SEC Panelists on “Astonishing” But “Not Very Sexy” Blockchain: Achieving Network Effect Will Produce Winners
Distributed Ledger Technology (DLT) is recognized as amazing to some and potentially valuable to many others in the financial services sector, according to various panelists in the Fintech Forum of the U.S. Securities and Exchange Commission (SEC), held November 14.
However, while DLT is probably "game changing" in terms of improving transactional efficiency, it is "not very sexy" in terms of where it sits relative to the existing fintech ecosystem and powerful factors such as cloud technology, said Brad Peterson, EVP and CIO/CTO for Nasdaq.
Peterson participated in a forum session focused on the impact of recent innovation on financial trading, settlement and clearance activities, which was moderated by Valerie Szczepanik, an attorney who is Head of the SEC Distributed Ledger Technology Working Group and Assistant Director, SEC Division of Enforcement.
They were joined by Chris Church, Chief Business Development Officer, Digital Asset Holdings (DAH); Emin Gün Sirer, Associate Professor Computer Science, Cornell University; Grainne McNamara, Principal in the Capital Markets unit at PricewaterhouseCoopers; and, Mark Wetjen, Head of Global Public Policy at the Depository Trust & Clearing Corporation (DTCC).
Opening the session, Szczepanik noted that DLT emerged from recognition that the technology, originally associated only with Bitcoin, could function as a means of value exchange, immutable documentation and a trust-building consensus mechanism for transactions.
Nasdaq's Peterson stressed that "innovation combinations" — a business model meeting an alternative technology — have regularly proven their impact in other sectors.
He listed Charles Schwab’s emergence as a disruptive discount broker (1975); eBay's disruption of "garage sales and swap-meets" (1995); PayPal's electronic money transfer entry (1998); and Napster's peer-to-peer music file sharing innovation(1999).
Peterson's backstory set the stage for discussion of DLT, with a subtext of pragmatism, diligence and the inevitability of change.
The main reason users will adopt blockchain is cost reduction, Peterson said. Then comes the learning phase, in which engineers, product managers and others acquire the needed skill and confidence to move projects forward.
Pain and Trust
PwC's McNamara said, "I've never quite seen what I've seen happening since I've locked onto blockchain," which she described as an "astonishing and new" technology. Adoption is coming on a “grand scale,” she said.
She explained that due to the Great Recession (2007-2009) and ensuing capital requirements and other strictures, bank stocks are trading at a 1X book value, versus 2X book pre-recession.
"Banks have almost missed out on an entire business cycle of innovation," because of such pressures, she said.
The resulting pain, particularly the need to improve banks' return on equity, has prompted the search for ways to reduce inefficiencies, while improving productivity and innovation, she said.
Evaluation of DLT options must include the classic "4 Ps": proof of concept, prototype, pilot and production applications, she continued. Other focal points include security, scalability, network capacity and the needs of each asset class. Ultimately, the projected return on DLT investment must also be assayed.
PwC is working on DLT proof of concept (POCs) and validation engagements in healthcare, industrial supply chain and internet of things (IoT), as well as financial services, said McNamara.
The Good, the Bad
Cornell's Prof. Sirer also made clear he's no fencesitter when it comes to discussions of digital currencies, DLT and new ideas like Digital Autonomous Corporations (DAC), the latter an automated organization run by rules encoded in smart contracts.
Sirer said unequivocally that the introduction of Bitcoin and blockchain, including the consensus system introduced by Satoshi Nakamoto in 2009, represent "an amazing breakthrough." And smart contracts, he said, have "amazing implications."
Sirer said he is not oblivious to risks that may come with expansion of blockchain’s spread.
Deterrents to blockchain could include scams, software developers resistant to change, and companies and institutions slowed by inertia, among other possibilities. Meanwhile, blockchain itself still needs work. Sirer pointed out that the performance of Bitcoin is not yet what it needs to be. He said Bitcoin’s transaction processing speed is a minute fraction of the speed of large incumbent exchanges.
Investment pouring into DLT startups will doubtless spur new offerings, he said.
"I also suspect," said Sirer, "there will be many, many, many absolutely horrible systems" and some "disasters" that will be widely reported. He added, investors "will be amply rewarded" for their successes.
Panelist Chris Church of DAH noted that the Australian Securities Exchange (ASX), is far along in considering the creation of a blockchain replacement for its entire clearing and settlement system, with full production likely to proceed next year.
Church said the latest ASX tech push sprang from taking a fresh look in 2015 at how to become more competitive with large peer exchanges, while reducing costs for the ASX and its member firms.
Church warned his audience against complacency, given that he views blockchain as advancing in many quarters. “Don’t be fooled,” he said.
Both Sirer and Church urged their audience to reach out to colleagues in other organizations that are already deep into blockchain.
Sirer said interest in blockchain is high in many academic centers, pointing to the Center for Cryptocurrencies at his Cornell University, of which he is Co-Director, and related initiatives at Massachusetts Institute for Technology (MIT).
Church singled out the nonprofit Linux Foundation's open source Hyperledger project as an important source of expertise, as well as counterparts in Britain, Canada, Australia, Singapore and other nations, as well as in the SEC.
Alluding to industry fear of disintermediation and loss of jobs in the financial services sector, Church said he doesn't see traditional bricks-and-mortar banks, custodians and others being generally disintermediated, unless individual players fail to transition to advancing technologies.
He added that “people who roll-up their sleeves and really get involved” in DLT transformation will not only drive down their costs — they will also be reap rewards when the focus shifts from improving efficiency toward generating new revenues.
DTCC's Wetjen said his organization has focused on reducing process costs since financial reforms in 2009 brought capital requirements that shrank global Clearing and Depository Services (CDS) volumes, resulting in more pressure for innovation.
In 2015, DTCC subsidiaries processed securities transactions valued at more than $1.5 quadrillion, and it provides custody and asset deposit services for securities issues from more than 130 countries and territories valued at $45.4 trillion, according to its website.
Citing DTCC’s exploration of DLT, Wetjen referred to his company’s ongoing proof-of-concept (POC) effort with Axoni and others, involving testing the use of DLT for credit default swaps (CDS). A DTCC decision on whether to proceed with implementation for that purpose is pending and could translate into “re-platforming” its Trade Information Warehouse (TIW) for derivatives transactions.
Additionally, Bitcoin Magazine reported in March that DTCC and Digital Asset Holdings would collaborate on POC development for a blockchain solution for the $2.6 trillion market associated with U.S. Treasury, Agency and Agency Mortgage-Backed repurchase agreement (repo) transactions. That work is underway, a DTCC spokesperson said today.
As reported in January, DTCC participated in a $52 million capital raise by Digital Asset Holdings. DAH is ASX’s preferred partner and strategic investor for blockchain development, according to an ASX statement of June 22.
The webinar will be publicly archived here.