The great blockchain debate

“Blockchain in the bond markets could be a Trojan virus that kills incumbents.”

That was the title of a panel I attended this week. It was a lively discussion that brought together bankers, issuers, investors, digital asset players, and technologists to share perspectives on blockchain and its implications for capital markets.

The basic question

The basic question of the panel was whether Blockchain is going to overhaul and “kill” the position of incumbent financial institutions (banks, exchanges, IPAs, clearing systems, etc). 

Speed of progress was something we discussed at length. There have been a reasonable number of “blockchain bonds” issued in recent years, but there’s nothing that looks like “scale.” Everything has been a “POC”. So the question is, why has it been so slow? Is it regulation? Are the cost savings not as great as assumed? 

Most of the participants were other fintechs working with blockchain in some shape or form, so Origin was the only company present that didn’t have an obvious “blockchain flavour”. So, for those of you who don’t have time to sit through a 90 minute webinar, I thought it might be interesting to summarise Origin’s house view on “Blockchain in the bond market”.

A complex picture

Firstly, it’s important to recognise that the international bond markets, (ie, those with an “XS” ISIN, where the vast majority of fixed income flow is), do not have a central authority that tells them what the rules of the game are. So, whilst in domestic markets the national government/central bank/monetary authority can get together and decide to create a CBDC (as France did) or enable regulation specifically authorising a new type of securities issuance (as Germany did with the electronic securities law), in the international markets there is no such authority. 

The international markets are made up of a patchwork of institutions who come together to create the market that exists today, and any change/evolution requires those institutions to collaborate and agree. It’s a bit like the United Nations. But it is still highly regulated as each institution needs to abide by the local regulations of all the areas they operate in.

Because of this, and because each institution needs to operate within multiple regulatory environments (for each local jurisdiction they operate in), the ecosystem architecture of the international bond market that has emerged over the past 60 years is incredibly complex. By ecosystem architecture, I mean the network of institutions that exist (central securities depositories, custodians, common depositories, paying agents, investment banks, exchanges, etc) and work together to manage each single bond.

The status quo

This market has grown and evolved over the past half century and as a result, there is a status quo of both business relationships and systems relationships. 

Even if there was a magic tech silver bullet that could replace everything, or if there was a ultimate higher authority that changed the rules so that we no longer needed this institution or that process, the inertia of those pre-existing business relationships and systems relationships is so strong, that change would be very, very slow. 

Our view is that whatever technology emerges to make the market more efficient, it will do so while leaving the roles of the primary actors (institutions) intact. Technology will help them operate more efficiently, but they won’t be “disrupted” away.

The regulatory angle

We also need to respect the fact that because we operate in a regulated environment, tech cannot just undo working practices in the way it has done in other areas. Indeed, we are finally seeing tech “bend” to regulation in other industries. 

One of my favourite examples is Uber. They weren’t a tech play so much as a regulatory arbitrage play. They tried to get away with classing their drivers as contractors, and thus avoid paying pensions/benefits/etc, and compete with the legacy taxi industry. Because they were big, they embarked on a “ask for forgiveness not permission” strategy. But as anyone who lives in London knows, the regulators finally took a look at the business and decided that they had to abide by the employment laws…and suddenly their cost base has gone up, and their competitive advantage vs the legacy taxi companies has evaporated. In fact, try to book an uber in London now, and you will find it’s nearly impossible and just as expensive as a black cab.

Two problems to solve

So what can technology do? How can it help the market? Our view is that there are two related but adjacent problems that people are trying to solve…and many people conflate the two. There is digitising the process and the data, and there is digitalising the assets (making the assets themselves “smart,” self-administering etc).

To use an analogy from retail banking…step 1 is get everyone onto online banking (or a mobile banking app; step 2 is to get people to switch their pounds and dollars to bitcoin and ether. In the debt capital markets, we are still in the era where you have to physically go to your bank branch to make a deposit or withdrawal. The “online banking” or “mobile banking apps” for debt capital markets haven’t been implemented yet. It’s only after you get everyone onto an application, and comfortable with the digital entry point for dealing with their money, that you can think about depositinging/withdraw pounds or dollars or bitcoin or ether. If you don’t have the online banking/mobile app entry point established, none of the crypto stuff is possible. 

The application layer

So at Origin, our focus is on being that application layer. By migrating the world from bank branches to online banking, we are taking a whole bunch of unstructured data and structuring it and digitising it. This means everything from pricing proposals to deal terms to legal elements. Our belief is that the vast majority of the value people are looking for from “tech in DCM” will come from this important step of digitising the process and creating that application layer. 

With automated documents and STP of deal data via APIs, we can already achieve T+0 settlement. You don’t need a distributed ledger to get there. And if there are benefits to DLT, they will accrue to that group of institutions I mentioned earlier (exchanges, CSDs, IPAs etc) … and it will be those institutions that decide how and when to implement DLT within their workflow (internally and with each other). And when they do that, they will need everyone to already be familiar with their “online banking app.” That problem (the one we’re solving) has to be solved regardless of where the market ends up.

So net net, our view is that “no,” blockchain will not be the Trojan horse that kills incumbents. Technology (potentially including blockchain) can do a whole lot to help these institutions do more business, with less cost, faster, and more profitably. And our vision is to be the application layer, the connective tissue, that helps the industry realise that future.