Banking and Financial Markets

Financial services and blockchain: Disruption on the trading desk

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On an increasing number of trading floors, new sections are popping up. Past the commodities, foreign exchange, and futures desks, you might see a digital assets trading desk — the “crypto desk.”

A few early players have had 9-to-5 crypto desks since 2015; others built 24/7 desks; still others are examining whether to start a crypto desk in 2019.

Essentially every business activity — from commercial air travel to ride-sharing — goes through a period of popularization followed by a period of professionalization. Somewhere in the more plumb areas of the S-curve, this transition occurs. There had to be a skateboarding subculture before there could be a Tony Hawk; the parallels between this progression and what we’ve seen in crypto trading are unmistakable. Today, crypto trading is in between its popularization and professionalization phases. As money flowed into blockchain in 2017, most market participants were doing the financial equivalent of flying a plane without anything more than compass.  With the market (comparatively) underperforming in 2018 and Bitcoin essentially at the same price levels as a year ago, many of the players have realized that they need more sophisticated instrumentation for navigating the market, and they have subsequently begun to tool up and professionalize their operations. Firms, including ours, began developing these tools to allow traders to build the kinds of models and pose the kinds of queries they are accustomed to using when trading in traditional asset classes.

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High-end blockchain analysis tools

There is growing interest in interpreting financial information that resides on the blockchain. More specifically, new and sophisticated tools enable users to discover opportunities, understand market events, test trading strategies, model hypothetical conditions, and, ultimately, outperform their peers. While many retail investors trade crypto assets on their mobile phones or tablets, we now see a market emerging for enterprise-grade, trading-desk-ready tools. These tools target the top of the market — not the crypto hobbyist — with a revolutionary feature set designed to delight the most demanding, most sophisticated customers.

This high-end blockchain analysis software is being built by startups showing it’s possible to attack and disrupt at a high-margin, high-performance point rather than at the commoditized, low-margin frontiers of a space. I developed and taught the Innovation Management curriculum at Northwestern University and I would generally tell students it was rare to see startups able to attack areas from any space that was not low-margin and low-cost, yet we see many startups in the crypto space doing precisely this and claiming valuable territory in the process.

I’m not a trader. Rather, I am an economist by training and have always been fascinated by financial markets for the same reasons mathematically-inclined sports fans gravitate toward baseball: the data available are reliable, usefully-annotated, and rarely in controversy. In the blockchain, I see a trove of verified information that is presented in ways that are not always readily-searchable or -queried; there is valuable data on the blockchain that is simultaneously “out in the open” and also difficult to visualize. The radical transparency of the blockchain is incredible and fantastic, but many pieces of the traditional trader’s toolset are missing. Now, firms are creating those tools — and other tools that are not possible to build in traditional markets because of their relative opacity compared to the blockchain.

Blockchain and radical transparency

Part of the excitement around blockchain revolves around radical transparency — both new, agile companies and established legacy firms can associate significant parts of their operations (involving data, physical goods, supply chain and more) with blockchain technologies without uncertainty around where data resides, the robustness of proprietary access protocols, or systems interoperability. Hence, blockchain creates a very rare scenario where firms from many industries can move to a new set of technologies (blockchain being more accurately described as a set of technologies rather than a single innovation) quickly with high speed of substitution against legacy solutions, low switching cost even at tremendous scale, and high confidence in predictable outcomes even in very complex use cases. This is only possible because the level of transparency on the blockchain — what occurred, who was responsible, where things (physical or digital) were transited from and to, is revealed at high resolution. What is so “radical” about this?

When I say radical transparency, I mean the exposure of elements necessary to answer questions one cannot answer with publicly-available information in traditional markets. Account balances are a simple example. On the blockchain, I can check the balance of a crypto wallet in a way that I cannot check the balance of a stranger’s bank account. I can see if wallets are transacting with one another or likely to be controlled by a common party, relationships impossible for me to uncover if I were given a list of bank account numbers and only publicly-available information.

