Thursday, April 7, 2016

From 'Blockchain Hype' to a Real Business Case for Financial Markets

From the Social Science Research Network:

Massimo Morini

Banca IMI; Bocconi University

March 21, 2016

Introduction: Blockchain Hype vs Blockchain Seclusion?
There has been a lot of noise in the press about the great potential uses for financial markets of Bitcoin-related technology, that could be extracted from the Bitcoin world and applied to existing markets to increase efficiency dramatically. Later, there has been a lot of noise about the fact that there is no actual use but all boils down to a generic enthusiasm called Blockchain Hype, and Bitcoin is the only reality where such technology can be fruitfully used.

This paper shows that there are real business cases for improving financial markets based on the lesson learnt from cryptocurrencies, but, differently from what the hype-enthusiasts say, they are not application of a technology to the existing business model of financial markets. They are reforms of the business model itself. What needs to be exported from the world of cryptocurrencies are aspects of the market organization, inspiration for a different accounting and legal system, and some aspects of the technology. These can be a huge contribution towards more robust, efficient and stable markets, but the process cannot be immediate and effortless, and can only be achieved within a market-wide strategic view.

One crucial misunderstanding here is the idea that Blockchain Technology can be exported to financial markets as they are to make them more efficient. This is meaningless; Blockchain technology was created to change some trust-based business processes to make them less reliant on trust; without structural changes in this direction the best of Blockchain technology is lost and just the inefficiencies are left. This misunderstanding is the perfect partner of the idea that Blockchain technology cannot be used outside the Bitcoin world. This is equally meaningless; Bitcoin was created to attempt a level of independence from trust sufficient to allow players to be anonymous and do without any legal protection; other business solutions based on a level of trust intermediate between Bitcoin and traditional finance can use similar technology and yet be very different from Bitcoins. But we must ready to use the concept of trust in a totally different way, as a way to analyze the different parts of a business process and the reason for its current inefficiencies and risks.

In the next we develop these concepts first in a parallel analysis of cryptocurrencies and financial markets. Then we focus on a specific business case regarding the collateralization of financial derivatives, that we describe bottom-up including quantifiable benefits in reducing costs, capital and risk. It is an example where the use of cryptocurrency technology is not more important than the business ideas developed in the analysis of cryptocurrencies; yet it was unconceivable before examples of distributed ledgers, smart contracts and oracles were visible in marketplaces. In fact, it was first presented in Morini and Sams (2015), in an introduction of the Blockchain innovation for the derivatives world.
SSRN download page (11 page PDF)