Inside the creation of Citi’s blockchain payments platform

Speed before scale is the name of the blockchain game for Citi.

On Monday, the bank unveiled an agreement with Nasdaq that allows it to actually put money on blockchain technology by linking its business payments services to Nasdaq’s blockchain platform, which is used for buying and selling shares of private companies, among other things. It’s not a proof of concept or an announcement of an upcoming announcement. It’s ready now for “real world” use, according to Morgan McKenney, Asia Pacific head of core cash management, at Citi’s treasury and trade solutions arm.

The technology integration means there can be a direct exchange of funds between Nasdaq and Citi — when someone purchases a share, for example — without the time consuming in-between messaging normally involved. Today when people try to move money, they do so through messaging platforms that need to be verified and reconciled so funds can be released. This partnership merges the ledger that shows moving shares and the one that shows moving money — and removes the need for a reconciliation process.

It’s significant to witness a blockchain solution in the wild. The more common strategy is to build large networks of technology contributors and co-creators of applications for the technology; those groups hardly have completed work to show. The idea behind the Citi-Nasdaq partnership, using Chain’s technology, was to create a “minimal viable ecosystem,” of just a few trusted partners — to be able to get a product to market faster, and focus on scaling the network later.

“Everyone is used to a minimum viable product, how do you extend that thinking to something thats going to involve multiple players?” said McKenney.

To have impact, blockchain technology needs a network effect — the more people use it, the more value it has. But building a network before executing a product or service can slow a group down, and the bigger the group, the easier it is to get caught up in ideas without much execution. One of the things that “helped translate the theoretical thinking to actual application” was considering the project’s “feasibility,” McKenney said.

“Could we launch this thing within a year? We did not want to be in this space where blockchain was too new,” to use in the foreseeable future, McKenney said. “Citi didn’t build a true killer app… it solved a true customer painpoint.”

It helped that Citi, Nasdaq and Chain have a previous working relationship and “didn’t start from scratch,” McKenney said. Citi and Nasdaq are using the fourth iteration of Chain’s Open Standard protocol. At this time last year, Chain unveiled the first version, which it built with Citi and Nasdaq as well as Capital One, Fidelity, First Data, Fiserv, Mitsubishi UFJ Financial Group, State Street and Visa.

Citi is involved in many collaborative efforts: R3 CEV, the 43-member bank consortium focused on building a distributed ledger for financial agreements; Hyperledger, a cross-industry collaborative effort to create a fabric layer with blockchain technology on which members can build other applications; and the Enterprise Ethereum Alliance, the privacy-oriented group developing solutions with open-source ethereum.

McKenney’s remarks about a minimal viable ecosystem highlight a growing conversation in the blockchain space and in fintech more broadly: that startups and legacy firms often refer to younger technology firms as “partners” instead of “vendors.” It’s difficult to be a vendor of new technology for financial services because no legacy institution wants to be tied to a single provider.

“We really have forged the new innovation model,” McKenney said. “This was created for Nasdaq with Nasdaq. The concept of co-innovation, or co-creation, is relatively new. Banks are still relatively early in that space.”

Wall Street’s top 6 bitcoin projects

bitcoin projects on wall street

Less than 1% of internet users are currently using bitcoin as an active currency, but incumbent financial institutions around the world are busy testing the blockchain technology that supports the digital currency. Many of today’s top blockchain projects are being run via financial industry consortia, comprised of top financial firms, technology providers, and consultants.

Here are a handful of the most meaningful bitcoin projects to date:

Credit Default Swaps
Participants: JP Morgan, Citigroup, Bank of America Merrill Lynch, Credit Suisse
Technology/service provider: Axoni

A handful of major banks, including JP Morgan and Citigroup, are testing blockchain technology to help with record-keeping for credit default swaps (CDSs). As an over-the-counter product, it can be a challenge to keep track of CDS transactions. This new test, administered by Wall Street’s unofficial librarian, the Depository Trust Clearing Corporation, successfully showed that payments, amendments, novations and compressions for CDS can be run on blockchain.

