2017 has been the year of cryptocurrency. And while the Securities and Exchange Commission (SEC) Chairman Jay Clayton's recent comments suggesting initial coin offerings (ICOs) may have to register as securities may have some virtual currency bulls on edge, the SEC's crypto-consciousness bodes well for broader capital markets.
During a November speech that he gave to the Institute on Securities Regulation in New York, Clayton warned, "I have yet to see an ICO that doesn't have a sufficient number of hallmarks of a security."
I'm about to dive into some jargon. Stay with me.
A fundraising vehicle, where developers kickstart their decentralized applications on the Ethereum Blockchain, a hybrid ledger and smart contract platform that enables issuers to offer virtual tokens to investors in exchange for bitcoin (BTC) or ether (ETH), Ethereum's proprietary currency, ICOs have much in common with stocks, bonds and their derivatives.
In this tulip-fevered, crypto-economy, where 211 ICOs have raised over $3.4 billion from investors according to analytics site Coinschedule, and bitcoin itself has increased in value from $800 to $10,000 in the last 12 months, Warren Buffet's folksy quips offer pearls of timeless wisdom, "it's only when the tide goes out that you learn who has been swimming naked."
The tide is governance.
Governance is the mechanisms, processes, relations, and laws by which organizations are directed and controlled. Recent SEC enforcement actions, like those taken against REcoin Group Foundation and Diamond Reserve Club in September, which are two questionable ICOs launched by businessman and accused fraud Maksim Zaslavskiy, are a harbinger of the coming nudist purge.
Thus, as regulators remove bad actors from the Blockchain ecosystem and drive the adoption of formal SEC governance standards, capital markets are primed for an anatomical restructuring they haven't seen since hedge funds usurped investment banks as Wall Street's centers of power.
The 90's paradigm shift was institutional. The emerging transvaluation is technological.
Blockchain technology has the potential to transform every aspect of the capital markets. Specifically, it could help financial institutions cut costs, deploy capital faster, achieve better transparency, and implement more secure governance standards.
It's a big deal.
Blockchain creates a new way of doing business.
Blockchain enables issuers and other key stakeholders to remove needless intermediary layers and redundancies that stymie securitization. Because it's an immutable ledger that executes contract terms directly between peers and transacts through cryptographically secure mechanisms, it ensures continuous reconciliation.
With just a few lines of code, this smart, distributed ledger can autonomously execute contract terms, eliminating the need for intermediaries and enabling digital security issuers to engage investors directly.
This platform would also make transaction settlement and clearing virtually instantaneous, nullifying the "T+3," (standard three-day transaction waiting period), which has handcuffed the financial industry for so long. T-Zero, founded by Overstock CEO Patrick Byrne, for instance, is making the trade the settlement.
Wall Street experiments with second-generation Blockchain technology like R3CEV (U.S.) and 3rd generation solutions like BankChain (in North America and India) are distributed database consortiums whose early adopters include, Goldman Sachs, Barclays, and J.P. Morgan Chase, Deustche Bank, and are in a race to create interbank chains permanently disruptive to SWIFT.
Security is paramount to innovation as adoption ensues
The recent theft of some 3.6 million ETH valued at $55 million by unknown hackers in 2016's of Ethereum's (ETH) decentralized autonomous organization (DAO) highlights the need for a more interoperable and flexible solution, according to Sky Guo, the founder, and CEO of Cypherium.
Cypherium negates the need to fork, combating the issues of chain weakness by developing a new blockchain, that will be highly scalable, permissionless and trustless.
In the case of the DAO, the hackers exploited a byzantine fault, a protocol malfunction that stymies consensus on the Blockchain, enabling them to find a weak spot in the application's source code and divert funds from the DAO's virtual wallet to an Ethereum wallet they controlled.
Unfortunately, Guo noticed the application developers were beholden to Ethereum's protocol-level governance, like the standard rules for consensus mechanisms, algorithms, transaction time and the size of transaction blocks. Network confusion prevented users from reaching consensus to stop the theft.
Thus, Guo advocates the use of practical byzantine fault tolerance (PBFT), an enhanced algorithm that prevents database anomalies from compromising network consensus.
Additionally, with greater application-level governance, DAO operators could have implemented business-specific rules to block the crypto theft.
Without resilient execution at the application level, Blockchain solutions may be inadequate for the financial industry and will put banks, investment companies, and insurance firms at great risk.
The bottom line
As a business owner, the foundation of how you store and protect capital and process transactions is shifting rapidly. If you're not paying attention to these kinds of headlines, start now--even if you think it's boring.
You'll thank me in a few years. I promise.