Delaware’s legislative assembly paved the way for blockchain stock exchanges this week. It’s important because almost all major corporations are chartered under Delaware law.
Matthew O’ Toole who is the chairperson of the corporate law section of the Delaware bar association wants to keep Delaware at the forefront of corporate law and in the lead in terms of using distributed ledgers to track and trade shares.
When I have talked to entrepreneurs about setting up exchanges to trade different products, they usually don’t understand how an exchange truly works. Most people don’t.
An exchange is a lot more than the front end. The front end is what everyone is familiar with. The bid/ask spread and the price. Simple, just match a buyer and a seller. As a matter of fact, programming an automated trading system that scales is a pretty simple task these days especially when compared to how it used to be.
The true value in an exchange is the back end. Clearing and settlement. Pays and collects. Record keeping. That’s what makes the front end transparent. In the competition between CME and CBOT, one reason CME won is CME owned its own clearinghouse. CBOT outsourced theirs. ICE bought the NYBOT because it had its own clearing. The contracts it traded had little value.
For over a century now, futures exchanges have had a leg up on stock exchanges. Futures exchanges had a rule that all trades had to be settled up prior to the next day’s opening. The market couldn’t open without that. In October of 1987, the markets came perilously close to not opening the day after the crash.
Stock clearing has always been a mundane but hugely profitable business. It is a regulated monopoly. The Options Clearing Corporation (OCC) is based here in Chicago. Since my friend Craig Donohue became CEO, they have engaged in a large transition to modernize. For the forty years prior, they could afford to be a staid, stagnant organization. It will be very interesting to watch the OCC and how it implements or tries to fight off blockchain.
All exchanges will have to implement some form of blockchain if they want to stay in business. It’s just too strong a technology. Futures markets for all their dynamism at their core are centralized databases. One lament of market participants is that “XXXX contract only trades a fraction of the world trade volume, yet it sets the cash price”. That might change with blockchain.
In the past several years, technology has actually caused a lot of market participants to go away from the centralized market. They are too small and can’t afford the higher costs of trading and holding positions due to oppressive regulations put forth by our overseers in Washington DC. Blockchain might be able to bring those kinds of participants back to the market, creating a deeper more transparent and liquid marketplace with a better price.
There are plenty of other uses as well that are easily recognizable. Registering shares is one example. One thing that might be a problem is the transparency blockchain registration might bring to a marketplace. If the ledger is public and searchable, big institutions will have to be craftier about how they build a position or cover a position.
Most people don’t realize how many breakpoints there are in the back office of banks, insurance companies, exchanges, and other financial institutions. At each breakpoint, a “broker” can set up shop and charge to let information flow through. Some of these breakpoints are heavily regulated.
Blockchain can blow that entire system to smithereens.