Hyperledger Project
Participants: JP Morgan, Deutsche Borse Group, more
Technology/service providers: IBM, Intel, Digital Asset, more

The Linux Foundation helped promote the development and uptake of opensource software. Now, it’s doing the same for bitcoin and blockchain technology. Originally launched as the Open Ledger Project and recently rebranded as the Hyperledger Project, the foundation intends to evangelize the future of finance and to create industry-wide standards. The project is a collaborative, cross-industry open standard for distributed ledgers supported by major financial institutions including JP Morgan, Deutsche Borse Group, BNY Mellon, and ANZ. The organization wants to spur discussion and imagination around the future of supply chains, payments, contracts, and ownership of digital assets.

Commercial paper trading
Participants: R3CEV
Technology/service provider: Chain, IBM, Intel, and Eris

R3CEV is a blockchain startup that’s structured as a consortium of numerous financial institutions, including dozens of banks. In addition to a test using the Ethereum network, R3 recently ran a pilot focused on commercial paper trading. 40 banks participated in the test case. Participants needed to model a financial asset (in this case, commercial paper) and structure a variety of smart contracts for trading that asset — all using blockchain. According to The Wall Street Journal, the goal of the test was to give the banks an opportunity to compare and contrast 5 different blockchain offerings on the market today, including Eris Industries, Ethereum, IBM, Intel and Chain.

Private company capitalization tables
Participants: Nasdaq

In a market with few IPOs, Nasdaq has found other ways to court entrepreneurs and venture capital investors. By building tools and offering in-house and via acquisition of other providers, the stock market seems intent on finding other ways to do business with private companies via Nasdaq Private Market. The same division is experimenting with blockchain technologies. Its blockchain product, Linq, is the first public trial of blockchain technology by a major global stock exchange. One of the first applications of the technology set will help entrepreneurs and private companies manage their cap tables. Eventually, firms using Linq could use it to create, buy, and sell new shares in their companies.

Repurchase agreements
Participants: DTCC
Technology/service provider: Digital Asset

Repurchase agreements, better known as repos, are contracts that enable financial institutions to borrow from one another on a short-term basis by selling securities and buying them back at a set date. DTCC takes in around $2 trillion worth of these agreements daily in the form of thousands of transactions. Participants don’t see a marked difference in their businesses by switching over to blockchain technology, as trades generally settle daily anyway. What it should do, though, is allow financial institutions that are involved in multiple repos to net them out against each other on a given day.

Darrell Duffie, a professor at Stanford’s Graduate School of Business told Fast Company, “I think it’s a smart move,” he says. “It will allow intraday settlement and better netting efficiencies, so it’s a win-win for liquidity in the repo market.”

Japanese Stock Exchange
Participants: Tokyo Stock Exchange, Nomura Research Institute

The operator of the Tokyo Stock Exchange intends to “assess the usability as well as the challenges of blockchain technology when applied to securities markets”. The Japan Exchange group is conducting this project with IBM Japan. JPX plans to conduct proof-of-concept tests to evaluate blockchain technology in markets that have low transaction data volume.

5 trends we’re watching this week

5 trends in finance this week

[alert type=yellow ]Every week at Tradestreaming, we’re tracking and analyzing the top trends impacting the finance industry. The following is a list of important things going on we think are worth paying attention to. For more in depth trendfollowing, subscribe to Tradestreaming’s newsletter .[/alert]

1. Goldman, JPMorgan Seen as Fintech Winners While AmEx Suffers (Bloomberg)
Goldman Sachs and JPMorgan will probably benefit most from the coming wave of financial technology disruption, rather than being supplanted by startups driving the change, according to a new survey.

2. 2015 Automated Platform Performance Review: Betterment vs. Wealthfront (Meb Faber)
Meb Faber with some good analysis on how Betterment performed this year vs. Wealthfront (and where Schwab and Vanguard come in). Hint: roboadvisors are neither “safe” nor are they one-size-fits-all.

