Episode Transcript
[00:00:00] Speaker A: Foreign.
[00:00:05] Speaker B: Welcome again to the next episode of our podcast series. This time again, we got me, Alberto Corvo. I look after the payments and infrastructure business here for Alvarez and Marcel. And I have two very esteemed guests who I've had the luck to know and work with for quite some time.
And I'll ask them to introduce themselves. Dick.
[00:00:27] Speaker A: Hey, Alberto, thanks for having us. Dick Taggart here. I am CEO of L4S Corp. Our product, Tapestry X is what we're going to talk a little bit about today and some of the needs in the market that we see.
My background is 40 years on infrastructure and Wall street at a broker, dealer, custodian, depository. Kind of went around all the bases over the course of my career and now find myself in a fintech trying to help solve some problems that still persist in the industry.
Thanks for having us. Turn over to Paul.
[00:00:58] Speaker C: Yep. Hi, Alberto, I'm Paul Dowding. I'm co founder and head of design for AlphaScore. With Dick mentioned our protocol, Taps reacts. I did start my career as manufacturing engineer, but transitioned to banking operations and similar to Dick, a long career in terms of operations management, product management, and strategy and innovation, all predominantly around global infrastructure, working with banks, with brokers, custodians, clearing houses, fund managers around the world.
And that's led to me seeing the potential of distributed ledger technology, or blockchains, and the requirements to really meet the very demanding needs of what are the financial and capital markets.
[00:01:44] Speaker B: Yeah. And just to dive right into it. So the promise of the technology, the technology has been around for a while, right? For a long while. I might even say. I always tell people that five years in technology is one geological era. So we are well into two geological eras, almost three. And while a lot has been done with this technology, there's still some issues. And as we try to leverage it for our industry, we always seem to hit the same problems. And so I think it's interesting to look how the market has addressed this issue. Right. So the story here is like everything is being recorded in our industry in ledgers, Right.
That's how it has been done. There's big ledgers, blotters, list of things, ladders, cash ladders, call it whatever you want, but at the end of the day, it's really a ledger.
When we started going towards more of blockchain, we lost the concept of the ledger. People seem to have forgotten about the ledger and all of a sudden everything had to be encapsulated into a smart contract, which makes sense in many ways, but also offers some Challenges. Right. Because how do you record future obligations within a smart contract?
And what I thought was interesting, we have a next episode that with someone that's going to say, no, no, the smart contract does everything because the smart contracts have the mutually agreed obligation. There's if, then else logic. It automates it. But then you lose kind of the traceability. And people say, no, you know, you don't need a traceability. You guys went for a completely different approach, which is more akin to what's been in the industry for quite some time. So, Dick.
[00:03:36] Speaker A: Yeah, let me, let me. Yeah, so you're right. We all grew up with, with everybody having their own ledger, right? The banks have a ledger, the brokers have a ledger, the asset managers have a ledger, the custodians have a ledger. They'll record it themselves and they do a lot of reconciliations between them. Right. So the prospect of a distributed ledger, where everybody's sort of operating on a single ledger is pretty interesting to all of us. Right. When that pot came out in whenever it was 20, 15, 16, in that, it would make sure that you didn't have breaks between the various counterparties. Right.
What we observed, however, was that the early distributed ledger technology, dlt, all those first generation shared ledgers, to use that term, did not have the ability to record a future obligation. They just recorded a settlement, a transfer between one party and another. Right.
It was a record of transfers as opposed to a proper accounting ledger that had debits and credits for future obligations that ultimately got reversed when those obligations were satisfied.
Right. So we believe that's one of the biggest sort of impediments to take up an adoption in the capital markets, because the capital markets are all about future obligations. Trade today, net it, finance it, settle it later. Right.
Give somebody a bond, pay interest over the next 30 years. Those are all obligations. And if you're not recording those obligations, you kind of only have the tail end of the transaction life cycle.
And it's not that useful to be, frankly. Right.
[00:05:03] Speaker B: And that's why, when I hear distributed ledger, I think it's a misnomer, actually, because it's missing the time portion. So it's a ledger without the time. And then. Is that a ledger?
[00:05:16] Speaker A: Yeah, it's a transaction log. So it is recording a log, but it doesn't have the notion of a future obligation like most ledgers would have. If I owe you some money, you write down your ledger. Right. Credit of account receivable. Right.
Doesn't have that in the existing dlts.
[00:05:29] Speaker B: Right?
