This is chapter 3 in The Blockchain Economy serialised book. For the index please go here.
The mistake that innovation experts invariably make is to underestimate how long change takes to happen. Usually it takes longer to play out and the end result is bigger than forecast. That was true during the Dot Com era.
This may be different in Real Time Settlement, which is a key building block of the Blockchain Economy, where change is happening far faster than most pundits expected.
In January 2016, I ran a workshop in Luxembourg with people who really understood the nuances of fund operations and payments. I raised the prospect of Real Time Settlement in Capital Markets and took a straw poll among the participants. This small but super knowledgeable group indicated overwhelming agreement that real time equities settlement a) would be mainstream within 10 years and b) that it would change the capital markets industry in fundamental ways.
(Commercial break: running workshops like this to help people figure out how to position for disruptive change is the sort of work we do at Daily Fintech Advisers. Please email julia at dailyfintech dot com if you are interested).
What was noticeable was that 10 years projection. That is like saying “an awfully long time”. Do you have any idea what your work life will be like in 10 years time? The mistake we all made at that time was thinking about existing securities. The payoff from Real Time Settlement for existing securities is significant but possibly not enough to overcome inertial resistance to change. Change normally comes from an intense need from people left out of the status quo – early stage entrepreneurs in this case.
A few months after that January 2016 workshop in Luxembourg, I wrote a post outlining Real Time Equities Settlement: three blockchain projects at exchanges.
At that time, about 18 months ago, the projects were technically real but at the Proof Of Concept (POC) stage. Fast forward to December 2017 and we see a flurry of real activity. Less than two years after that workshop and it is fair to say that Real Time Settlement is moving faster than we imagined. If I had asked at that January 2016 workshop in Luxembourg “how many people think we will see Real Time Settlement in live deployment within two years”, I suspect very few hands would have gone up.
Real Time Settlement impacts all Assets, both traditional financial assets (equities, bonds, currencies, commodities) as well as the opening up of non-traditional assets for greater traceability, tradeability and liquidity. As software is eating the world and The Blockchain Economy needs to be funded, the most critical asset today is equity, specifically the early stage equity that is lining up at the gates of Equity Token platforms.
Today we look at big news in December from three exchanges:
- Australian Stock Exchange moving their Settlement System to Blockchain
- Lykke Token Sale on 12th December
- tZERO Token Sale on 18th December
Santa is a ahead of schedule this year, with Real Time Settlement news from all the above tucked in his sack.
After those three big stories, we look at “the dog that did not bark” – why the NASDAQ Linq initiative has not turned into a significant deployment.
We also look at one pure play Equity Token startup platform from Germany called Neufund.
Before that we describe why Real Time Settlement is so important by telling the story of the Ferrari and the Donkey.
Trading and Settlement is the story of the Ferrari and the Donkey.
We measure trading in fractions of a second. That is the Ferrari. Then we climb out of that speed machine and get onto the old grey donkey to do settlement which takes 2 or 3 days (T+2/3 Securities Settlement).
All of that changes when we move to Real Time Settlement or to be more technically accurate – Concurrent Delivery Versus Payment (DVP)
The key points are:
• Both assets and funds need concurrent settlement. Transfer has to be final & unconditional, without any time lag between the two (any time lag is ripe for fraud). This concurrency requirement is absolute. Just faster (e.g. Getting from T+3 to a few hours or even minutes) does not meet the concurrency requirement, because hours or minutes are eons to a fraudster.
• Must be on a gross (trade for trade) basis. Any attempt at netting creates delay and creates a multi-tier market infrastructure that will impede innovation. We have Real Time Gross Settlement (RTGS) today – between Central Banks. The disruptive change is RTGS between individuals and companies in a permissionless network (i.e the way that the Internet works).
That BIS paper was written over 23 years ago in 1992! The requirements have been known a long time. We had to wait all this time for a technology to enable this. Then along came Blockchain….
A more updated paper from BIS in 2012 is here.
Note that the donkey does NOT need to become as fast as the Ferrari. In fact, it might be good for the Ferrari to slow down a bit as few can argue that High Frequency Trading (HFT) adds much value other than for HFT traders. What matters is that trading and settlement happens at the same time. In this case, the “human real time” definition matters (a few seconds, beyond which humans start to get impatient).
