Financial Blockchains: The Peril and Promise


Mentioned Companies: AMZN, GE, OSTK
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We recently had the pleasure of sitting on a panel hosted at ConsenSys, a leading Ethereum startup, to discuss the future of financial blockchains. Below we include a brief summary of some of the topics we found most interesting from the panel discussion.

 
 

Digital Assets

Trading within the capital markets currently involves a mixture of digital and physical assets, supported by a wide variety of underlying infrastructure. The assets that have not been digitized, also known as dematerialized, frequently cause backlogs because they cannot be transferred as quickly as digital 1’s and 0’s. For example, syndicated loans suffer from this problem, leading to an average settlement time of 19 days. At one point in the panel Richard Johnson, Senior Analyst of Market Structure & Technology at Greenwich Associates, said, “To really have the true benefits of blockchain, the assets need to be digitized.”

Since a blockchain is a digital ledger, it works most smoothly with digital assets. Using smart contracts, a blockchain can be used to automatically transfer digital assets between parties when the proper conditions are met. However, a blockchain can’t help to transfer assets that aren’t on its ledger, and in order to be on a blockchain’s ledger the asset must be digital.

Once all assets are digitized then we believe the speed and cost of clearing and settlement can be dramatically reduced. To that point, t0 (T Zero) is a blockchain company owned by Overstock with the motto: “The trade is the settlement.”

A New Form of Venture Funding

When talking about ARK’s focus within the blockchain space, Chris Burniske said:

When you look at the traditional asset manager space, it relies on the traditional flow of capital. For example, you [as a startup] start with your seed funding, then venture funding, then the company grows and IPOs. Then you can put it into your ETFs, mutual funds, or whatever it may be. Now, what we’re seeing…is the idea of the ICO (“Initial Coin Offering”)…sourcing capital in a decentralized way, quickly. You’re leap frogging much of the capital market infrastructure.

If a company raises money via an ICO, then it may never need to IPO. If a company doesn’t IPO, then it probably wouldn’t enter the capital markets as they currently stand, which would prohibit many equity investment managers from being able to invest in it. For a detailed explanation of this funding concept we suggest reading Fred Ehrsam’s piece, How to Raise Money on a Blockchain with a Token.

The panelists seemed to agree that the term Initial Coin Offering steps into potentially dangerous waters with regulators as it rings of security issuance. To avoid such confusion, Arthur Falls, Director of Media at ConsenSys, suggested that the community start using the term token launch instead.

Token launches are a means to fund a new blockchain protocol that provides a digital service to the world. Ethereum, the second largest cryptocurrency by market capitalization, was funded in this manner. The funding is done through the sale or issuance of native tokens that reside on that blockchain. The panelists unanimously encouraged entrepreneurs pursuing this idea to consult with legal counsel, as there are different ways to perform a token launch, some of which are more responsible than others. In particular, it is important to get familiar with the Howey Test, which is a test created by the Supreme Court to determine whether certain transactions, like tokens, can be considered a “security.”

Over time, if these blockchain protocols get popular enough, entrepreneurs may embrace token launches as a means to fund a multitude of distributed digital services. Then, the traditional investment manager may be shut out of a large swathe of innovative investments because there are currently regulatory hurdles with putting such tokens into ETFs, mutual funds, or other investment vehicles. For more on how big these tokens could get, we suggest reading a Union Square Ventures post on the matter.

Permissioned versus Permissionless
We think one of the most contentious topics discussed during the panel revolved around permissioned versus permissionless blockchain implementations within financial services. Permissioned blockchains—also known as private blockchains—restrict access to the network. Permissionless blockchains—also known as public blockchains—are open for anyone to join.

Historically, whether it be the internet, software engineering, or cloud computing, incumbents initially claimed that public networks couldn’t be trusted. These incumbents then watched as AOL faded into obsolescence and the open-internet triumphed; GitHub’s platform for open source software collaboration grew exponentially; and Amazon’s AWS AMZN public cloud rose to dominance, causing companies like General Electric GE to say, “AWS is our trusted partner that is going to run our company for the next 140 years.”

Similarly, it appears that overwhelming consensus by financial services incumbents is that public blockchains will hardly be used by the sector, largely due to privacy concerns. However, during the panel we happened upon the idea that by using zero-knowledge proofs one could construct a permissioned network within a permissionless blockchain. On the other hand, one could never create a permissionless network within a permissioned blockchain because the default environment already restricts access. Therefore, permissioned blockchains are a subset of permissionless blockchains, and so the financial services sector may someday end up using selective privacy within permissionless blockchains.

The full panel, along with audience questions, can be seen here, or on the State Change Podcast #33 titled, “The Future of Financial Blockchains.” Panelists included:

Arthur Falls (Moderator), Director of Media at ConsenSys
Chris Burniske, Blockchain Products Lead at ARK Invest
Richard Johnson, Senior Analyst of Market Structure & Technology at Greenwich Associates
Ron Quaranta, Chairman of the Wall Street Blockchain Alliance
Michael Wuehler, INFURA Project Lead at ConsenSys

Originally published on ark-invest.com

ARK’s statements are not an endorsement of any company or a recommendation to buy, sell or hold any security. For a list of all purchases and sales made by ARK for client accounts during the past year that could be considered by the SEC as recommendations, click here. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list. For full disclosures, click here.

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Fred Pye

Frederick T. Pye

CHAIRMAN, CHIEF EXECUTIVE OFFICER & DIRECTOR

Frederick T. Pye is the Chairman, Chief Executive Officer and Director of 3iQ Corp. He is also the Chairman and Director of 3iQ Digital Holdings Inc. Mr. Pye is recognized for creating and promoting creative and unique investment products for the investment industry.

Mr. Pye has managed private client portfolios with Landry Investment Management and various other investment dealers. Prior to this Mr. Pye was Founder, President & Chief Executive Officer of Argentum Management and Research Corporation, a company dedicated to managing and distributing quantitative investment portfolios including the first long-short mutual fund in Canada.

He was also Senior Vice-President and National Sales Manager of Fidelity Investments Canada and an integral part of the team that saw assets rise from $80 million to over $7.5 billion in assets under management during his tenure. He also held various positions with Guardian Trust Company, which listed the first Gold, Silver and Platinum Certificates on the Montreal Exchange.

Mr. Pye obtained a Masters in Business Administration from Concordia University.