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visit MIT OpenCourseWare at ocw.mit.edu. GARY GENSLER:
Today's a little bit of a discussion about clearing
and settlement systems. Maybe you feel you've
heard everything you needed from Jeff
Sprecher when he was asked a question when he was with us. Jeff runs some of
the largest clearing houses in the world at
Intercontinental Exchange not only because he started
in the energy business, but he has big credit default
swap clearing houses and energy clearing houses and the like. And he said, well, I don't know
about blockchain technology for clearing and settling. But I'm going to try this
Bitcoin project that you all know about and he talked about. But today we're going
to try to dig into, well, maybe there's something
there, because there are projects going on. And why are there projects? They're mostly permissioned
and not permissionless systems. But I think there's
something there. This will be one of
the more optimistic-- if you're judging how often
I get to the maximal side, I think there is probably
something there, at least for permissioned blockchain
projects in the clearing and settling. I'm going to-- we'll, of
course, go through the readings. And these are the sort of
topics we'll go through. Clearing and settling services-- I'm going to try to set this
stage as to what this is. Frankly, when I was on
Wall Street for 18 years, I couldn't really define
what clearing and settling. Sorry, Ross. You thought I could define
it when I was on Wall Street? What's that? AUDIENCE: I just strictly know
someone else can't either. GARY GENSLER: Yeah. Yeah. Well, when you're in the
merger and acquisition area, you usually don't
think about what it means to clear
something and to settle it. And frankly, even
usually when you're on the trading floor, that's
something somebody else takes care of. Just the nature of-- how many people have worked
on trading floors here? All right. So I'm going to have seven
or eight of you start. And you're on notice now. In about eight to 10 minutes,
you're going to help. You might prove what I just said
to Ross, that you can't define what clearing and settling
is because somebody else took care of it. But we'll see. We'll see. And then we'll talk about
blockchain technology applicability, some of the
projects that are going on, and then move over to this. There was a reading from
the International Swaps and Derivatives
Association, ISDA, what they're doing around
smart contracts in this space. But what I want to do
first is a little bit of talking about final
projects, because we're at that time of the year. And this is to help. Then I'm going to go through
eight or nine questions. If you haven't already
thought through your projects, these are eight
or nine questions that I would think you'd
want to think about, which is another way of
saying it will probably enhance your performance. What else can I say? And number one-- and it's
a little, small print. I'm sorry. Or no, it's not too bad-- is what's the value creation
proposition, or pain point, if you wish. So are you creating value? Are you solving a pain point? Or as Jeff Sprecher
would say, what are you doing that's going to make
something cheaper, faster, better? What's the value proposition? Whatever space. There's two or three groups
that are doing trade finance. There's one or two
doing payments. There's some group
doing commercial-- I mean, consumer credit
rating or so forth. There's a wide variety. There's one or two
groups that have come to see me that are doing
things outside of finance. But regardless, what's
the value proposition? What pain points
are you addressing? Or as Jeff would say,
what are you going to do better, faster, cheaper? If you can't answer
that threshold question, shake it loose. Kick it around. Or move on to a different
use case, frankly. Secondly, [INAUDIBLE]
you get into, like, what is this
blockchain technology? What transactions or data
is going to be recorded? Because this is
fundamentally, ultimately, a database technology, even
the permissionless systems. And you'll see a later
question is why this versus traditional database system? But what transactions,
what data-- whether it's health
care records, whether it's consumer
credit data, supply chain, moving a piece of property
along a supply chain, but what is the actual data
and transactions that you're recording? Questions? What multiple stakeholders
need to write and read access to the ledgers? And I underline
the word multiple. Because really, when you think
about the value proposition of blockchain technology,
it's about immutable records, or so-called immutable records. That's verifiable,
immutable records amongst multiple parties. And it cost extra money. Everything we've been studying
about in this semester is about there's
more complexity. There's more cost, in some
way, of this decentralized, even permissioned systems,
decentralized system. But you get something for it. You get some verification
of transactions, of data, of mutability. But you also have
to have some logic that there's
multiple parties that need to both write and read. A distributed database
that just does read only-- I can read my Bank of
America bank account. I can see what's in
that sort of ledger. It doesn't have to
be on a blockchain. So multiple parties writing,
why is that important? Forming consensus,
in this circumstance. Which specific cost of
verification or networking are you lowering? We talked about a lot of
the verification costs, whether it's privacy,
censorship resistance, whether it's some direct cost. Maybe you're going
right at something that's got a bunch of
economic rents in it. So there was a series
of verification costs we talked about. What networking costs
are you trying to reduce? There's probably been
something in the order of 4,000 or 5,000 white
papers, many that you can find. You can't find all of them. But if you're going
at something that you think a white paper
has been written about or a blockchain company
has been started on, figure out what the
competition is doing. And for the two groups,
and it may be more, that are doing something around
trade, finance, and supply chain, you know there's a
bunch of stuff you can read. We'll be studying
it next Tuesday. Alin? AUDIENCE: Can you give us an
example of a networking cost? I'm not sure what that is. GARY GENSLER: So
networking cost is often why people are using
a native token. But networking costs are
how to jumpstart a network. Uber jumpstarted a
network, in a sense, without blockchain technology. But an example of
networking costs are if you walked
out of the airport and you didn't think any drivers
are using this application, then you wouldn't be terribly
interested in using it. So-- AUDIENCE: But who
incurs the cost? GARY GENSLER: Often the cost
of building a network can be a tremendous startup cost. So how to start a
network often is you go to a bunch of
venture capitalists. You raise money. You advertise. And you try to get participants. And one of the challenges
of health care records-- we don't have our health
care experts in here today. I was looking around. We have two students from
Harvard's public policy school doing graduate work
and sometimes join us. But health care
records, for instance, there's some really interesting
blockchain technology solutions. But the networking
challenge is how do you get a bunch of medical
providers, hospitals, doctors, and users to actually
join the network. So that would be an
example of network cost is basically adoption often. Does that help? AUDIENCE: Yeah. GARY GENSLER: What are
the competitors doing? I'm not looking for plagiarism. But if you're in a space,
payments or supply chain or consumer credit
or some others, where there's three or six
or 10 white papers out there and maybe somebody has
even raised 20 million or a couple million in an ICO,
then it would be interesting. You should feel free
to look at those. And maybe you'll
be informed by it. And you'll say, yeah,
I'm doing it better. Or they've got it poorly here. Or their project's in Estonia. And I'm going to do a
digital ID project in the US. And our regulatory system
is different than Estonia. But I wouldn't be bashful about
