In the days before computerised trading and centralised electronic stock systems, Wall Street depended heavily upon messengers delivering paper certificates by hand. In 1968, the New York Stock Exchange facilitated 12 million trades in one day. Wall Street back offices attempting to settle and clear these trades were overwhelmed, and the messengers could not keep up with the demand.
The New York Stock Exchange attempted to curb the issue by reducing the number of trading days to four. It wasn't enough and disaster ensued. "In 1969 and 1970, over 100 member firms of the New York Stock Exchange, one sixth of the total, disappeared as a result of either mergers or liquidations. An undetermined but substantial number of firms outside the Exchange folded as well. Thousands working in the securities industry lost their jobs, careers, and fortunes in the conflagration," explains Wyatt Wells in Business History Review.
The explosion in trading changed the nature of the securities industry. Computers were introduced to handle the transactions and administrative systems, opening the door for brokers to not only conduct more business, but more types of business, prompting diversification.
Electronic trade, also known as e-trading, now dominates the securities industry. Experts agree that high-speed trading algorithms are now responsible for more than half of US trading. Messages are sent and received almost instantaneously and Open Outcry, the shouting and gesticulations on the trade floor, is now a thing of the past.
Despite these technological advancements, the fundamentals process remains the same. Central depositories and transfer agents still control large markets, although the trades are happening within milliseconds.
However, the new infrastructure introduced new issues, as regulators struggled to stay ahead of the curve. The financial collapse of 2008 demonstrated that not only had financial markets begun to operate at high speed, they had also become unacceptably and dangerously opaque.
The lack of transparency allowed risk to build and transmit across different sectors. Federal financial regulators lacked adequate tools to address these risks, and had limited knowledge of their size, nature and interconnectedness.
"Crisis resolution involved massive government interventions that caused a permanent transfer of losses to the public sector." - Lars Rhode, OECD Journal: Financial Market Trends, Lars Rhode
Lars Rhode states in the OECD Journal: Financial Market Trends, that the dynamics of the 2008 financial crisis were driven by the under-pricing of risk and a lack of transparency. Without the appropriate financial regulatory body controlling trades, the economy collapsed under the pressure.
The Obama Administration responded in 2010, by introducing the Dodd Frank Wall Street and Consumer Protection Act. The bill was designed to ensure that there would be a decrease of risk in the U.S. financial system. The act’s numerous provisions resulted in more than 2,300 pages, and were intended to be implemented over several years.
"The Dodd-Frank Wall Street Reform and Consumer Protection Act is one of the most complex pieces of legislation ever written,” states Price Waterhouse Coopers. “Financial service firms and other impacted organizations are just beginning to understand the Act's many facets and its full impact."
According to research from the American Action Forum (AAF), in the 12 months ending July 21st 2016, Dodd-frank compliance costs totalled US $10.4b. The total, since 2010, is US $36b.
As a result, firms have been rallying to find an alternative that will reduce their compliance overheads. Many are exploring blockchain technology, also known as distributed ledgers. "A blockchain-distributed ledger of secure, comprehensive post trade data, offering instantaneous information on pricing and terms to those with the right permissions, can help achieve this," says Steve Wager, Executive Vice President of Operations and development for the bankchain team at itBit.
"Dodd-Frank has been a transformative event for financial institutions. Regulators are as eager as industry professionals to see financial institutions emerge from this period of change as profitable and sound businesses." - Steve Wager, itBit Executive Vice President of Operations
The "right permissions," referred to by Wager, are a core component of permissioned blockchains. They are a closely monitored ecosystem where access is accurately defined and differentiated based on the role of each participant. Necessary rules for a transaction and purpose are carefully considered.
The nascent blockchain technology leverages core elements of classic blockchain architecture, such as immutability, the ability to grant granular permissions, automated data synchronisation and among others, provides rigorous privacy.
Permissioned blockchains have become a popular alternative to traditional e-trading. Former J.P. Morgan Executive, and CEO of Digital Asset Holdings, Blythe Masters raised US $50m to development a post-trade blockchain last year, which will be implemented by Australia’s major exchange operator, ASX Ltd.
While both permissioned blockchains and the current e-trading industry operate with centralised authority, other companies are taking a different approach. Equibit Development Corporation (EDC) is raising capital in an Initial Coin Offering (ICO) on 1st February 2017. The funds will be used to develop a peer-to-peer electronic equity system, called Equibit.
Chris Horlacher, Chief Executive Officer at EDC, learned a great deal about the structure of the securities industry during his time as Chief Financial Officer of Euro Pacific Canada. Horlacher became aware of inefficiencies in the market while learning about Bitcoin’s blockchain. He saw an opportunity for blockchain technology to be used not just as a monetary ledger, but for decentralized security trading.
Equibit Logo“I decided to shelve the idea until Bitcoin had more time to mature and I could be confident that cryptocurrencies were here to stay.” – Chris Horlacher, Chief Executive Officer at Equibit Development Corporation
In early 2014, when bitcoin hit an all-time high, Horlacher partnered with Marc Godard to develop the idea into a fully fledged securities registration and investor relations platform. “What we need is an electronic equity system allowing issuers to create, disseminate and maintain equity across a broad base of investors without the need for onerous record-keeping and intermediaries,” states the Equibit whitepaper.
The blockchain is based on the Bitcoin protocol, and miners will be rewarded with Equibits for securing the network. While EDC will contribute mining power, they also provide three complementary products; Equibit software for miners, the EDC web portfolio for investors and issuers, and EDC Supernode for developers wanting to integrate Bitcoin and/or Equibit.
The platform is designed to solve the problem of issuing, clearing and settling securities as well as investor relations, which is currently handled by centralised depositories and transfer agents.
“Quadrillions of dollars’ worth of securities are cleared through these entities and they charge a (comparatively) hefty premium to use their infrastructure,” said Horlacher. “They also handle shareholder communications, polling and proxy designations. Equibit replaces these services with an open, free peer-to-peer communications network.”