Australian Stock Exchange moving Settlement System to Blockchain
The Australian Stock Exchange (ASX) was one of the three POCs we profiled in our April 2016 post. The reason why ASX can innovate like this is very simple. ASX also owns the clearing and settlement system, called CHESS (Clearing House Electronic Subregister System). Around the time of our April 2016 post, ASX was announcing a $10.5 million investment in Digital Asset Holdings and awarding a contract to them to “radically speed up settlement in Australia’s stock market”.
The vision, in consumer terms, was spelled out by Elmer Funke Kupper, chief executive officer of ASX at the time:
“A retail investor in Australia should be able to sell their shares, go to the nearest ATM and get their cash out.”
The Santa announcement is that Digital Asset Holdings has done the work to use distributed ledger technology to replace CHESS after extensive testing and security reviews. This is not a world of “move fast and beak things”. Lots of money is at stake, so it has to work precisely and safely. The actual date for switchover is planned for the end of March 2018. They have clearly worked hard on EAU (Education Awareness Understanding) for the entire ecosystem. Their Press Release talks about having ‘given over 80 DLT system demonstrations to more than 500 attendees, and conducted over 60 CHESS replacement workshops for more than 100 organisations from the global financial services industry.”
A few key points:
- It is a ‘permissioned’ system on a secure private network.
- providers can interface via ISO 20022 messaging or directly with the distributed ledger.
This was a classic strategic investment deal. The PR also announces that:
“Coinciding with today’s decision, ASX will exercise its pro-rata right to participate in DA’s recent Series B fundraising and subscribe for US$3.5 million convertible notes.
What will be interesting to see is what ASX does with this. I doubt that they will be satisfied with making existing listings more efficient. They may want to use this to attract the best early stage ventures to list in Australia, possibly turning Sydney into the Fintech Capital of the World. Why do startups go to Silicon Valley? It is the Willy Sutton answer – it is where the money is. The place that makes Equity Tokens work for both entrepreneurs and investors will score big and Real Time Settlement is the critical building block for that.
Lykke Token Sale on 12th December
We missed Lykke in our April 2016 roundup but profiled them soon after. This relatively low profile Swiss Fintech Venture, run by a serial entrepreneur called Richard Olsen, is a pioneer of Blockchain-based asset exchange. They have been executing well and setting up globally, getting regulatory compliance as they go. (See here for earlier coverage by Efi).
Their Santa news is that “Lykke launches into future with two-year forward token sale”. This is for LKK2Y, a new two-year forward token (ERC20 based), launching on 12 December for a 24 hour window. Lykke’s previous LKK1Y token sale pioneered the concept of a forward contract, raising CHF 2 million.
The news is important for Equity Tokens because, although Lykke is better known in FX (Richard Olsen’s previous success was OANDA a retail FX pioneer), Lykke issued their own equity on their own platform and practice the transparency expected of a public company despite being only a few years old.
As per the company announcement:
“Each LKK2Y token confers the right to receive one Lykke Share, or LKK, exactly 730 days after making this request, whenever the request is made. Each Lykke Share represents a 0.01 stake in Lykke Corp, offers voting rights and the right to receive dividends. Because there is no fixed maturity date, holders of LKK2Y can choose to redeem their tokens at any time. In addition, after the initial sale window, unredeemed LKK2Y tokens can be traded on the Lykke Exchange like any other digital asset.”
tZERO – man on a mission, stock on a tear, big ICO in stocking
tZERO (aka T0) is a startup, but not a VC or ICO funded startup. tZERO was created by Patrick Byrne, CEO of US online retailer Overstock.com. The name says it all. This is a startup exclusively focused on real time equities clearing & settlement. (See here for earlier coverage by Efi). There are four reasons to play attention to tZERO:
- Focus. tZERO has no innovators dilemma, no existing revenue lines to protect.
- A technical founder with cash. Patrick Byrne is rich; he is not dependent on VC funding. He is also technical enough to understand how this really works.
- Motivation. As CEO of Overstock, Patrick Byrne has been badly hurt by naked short selling (quite different from ordinary shorting as explained here). Real Time Equities Settlement will eliminate naked shorting. Patrick Byrne is a man on a mission.
