I like the story of CLS (Continuous Linked Settlement), one of the most boring and important institutions in global finance. CLS is the world leader in FX settlement. It was launched in 2002, and just like with many other important things in the world, very few people have heard about it. That’s what I like about it. Also, the story of CLS is the perfect argument for one of my favorite quotes: “the older the problem, the older the solution”.
Now let’s talk about blockchain. When you give a little kid a hammer, everything looks like a nail. Blockchain is still a hammer looking for nails. Over 2016 it has been hailed as the future of insurance, identity, exchange and property tracking– mostly by people without skin in the game (media, banks, governments and consultants). Meanwhile, founders & VC’s with skin in the game, who tackle big problems in finance, are usually not talking about blockchain and not using it. Here are some of them: m-Pesa, LTSE, Lemonade, YueBao, LendingClub, Wealthfront. Isn’t it strange?
Technology serves us best when it solves a real problem. The financial system has huge problems: financial inclusion, friction in payments, low access to asset management, system risk from off-balance sheet derivatives… we can go on and on. Is blockchain, a database that someone invented in 2008, the solution to these problems that have existed for dozens/hundreds of years?
Let’s take an example. Can you use a blockchain to simplify and improve the settlement process in the FX market, as some articles suggest? Yes, you can. Blockchain is a database, and you can build anything with it. But would you?
In order to settle FX (example: EURUSD) on a public blockchain, the following needs to happen:
- Someone needs to invent a new multi-asset blockchain with EUR and USD ledgers
- The new blockchain needs to be perfectly interoperable with the existing financial system, which (as of today) stores nearly 100% of the USD and EUR in the world
- Financial institutions need to understand this blockchain and agree to store real EUR/USD value on it, because it solves a problem for them
- Financial institutions need to discuss the use of such blockchain with regulators and perhaps get their approval
- Existing trading venues or post-trade services may need to integrate with this blockchain (or disappear?)
- Financial institutions need to join the blockchain in large numbers and put large amounts of money on it
- Public blockchains need to pass the test of time
This list is amateur work by me. For blockchain to transform any area in finance, other big things need to happen. Arguably, I think we’re looking at 5-10 years.
Now back at CLS. Luckily, it was devised and launched before blockchain existed, to solve old problems in FX settlement. Here are some facts on CLS:
- It was started as a private initiative by a group of banks in 2002 (pre blockchainian era). It has 74 shareholders as of today
- It’s headquartered in NY, with main operations in London
- It’s designed to solve a real world problem, i.e. settlement risk in the FX market. It does it by being a central, trusted clearing house, and employing special settlement rules. In theory, it also aims to solve a liquidity problem
- It’s considered a market standard in FX settlements, being the largest of 8 global multi-currency settlement venues. In 2014, it settled 2.3 trillion USD per day. The single-day record as of today is over 10 trillion USD
- It currently settles 18 currencies, 64 members and over 9000 third party participants who operate under the members
- It played a central role in reducing risk during the 2008 financial crisis
- It’s one of 8 bodies that the FSOC (US regulatory body) labeled a “Systemically Important Financial Market Utility”
CLS is an impressive pillar of the financial system. A useful, beautiful and boring invention. What can we take away from its creation in 2002? That there are big problems in the financial system, and they can be solved by brainpower & cooperation– now.
Blockchain isn’t the (only) solution to old problems, and most problems are old. They arise from old technologies, processes, business models and power games. Companies that are changing finance big time know it, and they know blockchain isn’t the solution. They’re solving the root problems.
So- if you identify a big enough problem in the world today, show some mercy. Don’t throw a blockchain at it.
Note: as usual, there’s a bigger blockchain story that everyone is missing. While the institutions flirt slowly with blockchain, the geeks are moving fast and breaking things. Tens of millions have been raised in ICO’s recently. Hackers are playing with really awesome and subversive ideas such as SingularDTV (a funding & distribution platform for content makers, a la Netflix), Makercoin (FX contracts between crypto assets), ZCash (100% anonymous digital cash) and Golem (marketplace for idle computer time). These can be groundbreaking innovations that blockchain brings about- and they don’t happen within the financial system. They probably can’t.