A patent filing in early December by Goldman Sachs hints at the promise of digital currency to speed financial transactions.
The investment bank aims to create a cryptocurrency called SETLcoin, which would guarantee execution and settlement of securities trades within minutes, according to the filing.
The move, which was reported by American Banker, mirrors similar efforts by banks worldwide. At least 42 financial institutions, including JPMorgan Chase, Citigroup, Bank of America and Barclays, have joined a consortium that is developing distributed ledger technologies. Some of the same banks also have teamed up with the Linux Foundation to develop open-source software for business transactions.
To appreciate the potential of peer-to-peer technologies for exchanging stocks, bonds and other assets, consider the process as it exists currently. As described in the filing by Goldman:
“As implemented by [SETL.coin], a trader no longer trades securities by meeting at an exchange with an indication of cash for security and then settles the transaction seconds, hours, or days later, meanwhile bearing all of the associated credit risk in the interim.
Traders using the described technology exchange securities by presenting an open transaction on the associated funds in their respective wallets. SETLcoin ownership is immediately transferred to a new owner after authentication and verification, which are based on network ledgers within a peer-to-peer network, guaranteeing nearly instantaneous execution and settlement.”
The promise of the network turns on the so-called blockchain, a database for recording and verifying transactions that was developed in connection with the exchange of bitcoin, a digital currency that is traded independent of banks and governments.
In “Digital Gold,” his book about the origins of bitcoin, Nathaniel Popper summarizes the steps that form the process for exchanging bitcoins. As Popper describes a hypothetical exchange:
“To recap, the five basic of the bitcoin process were laid out as follows:
Alice initiates a transfer of bitcoins from her account by signing off with her private key and broadcasting the transaction to other users.
The other users of the network make sure Alice’s bitcoin address has sufficient funds and then add Alice’s transaction to a list of other recent transactions, known as a block.
Computers take part in a computational race to have their list of transactions, or block, added to the blockchain.
The computer that has its block added to the blockchain is also granted a bundle of new bitcoins.
Computers on the network start compiling a new list of unconfirmed recent transactions, trying to win the next bundle of bitcoins.”
For bitcoin, the blockchain enables the movement of money without a bank or central authority. For banks, the blockchain promises to virtually eliminate the risk that arises during the lag between a transaction and its settlement.
As Oliver Bussmann, chief information officer of UBS explained in August to CIO.com, instantaneous settlement means that someone who buys a share of stock for $100, for example, would settle the trade at $100, compared with a trade that takes days to clear, during which time the value of the share might fall, with the buyer bearing the risk.
Magnify that and you can understand why banks are experimenting with the blockchain. “The ability to do those changes within minutes or seconds instead of waiting two days for an execution… is a big change,” Bussmann said.