Blockchain Bamboo May Be Remaking Financial Markets

Mark Wang curls his upper lip in frustration. The six-year-old stares blankly at the mess of figures in front of him, painfully aware both mentally and physically over the seemingly insurmountable task of sorting them out.

Standing ramrod straight and armed with a menacing-looking wooden ruler, like an ominous cloud hovering over him, his strict and authoritarian father stands poised to deliver more admonition for errors. Mark knows that another mistake will bring a swift swing of the ruler and the sting of woodladen punishment against his already sore knuckles.

But Wang is determined to avoid both his father’s ire and the shame (that most Chinese of emotions) of getting another math problem wrong and fortunately for the father-son pair that night, he gets through the rest of his math homework with no further violence.

 

His eyes puffy from tears, Mark turns to the elder Wang,

“Father, why do I need to learn all this math anyway. It’s not like I’ll ever use it.”

But instead of the swift sound of the ruler coming down again, Mark’s father, perhaps in a moment of soft-heartedness (or perhaps weariness) quietly admonishes,

“Son, do you know why we keep bamboo in the home?”

“For good luck!” Mark chimes.

“Not just for that. But also to remind us of life’s journey.”

“You see son, the (Chinese) bamboo plant is a not just any ordinary plant. It’s special because of the way it grows.”

“To grow a bamboo plant, you must first water the plant for five years while it is still in the ground.”

“You mean?” Mark turns to his father quizzically.

“For five years after the bamboo has been planted, you must continue to fertilize the plant and water it, but nothing will come out of the ground during those five years.”

“And if you stop watering it or fertilizing it at any stage during those five years, it will never emerge from the ground.”

“And people who see you doing what you are doing, if they don’t know you are growing bamboo will think you are crazy. That you are working for nothing, because they cannot see the fruit of your work.”

“But the difference is that you know. And you know that if you stop at any time before the bamboo emerges from the ground, anything you’ve done before this would have been a waste of time.”

“But when the bamboo plant finally emerges from the ground, do you know how fast it grows?”

Mark shakes his head.

“When the bamboo emerges from the ground, it grows 90 feet in 5 weeks!”

Mark’s eyes glisten in wonder.

“So now I ask you son, does a bamboo plant grow 90 feet in 5 weeks, or 5 years?”

“Five years,” answers Mark.

“That is right. And that is why we do what we do today.”

“Because even if it doesn’t make sense, even if people around you laugh at you, ridicule you, no matter how painful or how difficult it is, just remember that the bamboo plant takes 5 years to grow 90 feet, but people will only see the 5 weeks’ worth of growth.”

“And that is why we keep the bamboo plant in our house — as a reminder.”

The Cryptocurrency Bamboo Marathon

Which is why despite the brutal sell-off in cryptocurrencies that occurred in 2018 and the continued chill of the so-called “crypto winter,” many cryptocurrency businesses are continuing to chug away at the underlying blockchain that supports cryptocurrencies, seeking to remake the underlying machinery of Wall Street and waiting for the day when their bamboo plant breaks free of the ground.

And that day may just be around the corner.

Despite billions of dollars spent and apparently very little to show for their efforts, states, regulators and lawmakers are finally laying the legal groundwork for the creation of “digital securities” — assets that closely resemble Bitcoin and other cryptocurrencies and could be used to represent stocks and other financial instruments, including derivatives. 

Wyoming is one of the latest states to give legal recognition to these digital securities, hot on the heels of its rival Delaware, which had done so earlier.

Both states are favored locations for company registration, thanks to the relative ease of the process as well as for tax reasons.

Not to be outdone, the U.S. Securities and Exchange Commission (SEC) has continued to refine its definition of what constitutes a digital security and recently introduced a bill to Congress with a goal similar to that of Wyoming and Delaware.

And cryptocurrency startups that were either not scams or still have runway, are continuing to build out product, developing platforms for creating and trading the new kinds of securities envisaged by the SEC and lawmakers in Wyoming and Delaware.

One of the more notable startups is Goldman Sachs-backed Circle Internet Financial, which recently acquired SeedInvest, an online platform for startups and accredited investors.

But regulations have been otherwise slow to catch up.

Not All Legacy Systems Are Bad

Capital markets handle trillions of dollars of trades and transactions daily, but employ numerous middlemen to make the system work.

Investment banks, custodial services, transfer agents, brokers and exchanges all stand between the companies issuing securities and investors buying them, adding to the friction and cost of these transactions.

Although cryptocurrencies promised efficiencies with direct peer-to-peer trading on the blockchain — a history of hacks as well as poor or non-existent institutional controls have left investors weary, wary and more often than not, both.

