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Distributed Ledger Technology as Financial Market Infrastructure


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Keynote first presented at "The Future of Financial Payment Services Driven by Technology Innovation" on November 22, 2016 from Korea Finance Telecommunications & Clearings Institute (KFTC) 30th Anniversary Seminar in Seoul, South Korea.

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Distributed Ledger Technology as Financial Market Infrastructure

  1. 1. Tim Swanson, R3 DLT as FMI 1
  2. 2. R3 Cannot fly an airplane without having airports to land at 2
  3. 3. R3 • Designing, building, and deploying modern financial market infrastructure (FMI) requires a different model than the typical fractured approach seen with entrepreneurs involved in creating social media platforms. FMI 3
  4. 4. R3 • Some of the difficulties and challenges include not only technological capabilities but due to the interconnectedness of global finance, and the breadth of regulatory requirements. • You need a diverse set of international participants otherwise you can become silo’ed once again. Not a social media app 4
  5. 5. R3 • In South Korea, just as in the United States and other industrialized countries, FMI takes years to design and deploy, and teams of IT teams to maintain and operate the production version. • Examples: • South Korea: KFTC, KRX, KSD • United States: Fedwire, DTCC, ACH, CHIPS, CLS, CME, ICE • International: SWIFT, Euroclear, Clearstream, TARGET2 Duct Tape 5
  6. 6. R3 Many of these systems were built prior to IP-based networks existing 6
  7. 7. R3 • Part of the motivation towards international collaboration: • mutualize and harmonize the post-trade processes among cross-border trading partners • stems from regulators in each jurisdiction wanting to reduce risks in the settlement process (e.g., reg reporting) • providing more transparency into the life-cycle of assets and agreements • reduce the duplication and redundancies of FMI which provides similar services • tap into emerging capital pools that have otherwise been silo’ed Trend Towards Mutualization 7
  8. 8. R3 The Shared Operating Model 8
  9. 9. R3 • Shared smart contracts solve for agreed standards for accurate, complete data. Receipt of digital signatures and consensus signals on a shared ledger solve for timeliness. The root causes of most data reconciliation errors between counterparties are eliminated • Operational costs are collectively >$100 billion USD for major financial firms. • Adding finance and risk related data reconciliation creates an even greater savings opportunity • Business processes across entities are the promise – automating those processes across trust boundaries. • Do it once, do it for all. No need to replicate then reconcile. Digital Signatures / Contracts 9
  10. 10. R3 Clearing & Settlement Enter Market Order Management Trade Execution Research / Modelling / Strategy Trade Management Collateral Management Single Shared Ledger What does this joint-back office look like? 10
  11. 11. R3 What does this have to do with DLT? 11
  12. 12. R3 • As Metcalfe's Law articulates, a network becomes more useful and valuable the more participants are connected to the network. • Consequently next-generation FMI needs to be inclusive from the onset, otherwise will become siloed off and become uncompetitive. • And DLTs in turn trend towards shared provisioning's The Core of DLT is a Network 12
  13. 13. R3 World Economic Forum Report on DLT
  14. 14. R3 The Significant Evolutionary Step of DLT
  15. 15. R3 Introduction to Distributed / Shared Ledgers & Illustrative Use Cases
  16. 16. R3 Distributed Ledgers at a Glance Distributed ledgers are records of agreement consensus with a secure (cryptographic audit trail maintained and validated by several separate computers nodes Agreement mechanisms evaluate information provided by participants to ensure consent among all relevant parties in an entry When a transaction is added to the ledger, the network is almost-instantly privy to this new version • Distributed ledgers leave behind a cryptographically assured audit trail and timestamp • All parties in the network keep a copy of their view of the ledger (consensus) (cryptographic) (nodes)
  17. 17. R3 Regulators • FX Settlement • Trade Reconciliations • Transparent Valuations • Cross Border Payments • Credit Efficiency • Loan Settlement • Derivatives Clearing • Collateral Management • Client Onboarding • Intracompany Settlement • Normalize Reference Data • Timestamping • Account Portability • Broker Fraud Identification • Securities Agreements as Smart Contracts • Crowdfunding • Virtual Identity • Credit Scoring • Cross Border Remittance • Vault/Escrow Services • Customer Deposit Cost • Peer-to-Peer Lending • Anti-Money Laundering / Know Your Client • Compliance Reporting • Risk Visualization • Basel III Compliance • Client Fund Transparency • Trade Reporting Distributed ledger technology has a myriad of potential use cases for financial institutions, regulators, operations & individuals Financial Institutions IndividualsOperations Illustrative Use Cases Leveraging DL Technology