looking at the competition. In fact, I would say that's-- we're a business school. You always look at
the competition. And you see if you can do
either what they're doing better or what they're doing
in a different geography or in a little bit
different market. Back to how Alin likes
to define things, I've not used the term
blockchain technology yet on this slide, have I? But why are append-only logs
at multiple party consensus the best solution? Which kind of goes
back to why not just a traditional database. But why append-only,
timestamped, verifiable logs? They're connected by
cryptographic hash functions. But why have these logs? And why have multiple
parties in essence form a consensus about
the state of the ledger? Alin? AUDIENCE: Yes. I have a question about the
timestamped, apend-only logs. Is that only relevant
in blockchain, that traditional
databases do not have these kinds of features,
timestamp and append-only logs? GARY GENSLER: They
can have time-- timestamps in essence. In essence, it's innovation
of the early '90s. And then Satoshi
Nakamoto grabbed it. It was the concept that
you take a block of data and you connect it to the next
block with a cryptographic hash function. And once you've done
that, then it's committed. You can't amend
anything that's before because it's a unique hash. And traditional databases did
not have similar commitment schemes. They do have other
commitments schemes, but not this commitment scheme of
taking a block of data, having the hash function,
which then means never shall you amend what came before. That's how I understand it. Did you have a different view
on traditional databases? AUDIENCE: Well,
I guess this gets to the root of the question. Is there something new
about blockchain technology? In my opinion, there
isn't, actually. 20 years ago, we knew how to
make a traditional database and make it full of power and
make it a census protocol, or what people nowadays like to
call a permissioned blockchain. So we knew how to do that. And that would give
you an append-only log. It's nothing exceptional. GARY GENSLER: Yeah. So there are debates as to
where is the border and boundary between a permissioned
blockchain and a traditional database. But I've chosen to, at
least for this class, a hyperledger fabric, we'll
call that a blockchain project. But recognize there are some
who would say, well, that's-- unless you have a native token,
it's not really blockchain. Eric. AUDIENCE: --one could call point
recent days that the trust is the key attribute that's not
the factor in this equation, because you can get a multiple-- I mean, multiple party consensus
doesn't have value on its own. It's actually multiple
party consensus is-- it's actually something you had
to come up as a necessity that stems from the fact
that you're dealing with a decentralized arrangement
in which you're not trusting any of the parties
that intervening in the exchange of information. Right? GARY GENSLER: Well, I
agree with the first half, that you wouldn't even
want to use Hyperledger Fabric unless you really
need multiple parties writing to the ledger. And I think that does
separate it a little bit. You could take an
Oracle database and allow it to be
multiple parties, too. But I think that separates it. You might be more the
purist than I am, Eric. I don't think it has to
be completely open, where you don't know all
the participants. But even in a
financial-- we'll talk about the Australian
Stock Exchange in a half an hour or so. And when we talk about that,
that's a limited closed loop. But they believe that
they are actually taking a lot of cost out
of the verification side. They think they're
getting a lot-- they're lowering
verification costs. And they would contend they're
lowering networking costs, because they don't have
the same reconciliations between multiple databases. Now, you might call
that verification cost. But I think they would
call it both verification and networking cost. There's multiple back offices
no longer reconciling. If your final project has
a permissionless system with a native token, why
do you need a native token? Is it to jumpstart the ICO that
you want to raise money for? I'm not averse to that. But at least fess up
and say that's how we're crowdsourcing this thing. If it's about that
you really believe there's some benefit
to the token economics, that it's an incentive system
to run your new competition to Uber or an incentive
system for health care records or an incentive system
for supply chain, talk about what that
incentive system is. And are you trying to motivate
jumpstarting the network or maintaining
the network later? And it could be both. It could be either. I'm just saying it would be
good to have a discussion. Is the native token
just about crowdfunding? Is the native token
also about jumpstarting this network and
then an incentive to maintain the network
amongst multiple parties? What trade-offs of scalability,
performance, privacy, security, coordination? I'm not asking
you to solve that. And in fact, you can even jump
ahead three and five and seven years and assume that
some of these things will be taken care of. So recognize that in the
permissioned blockchains, they seem to have a
higher performance, a lot higher performance, than the
native token permissionless systems. But if you're proposing a native
token permissionless system, I'd just like a short
discussion of how much these scalability issues matter
to you, particularly when most of the native token
permissionless systems can't handle much
more than 1,000 or a handful 1,000 of
transactions a day. It is true that Bitcoin handles
quite a bit more than that. But five or 10
transactions a second, is that going to work for
whatever your solution is? In fact, I'd like to see some
groups use native tokens. I want to have a variety of
things I read in December rather than reading
all permission systems. And then again, can a
permissioned blockchain or traditional
database adequately address whatever
use case if you do have a permissionless system? Thinking about that, how can
broad adoption be realized? Are you going to use a native
token to equip broad adoption? How are you going to get a
bunch of hospitals signed on? How are you going to get a
bunch of banks signed on? You're going to do
like Jeff Sprecher did and give 50% of his equity away. There was that
conversation he talked about he had with Goldman
Sachs, that he realized that was the only way to
get his business started in the late 1990s. But just how are you going
to get that adoption? And to the extent, this
might be a paragraph, but what type of customer
interface or how might it be better than other customer UIs? So these are just
some of the things, if you were thinking
about a real business. And I think that the
market is moving away from that big,
frothy bull market, where there was as many as
400 or 500 ICOs a month. And it was raising anywhere
from 2 to 5 billion a month. October was about 200 ICOs. And it was about 800 million. And I think it's going
to continue to decline, partly because they
don't all work. But partly because
people are now getting more rigorous as
to what's really going on. If you are using a
permissioned blockchain, you don't have to
tell me whether it's Hyperledger or Corda. But if somebody does
and you have something thoughtful to say there,
I'm intrigued to find out why this one versus that one. It's really just to show
your critical analysis of this subject. And if you want
to prove yourself on why it's Corda versus
Hyperledger Fabric, that'll be interesting if
somebody has a point of view. But I'm not looking for that
level of either computer science knowledge. This is from a
business perspective. Think of me as a
venture capitalist. If I was investing, how
you pull it together. So any questions on that? So we had six or
seven people that actually worked in banking. Who did we have at this table? Ah. So what's clearing? AUDIENCE: If I
recall correctly, you need to prove the identity
of the other party in order to make sure
that you're sending the asset to the right-- GARY GENSLER: All right. So you have to
prove the identity. So it's about validating and
authenticating an identity. Anything else in clearing? Who else worked in trading? I had somebody back at