3. Inside J.P. Morgan’s Deal With On Deck Capital (WSJ)
As part of the deal, OnDeck won’t put up any capital and will get fees to originate and service loans for J.P. Morgan, many with a value up to $250,000, previously considered too small to move the needle at the big bank. OnDeck also can use data it gleans from the partnership to improve its lending models. “We think it’s a watershed partnership,” said OnDeck CEO Noah Breslow.

4. Microinsurance Is The Answer To The Insurance Industry (TechCrunch)
In the wake of Lemonade’s giant seed round, the tech industry is buzzing thinking about the potential of disrupting insurance. Whether it’s peer to peer models or microinsurance, Silicon Valley is coming.

5. Nasdaq Linq Enables First-Ever Private Securities Issuance Documented With Blockchain Technology (Nasdaq)
Transaction by Chain.com Marks Significant ‘Proof of Concept’ and Major Step Forward in Use of Blockchain. Blockchain Holds Potential for 99%.

With SecondMarket acquisition, Nasdaq moves closer to liquidifying private shares market

with secondmarket, nasdaq investing in private share transactions

Nasdaq (NDAQ: NSQ) announced that it would acquire private transaction platform, SecondMarket. Founded in 2004, SecondMarket was the 2nd most active private tender market in the US. The company’s primary business is providing liquidity for employees in private companies to conduct private tenders to sell their shares, while providing their employers control over the frequency of the process and who gets to buy/sell shares.

Public markets cooling, hot private markets

[x_pullquote type=”right”]In 2014, there were 211 $40M+ growth rounds – just about one per day. In contrast, there were 15 US IT venture-backed IPOs with offerings greater than $40M last year, slightly more one IPO per month in 2014.[/x_pullquote]This acquisition comes amid a tepid market for tech IPOs. Public tech listings have fallen this year to the lowest point they’ve been in 6 years. Indeed, private companies are raising massive amounts of capital from private sources. Tomasz Tunguz, a venture capitalist, did the math on public/private markets disparity and it’s staggering.

There are a variety of factors behind the drop in successful tech companies deciding to publicly float their shares. Jeremy Kopelman of First Round Capital calls this the “private IPO phenomenon“.

According to the venture capitalist:

In my opinion, there isn’t nearly enough focus on “low frequency trading.” Public companies reprice daily. Private companies don’t have to reprice for years on end.

One key benefit of low-frequency trading in private companies is a long-term focus. It removes arbitrary time constraints on growth and profits. By relying on private financing events as “comps,” we risk pricing new financings (and creating new unicorns) based on stale valuations.

With public transactions cooling, Nasdaq has made it clear the exchange is looking for more growthy markets. Nasdaq established a partnership with SecondMarket’s larger competitor, SharesPost, in 2013. The partnership, called Nasdaq Private Market, never really found a lot of traction and Nasdaq reported it would be buying out SharesPost’s stake in the venture.

With the run-up in funding rounds and valuations on the private market, many companies are turning to tender offers to allow employees to take some cash off the table in a controlled manner, set and managed by the company.

“As companies extend their pre-IPO lives, they face increasing pressure to provide liquidity to employees and early investors,” said Bill Siegel, CEO of SecondMarket. “Our combined offering strives to give private companies a comprehensive, company-controlled solution to attract and retain talent, while also providing tools to effectively manage their equity ownership and secondary liquidity for their employees and shareholders.”

facebook trades in private shares

SecondMarket and SharesPost both saw their businesses enter a growth period as Facebook ramped up its business on the social network’s path to IPO.  Facebook was not only a driver but it was a huge percentage of the private stockmarkets’ business. After Facebook went public, SecondMarket decided to focus not on one-off transactions but more on the tender offer process, which companies lead and control.

