It’s all about blockchain – How will it change the way you trade? (Tradetech Keynote 19/10/2016)

It’s all about blockchain – how will it change the way you trade?

It’s all about blockchain – how will it change the way you trade?

Thx you for having me…it’s an honour and a pleasure to be here today

Well, am sorry it is a lie, a blatant lie because it’s not all about the blockchain.

I will try to answer this question in the next few minutes but in essence here it is: we shall see…well, it is happening and some of the consequences are negative, some of them positive.

Done, now that you know, you may go for a coffee, well maybe not just yet as I need to explain why in a little more details.

To me, as a non-tech person user and builder of financial tech for the last 17-18 years, simply put it is a technique to tie data, value, transaction, information together (I define information as data in better clothes) that once validated gets distributed into a network. The validation process which is another step after the transaction is approved between two parties create a block in a chain, recording and timestamping this block into a distributed ledger. The bigger the chain, the more secure it is.

I will not go into centralised vs. decentralised, permissioned vs. permissionless, mining vs. proof of stake vs. proof of existence…find me on LinkedIn so we continue that conversation at any other time.

Blockchain doesn't do anything: you need risk engines, market data, pricing engines, and exception management tools to feed data. Having said that there at least three things that make it sexy and exciting:

• Having a single view of the truth, one record, one transaction, one piece of data that is trusted, immutable, tamper-proof and disseminated real-time or close to real-time depending which blockchain you use. At this point, I need to stress that if you put a fake transactions or information, once validated it is fake forever. In that respect blockchain becomes a precursor of big data because you have one record in one place (in a p2p network but not all over the place in your architecture).
• Smart contracts. Nothing new here: they are programs that acts upon pre-determined conditions, if and when Donald gets elected then there will be an impact on interest rates and you will get auto-recalls, auto-expiry of bonds & contracts without any human intervention other than the little hands who created the smart contracts in the first place (they are not smart and they are not a contract)

It takes away reconciliation because a transaction in a blockchain is a change of ownership: from me to you instantly. No more nostro-vostro, debit-credit, prematching and matching: a single entry bookkeeping but because our GLs and recs are dual entry bookkeeping we might need to use what some systems in commodities have created which is a synthetic other side.

Whilst I am quite excited about the opportunities blockchain bring I am usually underwhelmed where we stand today. For example there was an announcement about a TRS being booked on Ethereum late last year and I thought, “What is the big deal?” A floating vs. a fixed rate are just two datapoints that are swap’d at a known date, how about the linkage to payments, collateral, trading, pricing, clearing, risk, legal obligations etc.?

Clearing and settlement become one. Theoretically, we can do TNow today without blockchain but the IT spaghetti we have created in every institution has generated a lot of dross, exceptions, reconciliations, translations, massages, little hands and cottage industries. I have worked in that spaghetti for many years trying to understand and work through it but more importantly make it better and I think I have a better chance to succeed from the other side. 

I don’t believe in the excitement of T Now clearing and settlement beyond what it means in terms of lowering costs and risks in Middle and Back Office. Think about the liquidity impact on buy-sides of having a real-time net or even gross liquidity for stat-arb, HFTs or even less active funds that need to pledge funds and collateral real-time to their brokers and PBs. As an intermediary, you cannot churn assets for 2 or 3 days and make some money on them. But in terms of collateral particularly for OTC, you can locate real-time and that answers the main issues with collateral today: velocity, quality and transparency.

You must be thinking: I am bored! Get on with the programme Alex! I want to understand the impact this stuff has on me and as the title says: “the way we trade”!

Let me blunt then first and comforting afterwards:

• If you are in a voice-trading business, you are gone within 10 years.
• If you are into inter-dealer brokerage you are dead.
• You are a prime broker? Well, you might be lucky to be working in the handful that will survive (we still need custodians and PBs to be our ledgers of digital assets, digital IDs or to be trusted issuers of these digital datapoints). 
• Correspondent banking, dead too because you don’t need to maintain relationships (with all the KYC burdens it implies) in a p2p marketplace (as long as the members are KYC’d by that marketplace and that marketplace is trusted) to get spot liquidity into currencies, even restricted ones.
• Fund admin dead because we will move into a real-time NAV that can be trusted and immutable. Today, it is synthetic at best and even if you take a snapshot of your NAV at any time you don’t know for sure if it as accurate to the cent.
• A trader in a private bank goes away because we are able to give the end client the ability to put orders directly through an app or let a robo advisor take over his or her financial goals.
• Asset Owners might face hedgies in a P2P network without the need of any intermediaries, buy-side to buy-side.