the back table worked in-- ah. AUDIENCE: Is it that they
have the assets to be traded? GARY GENSLER: They have
the assets to be traded. Well, most equity markets
trade on transaction date plus two days. So somewhere in
that two days, you have to confirm
they have the asset. That is correct. You don't have to do
it on t plus zero, normally by t plus 1. AUDIENCE: I think-- I could be wrong. But I think you had to do
as well would be the stock exchange knowing what is
the net exposure that you have at the [INAUDIBLE]. GARY GENSLER: Net exposure. Net exposure. Very key thing. So there's authentication. At some point between
execution and transaction, you have to actually know
you have the security-- and then net exposure,
which we're going to look at on another page. This simple chart of two
people cutting the lawns, but a buyer and seller meet. But a buyer and seller
meet in an exchange in traditional securities
markets through brokers. That's called an
inner mediated access. In the crypto exchange
markets, those two brokers on the left-hand side
and the right-hand side, the sellers and buyers
brokers, don't exist. In the crypto exchange
markets, basically you have direct access
to the market. But in the traditional
stock exchanges, whether it's London,
Tokyo, New York, Beijing-- where's the exchange in India? AUDIENCE: Mumbai. GARY GENSLER: Oh,
it's at Mumbai now? I forgot. 30 years ago, I visited it
and walked on the floor. It was called the Bombay
Stock Exchange back then. But regardless of where
the stock exchange is, there's some clearing house
separate from the stock exchange doing these functions
that we just talked about. So three steps-- execution. What's it mean to
execute a trade? Alpha, do you know what
it means to execute a trade without reading? Should I go back? AUDIENCE: Yeah. Because I've traded before. GARY GENSLER: Yeah. That's why I called on you. AUDIENCE: We did a great job
with a separate execution team. That helped us with that. But signing the docs,
making sure that the account information is all there, if
it's been done through NSDA. GARY GENSLER: All right. So this sounds like it's
about derivatives, executing a derivatives contract. But what if you're just buying
100 shares of Apple stock? What's it mean to
execute a trade? AUDIENCE: To be on the
phone or on the screen and agree on a price
and a quantity. GARY GENSLER: There you go. It's just you bid a price. And somebody hits the
bid or lifts the offer. Those are the terms when
you're on the phone. I left your offer. I hit your bid. Or at least it
was when I did it. Still? Or no, maybe not. What's that? Still. All right. Question? AUDIENCE: Just not
on the phone anymore. [LAUGHTER] GARY GENSLER: Ah, yeah. That's it. What's that? AUDIENCE: You just hit a button. GARY GENSLER: Just hit a button. AUDIENCE: I worked on the
[INAUDIBLE] desk at Goldman So we didn't talk to anyone. GARY GENSLER: You
didn't talk to anybody? Can you go months without
talking to anybody? AUDIENCE: No, we
talked a little. GARY GENSLER: What's that? AUDIENCE: We talked
a little bit. [? But it was always ?]
[? kinda ?] weird. GARY GENSLER: All right. I guess I'm a dinosaur. Yeah. Yeah. The screens that I used to
look at at Goldman Sachs, it was green. Yeah, yeah, yeah. You know. You know the screens. Kelly is thinking, what
is he talking about? Right? Look it up on the internet. [? You're ?] [? fine. ?]
[? You're ?] [? fine. ?] There wasn't any color
on those screens. So execution is
basically I buy, you sell, we agree upon a
price, a price and a volume. That's really what execution is. But when you execute, you still
need to do a few other things. And it's called
clearing and settling. When I was on a trading
floor, I couldn't have told you what
the difference was between clearing and settling. That was something
somebody else did, frankly. I'll admit it. They were really
terrific professionals. But they had their job. I had a different job. Clearing is performing
all of these functions. Authenticating
somebody is there, making sure you actually
have those securities, and importantly this
thing called netting. How about settlement? Anybody want to say? I know it's written up there. But anybody want
to just say what-- we've talked about ledgers
for seven or 10 weeks now. What do you think a
settlement really means in the context of a ledger? Did I see a hand up here? Yes, I did. I did see a hand up. What's settlement? AUDIENCE: Running the
entries on the ledger. What's in, what's out. GARY GENSLER: Right. It's making a final
recording on a ledger, finally moving
something on a ledger. You could be moving the
ownership of an asset or the ownership of cash. And when you do both
at the same time, it's called delivery
versus payment, or DVP. It's just a final change
of data record on a ledger. In the old days-- I'm talking about
before I was doing it. But 40 years to
hundreds of years ago, it was
physically delivering a physical piece of paper which
was a equity security or a bond security. But it all got dematerialized
starting in the 1970s. And by the 1990s,
it was pretty much-- in this country and the UK-- it was pretty much
dematerialized securities, that everything's digitized now
in the equity markets in nearly every country that
you're all from and maybe with some small exceptions. So execution is I buy,
you sell, volume price. We've legally agreed
to something verbally. And billions of dollars
can trade on the phone or in the computer. Legally, it's executed. Clearing is trying to make
sure that you actually have the securities, and
I actually have the cash. We do some netting. We authenticate. And settlement is actually
moving the data on the ledgers. Three steps. This is the benefit of netting. It was just one chart that
I could find somewhere. It's actually the
Australian Stock Exchange had it on their website. But if you have multi-parties
in the transaction, which was on the
left hand side-- and these are just arrows of
all the different transactions that could occur in
one little example-- and instead you interpose
a central intermediary, you can do a lot of netting. And look at participant
C. Participant C only has an exposure of
selling 35 of whatever they're selling, some stock, versus
all these other transactions. And this is a very simple case. But if you have 20 or a hundred
clearing members that are all big brokerage houses and
they're doing thousands or even hundreds of thousands
of trades a day, you have an awful
lot of transactions. And the gross transactions
versus the net is quite a difference. That netting can bring down
numbers 90 plus percent or maybe even 99% or more. So central intermediaries-- I know this goes against Satoshi
Nakamoto's whole concept-- but central intermediaries came
about in the securities market for a bunch of reasons. But one of the biggest
ones was netting. Brotish? And it's a really
important concept in the back office
of Wall Street. AUDIENCE: I'm not
familiar with the concept. So [INAUDIBLE]. GARY GENSLER: You're
saying you're familiar? AUDIENCE: I'm not familiar
with this concept, so a clarification question. GARY GENSLER: Please. AUDIENCE: When we
do netting, it seems that we are losing
a lot of information here from the
gross transactions. So is it-- GARY GENSLER: That's right. AUDIENCE: --just the
transfer of the asset is done through the
netting, but the records of all the gross
transactions are still there with the central intermediaries? GARY GENSLER: Very
good question. So are we losing information? Or are we just lessening the
lines of counterparty risk in the transactions? And the answer is,
if done properly, you still keep the
information of all of these. And in the real world, this
is just eight transactions. It's netted down to four. Right? So this is eight transactions
netted down to four. Usually this is millions
of transactions netted down to tens of thousands or maybe
millions of transactions literally netted down to, if
there was 100 clearing members, it would be 100
transactions, because they'd each have one net transaction
per security, per security. And so you need to
keep the information of the millions of
transactions to properly record for your
customers, for your taxes, for all sorts of other reasons. But you've netted down
