Joe Lubin, co-founder of Ethereum and founder and CEO of ConsenSys, is the keynote speaker at WFC 2019. As Dominic Hobson found out, he has a radical and exciting vision of the future of CSDs. To him, blockchain is more opportunity than threat to CSDs. But they must be prepared to reorient their strategies away from their current client bases, technology platforms and portfolios of services, and become nodes in blockchain networks. Access to a distributed but single ledger recording all transactions will enable CSDs to assume an important role in governance and, more importantly, bridge the silos that currently obstruct trading of and between asset classes new and old, of both the natively digital and the digitized variety.
Hobson: In seeking to preserve their position in the securities industry, should CSDs be thought of as platforms (i.e. as a new type of intermediary, like Uber) or as networks (i.e. as nodes in a distributed information network)?
Lubin: The best way for CSDs to preserve their position would be to become nodes in a decentralized network of CSDs. As more interbank payments become settled real-time through the advent of blockchain technology, and trust becomes more de-centralized in the network of validators, there will still likely be a need to have large institutions running many of the nodes of the network, and themselves acting as validators in the system. CSDs should devote resources to learning more about the technology. They are well-positioned to bring the eco-system together to drive early blockchain adoption in financial markets. This is especially true in that CSDs currently play the critical role of connecting financial institutions, based on their well-established relationships and IT integration with financial market players. There are increasingly low-friction blockchain software as a service (SaS) options to support CSDs, such as Kaleido, a Consensys business, which makes it easy to start up and link private, permissioned Ethereum nodes for a single organization or a consortium. Kaleido also offers collusion resistance tools where the public Ethereum network is employed to checkpoint private Ethereum networks.
Hobson: In the securities markets, blockchain can collapse into a single process what are currently four separate processes: issuance, trading, clearing and settlement. How should CSDs respond to that possibility?
Lubin: Just imagine how much collateral is frozen every night in the banking system. In the payments space, for example, ConsenSys worked with the central bank in South Africa on a project called “Khokha,” where it proved that you do not require the central bank to centrally record entries for the real-time gross settlement (RTGS) system. Blockchain technology allows real-time interbank settlement entirely recorded on the ledger. The central bank had a node and was able to oversee every transaction in a private, permissioned Ethereum eco-system. While CSDs will not need to play as much of an operational role in terms of clearing and settlement that they do today, they can still play a role in overseeing the entire eco-system. They may evolve to become stewards with the institutional knowledge to oversee the overall network, co-ordinate changes and upgrades on behalf of the market, and ensure the running of the financial markets within this new paradigm as a whole.
Hobson: If the operational role of CSDs in clearing and settlement transmutes into a governance role, will they also have a different role to play in issuance and trading?
Lubin: Open identity systems (uPort ID), US dollar-tracking tokenized money (Maker’s Dai, Paxos, Gemini, Circle’s Center, Adhara), and legally enforceable agreements (Open Law) can already enable issuance of digital securities (CapBridge, ConsenSys Digital Securities) tradeable on exchanges or via atomic swap protocols like AirSwap and 0x. Their natively digital nature squeezes all of the frictions and delays out of the system, enabling clearing and settlement to happen instantly and automatically as part of the transaction itself, facilitating extremely efficient delivery versus payment (DvP). What is more, since so many value tokens will be realized using the same technology, we will not need to silo what is traded. In the future, tokens representing equities, kilowatt hours, Beyonce tickets, crypto-collectibles, crypto-commodities and digital currencies will be able to trade against one another with regulation and compliance built directly into and handled within the smart contract infrastructure itself.
Hobson: CSDs have traditionally provided not just issuance but registration, safekeeping and settlement services to issuers and investors in a single market. Are blockchain technologies a threat to that model or an opportunity for it?
Lubin: Any organization that is not perpetually evolving will, with the disruptions from new technology, always face threats. CSDs need to be open-minded to the possibility that blockchain technology is an opportunity for them because, at its core, a de-centralized database infrastructure is more resistant to collusion or manipulation of data, and can reduce the number of separate, siloed processes into unified, more fully automated processes. Many jurisdictions around the world are deliberately incorporating existing platforms and instruments to issue and settle based on existing regulatory frameworks for securities. Many existing CSDs will need to test how easy it will be to adapt current securities regulations to the fundamental changes in capital markets that will be brought about by blockchain technology.
Hobson: Which tasks currently performed by CSDs can be done better and/or cheaper – or be eliminated altogether – by blockchain technologies?
Lubin: The market efficiencies of creating, trading, and settling a token, all secured by blockchain networks, are the main competitive advantage of this new technology. Settlements could be collapsed into a single process on a blockchain, in which the cryptographic assets are delivered against payment simultaneously. Cash and assets will move across at exactly the same point within the same system, so there is no risk of anyone being left short or left holding cash and securities at the same time. Naturally, the advent of smart contracts has a number of benefits, particularly in the corporate actions arena.