SecondMarket has facilitated over 70 tender offer programs and processed over $2.5 billion in transaction volume. Another player in the market, startup EquityZen is competing over similar business and currently has close to $30 million of private stock available for sale on the platform. The advent of equity crowdfunding was also seen as a way for startups and private companies to conduct “private IPOs” and sell stock to the general public. True openness hasn’t happened because of concerns over existing regulation and a reticence by companies to partake of the new frameworks created by the JOBS Act of 2012 and Regulation A+.

Regardless of how this plays out, Nasdaq is positioning itself to play a major role in the trading of private company shares.

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Stock markets continue to lose share to private exchanges

Institutional investors with large blocks of shares to sell don’t just open up an account at E*Trade and dump them into the market.  Doing so tips their hands and astute short sellers can hop a ride on stocks being disposed, making money along the way and reducing profits for the institutional seller.

Conversely, if an institution wants to accumulate shares in a relatively thinly traded stock, they can’t go out to a retail stock broker and say, “Hey buddy, get me 10 million shares of that hot new small cap tech stock.”  Doing so would cause the price to rise just by announcing such intentions.

How Institutional Investors Trade

To handle insitutional volumes of stock trading, traders do the following

  1. VWAP: Some traders will program trading software to purchase a maximum % of volume on given days (called VWAP or Volume Weighted Average Price).
  2. Smaller trades at various brokers: Sometimes traders will parcel out trades to multiple brokers to mask the fact that a large number of shares are being traded by one institution.
  3. Dark pools: And sometimes, when there is really an impetus to sell/buy a large chunk of stock, traders will go to their brokers and ask them to cross a block of shares on the low — by not going too public with the info.  Execution speed is paramount here and the action is as much in the data centers in New Jersey as it is on Wall Street.  These dark pools now account for 1 in 3 shares of stocks traded according to the Wall Street Journal.

In ‘Dark Pools’ Pick up Stock Trading Share, the WSJ takes aim at the rise in these dark pools.

The rise of so-called dark pools and other off-exchange strategies aimed at large banks and institutional traders comes as regulators on both sides of the Atlantic grapple with balancing the market efficiencies the alternative venues say they generate with the impact on individual investors.

Private venues are seen as a more efficient way for transacting large chunks of shares, but critics worry that if so much trading is done privately, publicly available prices set by exchanges will become less accurate. Dark pools are electronic platforms designed for institutions to carry out major stock trades anonymously.

Varying forces

Having 30% of trading beyond the veil of regulators and common investors creates a tiered trading system, something inherently seen as unfair and anti-competitive.  The emergence of internal stock trading platforms like powerhouse BlackRock recently announced are not new, they’re just taking on more volume and therefore, importance.  In general, we’re witnessing the rise of the machines and algorithmic trading which is the purest combination of technology and investing.  The stock exchanges like NASDAQ OMX ($NDAQ) and NYSE Euronext ($NYX) are pleading and crying to regulators to help right this wrong.

Beyond the histrionics, the stock exchanges are also developing technology to help lure institutions back to their platforms.  The NASDAQ OMX CEO was on Forbes recently touting the work they’ve done on PSX, an exchange that doesn’t give preference only to speed but also to size of trades.  This platform has already demonstrated its ability to bring many of the institutional trades happening offline, back online.

As Felix Salmon said in Wired, “In the wake of the flash crash, Mary Schapiro, chair of the Securities and Exchange Commission, publicly mused that humans may need to wrest some control back from the machines.”

‘Automated trading systems will follow their coded logic regardless of outcome while human involvement likely would have prevented these orders from executing at absurd prices.’

Giving up control to the computers is not really what’s at stake here.  Computer trading just reflects the rules-based logic entered by the humans who program the algos.  Rather, it’s the essential bifurcation of the markets: one for pros and one for the rest of us.  It’s the unleveling of the playing field at stake here that should have everyone concerned.

Source:

Dark Pools Pick up Stock Trading Share (WSJ)

Algorithms take control of Wall Street (Wired)

BlackRock to launch trading platform (FT.com)

photo courtesy of tenaciousme