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B-words and financial market infrastructures


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This presentation provides a general overview of financial market infrastructures (FMI) and how blockchains can be used to remove intermediaries in capital markets. It also briefly looks at several companies and consortia with respect to their differences and similarities. Lastly, it describes a novel solution in the form of "decentralized financial market infrastructure" that was first proposed in 2018.

This was first presented at the Ethereum Silicon Valley meetup in Santa Clara hosted at Mindrome on April 9, 2019. References are in the speaker notes.

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B-words and financial market infrastructures

  1. 1. B-words And financial market infrastructures (FMI)
  2. 2. Disclaimer ● These slides contain names of specific companies. This is for illustrative purposes only and is not intended to be seen as an endorsement. ● The contents herein does not reflect the views or opinions of anyone else but myself. ● I am not a lawyer.
  3. 3. Every two-and-a-half years...
  4. 4. Ground to cover Why are regulated institutions interested in blockchains and financial market infrastructure (FMI) and why have most of the proposed designs recreated intermediaries? This presentation discusses some of the history and nuance of what has become vaguer terms over time (e.g., “DLT” as a marketing term).
  5. 5. dFMI This presentation includes a few of the problems with mono-implementation architectures. It will briefly cover what FMIs are and what some of the fintech participants are claiming they can do to change or supplement FMIs. It also presents one model that bridges the research behind distributed, automated processes with the requirements that regulated financial institutions must fulfill. The new term for this is decentralized FMI (dFMI), an acronym first coined by Robert Sams and Rhom Ram through the evolution of the USC consortium incubated by Clearmatics.
  6. 6. Before we get into dFMI, what is an FMI?
  7. 7. According to the PFMI, the three main infrastructures are 1. Central Counterparties (CCP): perform netting and facilitate value, collateralization pooling, mutualization of risk, provide anonymity and ensure that delivery-versus-payment (DvP) takes place as promised 2. Central Securities Depositories (CSD): beginning in the early 1970s, these were set up during the transition from paper to electronic with mainframes as a means to electronically track ownership of immobilized securities 3. Payment systems Examples: DTCC, CLS, Euroclear, ICE, CME, ACH
  8. 8. FMIs live in the background, are socially useful but due to how they are setup and concentrated have become systemically important
  9. 9. What if... … there was a way to recreate the utility that specific FMIs provide, but reduce and/or remove their systemic impact?
  10. 10. But just use a database, right? Ironically, the quip that some maximalists use to criticize “enterprise” efforts would actually lead to further concentration and single-points-of-failure; e.g., their advice is bad for society Recall that FMIs to-date are governed and operate through a singular entity and if the goal is to reduce systemic risks, why would you advise participants to continue intermediating the marketplace which further concentrates risk?
  11. 11. Previous attempts at creating mental models Back in 2015, Robert Sams first coined the term “permissioned” chain to describe a network with specific attributes
  12. 12. CFTC testimony in 2016 regarding “DLT”
  13. 13. But the “DLT” term became misused by many different special interest groups and is mostly a meaningless marketing term today
  14. 14. dFMI - Information sharing can securely take place in full compliance with the law while simultaneously enabling market participants to mutualize infrastructure that would otherwise be run by a single trusted party. - Some of the services that intermediaries currently provide, can potentially be replaced and/or augmented by decentralized infrastructures or decentralized financial market infrastructure (dFMI). - dFMI also enables a change in business structure where a re-alignment of incentives can take place such that the firms taking the risks fully bear the consequences of these risks.
  15. 15. And what kind of non-intermediated network can enable secure sharing of facts and records? In theory: B-words!
  16. 16. Stereotypical B-words At a high level, it is a network that has: - Global state - Peer-to-peer validation (no intermediary) - Containers (blocks)
  17. 17. B-words in action A short list of live anarchic B-words that have these three characteristics: ● Bitcoin ● Ethereum ● Monero ● Cosmos ● Zcash
  18. 18. And what about that “enterprise” noise? Note: not an endorsement!
  19. 19. Non-exhaustive list of “startups” focused on capital markets ● Axoni ● Symbiont ● Digital Asset ● R3 ● SETL (under “administration”) ● Peernova ● Chain (Interstellar) ● CobaltDL ● Rise Financial ● Clearmatics ● Peernova ● ConsenSys Solutions (PegaSys) Note: this does not include consortia and “BaaS” which are separate topics
  20. 20. Q: Are these “vendors” actual vendors? A: Some want to be perceived that way... Are their end-products commoditized? Nope. How are they unalike? Great question!
  21. 21. Are some of them involved in chainwashing and “blockchain” theater? Most definitely! Are any of them “brickstring” technology? Yes!
  22. 22. Confusingly called “enterprise” and “DLT” DLT is kind of a meaningless term now, morphed into a marketing phrase "Something something enterprise something something DLT" It often encompases networks that do not have global state and are not peer-to- peer Examples are distributed messaging systems: Fabric (from Hyperledger), GSL (from Digital Asset), or Corda (from R3) That's not what the original meaning for DLT was but no point in dying on that hill Still worth pointing out the etymology, history, and nuance
  23. 23. A later presentation will dive into those companies and their efforts, so let’s take a step back and look at market structure in general
