Will Blockchain Enable Near Real-Time Capital Markets Settlement?

• A. Real time settlement will fundamentally change the Capital Markets value chain in a way that will move $ billions of value from old to new players and Blockchain is the technology enabler for this disruption.

Or

• B. Real time settlement via Blockchain is a fevered pipe dream of a bunch of tech-obsessed hipsters in a coffee shop who have no understanding of how capital markets settlement really works.

OK, you are back at school with a multiple choice question:

A is right

B is right

The Oxford debate rules start with a question. In this case, the question is

“will Blockchain technology enable real time settlement?”

One side proposes a yes answer. The other side proposes a no answer.

A more fun version is what I call the Pooh Corner Debates.

For those who did not grow up with Winnie The Pooh stories, here is the cast of characters:

• Tigger is the excitable cat, full of enthusiasm for every new technology, which will surely change the world for the better and do it right now.

• Eyore is the old grey donkey, who thinks it is all rubbish, that all this change will only end badly or won’t happen at all.

• Winnie The Pooh is a humble “bear of little brain”, who somehow gets to the right answer by asking good questions. We all want to be that insightful bear; but in the tech world the market is the only judge of what works or does not work.

Most of us in the tech world, especially those with an entrepreneurial mindset, are instinctively more like Tigger than Eyore. Smart Tiggerish entrepreneurs have learned to listen to Eyore. They don’t let Eyore’s negativity stop them. They use the issues that Eyore raises to create their to do list.

First lets hear the base case from Tigger on why a Blockhain based verification (using proof of work cryptography) is better than a trusted third party intermediary (the current model).

• The intermediary could delete a transaction, reversing history.

• The intermediary could censor a transaction, by refusing to enter it into the ledger.

We will now let Eyore respond on those two issues:

• The intermediary could delete a transaction, reversing history. Any intermediary that did this would lose the trust of their customers and be out of business in a heartbeat. This might be theoretically possible, but so is a meteorite destroying the earth in 2015; practically this is not a risk worth spending time and money to fix. In short, they could but they won’t.

• The intermediary could censor a transaction, by refusing to enter it into the ledger. Yes, nation states will force banks to adhere to rules to protect against money laundering and terrorism. Yes, intermediaries are forced to obey these rules. We can debate whether this is a good thing or a bad thing, but we cannot debate the reality. As long as nation states remain in existence, any settlement system (whether using Blockchain or any other technology) will have to allow for this type of censorship. In short, they will because they have to.

Tigger interrupts to point out that a Bitcoin based Blockchain is censorship resistant. Eyore putting on his most gloomy voice says “so you expect Banks and Nation States to support a Bitcoin based Blockchain – good luck with that”.

Then hear why the banks, investors and fund/wealth managers want real time settlement. They don’t care whether real time settlement is enabled by Blockchain or by any other technology. They are technology agnostic. Nor do they really care about the fees paid to an intermediary. Sure they like lower fees – who wouldn’t – but the ROI of a big new project based on lower fees looks suspect. No, the big win is not lower fees, it is the elimination of credit risk and market risk by settling in real time.

Lets hear from Eyore on that front:

• Anybody making that statement has no idea of the complexity of how capital markets settlement works. (If you do want to understand how capital markets settlement works, a PDF from DTCC called Lifecycle of a Security is the best starting point).

• Anybody making that statement has no idea of the performance and scalability limitations of Blochain systems. (This O’Reilly Radar article with contributions from Vitalik Buterin is a good starting point on this subject)

I am giving Tigger the last word on this debate (disclosure, I tend to agree with Tigger on this one):

Those are tough issues. No doubt about it. This is will need brilliant minds and big budgets. However there is nothing here that approaches physical science limits. We don’t need to go faster than the speed of light to make this work. And the money at stake from eliminating credit risk and market risk by settling in real time is so massive that brilliant minds and big budgets will be applied to the technical issues.

The Bitcoin Blockchain USP is censorship resistance. Censorship aka regulation is a fact of life that business people have to deal with. So it is unlikely that real time capital markets settlement will be built on a Bitcoin Blockchain.

Blockchain without Bitcoin will be amenable to censorship aka regulation. The Blockchain USP is deletion resistance aka immutability.

Of course Blockchain tech has to be as scalable, reliable and fast as current centralized database technology; but that is another story (aka subject of a different Research Note). There are serious questions around this, which is why we use the qualifier Near in Near Real Time Capital Markets Settlement. When we are moving from Settlement that takes 2-3 days, moving to few seconds will still change the game even if tech purists will point out that a few seconds is not real time.

So now you are back at school with your multiple-choice question. Did Tigger or Eyore win you over?

• A. Real time settlement will fundamentally change the Capital Markets value chain in a way that will move $ billions of value from old to new players and Blockchain is the technology enabler for this disruption.

Or

• B. Real time settlement via Blockchain is a fevered pipe dream of a bunch of tech-obsessed hipsters in a coffee shop who have no understanding of how capital markets settlement really works.

It is possible that there is a third answer. In strategic planning, it is always a question of probability. There is seldom 100% probability. The fancy name for this is Bayesian Statistics. My problem with Bayesian Statistics is that by assigning a number you assign a false sense of certainty. That is what you do with research to tell, where an authoritative body offers something like “XXX says there is 90% probability of yyy”. Investors and entrepreneurs actually work on research to know, where you have a much simpler High, Medium or Low rating; you have just enough certainty to take a next step action but you keep reviewing the probability as new data emerges. Daily Fintech Research Notes fall into the research to know category. So here is our rating:

• Capital Markets Settlement will move to Near Real Time but we don’t know what technology will be used. High.

• Capital Markets Settlement will move to Near Real Time using Blockchain without Bitcoin. Medium.

• Capital Markets Settlement will move to Near Real Time using Blockchain with Bitcoin. Low.

By Bernard Lunn