Nasdaq stands apart from the vast majority of people looking at blockchains and finance because they have actually built something.
During a fireside chat with Consult Hyperion's David Birch, Nasdaq's vice president of blockchain Fredrik Voss talked about what his team had learnt from the experience. The talk took place yesterday at the European Blockchain Congress, being held in London Docklands on April 26 and 27.
Back in December 2015 the Nasdaq Linq blockchain allowed an issuer to complete and record a private securities transaction, shortening the settlement time and removing the need for paper stock certificates. The underlying blockchain technology is supplied by Chain.com.
A second Nasdaq announcement in February 2016 involved Estonia's e-Residency platform and a blockchain-based proxy voting system for shareholders of companies listed on Nasdaq's Tallinn Stock Exchange.
Voss pointed out that the focus at Nasdaq is strictly at an application layer, as opposed to constructing the shared ledgers themselves. "We are trying to build applications and solutions of various use cases in capital markets, particularly the areas we are focusing on is post-trade processing, regulatory transparency, reporting, and actually reforming the relationship between an issuer of an asset and the holder and investor of that asset."
Voss said there were common sense reasons why Nasdaq had picked straightforward private securities issuance followed by the proxy voting application. "We chose these because the level of regulatory complexity is very low. There is not a lot of difficult legislation or regulation and also very little in the way existing infrastructure that we have to integrate with."
He added there are also applications which have not been announced: "We have some secret ones."
Birch asked about Linq, mentioning that it's constructed from a fork of the Bitcoin code base. Voss anwered: "The software that runs on a ledger supplied to us from Chain is a Bitcoin fork, but it has evolved significantly from that. It has features and capabilities that are not part of the original Bitcoin, and it's not using Bitcoin.
"What we have provided is a user interface for private companies where they can issue shares; they can transfer those shares to their investors. We have a user interface for investors, typically VCs in these companies, but could be any investor, that allows them to further transfer these shares to other investors if there is a secondary market transaction."
Voss said the immutability aspect of the blockchain and its golden record of provenance were useful here, and added the app could be deployed on any other ledger that gets an uptake.
He said: "It's the only representation of that share. There is no underlying book entry system. So we now have a system that allows for issuance and transfer of shares without the legal entity, the CSD; without the legal entity, the CCP.
Birch commented that people would therefore be keeping the shares in their wallets, and just the same way Bitcoin can be sent to someone's address and that's that, shares can be sent to someone else and that's that.
"It replaces the printing of a paper and keeping that paper in a vault, and sending it by FedEx. It keeps it electronically and it records it for posterity," said Voss.
"What happens if you lose your password - you lose all your shares?" said Birch.
"That is one of the interesting learning points," said Voss. "Even though you use a distributed ledger, there's a heck of a lot of governance needed. How do you solve that? Another is governance around the protocol - for changing that - and also since we are using a permissioned environment, you also need governance around the rules for remaining in the system; if you misbehave, what happens?
Turning to the second use of blockchain by Nasdaq, the proxy voting, Birch asked if this could not just be done online.
Voss said: "This is less about replacing existing technology and more about exploring the relationship with an identity vehicle. We are using the Estonian e-residency solution, so we are eventually working with Estonian government. We provide the application, they provide the identification process.
"Any person in the world can become an e-resident of Estonia. We can then use our app to issue voting tokens to an investor in these listed companies on the Estonian market. That allows them to securely vote remotely. But it actually provides a new feature as well. We can provide a service to proxies - with the token the proxy has indisputably evidence to the investor that they voted in accordance with instructions, which is not easy to do with existing solutions. So it allows us to explore identity, work with e-residency to explore that, and provide a bit of enhancement on the real world."
An often cited enhancement potentially delivered by blockchains is a move from two or three days clearing and settlement to near instant settlement, a fabled T+0. However, people who work in capital markets are likely to tell you there are good reasons for the time delay and that this move is less about technology and more of an act of will.
Voss unpacked the issue. "T+0 already exists for equity settlement. There are many markets that we supply technology to using traditional central database technology, particularly in the Middle East. The Kuwait exchange, the Saudi exchange - they already run on T+0. What is funny with that is they are looking at going to T+2 or T+3 to sort of get international compatibility.
"So T+0 is not an element of the technology; of course if you have immediate settlement you have less counterparty and systemic risk, so you free up that capital. But on the other hand, everything needs to be prepaid.
"We can certainly see how this technology can be leveraged to create efficiency in post trade space, free up capital, operational expenses, but it really boils down to a discussion of what market model do you want. Then that becomes a discussion between all the participants in the ecosystem; issuers, the intermediaries, the ultimate investors. How do they want their market to work?
"They have different desires and different needs. I think the shared ledger technology enables greater degree of choice, but it's actually not unique in its ability to achieve some of these new efficiencies. Yes, we are sure you can run a market without a CCP and CSD, but T+0 is already there."
The subject of how much integration distributed ledgers will have with existing intermediary infrastructure is encapsulated in questions like T+0, netting cycles, and securities repatriation times associated with shorting selling stock.
The way in which traded transactions are netted together can divide opinion on how distributed ledgers might work. Some from the startup community believe that placing trades in fungible pools, which in turn feed other fungible pools, is an unnecessary abstraction from a direct exchange mechanism; if you were to rebuild the system from scratch - particularly aiming at T+0 - why would you build in things like netting. Other people say netting is essential to optimise trading and keep costs down.
IBTimes asked Voss if its exploration of ledgers envisaged settling trades on a gross or net basis.
"I think it depends upon the market and the constituents of that market. Not the entire world will go to sort of gross settlement for every single asset class in the world. We will definitely have markets where people want to do netting.
"Instead of having netting on a T+2, T+3, they may say, we'll net over four hours. We'll have settlement cycle six times a day, and we will net in between, for example.
"This technology offers great choice in market model. How do we want our markets to work in the future? We haven't explored this to the nth degree, but you can actually imagine it allowing an issuer to make that choice.
"If I'm an issuer of an asset I could sort of decide that this asset should be settled gross time and that asset should be settled once a day. Or we can contemplate possibly working in parallel: when you trade a share, if both parties agree to settle at T+0, let's do that. If both parties agree to settle once a day, let's do that."