  24. 24. Seen and unseen intermediaries
  25. 25. Visible intermediaries On the anarchic (public) chain side, we see very large intermediaries in the form of deposit-taking organizations and custodians typically referred to as cryptocurrency “exchanges” and “hosted wallets” In a given day, a supermajority of on-chain transaction activity is movement from one intermediary to another, most of whom have terms-of-service and KYC / AML / CTF obligations (e.g., permissioned endpoints) And because nearly all of the miners / mining pools are identifiable, PoW chains have turned into very expensive networks in which most participants are paying for but not necessarily receiving “permissionless’ness”
  26. 26. Mono-implementation = intermedization Even if code is nominally open-sourced, if network participants depend on one specific group or vendor to maintain the codebase, you effectively have a single- point-of-trust and a single-point-of-failure… they have intermediated the workflow Why is this a problem? (1) The group or vendor could use their monopoly as leverage in negotiating roadmap changes (2) The network could suffer from a bug or hack and if every validator uses the same exploitable code, this could freeze the chain and even partition the network e.g., if Parity has a problem and geth doesn’t, the network can still operate
  27. 27. More visible intermediaries On the archic (“enterprise”) chain side, networks are frequently designed with the assumption that identified, regulated institutions will operate validating nodes and/or participate in the consensus building process Because there is no Sybil problem, then there is no need for PoW But in nearly every “enterprise” chain deployed thus far, most of the network sponsors have created a single-point-of-trust and single-point-of-failure: a specific vendor who operates the network and/or maintains a licensed form of the codebase If you have to rely on a single participant to run, manage, administer, and/or govern the network, then you arguably don’t need to use a blockchain
  28. 28. Fundamental flaws with “enterprise” today From a governance perspective, having a single company manage or administer a network is antithetical to having a blockchain which definitionally is a disintermediated network - This gives the company or group an outsized influence on decision making Why is it common? Because decisions have to be made and someone needs to do it; even some nominally decentralized networks have centralized coordinators for decision making (e.g., Bitcoin Core). But may be other ways to handle (un)structured “governance” (see Cosmos, POA)
  29. 29. Cont’d From a business model perspective, most of the “enterprise” companies are following the play-book of the traditional vendor-driven model (Oracle, IBM) which involves licensing software. The unit economics and revenue models are known and easy to comprehend. But this typically recreates the same vendor-dominated tech landscape we have today, market structure is left unchanged. And it can result in vendor lock-in which impacts the governance of the protocol(s). (e.g., vendor could use monopoly status as leverage)
  30. 30. Cont’d From a technological perspective, having a single company manage or administer a network and/or maintain a single implementation is a security hole - If the company is compromised then this could result in the same issues and abuses that maintainers of databases have - At the protocol layer, if the company has no competition, then there is a potential “Hold-up” Problem and the network can stagnant. Why is it common? Because it is familiar territory for investors, entrepreneurs, and developers
  31. 31. But what about consortia? In terms of governance of protocols and specifications there are key differences: For instance, both Hyperledger and EEA are non-profit organizations in which no single entity has a permanent seat on the governing or TSC board; they also provide a specification in which other implementations can be built on. In contrast, the Corda Foundation is currently sponsored by one for-profit organization (R3) and R3 occupies permanent board seats (2-of-11); the enterprise version of the Corda “software” is proprietary And there are many other consortia that lay somewhere between.
  32. 32. Trying to put this altogether
  33. 33. What is a solution? How about: changing the market structure by changing the business model And how can that be done in regulated capital markets? By using technology to automate the processes that previously used intermediaries and client-server architecture to accomplish
  34. 34. Clearmatics ● London based Tech R&D company founded in 2015 focused on core infrastructure. ● Employing 40+ staff with deep expertise in financial markets and blockchain engineering ● Developing distributed automation technology for capital markets ● Provide enterprise software platform & tools based on an Open Source Model ● Flagship project is the “Utility Settlement Coin” (USC), a digital cash instrument for settlements & payments
  35. 35. USC ● USC is an asset-backed digital cash instrument (using a segregated account at a central bank) designed by Clearmatics for use within global financial markets ● USC is a series of cash assets, with a version for each of the major currencies (USD, EUR, GBP, CHF, etc.) and USC is convertible at a parity with a bank deposit in the corresponding currency. Benefits include: ○ Improved capital efficiency ○ Reduced settlement and systemic risk ● Launched in partnership with UBS in September 2015, the conclusion of Phase II that validated the potential benefits of USC paved the way for the introduction of new partners in Q3 2017 with 17 consortium members in 2019.
  36. 36. USC Benefits ● Instant finality on settlement ● 24/7 to be compared against RTGS ● Bypass clearing houses and intermediaries, greatly simplifying the model
  37. 37. Questions / comments?
  38. 38. Appendix Interrelated topics include: ● Central bank digital currency (CBDC) ○ “Money flower” model ● Central bank digital account (CBDA) ● Fedcoin ● “Narrow bank” ● Settlement finality ● Commercial bank credit risk ● Sovereign credit risk