A world of frictionless commerce relies heavily on lenders being able to trust they'll be repaid – or if not, that they'll get something else in return.
But this "something else" – collateral – isn't nearly as easy to move as the money itself.
To solve this problem, a group of international depositories and stock exchanges called the Liquidity Alliance united this year to launch LA Ledger, a blockchain solution designed to do to collateral what bitcoin did for value transfer. Now, having completed the proof-of-concept, the group is ready to launch a commercial product with only one thing left in its way: regulatory approval.
While the participants have been in conversation with regulators since Q2 of last year, last week, the group transitioned from "informal conversations" to a "more formal presentation" with regulators, according to Liquidity Alliance member and chief commercial officer for post-trade services at TMX Group Brian Gelfand.
Specifically, the blockchain built using the open-source Hyperledger Fabric is designed to break down borders between pools of collateral trapped within national systems by migrating traditional collateral from a central escrow to a distributed blockchain.
And the technology has proved beneficial.
"The technical solution is very elegant," said Steve Everett, general manager of collateral management at Strate, which is also part of Liquidity Alliance. "We are meeting with the regulators ... and nine out of ten of the questions – because the solution is so elegant – are more on the legal and regulatory front."
While many proofs-of-concept have languished on the shelf since the early days of blockchain enthusiasm, Liquidity Alliance's latest push signifies a growing momentum behind central securities depositories (CSDs) seeing their work come to fruition.
Philippe Seyll, the co-CEO of Luxembourg's CSD Clearstream and a member of the initiative, told CoinDesk:
"The proof-of-concept will remain a proof-of-concept if we don't get the blessing of the regulators."
Collateral questions
This step of engaging regulators should not be taken lightly.
Each of LA Ledger's CSD and stock exchange participants – which also includes The Canadian Depository for Securities Limited, Norway's VPS and Deutsche Börse in Germany – are subject to different local regulations, as well as regional regulations that transcend country boundaries.
Learning how each member can be compliant with different controls while using the same blockchain is of utmost importance, Gelfand said, adding:
"One of the keystones of this whole exercise is you're dealing with regulated entities ... and this mechanism has to work and be approved in each of the jurisdictions in which we operate."
It can be quite complex.
For example, among the unknowns is how lenders can "realize" (the gain or loss resulting from a sale of an asset) collateral that has been tokenized on a blockchain.
Traditionally, collateral consists of digital accounts of ownership for homes, cars and commercial property, whereby if a borrower defaults, a complicated series of processes are initiated that result in the collateral being forfeited to the lender.
But on a blockchain, where each of those processes are compressed into a single smart contract with the collateral represented as a token, it's possible that certain delays meant to protect borrowers (something regulators will be particularly interested in monitoring) could be undone.
Continuing distribution
In spite of the progress being made with regulators, however, the customers of multiple LA Ledger participants have expressed concern that the true value of a pool of collateral won't be achieved if only a handful of countries participate.
During a joint session held by Liquidity Alliance members Deutsche Börse and VPS last month, a few of their large bank clients were given a deep dive into how the platform operates. While the clients came to the same conclusion as Strate's Everett – saying the technology was sound – they wanted to see more CSDs involved in order to reach "critical mass," according to VPS executive vice president Sveinung Dyrdal.
Drydal and Deutsche Börse's senior vice president Gerd Hartung both agreed that adding more members would be key to the blockchain platform's ultimate success.
Dyrdal concluded with optimism, though, saying:
"I'm quite sure we will see CSDs that would like to explore the opportunity of renewing their core by using new technology."
Sibos panel image via Michael del Castillo for CoinDesk (Left to right: Philippe Seyll, Gerd Hartung, Brian Gelfand, Sveinung Dyrdal, Steve Everett)