Some Waves In Crypto

This week, British regulators struck out at the exchange Binance and said it couldn’t operate in the UK anymore.  It was a body blow to Binance, but it won’t be fatal.  The initial trouble was figuring out how to get your money out of Binance if you were a UK investor.

Then, Deutsche-Borse said they partnered with British based TP ICAP to offer crypto derivatives trading.  Germany issued a license to Coinbase for custody the day before.

But, what I focused on was banks finally adopting blockchain technology to trade bonds.  Not Treasury bonds.  Treasury bond markets worldwide are very efficient and one of the main reasons for that is the existence of liquid futures markets.  If you have ever traded cash bond markets in corporates or munis, you know how inefficient they are.  Bid/ask spreads are wide and dealers have their own private books.  It is a license to steal.

For what it is worth, I have worked on starting a futures market for corporate bonds or muni bonds and it is impossible.  The theory works, but the practice doesn’t.  Ironically, at the University of Chicago one of the jokes is, “It works in practice but does it work in theory?” 

What I want to focus on though, is the startup crypto world and bonds.  I have seen quite a few deals in many permutations where entrepreneurs have the idea that they can tokenize a corporate bond or muni bond and trade it more efficiently.  It’s a great idea in theory.  However, putting it into practice is extremely arduous and tough.

I started seeing ideas around this as far back as 2014.  Because of my experience, I was receptive.  I love competition and competitive markets and think that they are better for humanity.  Seven years later, banks are “experimenting”.  Banks are using a blockchain for the back office, but they are NOT tokenizing the bonds.  It’s because banks see the back office as a commodity.  It’s a fixed cost to them.  The non-competitive book is what is important to them.  That’s where the profit is.

From the Financial Times,
“It’s essentially a glorified database,” said Matthew McDermott, head of digital assets at Goldman Sachs, one of the banks which handled the EIB deal along with Santander and Société Générale. “This technology reduces the number of intermediaries involved in any given transaction.”

Blockchain also offers a way to easily locate current holders of bonds — often a tricky task in the relatively fragmented world of fixed income where bonds are often traded directly “over the counter” rather than on centralised exchanges.

Billions of dollars have been poured into analytics to help traders locate debt securities to buy or sell, according to Kevin McPartland, head of market structure at Coalition Greenwich. “A universal database of who owns what, at least in theory, avoids the need for that,” he said

Traditionally, great internet companies put producers closer to consumers and eliminate intermediaries so this blockchain effort is on the right track.  In both the corporate and municipal markets there are very entrenched players.  It is highly dependent on relationships. However, what the current experimentations don’t embrace is the decentralization that is inherent in cryptocurrency.  It will be a long time for the players in the market to accept any decentralization and the existing network of distribution will fight it tooth and nail.

An aside, if you don’t know much about the structure of crypto vs the current internet, you won’t understand how big of a threat decentralization is to existing powerbases in industries.

Going further, those early entrepreneurs that saw the market wouldn’t have been a good angel or venture capital fund investments.  Why?  A few reasons that have nothing to do with the well-qualified teams I saw.  First, the educational hurdles and the reticence of the market to accept new innovation that is threatening to them would be a tough sale with a long adoption curve.  Second, the investor would have had to have a huge conviction that this was going to happen and be prepared to finance the company over a long period of time.

I think we will eventually have a decentralized muni and corporate bond market that is tokenized,  traded, and cleared on a blockchain. It won’t happen tomorrow.  What will be the tipping point for the market to change?  I don’t know.  The segment of the market that is focused only on speculation would be quicker to advocate for a change.  One big factor will be when corporate CFOs and municipal issuers realize that they could realize a lot more money for themselves in a tokenized decentralized market than the way things are currently done.   That will be a long educational process than people think since that target market is generally risk-averse and slower to adopt radical new technology.