– October 11, 2019
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blockchain connectivity

The negative sentiment in the cryptocurrency space is overshadowing significant blockchain advances. 

With the bearish sentiment that continues to dominate the Bitcoin and cryptocurrency market, it would not be unreasonable to speculate that interest, investment, and development are rotating out of the blockchain space. It is true that some of the air has been let out of the crypto balloon, with many non-crypto players launching competitive products and services and regulators continuing to scrutinize  — while simultaneously failing to provide globally applicable guidelines  — some of the most ambitious crypto projects. 

Enterprise investment in blockchain applications continues to develop and mature even in the face of the continuing crypto uncertainty. Not every project will succeed, and some of these examples may end up overshadowed by other initiatives, but that misses the larger point: that blockchain applications are already delivering cost savings, efficiency gains, and benefits to the marketplace. And, perhaps most importantly, they are forcing businesses to reconsider paradigms that, until recently, there was no reason to.

Ironically enough, some of the most interesting projects underway are led by financial institutions or consortiums of financial institutions, which are what Bitcoin was initially developed to replace. 

Self-Regulated and Ranked Crypto 

One of the largest headwinds against greater utilization of blockchain for financial-markets purposes is the lack of regulatory guidance as to what these cryptoassets actually represent. With the SEC, CFTC, IRS, and any number of other agencies offering commentary on cryptoassets, it remains a challenge for organizations to get a clear-cut response. Coinbase, a leading crypto exchange, is leading an effort to create a market-based ranking system for cryptoassets. Coordinating with other exchanges, Coinbase recently announced a plan to develop and launch a 1–5 ranking scale to assist market actors in determining whether a specific cryptoasset should be classified as a security or not.

This might seem unusual  — industry organizations with a vested interest in the regulatory outcome developing those same regulations — but it is actually based on current financial-market structures. Self-regulatory organizations (SROs) are nothing new in the financial-services space, and although the Crypto Rating Council has not been officially designated as an SRO, there is substantial industry precedent. FINRA is just one example of how financial markets are allowed to, for some purposes, regulate themselves. Cryptoasset taxonomy, especially given the slow pace of regulatory guidance, seems well-positioned to follow suit. They will have competition, though, as at least one industry leader is attempting to leverage blockchain technology for similar purposes. 

Blockchain for Capital Markets 

The distributed and shared nature of the ledger underpinning blockchain also makes the technology uniquely qualified to address the time and cost it takes to settle and confirm transactions. While some governmental and quasi-governmental institutions have attempted to limit, direct, or in some cases postpone the launch of blockchain services for financial-market transactions, the private sector is once again continuing to invest and develop options. Nasdaq, alongside other large exchanges like the NYSE and the LSE, has continued to invest financial and human capital to build out blockchains for trading. It is too early to forecast how these experiments and trading platforms will play out, but the benefits  — and investments  — are real. 

The prospects for using blockchain technology in securities markets are promising, but nowhere more so than in the global fixed-income market (estimated at over $100 trillion of securitized debt). While the prospects for tokenizing physical assets are clear, lowering or eliminating the cost of back-office processes adds another dimension where productivity is concerned.

A huge portion of overhead for banks and securities firms involves headcount, space, and compliance costs associated with back-office functions — confirming, processing, and keeping account of post-trade functions. Reconciliation (confirming the proper movement of securities and cash), purchase and sales (ensuring details of trade including price, time of sales, etc.), settlement, and registry functions can be done in an essentially fully automated manner with blockchain tech. Rather than every bank, broker-dealer, and pension fund having to maintain its own massive, centralized ledger with legions of people working feverishly to keep the numbers straight (rephrase), a consensus-driven process can quickly reconcile the positions and movements that “match,” leaving only the breaks (unmatched positions and cash movements) to reconcile. More effective use of technology, including blockchain, in back-office functions also has a direct positive impact on profitability. 

And with developments in artificial intelligence, breaks that reappear time and time again involving certain financial institutions, particularly bespoke securities, or during unusual times (holidays, unexpected market closures, etc.) will be learned, predicted, and resolved algorithmically. Counterparties or securities that are habitually problematic may trigger proprietary warnings, which in turn can be automatically transmitted to decision-makers in risk management, credit, and trading departments.

An additional benefit of moving these functions into a peer-to-peer framework will be a slow but steady decrease in operational risk since, as with price or fund flow activity, risks can be learned over time and factored into the decision-making process.

No More Madoffs

Smart contracts can be designed to facilitate stringent transparency requirements on asset managers, triggering warnings or automated audits when funds are claimed or directed in ways contrary to the specifications of bond indentures, operating agreements, or private placement memoranda. For stock-brokerage relationships, powers-of-attorney can be overseen and enforced in near real-time. 

With higher degrees of trust enforced by programmable and executable contracts, investors can focus more on performance and costs than administrative distractions, including but not limited to theft or misuse of funds. 

Taking things a step further, the truly intrepid publicly traded corporation of the future may make its revenue and earnings transparent to permissioned investors, obviating the need for quarterly earnings and the asymmetries that arise owing to privileged access to analysts. Sound far-fetched?  Perhaps, but it is only a short 12 years ago that the iPhone completely transformed the economy; predicting what will not happen is a surefire way to be wrong. 

Work in Progress 

Crypto winter was used to describe the dramatic fall in price that Bitcoin and every other crypto suffered after the frenzy of late 2017, the ripple effects of which are still being felt. The first wave of inefficient, fake, and fraudulent crypto and blockchain applications have been washed out, leaving the survivors to build out applications that deliver real savings and value: and that is nowhere more apparent than in the financial technology space. That development, and the competition that accompanies it, is good for both the blockchain market and the future users of these products and services.

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Sean Stein Smith

Sean Stein Smith is a Visiting Research Fellow at the American Institute for Economic Research, focusing on blockchain, cryptoassets, and the economic impact of these technologies. He is an Assistant Professor at the City University of New York (Lehman College), serves on the Advisory Board of Wall Street Blockchain Alliance, where he also chairs the Accounting Working Group, and chairs the Emerging Technology Interest Group of the New Jersey Society of CPAs.  His research has been quoted in dozens of scholarly and practitioner publications, and he is a regular speaker at accounting and technology conferences. Follow him on Twitter.

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Peter C. Earle

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Peter C. Earle is an economist and writer who joined AIER in 2018 and prior to that spent over 20 years as a trader and analyst in global financial markets on Wall Street. His research focuses on financial markets, monetary issues, and economic history. He has been quoted in the Wall Street Journal, Reuters, NPR, and in numerous other publications. Pete holds an MA in Applied Economics from American University, an MBA (Finance), and a BS in Engineering from the United States Military Academy at West Point. Follow him on Twitter. 

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