- A testing ground. Overstock is a public company that can “eat its own dog food”. “tZERO enabled to make history with the first ever public issuance of a digital security,” said Ralph A. Daiuto, Jr., Chief Operating Officer of tZERO.
tZERO today is owned by Overstock, a publicly traded (NASDAQ: OSTK) ecommerce. company. Their stock has been on a tear as investors see this as a way to bet on Blockchain. To realise that value, Overstock will need to separate the two entities. Doing a big ICO to raise money is key to that plan. That is what Santa has in his stocking.
The December news is that tZERO Announces Launch Date and Initial Terms for its Proposed Token Sale. Here are the key data points:
- Simple Agreement for Future Tokens (SAFT) term sheet
- Token Sale starting on December 18, 2017.
- Revenue participation in the form of a distribution, which will be a percentage of tZERO’s revenue
- Utility to pay for fees and/or services within the tZERO eco-system.
- The definitive terms and characteristics of the tZERO tokens will be set forth in an Offering Memorandum.
- For payment instructions and information on how to participate in the tZERO token sale prospective investors should visit www.saftlaunch.com and follow the prospective investor verification instructions.
NASDAQ Linq: the dog that did not bark
Nasdaq unveiled their Linq blockchain ledger technology in 2015 and successfully completed a private securities transaction for chain.com. Later,Nasdaq and Citi had announced an integrated payment solution using a distributed ledger to record and transmit payment instructions based on Chain’s blockchain technology. The technology overcomes challenges of liquidity in private securities by streamlining payment transactions between multiple parties.
In our April 2016 post we wrote:
“Nasdaq is taking a different tack. Their Linq project is aimed at private equity ie being able to trade, clear and settle stock in private companies. Nasdaq does not own the equities clearing system. That is done by DTCC. So they cannot do what ASX is doing. The focus on private equity could make sense, because private equity is a highly inefficient market where the state of the art is an Excel spreadsheet. It begs the question – “if private markets become super efficient and transparent, what is the difference from public markets?”
That analysis – basically that Nasdaq Linq suffers from Innovators Dilemma – shows up in what has NOT happened since then.
Nasdaq has gone quiet about Linq and appears to have pivoted to Bitcoin Futures (a big but quite different opportunity).
A “whatever happened to” search for chain.com has this revealing statement:
“Based on Preferred Stock Price, Chain does not have a stock symbol since it is currently private and is yet to have an IPO.”
Neufund: Pure play Token Equity platform
Neufund is a pure play Token Equity platform based out of Berlin, Germany. They are currently in the middle of their ICO, which they refer to as an ICBM (not to be confused with an Inter Continental Ballistic Missile). Description from their site:
Using our legal and technical infrastructure, startups and established companies alike can legally issue a new type of asset we call tokenized equity. Such crypto tokens reflect the value of the business operating in the real, off-chain, world and at the same time are as liquid as a currency.
We achieve this by formally linking traditional contracts with Ethereum smart contracts through mutual reference and code correspondence. Blockchain and smart contracts allow Neufund to accelerate the investment process, lower investment barriers, align interests of inventors and investors, and eliminate transaction intermediaries.
Bits Don’t Stop at Historical Analog Boundaries
Looking for analogies is normal but often makes no sense when disruptive technology hits a market.
In this market we could look for analogies as follows:
- The Blockchain version of an exchange is A
- The Blockchain version of clearing is B
- The Blockchain version of settlement is C
- The Blockchain version of a broker is D
In the Blockchain Economy many of these functions merge. The lines get blurred. Is an Exchange that holds assets like a Broker? Is a P2P Exchange really a wallet and is a wallet then the new broker? Exchange alone – the matching function – is unlikely to be a defensible position. The new normal will be Matching (Exchange) + Clearing + Settlement + Broker in one entity. That is highly disruptive to the status quo.
A new Funding Approach for a new Economy
When the Internet Economy was being funded, it was relatively easy to do an IPO. Now the bar is far, far higher. The Equity Token platforms, emerging from the wild anarchic long hot summer of ICO, will be the funding platform for Blockchain Economy. Many people said this would happen. Few guessed how fast it would happen.
You can reach out directly to discuss our advisory services by sending an email to julia at dailyfintech dot com
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