Last week, the exchange giant Nasdaq announced the launch of its SaaS based digital asset suite named the Marketplace Services platform.
As the exchange giant is best known for its technology oriented public stock market exchange, one would be forgiven for jumping to the conclusion that the company is getting into the business of operating a virtual currency exchange.
While Nasdaq is not launching a virtual currency exchange, it is rolling out a service which will empower companies across a range of industries to build new financial instrument that use Distributed Ledger Technology — a version of blockchain technology that more closely meets the needs of financial services.
Mature Organizations With Large Client Bases Now Backing Blockchain
What separates this from the usual announcements around adoption of blockchain is that it involves mature companies with large corporate clients coming together to offer what has been up to now seen as an interesting-abeit-immature technology that many believed was still many years away from large scale adoption.
That established companies such as Nasdaq and Microsoft are now backing blockchain and offering it to their clients is a signal that the technology has now become adopted by the mainstream. The client base of the two organizations alone is large before considering the footprint of Nasdaq DLT partners, R3 and Symbiont, which are both becoming the de-facto standard for Distributed Ledger Technology in financial services.
Nasdaq itself has a huge presence in the world of financial infrastructure today; the exchange giant has over 120 financial services clients across the world. Through its partnership with Microsoft, Nasdaq will be able to distribute its Marketplace Services platform through the software company’s Azure cloud offering, which used by most of the companies in the SP&P 500 and is available in 140 countries worldwide.
Hiding The Blockchain In The Back
Nasdaq has paid particular attention to the user experience in order to make blockchain more useable by financial professionals; historically doing anything in blockchain has required an engineering degree. By pushing technical aspects concerning the underlying blockchain plumbing infrastructure to behind the scenes, it has freed up users to focus on their core strength of being financial experts.
That metamorphosis from being a service that is highly technical, to one that abstracts the technology to offer an experience that a consumer is comfortable with is one that we have seen with the evolution of the Internet which used to be only the domain of bedroom coders but is now ubiquitous in everyday life. It’s a good sign of a technology that has become mature.
For Nasdaq, that move away from the technical is also paying dividends because it makes the value proposition of blockchain a lot easier for business leaders to understand, as Johan Toll, head of digital assets within the company’s markets technology division, which owns the platform, explains — ”The discussion has primarily turned from being a technology oriented one between technologists into one with the business, which is encouraging because that’s where the real money and the real interest will come from to motivate a transformation of the ecosystem.”
Aren’t Assets Digital Already?
The term “digital assets”, while somewhat confusing given that most financial assets exist in digital form and have done since the 1970’s, has emerged as a financial services shorthand to refer to financial instruments that are represented in computer code via “smart-contracts” and stored on a distributed ledger that is shared across multiple financial entities.
Related to that is tokenization, which is the ability to digitally break an asset into multiple pieces that can be bought and sold by investors. A good example of tokenization is Wave Financial’s effort in tokenizing of a whole year’s supply of Kentucky bourbon earlier in the year.
The innovation wave of digital assets has been heralded by many in the financial services sector as a development on par with, and even exceeding, the dematerialization and electronification of stocks in 1970’s and deregulation of the stock market in the 1980’s which led to a wave of stock ownership by retail investors.
Taking Out The Complexity
Digital assets can bring transparency and efficiency to the murky and manual world of Over The Counter bi-lateral transactions where financial instruments, rather than being transacted over an exchange, run the gamut through an old-boys network of broker dealers who use telephone, fax and e-mail to make deals and settle assets. That’s a huge segment of financial services today representing trillions of dollars.
It can also vastly simplify the technology that is used to issue, trade and settle assets. Typically each asset that is traded by a financial institution is supported by its own technology stack which is usually ancient, inflexible, and heavily customized over many years. That leads to banks needing to maintain an expensive hodgepodge of systems supported by an army of well paid engineers.
A distributed ledger based system vastly simplifies this landscape with a single platform that can be used across all the asset classes within a financial institution, with the ability to be easily configured to represent any of today’s financial instruments and with the flexibility and power to create innovative ones that would have been simply too expensive to develop with older systems.
