09 AugBlockchain has some history in financial services
This week, I would like to take a closer look at the underlying platform; Blockchain or to be more precise Distributed Ledger Technology (DLT).
There are two pillars of note that underpin the idea of DLT: firstly, the idea that each participant in the system keeps a copy of the entire balance sheet and ledger and secondly that the unique attributes of each transaction are stored and passed around the system. This is what makes “the platform”, on top of which transactions can be processed and assets & liabilities recorded.
Some wise commentators have written at length on DLT; rather than repeat them, I would point readers to the work of Richard Brown of IBM in this space (see below) and ask the reader to read on with the working hypothesis that DLT offers some technological advancement worth having.
Bitcoin is just an asset that uses this platform. It is important to separate the
two concepts: platform and asset. To date, it is the asset, Bitcoin that has attracted all the attention. In last week’s post, I suggested that there were three challenges to the use of Bitcoin as a means of payment: uncertain value, trust and lack of KYC.
The logical question that follows is whether there is a means of coupling a more trusted asset with the novel, innovative and useful platform that is DLT. This would mean that an existing asset would need to be “moved” from its current state onto a DLT platform.
Actually, there are several current practices in financial services where this idea of moving assets from one platform to another are already well established. One of them, securities settlement is something that many readers will be familiar with. Being Swiss, well partly, a local example will do nicely.
Major Swiss companies that want to make their shares readily available to US investors do that by means of American Depositary Receipts (ADRs). Imagine Nestle wants to encourage Americans to buy some of these shares. Nestle arrange this service with an agent; in their case Citibank, in the case of Novartis it is JP Morgan. The agent organises a listing on a exchange, quite often the NYSE, and also the settlement mechanics with the US Central Securities Depositary, the DTCC. A ratio or exchange rate is agreed; for Nestle it is 1:1, for Novartis is is 1:20.
Let’s say a major pension fund like CalPERS wants to buy 10 Nestle ADR’s. They buy those from Goldman Sachs, who in turn buy the domestic shares from UBS in Switzerland. Now a transformation is needed, the 10 domestic shares have to be turned into 10 ADR’s so Goldman can deliver them to CalPERS’ US custodian. Goldman will settle the purchase from UBS in Switzerland via its local custodian, who will use SIX Securities, where payment to UBS is effected. To transformation is what Citibank does. Goldman deliver the 10 shares locally in Switzerland to Citibank, who then deliver Goldman 10 ADR’s. As the appointed agent, Citibank is entrusted with ensuring it has possession and control of enough domestic Nestle shares to match the ADR’s in circulation.
Lessons to be Learned
From last week’s post, I hope there is an understanding that Bitcoin as an asset has some issues.
From this week’s post I hope I have been able to advance understanding to appreciate that Blockchain or DLT is a useful technology platform.
Importantly too, there is a need to appreciate that “transformation”, from one platform to another is actually an established practice in financial services.
In the next Blog, I will look at how the limits of the old and suggest how the new and the old might be put together.
My own epiphany in matters Bitcoin and distributed ledger technology is the result of three independent sources: I am indebted to Emmanuel Mogenet at Google for his inspiring gift of a Bitcoin, to Richard Brown at IBM for so readily sharing views and educating the latecomer and finally to Reid Hoffman for his seminal article in the May 2015 edition of Wired UK: “Reid Hoffman: Why the block chain matters.”
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