Real Time Settlement, A Unique Piece of The BlockChain

One of the things I never understood about back office financial payment systems was settlement.  Why did it take so long for things to settle?   In the futures world where I lived, we had daily settlement with corresponding payment, and collection.  But, everywhere else, it took days.

Blockchain can change that and it has some pretty big ramifications.

One of the things that financial people are focused on now post 2008 financial crisis is risk.  The futures industry requires a lot more margin to hold positions.  In Lean Hogs, prior to 2008, it was $50 to hold a spread.  Post crash, $1800 dollars per spread.  Margin changes, but traders will never see $50 ever again.

The futures clearinghouse works exactly like a closed blockchain.  What does the financial world look like if the same concept is unleashed?

It’s going to change stock trading.  Markets will be much more efficient because stock will get transferred and settled that day.  Variance will be taken out of the settlement chain, allowing banks and traders to use cash for positions more efficiently than they do today.  That should lead to lower costs and more profits.  This is back office efficiency, not front end speed efficiency.

There are lots of anomalies in stock trading today.  Big banks fudge the numbers on stocks and borrow them to short.  In a recent settlement with the US Department of Justice, Goldman Sachs will pay a $2.385 billion civil monetary penalty, make $875 million in cash payments and provide $1.8 billion in consumer relief.  It sounds like a lot of money, and it is.  But, I bet they made considerably more than that.  It also doesn’t account for all the knock on effects in other markets that were affected by their illegal activity.  It wasn’t just the mortgage market that fell apart in 2008, all asset and commodity markets tumbled in value.

A few entities dominate back office clearing in finance today.  Blockchain can totally upend that oligopoly.  The members of that oligopoly are trying to figure out what the cost/opportunity costs of fighting the change are today.   If they think they can make more money using blockchain, the transition will go a lot quicker.  If not, look for a lot of regulatory battles at the SEC, Department of Treasury and other regulators.

Credit card payment processing is highly centralized.  Currently, the bitcoin network isn’t fast enough to process payments like existing networks.  But, it’s early and technology changes.  There are some things that the bitcoin network has to figure out before they can compete.  One thing I wonder about; when processes are centralized, they can do a lot, but they can never do as much as a network.  How long does it take the bitcoin network to figure it out-and does that network of miners have to centralize to do it?

A corollary is in futures trading.  In the pit, we had a closed centralized network.  On the screen, we blew the network wide open and volume increased exponentially.  But, for that volume to increase exponentially, it had to centralize into several HFT firms from a lot of independent traders.  This is not unlike the change that will happen with miners when the bitcoin network goes to larger block sizes.  To be clear, I am not suggesting this is “bad or good”; it is merely an observation and a metaphor.

Blockchain obviously will change title search in real estate.  It will change back office processes in the trading of muni bonds, and other assets.  No longer will the market have to pay someone to do research to find out if something has a “clear” title.

This is why people have pivoted to blockchain.  If you talk about Bitcoin, most people think you are insane.  But, Bitcoin and blockchain are linked.  There isn’t one without the other.  If you post something on the blockchain and it has no bitcoin attached to it, there isn’t any value created.  This doesn’t mean governments will abandon their fiat currency anytime soon.  Far from it.  But, they will have to wrap their heads and operations around bitcoin.