for counterparty reasons. Does that help? Question over here. Sean. AUDIENCE: I was just curious. It's very understandable
for equities. But for principal
commodities, [? the full ?] commodity derivatives, for
instance in the clearing space, does it actually involve
the physical delivery of the netted
commodity [INAUDIBLE]?? Because there's a different type
for delivery, and how that-- GARY GENSLER: OK. So Sean's asked
the question, what if you're not dealing
with digitized assets, but physical assets? I think. You used the word commodity. But I was presuming
you meant physical. So some of the innovations
of the 19th century relate here when
they started to have standardized contracts
for commodities that were held in warehouses. In essence, to facilitate
some of this netting was also why central
warehouses, this clearing house in the middle in
physical commodities, could be a warehouse that held
the gold, held the silver, held the corn or wheat. And if they're holding
that corn or wheat, they started to have
specifications as to what standards there were. In gold and silver,
it was percent. It was called the,
let's see, assay-- I'm trying to
remember the word-- but what percent
gold or silver it is. But in corn and wheat,
there was a more detailed what's going into the warehouse
to commoditize it so that it was a standard contract. If it's truly physical and not
commodity, it's much harder. Then you can't really net down
my house versus Shimon's house. They're two different houses. Does that help? But literally by the
late 19th century, even in the commodities
space running out of Chicago, they figured out
central clearing houses with a lot of counterparty risk. So there's an economic
reason we have centralized clearing houses. And the biggest economic
reason is netting. And netting lowers something
called counterparty risk. Instead of having literally
millions of transactions, you'll have thousands. And you'll have less
counterparty risk. It also lowers one other thing. So it lowers counterparty risk. And what is the other
thing you think it lowers? Anybody? AUDIENCE: Transactions cost. GARY GENSLER: Transactions
cost because it's efficient. We used to call it you take
a lot of lines off the page. So in the old human
days, you'd have to have fewer humans
actually pushing paper. Hugo. AUDIENCE: Another
clarification question. So from the participants side,
so from a hedge fund side or whatever or a
trading desk side, do they just go about their
day trading everything? And then the next day
the clearing house tells them, OK, you made all
these transactions yesterday. But we really only
need 35 [INAUDIBLE].. Or how does it [INAUDIBLE]? GARY GENSLER: In that
case, looking back to this, you are either the
buyer or seller. And you're dealing
with a broker. So if you're a hedge
fund, you often enter into an arrangement
with a broker. And it's called a prime
brokerage arrangement. And you might have a prime
brokerage arrangement with more than one
Wall Street firm. But you rarely would have
it with more than three. So even if I'm doing a
trade through Merrill Lynch, if my prime brokerage
arrangement is at Goldman Sachs, Merrill is
going to get a commission. But they're going to give up
my prime brokerage arrangements to Goldman Sachs. And that helps me, me the hedge
fund, get more netting as well. And that's a development
in the last 20 years, this concept of prime brokerage. But to answer your
question, yes. I go about my business. I trade all day. And unless I get a phone call
or an electronic communication from my prime brokerage
saying you've hit your lines, you do have credit limits and
position limits in essence. But your prime brokerage-- and I might say, well, I
need something moved over. I need some more credit today. But yes. You go about your business
until your prime brokerage says slow down. Shimon? AUDIENCE: But [INAUDIBLE]
question says that if you're a lot like LTCM-- GARY GENSLER: Long-Term
Capital Management. AUDIENCE: --at some point,
they were running a balance sheet of a trillion dollars. And part of the reason
why, when bankrupt is they didn't want to use
one prime broker, because they don't want to
reveal all their trades. But then their prime
brokers could not net out their positions, because
I may hold one leg with you and another leg with you. The net may be zero. But there's no way for
you to actually reconcile that or reconcile that risk. So it's a real problem. GARY GENSLER: Long-Term
Capital Management was a hedge fund
operating in Connecticut. It was founded in
the early 1990s by a man named John
Meriwether, who is a very famous trader
from Salomon Brothers and very successful. And then he started it with
some remarkable finance faculty from here, at
MIT, and elsewhere-- Bob Merton, who is
a Nobel laureate. Brilliant, brilliant
team of folks. But they ran into a little
challenge four years later. They had about $125 billion
balance sheet, $4 billion in capital, and 1.2
trillion in swaps. Why do I know the numbers? I got the phone call with my
one-year-old sitting on my lap. And I picked up the phone. And I said, hello? And the voice on the other
line said, Treasury operator. I've got the Treasury
secretary for you. And I get on the phone. I go, yes, Bob? It was Bob Rubin. It was the Treasury secretary. Bob, what's up? It was a Saturday. Isabel was on my lap. He says, do you know anything
about Long-Term Capital Management? He goes through
some of the figures. I'll never forget. He says, I hear from Alan-- that would be Alan Greenspan,
who was the head of the Federal Reserve-- I hear from Alan that they
have over a trillion dollars of derivatives. That's Shimon's number. He says, is that a big number? Well, you have to understand,
Bob's sense of humor was quite-- at that moment,
he knew it was a big number. So I flew up the next day. And with somebody from
the Federal Reserve Bank in New York,
Peter Fisher, we sat around the
conference table looking at these facts and figures. And then I got back on the plane
and flew back to Washington to be with my family. The next day was actually Rosh
Hashanah, the Jewish holiday. And I wasn't going to work. And I had to call Bob and
his deputy, Larry Summers, up and give them my feedback. And I said, this
thing's going down. Bear Stearns was
their prime brokerage. And Bear Stearns, who 20
years later failed themselves, but Bear Stearns said, we're
pulling the prime brokerage account if you can't
post another half a billion dollars by Wednesday. Well, there was
no way they could post another half
a billion dollars, because their $4
billion of capital we could best figure on
that Sunday was somewhere covering around 400 or 500
million at that point in time. Well, when you have
a lot of leverage, you have $1.2 trillion of
derivatives which are all sort of leveraged in
one way or another and you've got $125
billion balance sheet, even with the best minds, the
best finance faculty-- and they really are
terrific individuals. And Meriwether was
quite a trader. Sometimes markets
go against you. Correlation risk, liquidity
risk, and so forth. So they pulled the plug
the next day, basically. That's the Long-Term Capital
Management story I remember. But it's just because I
kind of had to live it. But to answer your question,
you can trade all day until your prime broker
says, Hugo, slow down, because they're
extending credit to you-- the prime broker is-- intraday. And one of the big risks,
one of the big risks in the financial crisis-- and certainly Ben Bernanke,
who is chairing the US Federal Reserve and others had to deal
with it in the middle of 2008-- is most commercial banks,
so they don't have a broker. They're banks. They're the brokers
themselves-- were extending significant amount
of intraday credit to each other that, in 2008,
wasn't terribly well measured in the repo markets
and in other markets. And that's changed subsequently. But you wouldn't
have been a big bank. You would have probably
been shut down. Sorry. Or maybe not. So netting is the biggest
benefit of clearing. But it's also efficiency
and taking down a lot of operating
lines of code. This is a chart. I'm not going to spend
a lot of time on it. But this is right off the
