FIS’ Ted Allen charts his journey into distributed ledger, detailing the benefits this can deliver to securities finance and the challenges of adapting to the institutional market
I have spent the past few months of my life looking at all things blockchain and distributed ledger – and it has been quite an unusual trip. I started off this journey in blissful ignorance of the world of cryptocurrencies and digital assets, and wondering what, if anything, this might have to do with securities finance.
There were a few triggers that got me started; the press coverage about ‘risk free’ interest rates of 20 per cent, improbable sounding growth rates and market capitalisations, and excited remonstrations from colleagues asking if a crypto lending module for the FIS Securities Finance Suite was in plan. In the wider context of FIS, I became aware of the launch of new solutions and partnerships for crypto and digital assets that connect our broader base of FIS clients to the world of crypto and digital assets.
I have spoken to several people who are at an early stage in their understanding of crypto, who have concerns about a lack of fundamentals and reservations about devoting country-level resources to mining internet money. The volatility in crypto markets that has happened over the past few months is, of course, driving those concerns. There was the terror of the Luna collapse, in which US$60 billion evaporated, and Celsius, with apparently US$11 billion in AUM and offering 17 per cent interest on balances, which crashed into insolvency.
Looking at coinmarketcap.com, you will find nearly 300 exchanges listed that are dealing in around 10,000 currencies. As with many industries, there is a handful of big players and an extremely long tail, and no doubt those numbers will be quickly whittled down as the icy fingers of the crypto winter tighten their grip.
There may be a flight to quality, with investors preferring to accept more realistic returns for the perceived safety of regulated firms with a balance sheet and a credit rating. The large traditional custodians are setting up crypto custody services – and now, even the most prestigious and traditional private banks in the world are adopting new solutions for crypto trading, custody and staking programmes to offer a one-stop shop for crypto and traditional asset investments. There are also regulations coming in all the major jurisdictions that will curb the excess of enthusiasm and prevent further implosions.
Disruptive initiatives
What I found as I dug a little deeper is that distributed ledgers or blockchains are not the same thing as crypto, and that just because people such as Warren Buffet and Jamie Dimon seem to not like bitcoin, it doesn’t mean they don’t like blockchains. Digital assets and crypto currencies are not the same thing and pretty much any kind of asset can be represented as a token on a blockchain.
In fact, as I started to understand more about the technology underpinning the crypto and digital asset expansion and stopped being distracted by arguments about whether DeFi is better than CeFi, I realised that there is something very interesting here that really does have the potential to transform our financial world.
Put aside the questions around crypto currencies, the ethics of them, the theoretical valuations, whether they are a security or not, and whether algorithmic stablecoins can ever avoid death-spiralling. Take a look instead at how blockchain technology can be applied to existing markets and, potentially, solve some of the fundamental inefficiencies that exist in the system.
There are some very interesting disruptive initiatives in the securities finance market that seem to offer tangible benefits to the adopters, while solving the problems of adapting digital ledger technology to the institutional market. One of those problems is that anonymity is a tenet of the crypto trading world – but surely a pension fund is never going to be able to lend on a market where there is no visibility of the other side of the trade.
I enjoyed a simple analogy I heard that compared distributed ledgers to user-protected websites on the internet: just because the internet is public and open, that doesn’t mean you can get into everything without the right credentials. Similarly, not all blockchains are public, and you can solve the KYC problem on a private, permissioned blockchain.
This permissioned approach can make the benefits of the technology adaptable to the securities finance markets if you take your securities positions, tokenise them, and trade them that way. A loan of a position now doesn’t need to involve settlement and settlement lags and it doesn’t need to be constrained by trading hours. That has made intraday trades a possibility, which means lower reserves for intraday liquidity, less regulatory capital and lower settlement costs. Individual stocks can be borrowed for the time they are needed, not just by the day.
With the right legal, technical and regulatory structures, there are numerous trading and capital benefits to be gained. Likewise, much post-trade inefficiency can be removed once you remove the worry about bilateral reconciliations, settlement fails, margin calls processing, corporate actions and so on.
The securities finance industry can be a slow and clumsy beast, and it will take time for these changes to be adopted widely – but as the recent crypto winter curbs some participants’ enthusiasm for all types of crypto currencies, focus can shift onto the more interesting developments in this space. My view is that the potential these technologies show will inevitably win out in the same way that electronic securities did over paper. We have an exciting few years ahead.
