Blockchain for derivatives trading or inter-bank money “transfers” – its not as easy as you think!!

Securities are an easy case for a blockchain asset registry because a single issue of securities is essentially fungible. However, this is not the case where derivatives trading, or inter-bank money “transfers” are concerned.

The following extract from an International & Comparative Law Quarterly paper titled “Pause the Blockchain Legal Revolution” states the following:-

NAKAMOTO AND DOUBLE SPENDING

• It is convenient to use the example of inter-bank money “transfers” since it is the very example used by Nakamoto to illustrate the means by which blockchain technology can facilitate money transfers through disintermediation.
• Nakamoto misunderstands the role of financial institutions in inter-bank payment systems.
• The central problem, according to him, is double-spending and the role of these financial institutions is to serve as a trusted third party to ensure that no double spending occurs.
• Accordingly, if the same function can be performed by an algorithm, these trusted third parties can be disintermediated.
• He predicted that this would lower transaction costs because the presence of these intermediaries makes it impossible for “[c]ompletely non-reversible transactions … since financial institutions cannot avoid mediating disputes.”
• If this is correct, then we could simply apply the blockchain technology to the banking industry and achieve Nakamoto’s objectives without the need to create a crypto-asset such as bitcoin. In short, continue dealing in the same fundamental asset – fiat money – but keep records using the blockchain.
• The problem with this view, apart from its misprediction as to fees, is that it misunderstands how an inter-bank money “transfer” works and the nature of the trust a depositor invests in his bank when he deposits money with it.
• By depositing his money, a depositor is effectively lending it to the bank, who is free to deal with it as it wishes. The trust inherent in the process lies in the depositor’s belief in the bank’s creditworthiness and predates inter-bank transfers.

INTER-BANK MONEY “TRANSFER”

• What we call an inter-bank money “transfer” is far more complicated than most technologists appreciate.
• If bank money is simply a debt owing by a bank, then it must be obvious that an inter-bank money transfer cannot possibly involve the transfer of a fundamentally fungible asset since a debt is only as valuable as the creditworthiness of its debtor.
• In fact, there is no “transfer” of any property, only a transfer of value.
• Bank “intermediaries” are essential to the process of such transfers.
• This is demonstrated by examining what happens with an “in-house” money transfer where both payer and payee have accounts at the same bank.
• Here, the bank simultaneously reduces its liability to one customer (the payer) and increases its liability to another (the payee).
• It can do so not because it helps solve a double-spending problem but because it is a common obligor to both payer and payee. Where there is an inter-bank money transfer, the absence of a single common obligor complicates matters.
• For inter-bank money transfers within a single jurisdiction of the fiat currency of that jurisdiction, this complication is typically resolved by the banks’ relationship to the central bank.
• The central bank serves as the common obligor to the payer’s bank and the payee’s bank, thus allowing the adjustment of accounts across all four relationships:
• (i) between the payer and the payee;
• (ii) between the payer’s bank and the central bank;
• (iii) between the payee’s bank and the central bank; and
• (iv) between the payee and the payee’s bank.
• The role played by the central bank may sometimes be taken by a correspondent bank where the transfer crosses borders and/or is made in a foreign currency.
• There may also be multiple correspondent banks involved if the payer’s bank and the payee’s bank do not share a banking relationship with a single bank so multiple banks must be used to bridge their accounts.
• Such payments are the source of the most chagrin among bank customers, but they are slow and expensive because multiple banks are involved and thus many more accounts need to be settled before a transfer can be finalised.
• To apply blockchain technology without fundamentally changing the nature of banking and inter-bank money transfer would therefore entail the creation of not one blockchain ledger but hundreds of thousands of inter-linked subledgers, which, if they utilise different blockchains, create problems of interoperability.

Source

• https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3439918 / https://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID3439918_code1413313.pdf?abstractid=3439918&mirid=1&type=2
• Pause the Blockchain Legal Revolution - (2020) 69(1) International & Comparative Law Quarterly 135-175 [32 Pages Posted: 22 Aug 2019 Last revised: 6 Apr 2020]
• Kelvin F.K. Low - National University of Singapore (NUS) - Faculty of Law
• Eliza Mik - The Chinese University of Hong Kong (CUHK) - Faculty of Law; TILT; Melbourne Law School

Date Written: June 20, 2019