Hobson: Would you advise CSDs to work with “classic” blockchain or to seek to adapt blockchain to current services and structures?
Lubin: Private blockchains will slowly become irrelevant as privacy features on public ledgers improve. Public blockchains offer bleeding-edge open source software development, and private companies simply cannot compete with open source software. The reality is that the current private blockchain solutions are borrowing their technology from existing public blockchains. We would also expect that we will not have to give clients a “faster horse” but use the benefit of the Web 3.0 to develop a new paradigm for the financial markets.
Hobson: Financial market infrastructures are attractive to blockchain ventures because they have installed intermediary and client bases they can force – or encourage – to become blockchain users. Is there a foolproof way to transition them?
Lubin: There is no foolproof way to transition a market. However, the benefits of a blockchain system should speak for themselves. CSDs are perfectly positioned to co-ordinate and drive this transition on behalf of a market. The functionality in Web 3.0 should be seen as an opportunity for CSDs to now transform their businesses by adding value without intermediaries for the benefit of investors and issuers – which are the reason financial markets exist. Owners of securities will no longer need to trust third party intermediaries to hold custody of their assets for them. Instead they are empowered to hold the assets themselves, on-line, with wallets that only they have access to. Assets cannot be stolen even if their password is compromised, as the token itself may be programmed so that it can only be transferred between specific people and entities and perhaps only under certain conditions. Custodial services will evolve from “required” to “opt in.”
Hobson: What new asset classes, including digital assets, should CSDs be looking to expand into?
Lubin: It is our belief that all types of assets will be represented by digitally scarce cryptography, or tokens. Tokens of any asset are divisible. This means that high value single unit investments such as real estate or art can be fractionalized, providing further liquidity from investors that were previously priced out of the market. Through the digitization of these assets, we will see reduced friction and a more liquid global market for buying and selling them as well.
Hobson: How can blockchain-based market infrastructures work with legacy market infrastructures?
Lubin: We at Consensys believe in a design-based approach, where we can sit with a client and hear them out and assess their pain points. Not all problems are resolved through a blockchain solution, but when there is centralization and lack of trust and fragmentation of the general ledger that requires reconciliations and time delays, we can map with the client the way forward. We can build a proof of concept of a minimal viable product so that the client gets to experience the power of this technology. Once the client realizes the benefits of what it is presented, then we may be asked to scale it and deliver the product. Due to the transformational nature of this technology we tend to believe in re-architecting and not incrementally improving the existing processes. Our experience shows that building something new is faster and more cost-effective than fixing an existing platform, since current IT systems and technology stacks will only slow things down. Clearly this can only happen when the culture of the organization is dissatisfied with the status quo and signals the intent and ambition to embrace change.
Hobson: Are standards necessary to a successful blockchain future?
Lubin: Standards are very much necessary to provide clarity and transparency on various blockchain infrastructures. Most of the standards in the blockchain space are being defined and implemented exclusively on Ethereum. All of the main protocols and rules for Ethereum are open source and put forth by the community in the form of Ethereum Improvement Protocols (EIPs), which are voted on and adopted by the community after rigorous review and debate. Tokens themselves have seen a number of different standards, for creating different types of tokens. For example, ERC 20, or ERC 777 tokens. The Enterprise Ethereum Association is made up of many corporates that are working towards defining inter-operability and standards for blockchain development. Version 1.0 of the Enterprise Ethereum Standard is in place and guiding development, and Version 2.0 is scheduled for release soon. Consensys is also part of the Brooklyn Project, an initiative in co-operation with regulators around the world to promote token-powered economic growth and consumer protection. Version 1.0 of Framework for Consumer Tokens was recently released which defines best practices around the architecting of a consumer utility token*.
Hobson: Do existing international industry infrastructures accessed by banks and other intermediaries through APIs, such as SWIFT and CLS, have a long-term future?
Lubin: The networks and integration that these organizations have run very deep into existing financial markets and it would be very challenging to change that over the short to medium terms. In addition, these companies themselves are working on blockchain technology projects in different guises to improve their services to clients.
Hobson: Taking all factors into account, will the benefits of blockchain be realized more rapidly by revolution (i.e. the overthrow of the incumbents by new entrants armed with a new technology paradigm) or evolution (i.e. the gradual transition of incumbents onto a new technology paradigm)?
Lubin: I believe that both pathways will yield benefit and positive transformation. We will start to see the benefits of blockchain more rapidly in new and revolutionary areas. That is not to say the incumbents will disappear but rather the changes will take place more slowly in markets with entrenched processes and procedures and these changes will be evolutionary. The revolutionary aspects lie in the unlocking of non-traditional assets, which I mentioned previously. The evolutionary and revolutionary paths will track each other and be informed by each other, ideally merging into systems that serve the world better. Changes are happening exponentially. The future is already here – it is just not evenly distributed.