The Business of Blockchain

Coverage of the 2016 Investment Innovation Conference

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Digital Computer ScreenAs a speaker at this fall’s Investment Innovation Conference at JW Marriott Phoenix Desert Ridge Resort & Spa, (October 26 to 28), William Mougayar, author of The Business Blockchain and Blockchain Investor, spoke about the investment implications of blockchain technology. In advance of the conference, we asked William a few questions about the nature of blochchain technology, its impact on financial services and the challenges it poses for regulators.

What is blockchain and how do we deconstruct its impact?

The blockchain is the technology behind Bitcoin, which is its currency application. I like to explain the blockchain by having you think about it in three different ways. One is a technology approach, second is a business model approach and third is a legal/regulatory approach.

Technically, the blockchain is like a database that maintains a distributed ledger and that can be inspected openly – it can be looked at by different parties. In contrast, everything today works with databases — all the banks’ transactions, it’s really one database that has to synchronize with another database. There’s lots of integration work involved there.

What the blockchain does, it says well instead of having two databases, and instead of spending lots of time reconciling two databases and not being sure which one is the most up-to-date, why don’t we replace that with a common ledger, a shared ledger that we both have access to and that we both can control, that we both can write or read from. That way when we make an update, we both are on the same page, the same ledger.

The other side is that this now becomes part of a peer-to-peer transaction because you don’t need to have a third party, namely the banks, or financial institutions, or trusted parties, to authenticate this transaction for moving money from one place to another because the blockchain enables that transaction to take place from one peer to another directly.

From a different perspective, the blockchain is a market and now you want to think not just in terms of money, but in terms of anything that has a digital value to it or that can be represented by a digital value. If you can move money on the blockchain, any financial asset can be transferred or traded on the blockchain. The blockchain then becomes a rail or a new network for moving any kind of value.

The third facet is the regulatory or legal aspect, because now we are finalizing real transactions and they are legally binding, therefore creating a new dimension for existing regulations because they have to accept this new kind of recordkeeping, i.e., accept the fact that transactions that occur on the blockchain are bona fide transactions that need to be recognized from a legal perspective.

Blockchain is hailed as a disruptor. Who is feeling the impact?

There’s lots of effort, lots of companies that are targeting financial services institutions but you have to make a distinction between those companies that are primarily supporting existing models versus those that are there to create new business models.

The banks are not interested in disrupting themselves. They are interested in strengthening their business models or in lowering their costs or in speeding up the processing or in having fewer barriers between them. The blockchain is an enabler of efficiency. Currently, there are large financial stakes in clearing and settling transactions from financial assets, involving lots of bilateral, trilateral, multilateral agreements and there’s always somebody in the middle like a counterparty validator, a clearing house or a custodian bank and they all take some fees and there’s some delay involved. What the blockchain can do is that it can shrink all this inefficiency from a time perspective.

On the other hand, startups are emerging with a purpose to disrupt the banks and other financial institutions, and they are coming up with new models, companies like Clearmatics in the U.K., who is creating a new, decentralized clearing network for the over-the-counter derivatives market. They are not there to work with any incumbents or improve an incumbent’s position. Rather they are there to create a new clearing network. They are there to be this new kind of network, and bring with them the fullness of blockchain benefits from day one.

Where does regulation fit in?

If you regulate anything that’s new too early, then you will choke it. The analogy is the early internet days. If e-commerce had been regulated in 1996, 1997 then it wouldn’t be where it is today. There were some talks back then to create new taxes for e-commerce and put all kinds of rules on it. Luckily none of that happened. I’m not saying that regulation is not going to be needed because some regulation has benefits, especially to protect consumers, but my message for regulators is that they have to innovate as well. For example, in the area of recordkeeping, today there is nothing yet about the transaction’s finality on the blockchain. Is it official? Is it regarded as acceptable recordkeeping? They have to upgrade their regulations to accept recordkeeping when a transaction is emanating from the blockchain.

How will blockchain affect trading?

The impact is that many assets are going to be now traded on the blockchain. Either they will be created natively on the blockchain, instead of creating the asset in a database that goes on the Nasdaq or a clearing house, or you will move the existing asset on the blockchain. The effect will be more visibility. It is going to be less risky because today the financial networks are a mish-mash of proprietary systems and integrations that don’t all have visibility into each other; you have to wait till someone else reconciles something or a counterparty validates what’s happening on the other end, so there are lots of inefficiencies, lots of blind spots today in the financial markets.

What are the investment opportunities?

There will be new asset classes, cryptocurrencies specifically. If you’re a fund and you’re investing, you have to look at those kinds of emerging companies and tools and instruments.

Right now the sell side are driving it, but you never know, the buy side might get aggressive. I think it’s going to take some time because change doesn’t happen so easily. I would say the best thing they can do is get educated. Then you will have unique insights once you internalize what the blockchain is from your business perspective.
If you are interested in attending this event, please email Alison Webb to be considered, as limited space available.

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