On the blockchain, it’s possible to leverage data science tools to discern whether transactions are occurring between related parties, between individuals (or individuals and exchanges), and what the “geography” of the network looks like. This means researchers (once armed with powerful tools) can ask queries that are cumbersome, expensive, or impossible on other platforms — like “how many wallet addresses on the ERC20 network have ever had a million dollars’ worth of tokens in them?” (the answer: slightly fewer than half a million as of this blog post). Firms are taking public blockchain data and racing against each other to annotate, decorate, and organize it in new and exciting ways. From traditional databases to graph databases to high-performance data storage and retrieval designs, there is a healthy and innovative debate around how blockchain data should be harvested, stored, searched, and utilized. We see this in the sophistication of queries users seek to run — and the systems that must be built to accurately and efficiently serve users results.

Below is a SQL query for million-dollar wallets that might be used in a traditional environment:

Next is a GraphQL query for a similar search in a graph database:

All of these tools would be impossible to build in the traditional world; they exploit the radical transparency that is built into blockchain. On the trading floor and in the financial services world, transparency means having known counterparties, identifying trusted versus non-trusted addresses, recognizing key landmarks on the network landscape (these include exchanges, mining sites, high-trust nodes, groupings of affiliated wallets, and so forth) and analyzing the decisions and strategies of key competitors. On the ground, it means dealing with KYC rules elegantly, avoiding losses from mis-addressed or mis-timed transmissions of value, and knowing whether that wallet you’re about to accept a payment from has been used by someone in North Korea or Iran.

The fear of “too much” transparency

Some people view the radical transparency of blockchain as a problem or a threat. But whenever I open a payment app on my phone, the feed is full of people paying each other back for a rideshare or splitting a pizza. This kind of information, not long ago hidden from sight, is now easily shareable. Our collective norms, as a society and as users of technology, of what is public and what is private are evolving. Once, at the beginning of Twitter, most online personas were represented by anonymous eggs (curious why this is no longer the case?) shouting at each other. But, slowly, reputation on Twitter began to matter. By following and being followed, people assembled friends and networks. Twitter handles were no longer disposable, they were valuable pieces of identifiable intellectual real estate. The same is occurring now with lineages of crypto wallets, especially as blockchain-enabled credit scoring, asset-backed-lending, and other activities requiring continuity of identity come onto the scene.

Those lineages begin with the minting of tokens and the insertion of those tokens into wallets (the account-level mechanism on most blockchain networks), movements often associated with a mass-airdrop (delivery of tokens not intrinsically tied to a purchase) or an initial coin offering (ICO). A popular use for the most sophisticated research tools is tracking ICOs. An ICO is the first time a token is offered for sale (but rarely the first time that token appears on the network) and is — particularly on the ERC20 or Ethereum network — a common way for crypto-related projects to raise quick, non-dilutive capital (what is non-dilutive funding?). Savvy users with the right tools can identify who held the token in question prior to the ICO, characterize holders’ activities immediately before and after the ICO event, and even examine the holders’ other investment activities. This use of the blockchain’s radical transparency has produced a mixture of criticism and excitement. However, if we think of early holders of the token as analogous to insiders holding equity in a publicly-traded company, then the transparency offered on our platform is similar, though arguably superior, to the transparency offered by forms 3, 4, and 5 on file in the IRS’s EDGAR database.

Evolution of the crypto desk

Organizing and analyzing vast amounts of information in a way that is not just interesting, but actionable, is one of the most exciting challenges blockchain technology poses and one of my primary passions. The solutions to these challenges are central to the next generation of business — and, more broadly, the next generation of markets. Someday not far in the future, between asset tokenization and the expansion of blockchain-based ledger systems, the “crypto desk” will go away — all desks on the trading floor will, in one way or another, be shaped by (and be forced to incorporate) blockchain technology.

And a chorus of people from all industries — from the trading floors to the reinsurance markets to the logistics firms — are talking publicly now about how they’re betting on, and preparing for, that future.

Connect with me @karlmuth on Twitter to continue the discussion.

From time to time, we invite industry thought leaders, academic experts and partners, to share their opinions and insights on current trends in blockchain to the Blockchain Unleashed blog. The opinions in these blog posts are their own, and do not necessarily reflect the views of IBM.

FRST is a venture-backed blockchain analytics startup headquartered in Chicago providing enterprise-grade, trading-desk-ready software for hedge funds, trading floors, and exchanges. FRST recently emerged from stealth mode with an announcement it had raised a round of financing led by CMT Digital and Vestigo Ventures. FRST is on Twitter at @FRST_IO.

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Professor, Northwestern University - CEO of FRST

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