On the robustness of cryptobonds and crypto settlement | FT Alphaville

On the robustness of cryptobonds and crypto settlement

Online retailer Overstock last week became the first company to offer a corporate bond, valued at $25m, in the form of a “crypto security”.

Unsurprisingly, the story was pumped up by the crypto trade press, which has a habit of taking statements from vested interests at face value.

But, as Bloomberg’s Mark Gilbert has hinted indirectly there’s something hypocritical about lauding a bond for its transparent blockchain traceability features while at the same time providing sketchier than sketchy details about all its other aspects.

The little information we had from the press release suggested the bond lacked basic attributes of a bond, like an interest rate or a repayment date.

The focus instead was on how Overstock’s own CEO, Patrick Byrne, had become the bond’s first buyer — reportedly handing over $500,000 in a move evoking Jonas Salk’s self-injection of his polio vaccine.

Alas, still no details about who else may have joined the crypto bond club, or to what degree the bond was over or under subscribed.

But we did receive some further information from Overstock’s press office about the terms and conditions. It’s called a “top line income generation rights certificate” with “tokens” bearing a yield which fluctuates in line with Overstock’s performance. The paperwork states the bond will distribute 0.11 per cent of revenue to produce a minimum annual interest payment of $1.625m and a maximum annual payment of $1.75m — which works out to be a 6.5 per cent base yield, plus a share of revenue of up to a maximum 7.5 per cent over 5 years.

Curiously, despite its crypto blockchain status the tokens will still be registered on the books of a conventional transfer agent: the Continental Stock Transfer & Trust.

But that matters not because the crypto enhancement is connected to the “tokens” trading via “TØ.com technologies cryptotrading solution”, which guarantees same-day settlement if you buy and sell on the platform.

On the importance or not of same-day settlement

What we should really be asking is whether same-day settlement is all that revolutionary?*

If yes, the financial industry would first have to back-peddle on its historical claim that the billions of dollars of trades that fail to settle on time in the US simply isn’t a problem, just a boring back-office anomaly.

Then, presumably, we’d have to review the fairly innocuous reasons for why things fail: Admin errors; someone didn’t pick up a phone or read an email; insufficient penalties to encourage timeliness; and the most frequently cited of all, a lack of standard practices in the industry.

On the last point, as markets get more global and cross-connected there is undoubtedly a need to harmonise settlement practices, whether that’s for bonds, securities or cash settlements.

But it must be remembered that this process is more akin to deploying the metric system, consistent rules about which side of the road to drive on, getting rid of the QWERTY keyboard, than it is about staging a revolution.

Also, it’s not like authorities aren’t trying to encourage harmonisation.

As Reuters reports, next Monday the eurozone’s new single securities settlement platform T2S will go live, enabling the fluid and efficient settlement of euro-denominated stocks and bonds. The first phase sees Greece, Malta, Switzerland and Romania link up to the system, to be followed shortly by Italy in August and France and Germany by 2017.

The aim of the project is to unify the fragmented network of 30 settlement houses, all boasting diverging rules and standards.

But do clock the use of the word “platform” in the above. Effective settlement doesn’t rely as much on technology as it does on the initiation of network effects making it worth everyone’s while to use one specific platform rather than many.

Which gets to the heart of the problem of the blockchain revolution claim. Being able to settle trades on a same-day basis within a closed system (such as the bitcoin blockchain) isn’t really all that difficult. Indeed, most advances in real-time settlement and payments have been achieved by simply getting banks, institutions or users to commit to one platform over another. (And this has been the case as far back as the days of Girobank, if not before.)

Banks and financial institutions are the original platform and social network businesses. And always have been.

Still, the benefits of moving to a single platform can be undermined by the disadvantages of being beholden to just one platform provider. Hence the reason why overly dominant platforms often end up being decried as being overly monopolistic or in need of busting.

Also, in a free market it’s hard for a platform to permanently fend off competition — whatever the network advantages.

When new entrants arrive, however, they usually strive to differentiate themselves, which in turn invites fragmentation and divergence back into the system. And when fragmentation returns, so do intermediaries who know how to profit from building bridges between newly disconnected fragments.

And then, of course, we get the bridge problem … those who build bridges tend to like to charge tolls for their use. Which is how we end up back at square one: a fragmented, disjointed and irregular market where middlemen who know how to delay or obfuscate processes thrive — opening the door to? You’ve guessed it, system consolidation.

Blockchain as just another platform

So does blockchain really change that pattern? Unlikely. Ultimately, it’s just another platform seeking to standardise the way the financial industry organises and processes data for harmonisation advantages, meaning it’s as vulnerable to platform-hopping trends as any other system. Furthermore, when it comes to crossing into other systems, there’s no frictionless advantage at all (hence why you still need to rely on a toll-charging middleman to swap you litecoins for bitcoins).

True, blockchain does distribute/replicates data across many channels, something which genuinely does improve resilience versus other platforms. BUT! (and there’s always a but), if you had the means to download the entire transaction history of every financial market in the world, store it on your hard-drive and monitor it singlehandedly just to make sure there was never any discrepancy, would you really want to? Is the upside — namely, the off-chance you might need the data to ascertain an asset belongs to you not someone else and hasn’t been tampered with — really worth the cost of holding and continuously processing all that data?

For most people with jobs, families, real interests and real responsibilities, the answer is no, probably not. There’s a reason why we outsource this stuff to experts and trusted third parties. It’s more efficient and cost-effective to do so.

Blockchain exploitation

To end, some points to bear in mind when listening to blockchain crypto settlement hype:

1) Blockchain in its current form is a hugely expensive platform. The only reason users appear to get a free ride is because speculators and “investors” are, for now, willing to subsidise its expensive nature.

2) Given the free nature of the resource, should we really be surprised a growing army of companies and organisations have noticed there’s a free resource out there to exploit and profit from?

3) That the “TØ.com technologies cryptotrading solution” is capable of tracking a security faithfully through its own system really isn’t revolutionary. Any depository trust can do that. The issue is tracking and eliminating every other claim and/or thing which might be pinned to that.

4) Speaking of the problem: if I acquire bonds through the “TØ.com technologies cryptotrading solution” but then decide to issue my own personal tokens against them — bearer promises in their own right — is the blockchain really any wiser as to where these claims reside? No. It thinks I own them, when really I’ve sold them on “offchain” to someone else.

5) True T+0 settlement occurs when two assets are exchanged for each other, not one. A blockchain may be able to track and record a single asset’s flow through its own system, but it can’t force the simultaneous transaction of cleared funds against those assets.

6) When dealing with a bitcoin-denominated transactions, blockchains can — we guess — encourage the development of a pre-funded regime where assets/funds are never transferred until cleared funds/assets are visible in a respective counterparty’s wallet. But that doesn’t necessarily mean settlement delay or failure can never occur. If transacting against non-bitcoin denominated funds, the blockchain network still has to wait for a message from an outside network that cleared funds are available and it’s safe to transfer assets.

7) On the basis of the above, blockchain’s most attractive feature is probably that of providing entities with little to no reputation in the market with some sort of easily accessible “proof of once having touched the securities in question”. It can’t, however, overcome the risk that the assets have already been promised to someone else or that they are being held in custody for another party.

8) It already takes up to 48 hours — T+2 — to transfer a properly secured bitcoin around the system. If and when assets of much higher value are attached to bitcoin tokens, it’s likely that delay will get longer not shorter.


*Russia went from T+0 to T+2 settlement in 2013 because pre-funding trades wasn’t very efficient.

Related Links:
Overstock must restate finances, again – Sam E Antar
Overstock net income over time – Wolfram Alpha