  18. 18. R3 • “Blockchain technologies could reduce banks' infrastructural costs by $15-20 billion a year by 2022” • Santander / Oliver Wyman • “In the personal motor insurance industry alone, smart contracts are estimated to have the potential to result in approximately $21 billion in annual cost savings globally for insurers through reduced processing costs” • Capgemini • “Blockchain technology could streamline the clearing and settlement of cash securities, saving capital markets $2 billion in the US and $6 billion globally on an annual basis” • Goldman Sachs • What is the current size of the business opportunity globally? And future expectations? Savings is One of the Main Reasons for Current Interest
  19. 19. R3 Regulatory drivers
  20. 20. R3 Over the past two years a multitude of governmental bodies globally have held public and private meetings to gather information regarding the role, if any, that DLT and orthogonally related technology such as multisig could play in the formal financial system Regulatory Drivers
  21. 21. R3 A number of topics around the regulatory challenges and opportunities surrounding it. This includes: • Definitive settlement finality and legal status of ‘smart contracts’; in some jurisdictions, regulators have the authority to mandate reversals in markets such as equities, how does this impact DLT design? • In the event of a bankruptcy or default of a trader or operator on a DLT, how does this impact trades conducted by the entity in a network that spans multiple jurisdictions? Regulatory Drivers
  22. 22. R3 • Transparency, privacy and risk modeling that regulations currently require and how those would be carried over onto a DLT platform -- this could include data privacy and jurisdiction laws as well • How to handle regulated data? • What are the legal implication/requirements around executing ‘arbitrary’ code on different machines across different jurisdictions? • Can ‘smart contracts’ take custody over assets on a DLT platform? Are the machines that execute the code of these contracts seen, in the eyes of each jurisdiction, as custodians? Cont’d
  23. 23. R3 Who can run validators / processors? 23
  24. 24. R3 • In terms of capital markets: how are the following functions currently handled by the jurisdictions our members operate in and how could that change with DLT? (valuation, margining, custody, netting, defaults) • Can a ‘unified data standard’ arise through the use of DLT and provide a “golden copy” record that meets current reporting requirements? Cont’d
  25. 25. R3 How to tie legal prose together with contract code? 25
  26. 26. R3 Central Bank-issued Digital Currency
  27. 27. R3 Why Are CBDCs Interesting? • Today, no central bank issues a digitized version of their currency o Since central banks are the arbiters for what is and is not a currency (Dollar, Pound, Euro), no digital currency exists today as legal tender • Today, intermediaries, such as commercial banks, act as critical on- and off- ramps for retail purposes and play an integral role in how people store and exchange money. • If a central bank were to issue a digitized currency, we could have • Peer-to-peer clearing and settlement free of certain intermediaries (commercial banks). • A digital record of all transactions. • “Programmable money” which could expedite payments. • Address Rogoff’s “Curse of Cash”. • New monetary policy abilities: Zero-lower bound. o In theory, this could enhance the existing financial system.
  28. 28. R3 CBDCs Are Not Cryptocurrencies CBDCs Bitcoin • Money is a central bank liability. • The tie to the government anchors value. • Monetary policy controlled by central bank. • Money is an asset. • There is no anchor for value. • Monetary policy controlled by pre-set terms of currency creator.
  29. 29. R3 Bank of England (BoE) • Recent activity suggests greater interest in CBDCs o Feb 2016- “Centrally banked Cryptocurrencies” (RSCoin) by UCL George Danezis, Sarah Meiklejohn o March 2016- Deputy Governor Ben Broadbent Speech o July 2016- “The macroeconomics of central bank digital currency,” John Barrdear and Michael Kumhof o July 2016- “Digital Currencies research questions” o Sep 2016- P2P Financial Systems 2016 @ UCL, Victoria Cleland Speech o Sep 2016- “A new RTGS service for the United Kingdom: safeguarding stability, enabling innovation” • The Paper’s CBDC model o The paper is 92 pages long, and half involves a DSGE model. o The paper focuses on CBDCs interaction with bank deposits, and the model abstracts out government-supplied money given its small percentage. o Assumes “normal” economics times (1990-2006) in the U.S economy. o 5 participants: Banks, Households, Financial Investors, Unions, Government.
  30. 30. R3 Why are CBDCs desirable for DLT? • Bottom line: in order to have on-chain settlement finality (DVP), need to have cash-on-ledger. • Otherwise financial institutions would still need to settle “off- chain” via external reconciliation processes and mechanisms which according to an estimate from Autonomous research, collectively costs the industry $54 billion a year. 30
  31. 31. R3 DLT Hard Topics Governance Scalability Security Integration Identity Economic Impact Trusted Oracles/Services Dispute Resolution Performance Comparisons / Benchmarking Standard Evaluation Criteria Network Topology Smart Contract Representation Threat Zone Analysis “Permission” to Advance Interim StatesSTRIPE Threats Sharding & Lite Nodes Necessary Controls Privacy / Private Fields Interoperability with other DLTs Upgradeability KYC / AML
  32. 32. R3 • Definitive legal settlement finality / legal recognition and standing of smart contracts • Regulate data / data custody / data sovereignty • Governance and dispute resolution • Fit-for-purpose: not a fork of a cryptocurrency Four in Particular 32
  33. 33. R3 Contact 33