Ledger Group to work on standards that would allow interbank ledgers to be developed.

"We believe that the first step must be to establish industry collaborative joint working groups, operating alongside the banks that will ultimately use the technology, and their experts in financial technology and market structure," Cooper says. "R3 is hosting a collaborative lab environment that will be the first available 'sandbox' to test and validate results from prototypes and proofs of concept on the leading distributed ledger protocols. In addition, we're launching an open source initiative to facilitate broad contributions from across the industry."

Philippe Denis, chief digital officer at BNP Paribas Securities Services which has joined the R3 consortium says that the purpose to which a distributed ledger system is put defines the need for collaboration.

"We are working with R3 so that where a collective approach is needed - as has historically been seen with SWIFT for interbank payments, and FIX Protocol for securities messaging - we will be at the forefront of that movement," he says.

A billion to one

Building distributed ledger systems that are accessible by a specific group of users - banks, clients, issuers - is big business but not complicated. Consequently there are different visions as to how the technology will develop.Michael Mainelli, executive chairman at Z/Yen Group says his firm has constructed several hundred distributed ledger platforms. Speaking at the Mondo Visione Exchange Forum on 12 November 2015 he said very few financial services firms have asked themselves whether they can build their own.

"They are darn easy to build," he said. "I run a very small firm, I don't have 25 people working on distributed ledgers and so if we can make a couple of hundred it really is a job that someone can do quite quickly when they get going. I think financial services firms are going to wake up [to this] over the next few months."

Other firms expect that a tried and tested product that is usable by multiple firms can prove valuable. Digital Asset Holdings has developed the Hyperledger, a shared ledger technology system designed to move value across the world "as quickly and easily as sending an email". The cost and time required for transactions currently should therefore be eliminated while the system provides a "universal record of truth" for all parties according to the company.The company has stated particular applications for its solution such as reducing the settlement time for corporate syndicated loans, increasing liquidity in the market for repurchase agreements (repos) and providing full transparency of asset ownership for securities.

Cooper considers that a multitude of competing blockchains could be detrimental to the technology's adoption. "It is a common mistake with emerging technology to build and launch it to the market in isolation, hoping it will be effectively adopted and used," he says. "We don't believe that approach is effective, certainly not for bringing distributed ledger technologies to global financial markets. The key to developing these evolving technologies in a way that is meaningful and efficient is to work in collaboration with the industry to develop a shared solution, combining resources rather than spending time focusing on individual projects that would then effectively require duplication across institutions.

It's not what you do, it's the way that you do it

Another start-up, Setl, has developed a system with a specific market - central banks. Currently, central banks provide liquidity to settlement banks based on those settlement banks which are net payers to have sufficient liquidity at the time of the clearing. The terms under which those sorts of facilities are offered will typically be a repo against a pool of collateral deposited by the clearing member. That liquidity provision is currently only accessible during the fixed opening hours of a central bank.

By automating the transfer of central bank money using a permissioned distributed ledger, commercial banks would be able to access funds - for example pound sterling from the Bank of England - in exchange for collateral across the 24 hour global trading period. That increases liquidity in itself, but also by removing the need for a collateral buffer, fewer reserves of the settlement banks would be tied up unproductively, increasing the potential liquidity and profitability of their assets.

Peter Randall, chief operating officer at Setl, has said that the use of a permissioned rather than public blockchain reduces the need for a full chain of every historical transaction. He says Setl has already reached 5000 transactions per second in test lab conditions and expects to reach 100,000 per second when the technology has been "weaponised". "That's about the right starting point for this sort of venture," he says. "We could allow the central bank to be open seven days a week, but in a controlled way."

Distributed ledgers are already in practical use. On 27 October 2015 Nasdaq announced that several companies have signed up to use its Nasdaq Linq system, a digital ledger technology that uses blockchain to facilitate the issuance, cataloguing and recording for the transfer of shares in privately-held companies on the exchange operator's private market.

Speaking on Bloomberg news on 6 October 2015, Nasdaq CEO, Bob Greifeld, said "We're going to put the share trading on Nasdaq Private Market on the blockchain. The clearing and settling will happen in the blockchain. You will be able to clear and settle a transaction in ten minutes. Public trading "is in the future" he said, adding "With private markets we can control the whole vertical stack [from trade to post-trade.]"

Denis notes that BNP Paribas Securities Services has also engaged in the development of proprietary blockchain proof of concepts. "We have proven the concept for various stock process and issuance and we are in the process of testing the business case for these topics," he says.
Under the engine of blockchainBlockchain was built to automate the transfer of value in the absence of any authority for bitcoin's open source transfer mechanism. It uses cryptography to validate current ownership of value and transaction, thereby keeping an unhackable record of who owns what, which cannot be altered. It is a distributed ledger system, which means everyone connected to the system has access to it.
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from BNP Paribas Securities Services

Dan Barnes – Managing Editor, Asia Etrader

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