One of the things you most fear of losing is getting pummelled by blockchain: information asymmetry. You have a pricing power over me because you know something that I don’t and in a transparent network this goes away (well, you may be able to protect that asymmetry with permissions on what and who)

Now for the sobering part, by the way, I am not the enemy; my goal is just to wake you up if you didn’t know this was happening:

Whilst the SEC has authorised overstock to issue crypto-bonds and shares, whilst BNP, Nasdaq and closer here Otonomos create cap tables…which is fine and the start of the workflow, we are not there yet to link these primary ecosystems on blockchain to a secondary market whether crowdfunded or traditional one because they are not linked to payments, banks accounts, clearing and so forth yet.

Creating a digital asset is quite easy but if you build it that doesn’t mean they will come, 

I see the following impediments:

• Trust about your ability to issue quality assets at the right price
• Legal framework of crypto stocks in terms of issuance, tax, ownership and dispute resolution. (SEC has granted only one company, Overstock to issue stocks). No court has rendered any judgment yet.
• Data privacy laws. Whilst permissions may be set (what, who), there are no legislations covering onshore vs. offshore distributed data.
• Settlement finality. Directives and rules need to be amended to cover a T + “Now” clearing.
• Appetite for stocks. 
• Institutional clients have a fiduciary duty.
• Price discovery must be thought trough as market-making activities may disappear
• Liquidity
• Adoption at marketplace level
• High barriers to entry for trading (not perfect but not broken), a lot of investment has gone into HFT, darkpools, exchanges, SEFs, MTFs etc.

Loss of revenues for custodians and other intermediaries (small brokers, transfer agents, bookrunners) in a T+ “Now”, P2P market. Let’s not forget these custodians and intermediaries are more likely than not to be banks (well, part of banks) and more importantly, listed.

A great opportunity I see linked to digital assets is about getting your clients to trade in dollars value rather than quantity. Think odd lots on steroids because you know who owns what where real-time with fractional ownership.

In private banking, you may splice rare and expensive artwork, jewellery, wine, properties and in consumer banking you give the opportunity for less financial savvy or people with little savings to get their financial goals met.

Whilst a lot if not the majority of working blockchain use cases I have seen and heard of are about timestamping an immutable record into a distributed ledger which leaves me underwhelmed because of the lack of thinking in terms of ecosystem (for example how do you link the provenance and quality of diamonds to trading, prices, liquidity, collateral?), one use case of a pure ledger play is actually very attractive: digital ID.

Imagine that inside your firm you have one record and one record only of a client that you can permission throughout different business lines.

Granted that for anything external you may need a utility recognised by a regulator but nothing stops you from creating a digital record of that ID today in a crypto golden source.

Let’s take this a bit further…

Imagine that Alex123 is a snapshot of me today: my qualifications and diplomas (a very thin layer), my police record (hopefully blank), my career (with its low peaks and deep troughs), my health records, wealth, sports achievements etc., etc.

What makes it interesting is that for once I will be in control of me…well, I try to be most days anyway, at a level where I can permission who sees me, uses my ID…and for that I need a central, trusted entity that will issue “me”.  

Imagine the power we would have in our relationships with banks and insurance companies because we might stop the permissioning at any point in time if the service we receive is deemed unsatisfactory.

Remember one thing: tech is not that important though it may affect us positively and/or negatively. It is just an enabler of better User Experience as well as diversified revenues., better risk management and controls

We live in an exciting times replete with a lot of hype but we got to still be at least aware of what others are working on to be prepared to join or fight. Not knowing and not doing anything is not an option. 

A blockchain doesn't do anything but coupled with IoT (for insurance, risk management, consumer lending), big data, artificial intelligence (for robo-advisory) it becomes very powerful.

It’s not all doom and gloom because with the new technologies we are able to create new assets, new revenues opportunities through having bigger, faster & cheaper datasets.

We have a lot of work to do to get there and let me be clear: all of us today..,directly or indirectly – we need to know about these things to shape the agenda… Passivity is not an option.

After today, you can’t say: “I didn’t know”