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. This is different in one critical part of The Blockchain Economy – Real Time Settlement – where change is happening far faster than most pundits expected.
This is Part 1/Chapter 6 in The Blockchain Economy book. This serialised book is a practical guidebook for investors, entrepreneurs and employees who want to learn how to prosper during the transition to an economy where value exchange is permissionless and disintermediated. For the index please go here.
This Chapter describes:
- Trading and Settlement is the story of the race car and the donkey.
- Why the speed of the move to real time settlement took so many pundits by surprise.
- Innovation from 3 types of exchange.
- “The dog that did not bark” – NASDAQ.
Trading and Settlement is the story of the race car and the donkey.
We measure trading in fractions of a second. That is the race car. 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 two decades 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. What was a gleam in the futurist’s eye in 1992 is a bit of smart contract coding today.
A more updated paper from BIS in 2012 is here.
Note that the donkey does NOT need to become as fast as the race car. In fact, it might be good for the race car 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. We might soon see HFT for crypto assets using an offchain network such as Lightning Network, but today we have replaced a race car and a donkey (legacy) with one reasonably fast car (Blockchain).
Why the speed of the move to real time settlement took so many pundits by surprise
In January 2016, I ran a workshop in Luxembourg with people who really understood the nuances of fund operations and capital markets 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 securities settlement a) would be mainstream within 10 years and b) that it would change the capital markets industry in fundamental ways.
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 who rode the ICO wave.
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, the projects were technically real but at the Proof Of Concept (POC) stage. Fast forward a couple of years after that January 2016 workshop and we see Real Time Settlement in a lot of exchanges. The move to Real Time Settlement happened 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.
Innovation from 3 types of exchanges
- 1. Legacy Equity Exchanges. Many are moving their Settlement System to Blockchain. This is only possible for exchanges that also own the clearing and settlement function. Two examples are Australian Stock Exchange (ASX) and Swiss Stock Exchange (SIX).
- 2. Pure Play Crypto Exchanges. They do Real Time Settlement using smart contracts natively. There is no concept of a post trade settlement process on a Crypto Exchange. It is as out of date as a daily batch closing cycle in a core banking system.
- 3. New exchanges that aim to do both Legacy Assets and Crypto assets on a single platform. Two pioneers in this area are Lykke in Switzerland and tZERO in America. They first tokenize those Legacy Assets assets, then they trade them.
The competitive dynamics between these three types of exchange drives the pace of change.
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.”
Real Time Settlement of Cross Border FX is now a 3 horse race with JPM Coin & more will join soon
Update 2nd March 2019
Until recently, there were 2 horses in the race for Real Time Settlement of Cross Border FX:
- Swift using DLT. SWIFT could do this easily at a technical level (any of the permissioned Blockchain systems will work) and as they are owned by the banks, they will get through the right doors. This is SWIFT’s game to lose.
- Ripple XRP. Never underestimate the ability of legacy bureaucracy to snatch defeat from the jaws of victory; so SWIFT may blow it and hand victory to a brash upstart like Ripple XRP which is publicly fighting SWIFT for the bank’s attention. However, there are serious questions about a) whether a speculative coin like XRP is useful addition to a messaging system (Ripple ILP) and b) whether a speculative coin like XRP could be classified as a Security by regulators.
Now JPM Coin is the third horse in the race that will take business away from both the other players:
- Swift will lose volume as big banks emulate JPM and settle using their own Coin. Expect something like CitiCoin, GoldmanCoin, HSBCCoin, DeutscheCoin, etc to announce soon. They may choose a) different branding b) different base currencies (eg EUR), but this is low hanging fruit for the Big Global Banks.
- Ripple XRP will be forced to pitch for smaller banks (who will tend towards loyalty to SWIFT) as the Big Global Banks go for their own Coins.
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