Australian Stock Exchange website. And I thought, well,
why not take that? They have 2 million investors,
the market participants or brokers in a much
smaller market than the US. And Australia has 77 brokers,
registered, regulated brokers. And then they have the clearing
house called CHESS, C-H-E-S-S, which I can't quite remember
what it all stands for. But SS is Settlement System. Clearing house-- AUDIENCE: [INAUDIBLE] GARY GENSLER: What's that? What's it? AUDIENCE: Clearing House
Subregistered System. GARY GENSLER:
Subregistered System. Thank you. Is it Equity for E? AUDIENCE: There is none. GARY GENSLER: There is none. But they have the Australian
Stock Exchange Clear and Australia Stock
Exchange Settlement, because they actually put it
in two different places, two different things. The clearinghouse is doing
what we talked about-- mostly netting, lowering
the lines of code, and then settlement. And basically, because we're
in a trade day plus two days, on the first day is all the
clearing and the netting. And you better show up
with your securities. And on the second
day is settlement. Electronics and technology
could make this simultaneous. But most market
participants like to have some ability to do
gross trading against net's positions. So there's a lot of
economics and market practice and structure behind keeping
some delayed settlement. And the markets have
grown up around that. Ross. AUDIENCE: If it's not delayed,
if it was instantaneous, wouldn't that get rid
of the benefits of net? And you'd have to have every
trade go right through. So it has to be that you
wait until the end of the day or whatever period
[INTERPOSING VOICES].. GARY GENSLER: So Ross just
raised the number one reason, economic reason, why
simultaneous clearing and settling is not
that likely to happen. The markets have
built themselves around the benefits
of netting and also stock loan, the ability to
borrow that security somewhere. But you're absolutely right. If there were simultaneous
execution and settlement, which is what the Bitcoin network
in essence is supposed to be and blockchain networks can
be, then you, in essence, have to prefund. Every time Hugo
trades, he's going to have to provide
his security to trade. But then Tom would get
the security faster. It would change the entire
prime brokerage model. It doesn't mean markets,
Ross, couldn't adapt and be structured that way. But it would be fundamentally
a different structure. Is this is a hand up? AUDIENCE: So the [INAUDIBLE]
is really big with derivatives. I don't see it. I don't see what we use-- I don't see it being a
primary issue with equities. So if you were going to apply
this to equities, trading, any cash instrument
basically, I don't see the huge economic
value for netting. GARY GENSLER: The huge economic
benefit for netting currently is a lot of
operational efficiency. AUDIENCE: Sure. But if you're going to
place that with some-- GARY GENSLER: No. And then also, because there
is two day counterparty risk, you are lowering
that two day whatever measure equity volatility, two
day equity volatility risk, usually not collateralized. AUDIENCE: I'm just
commenting on whether this-- you said the price that you pay
for replacing this system with the blockchain based one would
be that you cannot net up. GARY GENSLER: I should have
said something in addition. And the market
participants would have to then prefund their trades. I think the larger thing-- so if I speak in too much
financial technology, let me say current markets
are you can sell or buy a security without owning the
security or having the cash. You can buy something
and not have the cash. You have to deliver
the cash in two days. And usually by that
evening or the next day, you have to show
you have the cash. You can sell a security
without owning the security. And you only have to
really kind of deliver it, generally speaking,
the next day, on t plus 1. If you went to a true
simultaneous clearing settling and execution market,
you'd have to have the cash and the security
before you execute. And I think that's the
larger piece of it, much larger than netting. AUDIENCE: I understand the cash. But you need the
security, right? Because if you're
going to buy it-- if you sell it and
you don't have it, then you know it's going
to take two days to get one to cover your first. GARY GENSLER: So through your
prime brokerage arrangement-- Hugo, remember, has a couple. He's a big hedge fund. And he has what's called
a prime brokerage account. Not at Bear Stearns
any longer, but maybe it's at Goldman Sachs. He's kind of fancy. He's getting that. Then his prime
brokerage account, in his legal contractual
arrangements with them, they will find that
security for him, maybe from some other customer. Maybe that security is
held in somebody else's what's called a margin account. And they will enter into
what's called a stock borrow. But when he executes
on the phone, he doesn't technically
already have that security. He could be shorting it. And his prime brokerage
account could then go find it from the Goldman Sachs network. AUDIENCE: But it's not
because you have plus two. But it's because
you have a broker. GARY GENSLER: Yes. That's right, combined
with t plus 2. Let's take this. And then I'm going to move on. AUDIENCE: Can you just
take that one step further and explain why that's
beneficial broadly versus just the system
we've grown accustomed to? GARY GENSLER: It's a
really good question. Is this just the system
we've grown accustomed to? Or is it beneficial? It's hard to tell. It is definitely
the system we've grown accustomed to over
a couple of centuries. And as we've gone from
transaction date plus five, which most markets
were I'm talking about 50 and 100
years ago, maybe it was even t plus
10 at some point. But t plus five to t plus
three to now t plus two, we've started to challenge that. But in the US, the
Depository Trust Corporation provides same day settlement. And very few accounts ask
to do same day settlement. And I think it might be just
they've grown accustomed to it. But I think there is some
benefit in this stock, loan stock borrow side. But I stand with
what I said earlier. I think the market could
work the other way. But it would be
a big adjustment. And there are some
benefits, because then Hugo, this hedge fund,
is being extended credit by his prime brokerage account. And the prime broker is
making some money on it. But also Hugo's taking
risk in that arrangement. Prefunding it would
be a different model. Some argue it would have less
liquidity in the marketplace. It would make shorting
stocks a little costlier. I'm not sure they're right. But their argument
is that I'd have to borrow the securities
always, 100%, and halve it off before I sell, even if I'm
a multi-billion dollar hedge fund that has some
credit worthiness. Kelly. AUDIENCE: So the paper mentions
that their new system fails to basically recognize these
challenges, such as the fact that it'd be
advantaging the capital and operational efficiencies. But it goes on to
say that it would be a step backwards for the
world's most liquid market. So what would necessarily
be implications for illiquid markets? Would it basically be that
people can make trades without having to interface
with extensions of credit? GARY GENSLER: Are you talking
about illiquid markets that are centrally cleared
or illiquid markets that have no central clearing? AUDIENCE: I guess maybe both. I'm just trying to understand
what the counter would be, that saying that there would
be advantages, efficiencies in liquid markets. But what with the opposite be? Would there not be implications
for the [INAUDIBLE] markets? GARY GENSLER: So
Kelly's asking-- I don't remember the
comment, because it was in the Australian
Stock Exchange one. So in non-cleared
markets, things that are just so
illiquid-- my house. It's not cleared. It's not centrally cleared. Certain parts of the derivatives
markets aren't centrally clear. They're not, quote,
"liquid" enough. So I don't know. I don't know the comment. Maybe see me in class. And I'll look at the comment
and try to nail it for you. Is that all right? So I wanted to put this chart
up, because it was from 2011. I remembered it when
I was at the CFTC. But somebody at
