Within the next five to ten years, blockchain, the technology behind Bitcoin will be widespread, but this does not necessarily mean the revolution of cryptocurrencies, but rather a breakthrough in enterprise IT infrastructures. Blythe Masters, CEO of Digital Asset, said in an interview with Portfolio that blockchain could help financial institutions prevent crises by reducing systemic risk and enabling them to comply with regulatory rules. She also shared details of the company’s common blockchain project with the Australian stock exchange.
Portfolio: Digital Asset is currently working on blockchain-based securities processing and clearing systems. Can you tell us a few details about exactly what you are dealing with and what your projects are?
Blythe Masters: Our company is working with distributed ledger technology, and we are looking for its practical application for corporate clients - primarily financial institutions, market infrastructure managers, stock exchanges, and clearing houses. Our customers are developing transaction acceleration solutions (STPs) based on distributed ledger technology (DLT), which has a lot of advantages: efficiency, speed, accuracy, and elimination of the need for reconciliation. All this reduces delays, risks and costs as well as generating new business opportunities on a platform that connects different ecosystem participants.
So, we're not dealing with cryptocurrencies or digital payment systems, but solve other problems with the underlying technologies. We employ 170 people worldwide and we are growing fast, we have six offices, one of them here in Budapest.
What is the Budapest office focused on?
We employ 10 people in Budapest, and we expect this number to increase considerably in the next year. The Budapest team supports a number of initiatives i.e. platform building and software development, but there are also projects led by teams in other offices that are supported by our specialists in Budapest. The Budapest team is part of the global organization, they are not tied to a specific product.
The government wants to establish a regional tech center in Budapest, which is part of the blockchain, including Digital Asset Holdings. Do you think it is realistic that the Hungarian capital will become a regional blockchain center?
I think it's a pretty realistic goal. You have the technical expertise and professional base here in Hungary. Hungarian educational institutions create a very well-trained workforce. We also have our office in Budapest because we also want to use local skills. We would like to hire a wide range of local professionals; programmers, IT professionals, corporate software developers. There are also many companies in Hungary that produce a wide range of experienced professionals.
Globally, the biggest challenge for our industry - in fact, the entire tech sector - is the lack of experienced technical professionals. Hungary has professionals with this technical expertise and a sufficiently supportive business environment. So the goal is realistic and we are here to contribute to this.
A stock market based on the Australian Securities Exchange is being developed. Exactly what does this project look like? What status does it currently have? Are there other stock exchanges that are interested in this solution?
We've been working with ASX, the Australian Securities Exchange, for a couple of years. It all started with a design and a prototype, last December ASX decided to move forward with a project to replace the technology underlying its CHESS system, which provides equities post-trade clearing and settlement services for the Australian marketplace.
ASX announced its intent to implement a DLT solution from Digital Asset in December and the implementation plan was introduced to ASX members in a consultation paper that was published in April. The paper discusses the expected functionality of the replacement system, and the timeline for performance testing and system migration, which is expected to be complete by 2020-2021.
This will be the first case where a major market infrastructure has replaced an existing system with a blockchain-based solution. There are, of course, other blockchain projects in the world, but none are as ambitious or relevant to the company's main activities as it is. That is why it will not only be interesting to us and ASX, but to the whole industry. And yes, at Digital Asset, many other stock exchanges and clearing houses are interested in technology in the United States, Europe and Hong Kong. But there are also our clients who operate non-market infrastructures and are not even financial institutions, but payment systems or healthcare companies. ASX is the leader in its market, but not the only one in the world, there are a number of similar projects that can be started later. Replacing a component of a market infrastructure always takes a matter of years, not months, whether it is an emerging technology, like a shared ledger system, or a mainstream technology.
Some banks say that blockchain and digital ledger technology are overhyped phenomena and in reality, they will see very narrow usage in finance and trade. Meanwhile, Ripple’s CEO thinks that as soon as 2019, a large number of banks will be using their XRP platform for trade finance. What is your take on this?
Interestingly enough, when blockchain was in the early stages of development, we could not really see its potential at the time. In part, this was due to the fact that the original blockchain invention, which can be interpreted essentially as the evolution of a traditional database architecture, could first be linked to cryptocurrencies. Cryptocurrencies were widely thought of as dangerous technology for the banks because they were used for fraudulent activities, the extreme price volatility, the use of cryptocurrencies to finance terrorist activities and concern about investor protection also arose. Because of this, cryptocurrencies attracted a lot of noise before the benefits of the technology became the focus of attention.
In 2015, when interest began around blockchain technology, a lot of capital began to flow into development, education and software related to blockchain. Technical applications of the technology have also prompted the industry to address specific problems, such as Isda’s CDM project, which aims to make derivatives contracts compatible with smart contracts. This initiative demonstrates that banks and non-banks are looking at the potential of this technology.
How popular will blockchain-based solutions become? I think they will be widespread. There are already signs of this, as many companies already build the infrastructure, which will allow the blockchain to spread widely over the next 5 to 10 years. There is no financial institution in the world that does not study blockchain, and even most of them work on the practical application of blockchain.
Initially, there was skepticism that blockchain was a technology that was looking for a problem to solve: this is not a healthy dynamic. Technology has to start with a problem and needs to develop to solve this problem. When the Blockchain was created, it was created to form the basis of crypto assets using a completely open and public network that could be used to make anonymous transactions fast. These features are not suitable for a large, regulated financial institution.
