The 2018 Crypto Crash may have left investors smarting – crypto lost more than 80% of its value – but this market crash isn’t all bad news. The excitement created by the crypto bubble helped generate significant interest, investment and innovation in blockchain. But since blockchain was the technology underpinning the Bitcoin and Ethereum networks, most investors couldn’t look beyond this application. Now, post-crash, blockchain is getting its chance to shine. Major players are tightening their belts and refocusing on developing higher value distributed ledger (DLT) applications and use cases, including scalable blockchain platforms. And that’s just the beginning. The real killer app for 2019? Blockchain ecosystems that can power marketplaces like foreign exchange (FX).
More Than Just Bitcoin: the Emergence of Scalable Blockchain Platforms Across Industries
In the background of the crypto craze, tech firms and financial consortia began developing on blockchain platforms, services and protocols. IBM, for example, invested $200M in a blockchain powered Internet of Things (IoT). Amazon, R3 and other organizations have all launched variations of turnkey blockchain solutions, creating a wealth of new possibilities in the financial markets and beyond.
Successful blockchain-based energy trading, property title, payments, and supply chain use cases are showing promise. Yet the financial services sector has been slower on adoption and uptake. There are a few headline grabbers last year like HSBC’s $250B processing success, but other coverage reported consortia and project failures. With all the resources that have been assembled by the world’s largest banks, industry leaders and investors want to know…’where’s my jetpack?!’
Simple, Fast, Cheap: The Optimal Blockchain Use Case
The pressure to get on the blockchain bandwagon has caused many development teams to shoehorn blockchain tech into inappropriate use cases. It’s a classic Occam problem: Blockchain isn’t – and shouldn’t be – the solution for every need. In some contexts, blockchain will perform more slowly, add unnecessary complexity, be more energy intensive, and flat out be too expensive to develop. Blockchain won’t cook your Thanksgiving turkey. But in the right context, it can provide immense value where current systems fail.
Blockchain’s first killer application was secure, decentralized tokenization that preserved data integrity. The next killer application will be a more highly targeted solution for fixing efficiency gaps, data integrity problems, and underpinning ecosystems of exchange.
In late 2018, Joseph Lubin of Consensus addressed the Dev Con 4 conference saying, “The next (*blockchain) killer app is a killer ecosystem.” Ecosystem can have many definitions. Amazon, for example, could develop an Amazon coin or token, distribute everything on a ledger, and pay supply chains on smart contracts– all powered by blockchain. Other market ecosystems do not require such pervasive rebuilds. Enter FX.
The Next Killer Blockchain Ecosystem: Foreign Exchange (FX) Markets
In FX markets, every unit of currency does not need to be tokenized. Rather, large blocks of currency or digital units (capital or collateral) need to be held and transacted efficiently. The data that identifies presence must be certifiable (data integrity). The speed of cross border transfer must be faster than three days.
The FX markets transact about $5.1 Trillion daily, however the technologies, platforms and processes used to move this money are antiquated, expensive, inefficient and insecure. Already, commonly-known consumer-facing FX players such as Ant Financial, M-Pesa, TenCent, Transferwise, Revolute and Western Union are all examining blockchain use cases for remittance and cross-border payment. However, consumer-facing FX is a small segment of the FX marketplace. The real opportunity lies with modernizing the B2B FX back office.
In such a large yet inefficient marketplace, blockchain technology offers significant advantages:
Back office network efficiencies for market makers
Increased data security for all parties
Increased transparency for markets and regulators
Reduced risk for traders and lenders
Ability to optimize reserve capital holdings
FX Opportunity: $100 Million Per Day
The scale of the FX optimization opportunity is attracting major players. CLS and IBM, for example, are in the process of launching a ‘netting’ system that will handle 2.9 million daily transactions. Currently, these transactions result in an average of 25,000 disputes annually, tying up an estimated $100 million in capital. The CLS/IBM netting system could improve capital efficiency by 40 percent– and this opportunity is just the tip of the iceberg.
Consider Amazon as a simple retail example. In this case, an internal token (Amazon coin) and set of smart contracts could efficiently govern and track on the Amazon platform, reducing friction via ledger efficiencies versus payment processor friction. For FX back office, the ecosystem is structured a bit differently than this retail example. In a large scale FX environment, the ecosystem contains market makers, lenders, borrowers, and regulators. The current FX ecosystem binds lender funds for three days. Transactions fail to clear due to time zone differences in operating hours. Balance sheets become illiquid. For each moment shaved off the three day trade clearance cycle, significant value is gained by all parties.
How 9th Gear is Building the New FX Backbone
9th Gear is building the technical architecture for the next wave FX ecosystem. Placing a blockchain base layer at the center of this B2B marketplace will enable same day trading and settlement. In this blockchain ecosystem, institutional traders and lenders can come together for faster, more secure and lower-risk trades that are open to vastly more participants.
Same-day trading and settlement would eliminate the time zone challenges that cause trades to fail, freeing up collateral. Return on intraday holdings allows for intraday lending and optional investment. Credit risk is reduced through the “fund then trade” mechanism. Liquidity risk is also reduced: By disaggregating trade, many lenders can fill gaps. Post-trade, a single source of truth can quickly resolve disputes and remediation issues.
But what about the challenges that have made other financial blockchain applications unsuccessful?
Harkening back to the “Simple, Fast, Cheap” mantra, 9th Gear is not trying to use blockchain to solve every problem in the FX ecosystem. Rather, 9th Gear’s team thoroughly examined the FX sector, rearranged the rules by which FX players currently play, and inserted blockchain as a fulcrum to deliver on promises of data integrity without requiring all of the overhead.
9th Gear’s broader systems approach utilizes the strengths of blockchain as a base service protocol to generate a robust and secure ecosystem for FX transactions. Critically, it leaves out the superfluous complexity and processing required to build everything on the chain. The collateral and capital efficiencies gained by implementing 9th Gear solutions far outweigh implementation costs. By substituting technological tools at different leverage points, time-to-integration is also reduced. Simple, check; fast, check; cheap, check.
The surprise of this story? The great crypto-crash may end up giving traditional fiat currencies a new life. Harnessing the same technological underpinnings used to power crypto, FX markets can now benefit from enhanced data integrity – saving collateral, costs, and improving time to settlement.