 

And though the current market system is inefficient and expensive, it comes with certain institutional-grade protections which are as yet absent in cryptocurrencies and digital asset trading.

For instance, clearing houses, which make sure that trades get settled, set aside money to protect against extreme losses and transfer agents keep track of securities and ensure trades are accurately recorded.

To be sure, use of the blockchain, an immutable and almost instantaneously updated decentralized ledger would remove the need for transfer agents, bu tthe role of clearing houses as insurers to the entire system might still be of value.

Consider that clients of QuadrigaCX — the Canadian cryptocurrency exchange which lost access to an estimated US$190 million in client monies when its founder mysteriously died with the passwords to the funds — had almost zero recourse against the exchange and it becomes immediately obvious why the industry should not be too hasty to cast away all of the institutional structures present in financial markets.

Under a blockchain-based trading system, creating a new security would be as simple as filling out an online form and trades could (depending on volume and the number of transactions a protocol is capable of supporting) clear in minutes.

And because the blockchain is an immutable and decentralized ledger, trades could be tracked and instantly verified, removing the need to post collateral.

Information would also be immediately promulgated throughout the blockchain and visible to all market participants — eradicating any perceived informational advantages that physical proximity to the centralized exchange currently provides in financial markets.

But of course, transactions on the blockchain are also irreversible — a factor that needs to be considered especially in the face of likely human error.

One solution of course is to ensure algorithmic controls to prevent such human errors — something which the aviation industry has adopted when designing aircraft.

While human error cannot be completely eradicated, it can, at the very least, be minimized.

Erasing the Middleman

According to Mark Smith, CEO if New York-based Symbiont, which is building platforms for trading digital securities,

“There’s no need for that big, clunky middle layer.”

Circle’s CEO Jeremy Allaire is even more optimistic in the potential of the blockchain technology that underpins Bitcoin and other cryptocurrencies, suggesting that companies will eventually be able to raise capital, maintain shareholder lists and go public on systems built on blockchain technology.

“It’s very difficult for people who start companies to find capital and for investors to invest in them.”

“If you could really digitize this, it makes the market more open and less friction filled.”

Part of the draw of the initial coin offering (ICO) fever that gripped the more speculative (and wishful) corners of the investing world in 2017 and 2018 was that ordinary, retail investors were able to gain access to pre-listing ICO pools, similar to pre-IPO shares that only accredited and institutional investors have access to in the financial markets.

And while many ICOs were scams or nothing more than dressed-up startups with tenuous business models, the spiel that was being pedaled to regular investors of being able to make multiples on their investment proved irresistible.

But with greater regulation and more institutional participation, the possibility of increasing access to exclusive pre-IPO-type deals to regular investors might help to create a more egalitarian market as well as increase access to opportunities in a more orderly and safer fashion.

Preaching to the Choir

And it seems that even some of cryptocurrency’s biggest critics have come around.

At a congressional hearing last month, JPMorgan Chase CEO Jamie Dimon, who has been a beacon of criticism against cryptocurrencies spoke about the benefits of distributing his bank’s own digital currency — JPMCoin — on a blockchain-based platform.

“Instead of having to call each other’s bank up and see what happened to that shipment from Singapore, we just go to the same screen and see it right away.”

But while the efficiency, savings and perhaps the increased market size may be draws of adopting blockchain technology, the unclear legal status of digital tokens means that their widespread use is still some ways away.

Whether it’s the legal status of digital tokens that are taken to represent assets, custodizing these tokens, or the information that would be visible on the blockchain ledger — there are still many serious legal ramifications that need to be worked through.

But there are forces in Congress who are determined to see these issues through.

Take for instance Ohio representative Warren Davidson, who sponsored the Token Taxonomy Act that would define digital tokens at the federal level — Davidson has emphasized that making laws to protect digital securities would be as important today as overseeing the internet was in the 90s.

“It really is, at every level, from capital formation to law enforcement to consumer protection, to our advantage to provide regulatory certainty.”

“Every day we tarry we’re losing market share.”

The aftermath of the ICO bubble and bust, which raised and burned through billions of dollars, shows what happens when lawmakers are slow to provide a regulatory framework — creating a regulated stable version of ICOs may perhaps meld the best of blockchain technology with traditional finance.

And blockchain technology could also provide the SEC with better surveillance and monitoring capabilities, with the SEC itself perhaps functioning as a node on the blockchain, with the same level of access and information as other market participants.

For now at least, both market participants and regulators are continuing to water the blockchain bamboo plant, whether or not it will emerge from the ground eventually will depend very much on that commitment to the cause.