Yeah. And so you know, I know and probably everybody knows how a smart contract tries to tackle this, but as I said, that will be for another episode in this case. What have you guys tried to do? And there's other people have thought about it, but what have you guys tried to solve for and how.
[00:05:53] Speaker C: There's a couple of things that, you know, when Dick was talking about it, that fundamentally, you know, it's a state change or transition, a transaction log, and it's in continuous part of the, you know, blockchain is a continuous hash linking, but they also made the ledger sort of continuous. So it doesn't actually have the concept of a transacting period. You might record an event on a day, but that's it. So because there's no transacting period, there's no concept of the future, because if you can only do a transfer, you can only do it today and you can say what happened in all the history.
So there's one sort of fundamental thing of this being a continuous chain that only goes up to today.
Then the second thing is really, and this is what's the origin of smart contracts is the fact that Bitcoin could allow you to move Bitcoin from one person to another. And when Vitalik Buterin created Ethereum, he said, I need it to do more than that or I need it to be conditional.
Well, there was no life cycle engines in crypto, there was nobody trading them. So he created smart contracts to say I need a process to do other things that are conditional. But again, it's relying on that state change log rather than anything else. What we said was, how do you do a ledger? You know, every day or every period you have starting balances, transactions and ending balances. You archive the transactions, carry forward the balances, but that gives you a transacting period. You've still got a continuous hashlink record, but you've got distinct periods. But if you're hash linking journals, accounting journals, double entry accounting journals, you can do payables and receivables in the future date. Whereas really a blockchain, the classic blockchains are just a single entry ledger. They're just recording a balance of one person versus a balance of another person. There's no independent ledger accounting for all the activity.
And so our design looks like a ledger that's today, but also accommodates all the types of transactions and particularly future data. Paired receivables.
[00:07:54] Speaker B: Yeah.
And again, it's an interesting concept because as I think about how things evolve through time, it allows you to see an evolution without Having to analyze the whole blockchain, because you could, in theory, you could do the same with the current technology, but then you have to build it on top, and you have to say, okay, what has happened? What has happened to this particular thing? Until you can reconstruct, you're essentially doing a trial balance and then a reconciliation, and then you put it together, which is doable, but it's not.
[00:08:28] Speaker A: Everybody does that today with their central ledger. Right. They're just not doing it on a truly networked basis with all their counterparties. That's the missing piece. Right. They're sending messages back and forth about transactions, and then they're independently doing their ledger thing and trying to reconcile those things. And there's always differences for various reasons.
[00:08:46] Speaker B: Yeah. Which is what creates the operations and what creates good operations versus kind of okay operations.
So, yeah, that's exactly what's been the history. So I think that as we go towards a more distributed, true ledger with smart contracts layered on top of that, then you can have kind of the best of both worlds, which is probably gonna take a little bit, but at least there's very smart people and very smart money going into solving this type of issues.
But then the natural next step is to talk about interoperability, right? So when we talk about that is to say, okay, that's fantastic, but all of this works if you are on the same dlt, and how do you get these different protocols and different chains to communicate with one another?
And how do you integrate or reconcile or make sure things happen the way they are supposed to be without compromising control? Because again, very, very old client of money used to say, if I have to break budget or control, I break budget 10 times out of 10. But control, it's sacred. So I always start from that. How do you not raise control? And when you start having the same information or even two different views of the information to different places, then you start having that issue.
[00:10:14] Speaker A: So, yeah, I would say if you look at history. Right. Well, I grew up in capital markets as they became globalized, right. And I can remember when I started at Morgan Stanley. Long time ago.
Right. And we were investing internationally. Every market had its own protocol, right. Uk, Japan, Australia, India.
We're sending faxes to them to move cash and securities and settle trade. So ultimately, the Swift network evolved as a standard, Right. For interoperability between those markets, even within the US Market. Yeah. Lots of different protocols for different asset classes. And so the industry developed standards to harmonize things, centralize things.
And so we're an early stage now of the whole kind of cryptocurrency, tokenized reward assets. And the same thing's going to happen. Right. You've got lots of different protocols, rightly so, developing, trying to find ways to get traction. There are also firms in place to standardize, interoperate up, operate them.
Some of them are robust, some are not so robust. Right. You got to really do your homework on how secure is that link between A and B and does it really give you as an institution in particular. Right. Which is our background, the security you need to know your assets are settled properly and held properly and all that.
