A postcard from Blockchain’s bleeding edge

April 14, 2017 03:00 PM

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A year ago, in our inaugural fintech issue, we wrote a feature  describing how 2016 would be the year the bitcoin ecosystem would complete its shift from exploring use cases for digital currency itself to the applications possible from harnessing the blockchain (see “Settling on the Blockchain,” Modern Trader,  May 2016).  The article pointed out how blockchain — or as more accurately described these days, distributed ledger technology — would evolve as a revolutionary way to clear, settle and process a wide range of transaction and transfer-based operations. 

As a refresher, the blockchain is the bitcoin’s settlement mechanism. It is essentially a massively distributed, online ledger that does not rely on a centrally managed database or group of databases in order to clear trades. Instead, it uses a decentralized global network of millions of computers that work together simultaneously to provide a quick, secure and trustless environment that strips out the legions of middlemen that exist between buyers and sellers. 

In last year’s feature, we profiled a startup named itBit that was at the bleeding edge of this shift. The company’s Bankchain product is a perfect example of the game-changing nature of distributed ledger technology in the financial services sector. Bankchain is a private, members-only version of the blockchain that provides instantaneous settlement, greater automation, reduced counterparty risk, lower capital requirements and increased operational efficiencies.

Since we discussed  itBit last year, tremendous activity has taken place, and blockchain now headlines virtually every discussion about fintech. Most notably, Patrick Byrne’s (Modern Trader’s CEO of the year) Overstock has executed the first bona-fide public securities offering relying on blockchain technology developed by its T0 subsidiary, while hundreds of patent applications for permutations of distributed ledger technology have been filed. Also, a raft of blue-chip companies – Ernst & Young, PwC, Deloitte, IBM, Microsoft, Accenture, JP Morgan – are hard at work developing both internal and external blockchain applications, while organizations like financial industry consortium R3, Blythe Masters’ Digital Asset Holdings and countless startups are all hard at work progressing their blockchain proof-of-concept work to deployable products. 

For itBit, the year since our feature has also been busy. The company rebranded as Paxos in September 2016 to delineate the company’s Bankchain efforts from its institutional bitcoin trading platform, while in October it announced a collaboration with EY (formerly the Ernst & Young accounting firm) for a next-generation blockchain settlement service that brings instant settlement and true delivery-versus-payment capability to the gold market. The effort also involved a groundbreaking pilot between Euroclear and Paxos in which more than 600 over-the-counter test bullion trades were settled on the Euroclear Bankchain platform during the course of two weeks.

Paxos also recruited a marquis board of directors, including former Federal Deposit Insurance Company chair Sheila Bair, former Senator Bill Bradley, former chair of the Financial Accounting Standards Board Robert Herz, former chairman, president & CEO of Lotus Development Corporation Jim Manzi and former NYSE CEO Duncan Niederauer. If you don’t think blockchain is about to rewrite everything we know about finance’s back office — and soon — you’re in for a big surprise.

Modern Trader caught up with Paxos CEO and Co-founder Charles Cascarilla to get his thoughts on where blockchain technology stands and how his firm is keeping abreast of both the technology, which is moving at warp speed, and the competition. 

Modern Trader: What have been the three most important developments in the blockchain world, particularly related to settlement, since our feature last year? 

Charles Cascarilla: There has been a lot of attention on the post-trade space since your last feature, and while there are many initiatives, only a few have the necessary required mix of funding, engagement, relevance and capability.

For us, the biggest development has been Euroclear Bankchain; our joint venture with Euroclear is progressing rapidly, now including 20+ major market participants across the precious metals market. We have now run two pilots in which participants have been able to settle thousands of transactions simulating the transfer of gold versus cash.

MT: Tell us a bit more about your decision to rebrand itBit into Paxos. 

CC: We launched Paxos to underscore the company’s goal to leverage consensus-driven blockchain technology to transform the way global financial institutions work together. The name Paxos is inspired by a technical term that represents a process for reaching consensus, which fits nicely with the overall company mission. 

MT: Compared to a year ago, the fintech world is now awash with blockchain predictions. How close are we to actually seeing market adoption of products? How much of the blockchain settlement work is being done internally at large financial firms versus consortiums like R3 versus startups?

CC: We tend to look at this in two phases with regards to adoption. The first stage is proving the technology can deploy and solve real problems. As far as we know, there is no inter-institution blockchain platform currently fully in production, and Paxos hopes to be the first to achieve this. Once the technology is proven, the second stage of adoption should accelerate. It’s conceivable that in  several years we will enter this stage in certain markets.  

Historically, technology development has happened outside of large financial institutions for a number of understandable reasons: regulation, capabilities, development budgets, etc. We expect that [generally] to remain the case with blockchain settlement work.

MT: A few years ago some observers forecasted a splintering of blockchain efforts into individual use-case silos using side- and private chains instead of writing to the bitcoin blockchain. Is this happening, and what do you think will ultimately be more prevalent?

CC: Clearly this was a good prognostication. A tiny fraction of the blockchain projects we are currently aware of contemplate using the bitcoin blockchain.

MT: Despite tremendous attention on blockchain and increasing acknowledgement that it will play a major role in the back office world of financial markets, what are the obstacles keeping the technology from quickly going mainstream? And what, if anything, could still go wrong to derail the whole thing?

CC: The key obstacles are actual deployment and usage of the technology for relevant problems, [and the main risk is] execution. Financial institutions have built complex and many times proprietary processes in their back offices. For a blockchain solution to be successful across multiple institutions, the execution must fit various institutions’ business practices. 

MT: Not that long ago, bitcoin and blockchain were considered by many to be inseparable at any kind of scale. Has that calculus changed in the last year? Can bitcoin fail (or remain static), yet blockchain technology thrive?

CC: Bitcoin is currently seen for what it ultimately is now — a specific usage of blockchain solving a specific problem, in this case public trust. While it is a valuable, high profile and important problem that is potentially solved, it is not a referendum on the viability of blockchain broadly.

The last year has proven that institutions are realizing that bitcoin was really the first popularized application of blockchain and that the underlying technology — a blend of cryptography and distributed database technology — has many other applications in various fields. Thus we believe that the fate of the two is not entirely correlated.

MT: How would you characterize the shift in sentiment among Wall Street institutions since our article last year?

CC: Many institutions are still committed to looking for ways to effectively deploy blockchain technology and many still remain bullish on the technology’s ability to revolutionize middle and back office processes. However, it could be said that the hype that surrounded blockchain early on has begun to be replaced by a more measured and realistic approach to proving and implementing the technology.

About the Author

Steven Lord is Managing Editor of FINalternatives.com and the founder of Modern Money Group. He has studied bitcoin since shortly after its inception, and has become a leading expert on the digital currency ecosystem. Lord has led several companies in the financial technology, investment media, brokerage and asset management sectors in the United States and Europe.