the Fed of Chicago made this chart about
the US clearing systems. Yellow are all clearing houses. Red, the SEC, the Federal
Reserve, New York-- AUDIENCE: SBD? GARY GENSLER: Yeah. SEC, CFTC, and the
Federal Reserve. But they might have-- New York. I don't even know
who New York SB-- AUDIENCE: New York State
Board of Derivatives. GARY GENSLER: Yeah. Somebody from the
Chicago Fed was trying to make the case that
our regulatory system in the US was a little bit complicated. And I think this was in
the midst of the debate about Dodd-Frank,
that they thought all oversight of
clearing houses should move to the Federal Reserve. But I remembered the
chart and found it. And I wanted to
share it with you. But the yellow are all
the clearing houses. There are a lot of
clearing houses in the US. There's one for bonds. There's one for equities. There's multiple
ones for derivatives, both from cash and
interest rate derivatives to energy derivatives to
credit default derivatives and so forth. There's ones for options. So I just wanted to lay it out. Finance is pretty complex. This is all
digitized, by the way. But in this
complexity, that's also where I think there's some
opportunity, whether it's permissioned blockchain
and not fully permissioned list with tokens,
and inspired by-- the green are exchanges. And I don't even think they
put a color up for brokers, did they? Because then you'd
have hundreds. There are multiple parties
sharing ledgers and reconciling their ledgers. Reconciliation means
I keep a ledger. Tom keeps a ledger. It's both on our
database systems. And we keep testing and ensuring
that we have the same records. This is a system that,
by its complexity and by its copies of
ledgers and reconciliation, has a lot of opportunity
for greater efficiency. And the question is whether
blockchain technology, maybe permissioned, can bring
some of that efficiency. That's the thought. And that's what the
chart was just trying-- by the way, the Congress
didn't agree with the Fed. They left the authorities
at the SEC and CFTC. And those are for
stories other times. I personally felt it could
be a shared authority. And we ended up with
some shared authorities. But I thought that the CFTC
and SEC have domain knowledge. And it really important to keep
the SEC involved in securities clearing and the CFTC involved
in derivatives clearing for that domain knowledge, but
that the Federal Reserve also came in under something called
Title VIII of Dodd-Frank. And they also got authorities. So we made it more complicated,
because now there's multiple dotted lines for this. The Federal Reserve basically
has an account with everybody. Or they have some
oversight of everybody. So then the question on
blockchain technology, could you take the clearing
house out of the middle and do the thing on the right? And my question for you all is,
do you think the economics-- I'm not talking
about the technology. I'm not talking about
whether it's performance. If you wish, you can go five
or 10 years down the road and say it's got all this
scalability and performance. Do you think the technology,
without something in the middle, what's
the economics about that? Anybody? Eilon? AUDIENCE: I still want
to support the left side for liquid markets
because of the netting. GARY GENSLER:
Because of netting. AUDIENCE: Yes. I can't see a
blockchain solution working well when
you need netting to enjoy the efficiencies
of selling and shorting, shorting basically. GARY GENSLER: Yeah. But the question really
is, can you somehow, on the right with
shared ledger, still get some benefit of netting? Right? You're saying you're
inclined here, because you want to get the
netting for economic reasons. So as a ledger structure,
can you get the netting here? Shimon? AUDIENCE: You don't
need the netting if it happens simultaneously. Netting is it it is basically-- again, with cash instrument. I'm not talking
about derivatives. Derivatives is a
different issue. With cash instruments,
the only reason why you have
counterparty risk is because it's not clear--
it was my understanding. Correct me-- is
because you don't have instantaneous settlement. If you have a
[INAUDIBLE] settlement, then you don't
care about netting. AUDIENCE: You care because you
face so many transaction fees. AUDIENCE: No. But that's going to be
a lot more efficient. So why-- again, do you think the
[? real ?] transaction fees are a big economic issue here? AUDIENCE: Yes. That's what I think. GARY GENSLER: And I'm
sorry that you don't. AUDIENCE: So now it's fine. I don't know. I mean, I don't know. For really intense
help, how much do you pay per transaction with
the clearing house and without? Maybe the net will give you
only 10% of the transaction. But the cost of having
the clearing house is more than 10 times. AUDIENCE: Maybe. AUDIENCE: So the economics
depends on those numbers, I think. GARY GENSLER: Is
that a question? Hugo? AUDIENCE: Yeah. So you still can get
some of the netting. Let's just talk about blockchain
transactions on Bitcoin. You can batch transactions. So you can have multiple
inputs and multiple outputs. And that's kind of like netting. Then you have to
have a second system on top of that that
keeps track of what's going on throughout the day. And then it just
does the transactions on a daily basis or an
hourly basis or whatever. That takes care of that netting. Right? GARY GENSLER: So
Hugo contends maybe you can get this economic
thing called netting and still have a shared
distributed ledger. Or you could do it off chain. I think, Shimon
to your question, this is a big
economic thing either because we've just
grown accustomed to it over a couple centuries or
it's fundamental to how markets trade, that we don't prefund. It's that economics that
blockchain technology will challenge. But we might stay with
a central clearing house if the economics are that value. Well, the economics of, in
essence, not prefunding, and thus, some
delayed settlement. Whereas in the past, we always
had delayed settlement at first because there was
so much paperwork. We had to have
delayed settlement. We went digitized. And now, really in 2018, we
don't need delayed settlement or batch processing. So now you've
exposed, well, wait. What are the economics? Tom and then Alin? AUDIENCE: Could you still
have a delayed settlement with a blockchain system just
by using a smart contract? GARY GENSLER: You could. Absolutely. AUDIENCE: I mean, you
still keep this system that people are
accustomed to, but do it without the economic red
for the clearing house's sides or [INAUDIBLE]. GARY GENSLER: Yes. And it's what the
Australian Stock Exchange says they are using with the
digital asset company, Blythe Masters' company that's
their outside vendor using the HyperLedger Fabric. And they're using the code. They call a DAML, or Digital
Asset Machine Language? I don't know what the M is. But they call it DAML. Alin? AUDIENCE: Yes. We've said you cannot
prefund on the right. Is that correct? GARY GENSLER: I think you
could through smart contracts. I think you could find this. But the challenge with just
the picture, the picture suggests there's no
central counterparty to do all the netting. And so the question is, can
you have this ledger structure and still find a way to
net down all the positions? AUDIENCE: Well,
like Shimon said, there is no need for that. You get that implicitly
by recording everything and executing. GARY GENSLER: But if you're
recording-- all right. I'm agreeing with that, too. But that's where I
get to if you need to do Shimon's approach, which
is simultaneous execution and settlement, then
you need to prefund, even if that prefunding
is by nanoseconds. But you need to prefund. AUDIENCE: Not necessarily. You could, sort of
optimistically, you could post a transaction that
says, I want to buy a stock. And I'm not going
to prove to you that I have money to buy it. You record it, if you were
saying optimistically. And later on-- GARY GENSLER: It depends. The word record-- let me use
a different word, settle. Settlement means final
legal rights have moved from one party to another. So the word settlement
has a meaning that I just want to come back to. It means I'm
recording on a ledger that I no longer