[00:11:35] Speaker B: Yeah. And when you think about it, would having a common true ledger allow for some easier interoperability? As long as people write onto this ledger being entitled with some common language and understanding then how it's implemented on different chains, that may be. So instead of having the interpretability at the top, maybe we put it at the bottom of the chain.
Once it's executed, that comes as a result.
[00:12:08] Speaker A: It's a question of how do you get to critical mass though, right?
[00:12:11] Speaker B: Oh, of course.
[00:12:12] Speaker C: No, I said that's, that's. I think that's the, one of the key issues and that's actually the real potential of blockchain or distributed ledger technology is that it becomes a consistent protocol to merge all types of assets. And if you think about it, in the current days, what Dick was saying is the big brokers, the big banks basically were an entry point to the multiple infrastructures. So the interoperability or the transfer between markets was done as a layer above the markets. And if you look at all the blockchain protocols, they're very specialized or they're very use case driven and they tend to be these walled gardens. So the solution apparently is to create a layer above it and then try and bring all them to talk to each other. Whereas really just what you just said. The point is if they start to operate on the same ledger, then once you've tokenized an asset, you've got the same protocol regardless of where the asset is or what type of capacities. And therefore you create interoperability by its universality, not by just linking everything. And that's our approach.
[00:13:20] Speaker B: Yeah. And offers much more freedom to implement on top as long as you write in a consistent, in an orchestrated fashion. That brings other issues as to, okay, who's entitled to write, who's entitled to write rot. Who agrees that that needs to be so not simple, but it's definitely something that could address the interoperability questions.
[00:13:43] Speaker C: Well, that's the other Thing is, the network to network connection is like, you know, the old banking or brokerage networks without the clearinghouse, they had accounts with each other, so they were debiting and crediting their accounts. But matching, that's what you can also do. Network to network at the same protocol. A lot of the linkages today rely on and again, sort of like having a, what they call a wrapped asset with a smart contract. But that's not a direct linked or control point between two. It's just saying if everything's untouched and the smart contract runs and everything will be fine when it comes back. But it's, there's a lot of, you know, there's no guarantee of the control or the certainty in that. Whereas with the accounting, you've got a fully reconciled and accountable ledger to say, I own that and I can bring it back if I want to.
[00:14:33] Speaker A: The world figured this out with Internet protocol, common standard. It figured it out with telephone protocol. You can pick up your phone and call anybody in the world.
I think it'll ultimately shake itself out here.
Whatever is simple and robust will ultimately people will gravitate to.
[00:14:49] Speaker B: No, absolutely. But what the big difference is, I think in both of the things you said, and this brings us to a topic of data management and its governance, right, Security master. It's always been an issue in our industry and everybody has its own security master. And that creates, you know, for us, you know, all walls in the industry.
Issues with reconciliations is issues with, you know, who says what, who pays what, the collateral. I mean, it's the, it never ends. So one of the things that could be interesting in this is, okay, is there a way to centralize the data governance?
But again, who does what, how, who says what is correct.
But yeah, how do you see this happening leveraging smart contracts and at a distributed level, do you think?
[00:15:51] Speaker A: Yeah, look, if you think if you narrow it to tokenized real world assets, tokenized stocks and bonds, right, which all have their traditional market reference data, right, Their ISIN number, some of the basic information about the asset.
Even today in the world we live in, people get that data different in their different ledgers and it causes reconciliation breaks. If we get to a more commonly used protocol that everybody's using, part of the governance of that set of participants will be to agree on the market data, the reference data that will be used. Right. The core reference data. To know what is, what an asset is, you've got to sort of agree on that. Just like everybody agrees on telephone numbering system or a URL address right above that you can have all kinds of variations. People may disagree on what the earnings potential of an income asset is, but there's got to be some core data that everybody sort of signs up and agrees.
[00:16:50] Speaker B: No, but I understand for stocks and bonds. But what do you do when you start having more complicated things like derivatives, OTC derivatives, loans.
[00:17:01] Speaker A: Yeah, it's a hard one. Right. Because you may have bilateral agreement between two counterparties on that they have to agree terms on an over the counter contract.
But once it gets into a wider community, you might have some differences when you try and clear those things.
You know, again, I think the market was pretty successful with clear derivatives because they were able to get some of that core reference data to be agreed and used in common.
[00:17:25] Speaker C: And although a clearinghouse or the, you know, has the benefit of being, you know, can be a central authority for the ultimate settlement and their referential data. A lot of the problems with referential data is that the participants are recording the securities in multiple systems and the discrepancies are between those systems.
