Over the past two decades, technology has revolutionized trading, execution and investing-and the pace of change is only accelerating today.
I believe that we are, for fans of The Matrix, at a "blue pill or red pill" moment for the financial markets: We can choose to see reality as it's presented to us, or as it truly is. What if data were available to see the flaws, the gaps, and the distortions that form the basis of the financial markets today? What if the "bid" and the "ask" for every OTC market were available, and the "price" and "value" of the underlying instruments were clear and referenceable? How would that change research, portfolio theory, trading and the banking system as a whole?
Data, particularly financial data, looks and feels a lot like something too 20th century for any technologist to want to admit: petroleum. Think about the vertically integrated process that precedes pumping gas into your car. Underground and underwater exploration leads to drilling, a pipeline is built to transport the crude to a refinery, where it is distilled and turned into consumable products, at which point it is thrust into a distribution network, where consumers can get petrol for their cars or 3-in-1 for their garage.
It might seem strange in today's world of zeroes and ones to equate financial data to a fossil fuel; however, products with such high data value as stock loans, OTC swaps, and derivatives; and markets like corporate bonds, muni's, mortgages, and foreign exchange are data deposits as rich, untapped, and necessary to economic development as the Permian Basin, North Sea, or Saudi Arabia. The problem is that the drills, pipelines, and refineries for data technology have been siloed, rather than vertically integrated to capture this financial crude and distill it for consumption, until now. Technology, regulation, and capital markets are about to meet at the corner of Blockchain & Data.
- TheStreet's "Investor Boot Camp" conference hosted by Jim Cramer on May 5 is a must attend. Learn more here.
For the last two decades, capital markets regulation has resulted in a focus on speed of trading and investing. Speed became the focus because there is a standardized data set enabled by the FIX ("Fixed Information Exchange") Protocol, which allowed tech-enabled trading to go faster and faster. In today's world, the focus of technology is not on performance, but on payments, and permissionless, decentralized ledgers, otherwise known as DLT or blockchain. However, the way equity trading evolved is instructive, because speed and choice followed standardization.
Blockchain-The Next Revolution?
For more than three decades, the crypto-anarchist Cypherpunk movement has been at center of debates over digital privacy and the use of cryptography to achieve social and political change. But the movement did not truly hit its stride until the pseudonymous Satoshi Nakamoto published the now-famous Bitcoin white paper in late 2008.
Arriving during the depths of the Financial Crisis of 2007-2008, the concept of a decentralized ledger found a ready audience among students and intellectuals with coding skills. Rather than "occupy" Wall Street, blockchain technology provided a means to attack the status quo by developing new ways to pay, store money, and disintermediate networks of economic trust, so that it can all be done from our phones, and without banks.
Over the past 12 months, cryptocurrency and blockchain technologies have exploded further into public consciousness, leading to greater attention from investors, the financial press, and regulators alike. Many mainstream commentators have heralded blockchain as the next great financial revolution-but even crypto's most ardent proponents will readily admit that the technology is still in its infancy.
While distributed ledger systems do hold great promise for a variety of future applications, it will lead to something quite counterintuitive: Settlement cycles will go to zero, but price discovery will get harder and harder.
If we look at equity market structure as a precursor for what will happen in blockchain, the results are fairly easy to predict. In equity markets, the speed at which trades are now executed is pushing the limits of computer technology, and commission rates have dropped-but the constraints of liquidity and true price discovery, the key elements of trading, have made running a portfolio more difficult.
Overlay that with more stringent capital rules, and it is no wonder that active managers, though coming off of a good year in 2017, have found the current market, and its volatility, to be challenging. One word of advice for the Silicon Valley types thinking that blockchain is an irresistibly disruptive force: Wall Street is skilled at separating price and value, time and money, speed and risk. For all of you thinking that DLT will replace prime brokerage, custody, swaps and revolutionize capital markets, think invisible ink.
Pricing, Pricing and More Pricing
The performance and payments revolutions have created a voracious appetite for better pricing data, including more transparent reference data, metrics, indicators, benchmarks in both listed and unlisted markets. An era of vastly greater informational integrity is here -- the tech exists, and unified protocols are already being adopted. The establishment of these protocols will lead to a reinterpretation of established benchmarks, financial indicators, and government statistics over the next five to 10 years.
Among the first things to go will be those benchmarks and indicators that rely on contributory submission, where bad data tends to be ignored and tolerated.
While our focus at S3 Partners isn't specifically on blockchain, we are excited about the power and insight that financial technology and data analytics can bring to existing market structures. It is clear to us that the industry is in the midst of a revolution that will have enormous consequences for the future of global finance. With new protocols and technology, financial market participants will finally be able to answer the question, "What is real?"
Bob Sloan, the Owner of S3 Partners, has been recognized by Institutional Investor as one of the leading innovators in trading technology and is in the Global Custodian Hall of Fame. S3 Partners is a market-leading financial technology and analytics firm in New York, whose Prime Information Exchange ("PIX®") protocol harmonizes and standardizes data for all listed and OTC markets and products.