have legal rights. So this alpha has
legal rights to it. And I think you would have
to prefund if you were doing true settlement ledgers. AUDIENCE: Sure, sure. I guess I'm saying it seems like
you could simulate the clearing house. In the right side
of this picture, the clearing house
just distributed using the consensus protocol. GARY GENSLER: Right. I think you're right
that you could. But if you're going
all the way to where Shimon is, like Bitcoin, and
you're doing final settlement, final settlement
recordation, then I think you have to prefund. A couple of questions over here. Eric, Ross. AUDIENCE: The reason that the
prefunding was [INAUDIBLE] performed in the validation of
the block process, because-- GARY GENSLER: It could. I said it could even be
done during the nanoseconds. But it has to be done before
you move the settlement. And that's what's
called clearing. So it's a question of whether
you have simultaneous execution and settlement, or you still
have execution, clearing, settlement, even if
separated by seconds, but still literally
get granular. I apologize. This stuff is that granular. Back here. And then I'm going to move on. AUDIENCE: Why do you
consider prefunding-- maybe you don't. But it seems simply
you consider prefunding before you're
allowed to transact a negative economically. GARY GENSLER: I
shouldn't sound that way. It's just that for
a couple years, we've had delayed settlement. And so I'm saying if you are
a proponent of a system that has simultaneous
execution and settlement, you just have to deal with it. You're changing
the economic models that have been so common
in the capital markets. And when you take
that on, you just have to think through what are
the economics of that shift, from in essence a
delayed settlement, thus modest but
real counterparty risk that Hugo's got a prime
broker and he's got that, and moving to this new
model in capital markets. So I shouldn't come
across as negative. But I'm saying at least
it's a hurdle that you've got an adoption curve that's
going to be a challenge, I think, at a minimum. DTCC, when I first
spoke to them-- and I've had a lively, ongoing
dialogue with the folks there on an occasional basis. This was the biggest
issue they raised. They said they looked
at blockchain technology starting several years ago. They talked to
their customer base. And they couldn't find that
their customer base really wanted to go to simultaneous
execution and settlement. They have same day settlement. But it's end of day settlement. So there's still several hours. But they said, we
don't have a lot of customers that really
want simultaneous execution and settlement. Now, that was commenting
on the demand side. It's another
question whether you could adopt this lower cost,
do something, and change your capital market. So this is another look at it. This is also from the
Australian Stock Exchange, I think, website if I remember. But maybe it was
another website. The question is, could you
take out these middle parts? This is like
blockchain architecture for clearing
central counterparty and the central
securities depository. Because there's also somebody
who's got the central registry, and that central registry
are the two things. Could you take this
out completely? That was the
question, in a sense. So here are the projects that
are actually live or being explored. And we're going to
talk a little bit about Australian Stock
Exchange in the few minutes we have left. But this Australian
stock Exchange Project started in 2016. A bunch of requests
for proposals, like higher digital
asset holding, they're actually
actively working on it. It's a 25-year-old system. And Jeff Sprecher said it, too. He said, you know, they
had a legacy system they needed to replace. They decided to go with the
new technology of the day. But Jeff wasn't
convinced they had to. But they feel that it
was the right thing to do, to go with that
new technology of the day. They believe-- and they've
put out reports as recently as several weeks ago. They believe they're
on the right path and that 15 or 20 years from
now, every clearing house will be using what
they would consider a permissioned
blockchain solution, because it will so significantly
lower the back office costs for their
market participants who are now holding records. Each bank, was it 77 members
from an earlier-- yeah. Each bank has to hold records. It could be held
in a shared ledger. And they would lower
the reconciliation cost. And they believe
the second advantage is using smart contracts. Now, are they exactly
the smart contracts like on the Ethereum network? No, because they don't
have a native token. They don't have a DAP
and a native token. But it's still automating
certain processes, automating certain I'll call
it back office processes. So they're very committed to it. And they're going to
roll it out in 2020. And then, for 12 months,
run it simultaneous with their legacy system. So their cut over for
assuring that it's resilient is at 12 month test. Most major market
infrastructures that roll things out do not roll
simultaneously for 12 months. But they all roll simultaneous. Whether it's a month,
whether it's 90 days, you can't cut over the back
office of the New York Stock Exchange and just
test it for one day. Or you can. It's just kind of
choppy and a big risk. AUDIENCE: Quick question. Are they going to use a stable
coin to settle the transaction? How are they going to
settle the transaction? Because I can see how you
issue securities digitally. But you cannot issue cash. GARY GENSLER: So
this is very good. It's very good. So all of these
clearing houses, they are the final custodian
for the security. Securities are dematerialized,
meaning they're all digital. And so those digital
assets are held on a ledger and what's called
the golden record. This is the words used in
the securities business. The gold record or the
golden record, meaning it is the legal,
verifiable thing you can go to in a court of law. And it says, this
is who owns this. Alpha owns it. Not Hugo. Sorry. You're working with Goldman
Sachs, though, right? That golden record is
there for securities. Who has the golden
record for cash? AUDIENCE: The central bank? GARY GENSLER: The central
bank or the fractional banking system, their commercial
bank subledger. Clearing houses
around the globe would like to be able to have direct
access to central bank money. And they currently do not in
any of the major jurisdictions that I know. I think. So what Australia does now,
this is what they do now. They net everybody down. They get to t plus two. They're on that second day. Everything's netted down. And they're about to do
the whole closing out. One second before they do
the security settlement, they do the cash settlement. They call this Delivery
Versus Payment, DVP. But they're a clearing house. And they do not want to take
risk with the central bank. They take all the money
and settle all the cash with the Royal Bank of
Australia, RBA I guess. Do I have the right name? Or is it a different-- is RBA
one of the banks in Australia? But they settle all the cash. And just within a
second, they settle. We think of it as DVP. But it's actually
technically not. Inside their clearing
systems, they have a form of
Australian dollars that is effectively digitally,
in their system, digital money. In essence, what
they're doing is clearing their internal digital
money versus Royal Bank money. AUDIENCE: Thank you. GARY GENSLER: All right. Sorry. So these other projects-- Estonia, the Tallinn
Stock Exchange, is exploring proxy
voting and registration. What's interesting-- who runs
the Estonian Stock Exchange? NASDAQ. NASDAQ. So NASDAQ runs it. And they're doing this project. NASDAQ announced and went
live in 2015 on an illiquid. So Kelly, you asked me
about illiquids earlier. NASDAQ started a blockchain
technology platform in 2015 on private securities,
which were not-- they certainly weren't liquid. I don't know enough about
what they did there as to how illiquid they were. But they felt, all right, this
is a place we could do this. And it's still gone live. It's got very little use. But it's still there. And they say
they're going to try to do it for mutual funds,