The technology therefore had to develop overtime. It is now possible to create a private permission network, which can align with various supervisory requirements for onboarding and KYC systems. While bitcoin transactions are published to a public ledger, this is not the case with private, or permissioned blockchains.
The development of programming languages related to smart contracts has made it possible to use DLT in the corporate, or enterprise, sector as well. The smart contracts previously used general purpose programming languages, which created the potential for errors to occur as developers tried to program a variety of potential outcomes. The development of functional, domain-specific languages has already reduced the occurrence of unpredictable outcomes. Digital Asset had to develop its own programming language, called DAML, which is easier to use and reduces the time needed to program applications for DLT platforms.
To answer your question: such solutions have been growing on the supply side. Looking at the demand side, we get a similarly impressive picture. The technology has evolved, it has become more reliable and it comes at a time when the market really needs it.
If you think about it this way, we will figure out the need present in the world. Today, we still have very inefficient systems for financial services. The internet has completely changed things. Now, the information is available from anywhere in the world right away. Now it's not about information transfer, it's about value transfer. When it comes to value, absolute security, encryption and accuracy are required. Essentially, we are talking about the future role of people in this industry as well. Previously, the financial system had enormous complexity because the data related to financial transactions was maintained in silos, and a lot of people had to be involved in decision-making.
This complexity brought a lot of extra costs and delays. The more costs you have, the lower your returns will be, lower profits bring lower returns to investors; pension funds, hedge funds. In a low interest-rate environment similar to the current one, this is a particularly big problem.
Add to this the increase in data storage and processing efficiency, AI, big data analysis, quantum computing - all of which are part of a much wider technological revolution. These technologies rely on accurate and trusted data; which distributed ledger technology provides. If you put poor data into an artificial intelligence system, you will derive poor results from the processing of that data.
There are, of course, challenges, such as establishing universal technical standards, or building a common network between market participants. However, this has been accomplished in the past, for example, by SWIFT or DTCC.
There have been technologies in the past that have responded to such problems, but the response has never been so fast before. So yes, this is a big breakthrough that will spread widely.
Blockchain has also attracted the fantasy of hackers, at least in the world of cryptocurrencies. What security measures can they take against banks, financial institutions?
High profile hacking attacks and fraud on crypto money markets cannot be linked to the vulnerability of technology behind the blockchain systems. During these incidents, stock exchanges are being hijacked by hackers. This does not happen because they have access to blockchain technology, but because they have access to the security keys and system of the storage facility. If you do not adequately protect your clients' assets, it is no longer a blockchain system or a traditional system - the SWIFT international banking communications system has been successfully attacked and cracked several times.
DLT technologies used by companies are different from traditional databases that store information in more than one location. Different nodes of a shared ledger system operate simultaneously and data can be easily replicated if necessary. This is an enhancement over conventional systems.
Another aspect is that in the case of cryptocurrencies all information stored in the blockchain is divided, replicated in each node. This means you can re-create them instantaneously, at any time, so you cannot lose them. But if you do this for example on a stock exchange with shares, basically, everyone's data is replicated on everyone's servers and this is impossible to protect using just encryption, and this is still impossible to protect by encryption. This is a huge security risk, which is totally unacceptable.
Our enterprise blockchain technology does not replicate and store the complete data set on the servers of all players on the network. Data is kept in private storage and only certain parameters and proofs related to a transaction are shared among the participants. In doing so, hackers do not know how to break the whole system, because they only see a snapshot of the data on one server. They would only succeed to garner all the data related to a transaction if they hacked the entire network, which is essentially impossible to do.
Instead of maintaining replicated data sets on every node of our blockchain, we store a "cryptographic hash" of the dataset, which is conceptually similar to a fingerprint. If someone finds your fingerprint, they might know who the fingerprint belongs to but they cannot copy it or change it. And, even if they know whose fingerprint it is, they are still unable to recreate the person from the fingerprint.
So, regulators and market participants can rest easier: shared DLT technology does not pose additional threats.
From the first line you looked at the 2008-2009 world market crash and the subsequent economic crisis. Now, many people think that we can be close to a next, equally tough crisis. What do you think?
The same conditions that led to the previous crisis do not exist today. It is highly unlikely that the next crisis will be triggered by lending problems. In the financial system, leverage is much lower on average in the world.
Of course, interest rates were very low for very long, now that the central banks will start slowly raising interest rates, this will significantly change the situation. The public sector debt is high today, but private sector debt is not and it was the latter, i.e. private debt, which instigated the last crisis.
So I do not expect a kind of crisis like 2008, but that does not mean that there are not a lot of known and unknown risks in the system today. Among other things, distributed ledger technology is also needed to solve such problems: mainly international securities trading and transfers are taking place slowly, which is risky because economic shocks are slower to respond to market participants. The irony of bringing a shared technology mainstream is that regulators can see market activities in real-time and control the various market processes. So they can respond to market problems faster than they can with existing technology in place. Thanks to blockchain, they are also more likely to reach a consensus on market issues in many cases, as well as reduce market inefficiencies.
While regulators may be concerned about cryptocurrencies, they are often enthusiastic about blockchain technology and its potential to reduce risk created by securities issues.
