Blockchain

The Next Generation of Decentralized Ledger Technologies Can Help Create The Internet of Smart Assets

By Kevin Sekniqi, Co-Founder and Chief Protocol Architect, AVA Labs, and
Phillip Liu, Head of Strategy and Operations, AVA Labs 

Despite having entered the digital age decades ago, financial markets have not fundamentally changed much since their inception. A few markets, such as equities and a small collection of futures contracts, have enjoyed a high concentration of capital and public interest, and thus have become hyper-efficient. Despite this collection of highly liquid markets that exist today, significant inefficiencies still prevail within the financial ecosystem. For example:

  1. Raising capital remains difficult for many of those without the right access points. 
  2. A multitude of assets sit on balance sheets unable to be traded. 
  3. Creating new types of assets for trade is a non-trivial process with significant compliance overhead. 

With the advent of decentralized ledger technologies (DLTs), popularized by the introduction of Bitcoin, we have seen the possibility of entirely transforming financial markets. On the enterprise side, DLTs promise to make data ownership and transfer simpler and more transparent, thus solving many of the issues currently arising from siloed data [1]. This, by itself, could prove to be transformational for how we mechanically, and functionally, conduct business logic in the future. On the financial side, however, Bitcoin has only upended one type of market: currencies. Other types of assets, especially those currently not trading on major global equities or futures exchanges, have seen little — if any — change. 

A reimagination of financial markets is necessary. What if we could build a global, unified network and language where creation and trading of compliant assets was as easy as writing and sending an email over the internet? The internet experienced a Cambrian explosion when open APIs become available for developers to use, allowing composition of simple, primitive calls into a complicated network of services that now power our day-to-day business logic. Can a new Cambrian explosion be witnessed for finance? 

One of the most important consequences of open financial APIs is the ability to enable efficient fractional ownership of assets that are currently highly illiquid and cumbersome to trade. Additionally, a unified framework would allow new classes of assets to emerge as DLTs become prolific and interoperable on a global scale. Although this idea has been explored via tokenization of assets, such as for example via ERC-20s (the technical standard used for smart contracts on the Ethereum blockchain for implementing tokens), it has not yet materialized into large-scale deployments because of improper architectural constructions. 

So what has prevented, say, Ethereum, from sweeping over the financial sector? The first set of problems are well known in the space, and include primarily performance guarantees. Public blockchains/DLTs take anywhere between minutes to hours to transact, and operate at a few transactions per second[2, 3]. Conversely, private DLTs that use a different set of technologies, perform at high speeds, but are unable to scale to many computers jointly maintaining the underlying ledger, which is important for high security and fault tolerance. Although not impossible, it is arguably difficult to build a future-proof, robust financial fabric with such guarantees. Lack of performance notwithstanding, the most important limitation is due to the current monolithic design of DLTs, which enforce a common set of validators without an option for issuers to enter into special types of agreements with validators. This, by itself, can be a deal breaker, since legal recourse is impossible. 

Instead, what would an ideally envisioned “internet of smart assets” look like? It would be a network of high performance and interoperable private and public DLTs, where asset exchange can be conditionally applied given the terms of each contract, and which are automatically verified and resolved by the network of validators. Programmable smart assets, in comparison to current smart contracts, may trade themselves as certain market conditions are met, enabling risk management to be built into the asset itself. All of this occurs 24/7, in a compliant manner, while eliminating middlemen and unnecessary overheads. 

A global, unified system that allows easy tokenization of all types of assets, while being compliant, instantly allows entrepreneurs and institutions to access a broader pool of capital than previously possible. However, the real benefits of such a system expound from network effects. In particular, the common and interoperable language of smart assets allows certain classes of assets to be traded instantly and directly with other classes, allowing rapid compounding of liquidity. Furthermore, being able to create entirely new smart derivatives of various underlying assets allows market participants to reduce their overall risk using a broader pool of levers. 

We are currently witnessing a substantial shift in the operation of financial markets, as interoperable, open financial networks make it easier both to create, discover, and trade assets and capital. This shift will radically transform financial markets, finally bringing them up to date for our digital age.

References

[1] Palatnick, Robert. “Governing DLT Networks: DTCC Thought Leadership.” DTCC, http://perspectives.dtcc.com/downloads/whitepaper/governing-dlt-networks. Accessed 8 Oct. 2019. 

[2] https://www.investinblockchain.com/vitalik-ethereum-needs-100k-transactions-per-second/

[3] https://www.comp.nus.edu.sg/~prateeks/papers/Bitcoin-scaling.pdf

[4] https://usa.visa.com/run-your-business/small-business-tools/retail.html

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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