By sharing a single ledger, companies no longer have to reconcile information as there is a single version of the truth, that removes the costs of humans providing reconciliation and removes the opportunity for costly errors. Furthermore, many of the traditional middlemen that were needed to navigate issuance, trading and settlement (CSDs, CCPs, and some custodians and broker dealers) are no longer needed. That further takes out cost and improves efficiency.
Another challenge that has hindered issuers has been that they have been hindered in being able to offer their financial instruments to foreign investors as they don’t have the expertise to understand what the local regulations are.
That’s an area where digital assets are removing this burden. Digital asset technology can be pre-programmed with relevant regulatory rules for each country meaning that the issuer doesn’t have to be knowledgeable about the intricacies of a given geography, and can instead select countries that they want to support from a list. The computer code in the digital asset takes care of the rest.
Crossing New Boundaries In Financializing Industries
Perhaps one of the most compelling aspects of digital assets is that it has the potential to bring the power of financial services to a whole new set of markets that have not previously been touched by financial engineering.
“We see other industries beyond the capital markets,” says Toll, “we see an ask [from clients] for institutional grade services to digitalize new types of assets such as in the insurance, healthcare, betting, real estate, and commodity agriculture industry and sustainable contracts. Wherever there is a need to actually more efficiently start to trade assets of value.”
That’s an important point; the capital markets industry is already saturated with too much money chasing after too few investment opportunities in a fairly narrow set of financial instruments. However, these financial instruments represent the tip of an iceberg of possible assets that could be financialized and traded. And that’s a big opportunity that Nasdaq sees, and it’s a capability that its clients are already asking for.
The insurance industry, for example is one that has started to court the buy-side in the capital markets space by offering new instruments (“Insurance Linked Securities”) that allow it to transfer the risk of its insurance contracts to investors by way of a bond. Blockchain will enable the acceleration of this trend.
Digital bonds are also emerging in markets as such as sports and betting. NBA athlete Spencer Dinwiddie, for example, recently proposed to offer shares to investors in his player contract using blockchain.
From Toll’s vantage point, he is already seeing traditional investors looking for these more exotic types of investments in new industries — “We primarily see demand in our classic market infrastructure operator client base looking to see how could they can potentially trade and issue and manage new types of financial assets. They tend to classically trade equity fixed-income derivatives and now looking to see how could they potentially expand their business.”
Nadaq’s Marketplace Service offering has also set its sights on making settlement quicker, easier and cheaper. And it’s doing that, in part, by digitizing dollars.
Settling assets — that is the exchange of a financial instrument for money — has become markedly expensive since the great financial crisis. Regulators now require broker dealers to hold far much more cash in reserve to cover the risk that their counterparty is unable to fulfill their side of a transaction. The sums are staggering, with a typical Wall Street firm needing to set aside billions of dollars in reserve against this settlement risk.
Moreover, there are multiple parties involved in the settlement process today, and the cash and assets are passed between middlemen in an an elaborate choreography before the settlement is completed, typically two days later.
With digital assets, cash is converted into a digital representation on the blockchain and swapped automatically for the digitized asset. This is far more efficient as it can occur in seconds and without the need for middlemen. It means that banks no longer need to carry billions of dollars on their balance sheet which saves them a significant amount of money.
That may sound far fetched but digitized dollars on the blockchain are used for settlement in equity market in the U.S, today; Paxos recently launched its settlement service which is used by banking giants Credit Suisse and Instinet.
Collapsing the payment and security infrastructure into one takes out complexity and risk, explains Toll — “Traditionally we had a separate payment network and separate security infrastructures. What blockchain and smart contracts can provide us with one complete service and a network to manage both the assets and the payment leg. We can now cryptographically guarantee that Delivery versus Payment (DvP) will occur and you don’t necessarily need a central operator to ensure that will happen any more.”
Digital Asset Platform Competition
Nasdaq’s offering places itself in direct competition with a crowded market for digital asset lifecycle management platforms, including Tokensoft, Securrency, and Securitize among others, but Toll isn’t concerned. “We run and operate 28 markets ourselves and have delivered technology for thirty years so we are very well-known in the industry of capital markets as a trusted provider of services and technology, so I think we clearly see that we have an edge there.”