when you and I can just by interest in mutual funds. And NASDAQ's going to
offer that to mutual funds, partly because
mutual funds aren't in DTCC from what I understand. The others are just
really some tests. Japan Exchange Group for
the Tokyo Stock Exchange has done some tests. They've written papers. They're sort of
interesting papers. The last one was
earlier this year. They're really trying it
just on post trade matching. One of the securities firms
in Japan, I can't remember, is really pressing the Tokyo
Stock Exchange to do this. So there's some local commercial
politics that are going on. I can't remember
which exchange is-- not exchange. One of the brokerage houses
is pushing them to do it. All permissioned systems. No, to my knowledge,
permissionless systems. Let's talk about ISDA for
a few minutes, derivatives common domain model. One of my former commissioner's
colleagues, Scott O'Malia, runs ISDA. That's a international
trade organization. It's largely, largely
dominated by the 16 big banks around the globe that
probably transact 98% or 99% of derivatives around the globe. And it was started in the
1980s to do all the forms, all the forms to enter into the
legal contractual obligations called swaps. And over the years,
it's transitioned. It's also an advocacy group. And it lobbies
various regulators in Europe and the US and Asia. But they've, a year or so
ago, said, wait a minute. We could take a lot of the back
office of swaps, particularly swaps that are not going
into clearing houses. So it's called the non-cleared
or uncleared swaps. And maybe we can
create smart contracts to automate a bunch
of contractual terms. So that's the
second bullet point. And they contracted out. They put out a
request for proposal, basically, for
somebody to come up with machine readable
standard representation. Call it code, a
scripting language. I can't remember if it's-- oh, it's written in JavaScript. So written in Java
and JavaScript, a standard machine readable
code of various events. If it's a 20-year swap that's
going to pay every quarter 80 quarterly payments, each of
those quarterly payments, fixed versus floating
payments, is somehow put into machine readable code. And Scott and ISDA's
view was, if we could get a broad consensus and
publish that machine readable code that everybody agrees on,
maybe that machine readable code could take the
place of legal contracts. ISDA, for 30 plus years, one
of their lines of business is creating those
legal contracts. Maybe we can get a
step ahead of this and get consensus amongst
these 16 big banks. There's about 100,000
users of swaps when you say all the customers. It's not measured in
the tens of millions. I doubt anybody in
this room personally has a 20-year or 10-year swap. But I don't want to embarrass. Maybe somebody does. But it's an institutional
product, largely. That's their product. And it covers new
transactions, rate resets, partial terminations,
as I listed up there. Questions? And it's definitely very
much inspired by Ethereum and smart contracts and DAPs. But in essence, it's not
really blockchain technology. It's inspired by it, in a sense. AUDIENCE: They're just rewriting
the contracts instead of-- they think they can have more
specificity and certainty of about what the contract
means by writing it in contract. GARY GENSLER: And importantly,
importantly, efficiency-- to automate that which
humans are still doing, even if it's in written contract. So it's also automation
that's inspiring them. But you're absolutely right. It's taking legal contract,
getting into machine readable JavaScript code, getting
consensus on what that code is, getting some courts
to recognize it. And then you won't
even need to write some of this, a rate reset
or a partial termination, into the contract. You'd be referencing this. The longer term
objective is to say maybe we can put even more
of it right into code. AUDIENCE: People would have
to pool their money somewhere. It's like we were
talking about, right? GARY GENSLER: That's correct. AUDIENCE: It's going
to execute itself, which is going to have to be
a pool of money somewhere. GARY GENSLER: That you might
have to some prefund or self fund or something. Let me go back
here, and then up. AUDIENCE: If they're using
blockchain on it, it can't be-- GARY GENSLER: They call
it a blockchain project. But it's a-- I think I've tried to
capture the essence of what I think they have here. It's definitely
blockchain inspired. I'm just not sure it's really
stored on a blockchain. AUDIENCE: Yeah. Because if you look at
credit default swap, you have to reference a credit
rating somewhere digitally. And wherever that's referenced
digitally, if someone makes a mistake, does a
transaction period that's based on that mistake
and it's fixed, someone's going to have
to be able to reverse that transaction. GARY GENSLER: So
what's raised is what about if it's referencing
some oracle, referencing some price source,
and there's an error. I believe, as I
understand it, they're writing some of that
into the code as well. So if it's referencing a
price off the New York Stock Exchange, how it does
that, what open API it references, how it pulls it. And they're trying
to say, let's make sure that it's what's
really verifiable. There's one more slide
on this that will help. This is their steps. This is their publicly
disclosed five steps. This was in an October paper. It wasn't part of your reading. But select the parts of
derivatives contracts first. Automation would be worthwhile. They're effective. It's efficient. Let's find something
we can automate. Ross, that's their key driver. Then try to express it the legal
terms in a more formalized way. Get some standardization
about the law. Get that be represented
as functions, meaning computer code. So where can we be
efficient and automate? Where can we take
the legal words and get agreement,
put it into code, combine that into templates? I think some of this
is referencing oracles. And then validate that
the templates actually work and, ultimately, even
get some courts of law to accept them. That's their game plan. Shimon? AUDIENCE: I was thinking
that there is potentially huge implications beyond
efficiency, right? Because if you're at
Treasury or Goldman Sachs signs a contract with
someone at Orange County, their ability to
assess what is actually written in the 30-page contract
was minimal or will be minimal. But it's a lot easier to do
risk management or assessment if you could just
use it as an API. And you have an
outside company's basically providing you
with the risk analysis. Right? GARY GENSLER: I agree with that. We're still very much
at the early days. But I think this is an
interesting, real, live thing. There's a lot of
money behind this. The markets are hundreds
of trillions of dollars. If my former colleague
and ISDA pulls this off, they'll probably drive
some efficiency automation. They might lower some
counterparty risk and event risk or crisis risk. I think you could embed
these into true blockchain technology. But I'm not sure it's
dependent upon it. The automation of
a smart contract. Next Tuesday, next
Tuesday there's a couple extra readings. We swapped out some readings. It's trade finance. Thank you. [APPLAUSE]
"But in the US, the Depository Trust Corporation provides same day settlement. And very few accounts ask to do same day settlement. And I think it might be just they've grown accustomed to it. But I think there is some benefit in this stock, loan stock borrow side. But I stand with what I said earlier. I think the market could work the other way. But it would be a big adjustment. And there are some benefits, because then Hugo, this hedge fund, is being extended credit by his prime brokerage account. And the prime broker is making some money on it. But also Hugo's taking risk in that arrangement. Prefunding it would be a different model. Some argue it would have less liquidity in the marketplace. It would make shorting stocks a little costlier. I'm not sure they're right. But their argument is that I'd have to borrow the securities always, 100%, and have it before I sell, even if I'm a multi-billion dollar hedge fund that has some credit worthiness." - Gary Gensler, 2018 MIT
Fucking great job here. I still have faith in GBaby