Craig Pirrong is Professor of Finance and Energy Markets Director of the Global Energy Management Institute at the Bauer College of Business, University of Houston. He has a PhD in Business Economics from the Graduate School of Business at the University of Chicago.
In this opinion piece, Pirrong takes a hard look at the hype surrounding blockchain technology and finds that it isn’t necessarily justified.
If you’ve been paying the slightest attention to financial markets lately, you’ll know that blockchain is The New Big Thing. Entrepreneurs and incumbent financial behemoths alike are claiming it will transform every aspect of financial markets.
The techno-utopianism makes me extremely skeptical. I will lay out the broader case for my skepticism in a forthcoming post. For now, I will discuss a specific example that illustrates odd combination of cluelessness and hype that characterizes many blockchain initiatives.
Titled “Blockchain startup aims to replace clearinghouses,” the article breathlessly describes a post-trade start-up based on hyperledger technology that it says is designed to “disintermediate central counterparties (CCPs) from the clearing process, effectively removing their role in key areas”.
I have often noted that CCPs offer a bundle of many services, and it is possible to considering unbundling some of them. But there are certain core functions of CCP clearing that this blockchain proposal does not offer.
Most importantly, CCPs mutualize default risk: this is truly one of the core features of a CCP. This proposal does not, meaning that it provides a fundamentally different service than a CCP.
Further, CCPs hedge and manage defaulted positions and port customer positions from a defaulted intermediary to a solvent one: this proposal does not. CCPs also manage liquidity risk. For instance, a defaulter’s collateral may not be immediately convertible into cash to pay winning counterparties, but the CCP maintains liquidity reserves and lines that it can use to intermediate liquidity in these circumstances. The proposal does not. The proposal mentions netting, but I seriously doubt that the blockchain – hyperledger, excuse me – can perform multilateral netting like a CCP.
There are other issues. Who sets the margin levels? Who sets the daily (or intraday) marks which determine variation margin flows and margin calls to top up IM? CCPs do that. Who does it for the hyper ledger?
So the proposal does some of the same things as a CCP, but not all of them, and in fact omits the most important bits that make central clearing central clearing. To the extent that these other CCP services add value–or regulation compels market participants to utilize a CCP that offers these services–market participants will choose to use a CCP, rather than this service. It is not a perfect substitute for central clearing, and will not disintermediate central clearing in cases where the services it does not offer and the functions it does not perform are demanded by market participants, or by regulators.
The co-founder says “[c]entral clearing is turned into distributed clearing.” Er, “distributed clearing”– AKA “bilateral OTC market.”
What is being proposed here is not something really new; it is an application of a new technology to a very old, and very common, way of transacting. And by its nature, such a distributed, bilateral system cannot perform some functions that inherently require multilateral cooperation and centralization.
Article Source: http://www.coindesk.com