But the opportunity with a distributed ledger is not only do you have that central authority to agree the consistent, but that becomes the ledger that the participant is then using. They're not recording it in their ledger and then sending it. They're actually using the distributed ledger as their primary, their sub ledger to their general ledger as opposed to they've got a general ledger, their system, and then it talks to a depository and those gaps are where all the inconsistency come in. So we, if we can start to remove those gaps and the goal would be that then that becomes the golden copy to flow up to the other ledgers. And so there's, there's a, exactly the point you're making. It's not a centralized control, but it's a consistent control across the network.
[00:18:30] Speaker B: Yeah. And, and if you were to have this golden copy that is shared and everybody agrees that that's the way to go, then everybody takes from the city central. Well, applies it to his own system because they're not going to change the current systems and the current system are not going to just do it regular. So regularly you bring it in, you use that. And that would cut a lot of the discrepancies that then it remains because different systems record things slightly different. And so there will be a challenge to interfacing. But I think that besides the tokenization of real world assets, I think that this type of opportunity with the centralized data is probably one of the most interesting things that are going to happen on dlt. And I keep hearing and seeing people investing in that to be able to create that, because.
And it's one of those network effects. The more people are going to get in, the more, the more it's going to happen. And an industry utility will have to step in and set it up. But that's probably the most interesting thing.
So as we come towards the end of our podcast, Dick, what do you think?
What do you think the next five years will bring to this technology? Another geological era? Where are we going to be?
[00:19:56] Speaker A: Look, I think the first five years, you often use the analogy, right. Is you got a bunch of engineers sitting around, around a table. Somebody came in and they dropped a bunch of transistors on the table and said, why don't you see what you guys can figure out, what these things can do, right? And so there's been a lot of sort of, you know, put some juice into the transistor, see what it does, see what you can make happen. Experimentation, I would call it. Right. I think that time period, that era is now over. We know what it can do, what it can't do. I think people are now going to get real.
We're seeing this already with, what are my business requirements for replacing my traditional central ledger with a distributed ledger that's got real accounting in it, as we talked about, as those requirements get clear and people look around for solutions, they'll find some. Also find things that don't work and don't scale.
You'll have a gravitation to solutions that meet the full requirements of the existing players, and you'll have capital flow there and you'll have adoption. And that'll. That will take out a lot of cost. Right. All that reconciliation cost that goes across the industry, it'll. It'll help with the creation of new products and services.
Right. That. That aren't able to be done today because it's just too much friction.
So reducing costs, reducing risk is, Is huge for our industry. Right. And that then opens up kind of new product, new revenue, the ability to sort of democratize a lot of this finance and get it all the way out to the front end, right. Into the, into the, into the hands of retail investors without all the middlemen. That's the play.
[00:21:35] Speaker B: Yeah, I would agree. I mean, I think that the future is going to be even more exciting than the last few years because now we are really into an institutional phase for all of this, and that's where we really switches gears.
[00:21:52] Speaker C: Yeah, I think I always love the Yogi Berra quote that the future Ain't what it used to be. But the one analogy I always like to use is if you went to the late 90s and you went to a telephone company and said, In 20 years your major competition is going to be that nascent online bookseller, Amazon, and that DVD delivery service called Netflix, they'd have looked at you and said, how?
Right. And then it's because the Internet protocol made communication commoditized and content became key. And so the telephone companies got in with cable companies and these distribution services got into content distribution.
So, you know, it's very hard to imagine what could happen with, with distributed accounting technology being, you know, commonplace. But the real threat to the banks and brokers if they don't get with the program.
There's big companies with natural networks, social media, telephone companies, mobile phone companies, even retail stores like Walmart. They have natural networks and they have limited banking and brokerage licenses. And there's the real potential. People could take a greenfield site and use this technology to just implement a new market or replace an old one. And so this is where I think you're right. We're at the institutional phase where people are taking this seriously and they're working out how to make it. But the competition could come from really some surprising places, I believe.
[00:23:17] Speaker B: Yeah, yeah. And look what I love about technology, what I've been loving about technology for the last 40 odd years, it's the ability to make us do things and allow us to do things that nobody had thought before. So. So yeah, I'll leave you with that thought. Thank you very much, Deacon Paul. Thank you very much for whoever listened to, to this. And again, we're looking forward to another of these in five years where we'll see right or we were wrong.
[00:23:44] Speaker A: Okay, thank you, Alberto.
