Zero Hash and the Future of Post-Trade Settlement for Digital Assets
Today, we announced the launch of our settlement solution that aims to solve the series of post-trade challenges that face the digital asset industry. Zero Hash, a wholly owned subsidiary of Seed CX, already services our own markets, and now we are excited to announce that it is being implemented into the trade cycle of traditional brokers, single-dealer platforms, FX ECNs and other institutional trading venues.
What is Zero Hash?
Satoshi Nakamoto’s whitepaper Bitcoin: A Peer-to-Peer Electronic Cash System, described Proof-of-Work in the following way:
To implement a distributed timestamp server on a peer-to-peer basis, we will need to use a proof-of-work system… The proof-of-work involves scanning for a value that when hashed, such as with SHA-256, the hash begins with a number of zero bits.
We can therefore say that settlement finality starts with a “zero hash.” As a company, Zero Hash makes settlement finality its primary commitment. We deliver on this core focus by serving our customers in the following roles:
- Calculation agent. As a calculation agent, Zero Hash acts in good faith to make determinations relating to any adjustments, valuations, settlements and compressions that occur throughout the life of a trade. This includes the calculation of initial margin, variation margin and final settlement, amongst others, for spot, repo and derivative transactions (forwards, options and more).
- Settlement agent. As a settlement agent, Zero Hash effectuates the movement of fiat currency and digital assets as a result of trading activity. Zero Hash maintains an internal ledger of ownership of fiat currency and digital assets and, with regard to digital assets specifically, actually performs “on-chain” settlements (something we’ve written about before — here and here).
In short, Zero Hash is an institutional settlement utility for the digital asset space.
Right now, Zero Hash is being used as the settlement backbone for all trading on the Seed CX spot market, Seed Digital Commodities Market. In the near future, Zero Hash will also provide settlement for trades executed on the Seed CX derivatives exchange, Seed SEF. Zero Hash has been designed and built from the ground up to receive trades from multiple sources.
Today, we’re proud to announce that Zero Hash is actively integrating its offering of calculation and settlement services to groups that are looking for a trusted source to manage post-trade operations. We call this service offering Settlement-as-a-Service, or “SAAS”. SAAS is designed to settle trades for dealers, Over-the-Counter (“OTC”) brokers, exchanges and funds. The message to any potential client is simple: we’ll look after the post-trade and let you focus on what you do best — matching and execution.
What are we solving?
Post-trade settlement infrastructure in the digital asset space is sparse, resulting in a fragmented market with significant room for improvement. Let’s think about some of the largest problems that exist in digital asset trading today.
- Who goes first? Counterparties that submit orders to buy and sell to OTC brokers must move capital between each other post-trade. This is currently a process whereby one party “goes first,” i.e. one counterparty must send the cash before receiving the purchased asset, or vice versa. The counterparty risk is especially real when either counterparty is new or relatively unknown — a common occurrence in a burgeoning industry such as digital assets.
- Regulatory risk. Overcoming regulatory hurdles can be a difficult and prolonged process. FinCEN considers the movement of currencies and digital assets to be money transmission. Even principal traders are arguably covered, meaning that any group receiving and paying customers for digital asset trading is at risk of noncompliance.
- KYC/AML risk. KYC/AML is a strict regulatory requirement for entities dealing with money, which encompasses digital assets in multiple jurisdictions. This is a regulatory burden and requires significant infrastructure to perform sufficient review — not only on counterparties to a trade, but also on every inbound and outbound transaction.
- Poor transfer rails. Another problem related to settling against many different counterparties in different forms is the overhead of managing the various delivery mechanisms. Difficulty obtaining and keeping banking partners in various fiat currencies, varying custody solutions, wildly different APIs, etc. mean that every counterparty requires an individualized process. This forces unnecessary overhead onto companies whose primary business value is trade execution.
- Insufficient trade reporting. Traders’ accountants often require detailed reporting information, yet access to data is often a complex and difficult process.
- Capital inefficiency. The digital asset space is highly fragmented. Having to store capital across many exchanges, dealers and brokers is capital inefficient.
- Operational burden and security risk associated with key custody. There is a large threat and risk with regard to holding private keys. As I wrote in a previous blog, one recent report estimates that investors have lost $880 million in the last two years to hacks and scams.
What’s our solution?
Zero Hash has been built to address each of these issues head on.
- Escrowed capital and PVP transfers. The Zero Hash SAAS solution allows users to deliver fully executed transactions to a known service provider (Zero Hash) who ensures that movements are only executed when both sides have fully funded, i.e. payment-vs.-payment (“PVP”). This completely eliminates the question of “who goes first?” and allows counterparties to more freely execute against one another.
- Regulatory umbrella. Zero Hash is a registered Money Service Business (“MSB”) and FX Dealer with FinCEN (US Treasury), and money transmitter in 31 of the largest states across the U.S. This infrastructure can be leveraged by participants uninterested in the regulatory investment and resulting overhead.
- KYC/AML support. Leveraging the Zero Hash compliance and operations teams allows customers to connect with more counterparties in a secure way. Leveraging the review performed by Zero Hash can increase the liquidity pools available to any one participant. Your KYC/AML process can be simplified to “Are you on Zero Hash?”
- Flexible trade-reporting system. The Zero Hash SAAS solution provides multiple entry points to deliver trades: REST API, FIX STP, instant messaging, phone, email and a web-based GUI.
- Sophisticated downstream reporting. Zero Hash focuses on reporting infrastructure compatible with fund administrators and accountant needs. Zero Hash is also in progress to secure its SOC 1 status.
- Capital efficiency. Having one (or fewer) spots where capital is held can improve trade and settlement efficiency, thereby increasing the ability to trade across many platforms. Capital held at Zero Hash can also be allocated to settle trades executed on Seed CX markets or on third party platforms. Further, Zero Hash, as a registered FX dealer can facilitate the conversion of the 19 different fiat currencies and all digital assets that it supports.
- Secure key management. Zero Hash has made a huge investment into secure key management, with vetting from various regulators. Using Zero Hash allows groups to easily access multiple digital assets and 19 fiat currencies.
How does it work?
Our website offers an interactactive graphic on the post-trade flow, and how Zero Hash is involved. There are two types of trade reporters: a standard participant looking to report some trades for settlement, or a “Platform Operator” looking to use Zero Hash as a complete back office solution to their execution venue. The process is effectively the same for both.
Trading occurs on Zero Hash-supported platforms
Orders are submitted to the various platforms run by Platform Operators partnered with Zero Hash. Supported platforms include Seed Digital Commodities Market, Seed SEF, OTC brokers and other execution venues to be announced soon. To our own market, orders can be submitted over a rich API, over our robust trade GUI or through one of our connectivity partners. Once orders match, a trade is executed.
Trades are submitted to Zero Hash
Trades are delivered to Zero Hash as they are executed in real-time or in batch format. This will generally be done by the Platform Operator, however participants can also submit trades to Zero Hash directly. Zero Hash prioritizes maximum flexibility, and so trades can be delivered over a REST API, a FIX straight-through-processing (“STP”) facility, instant messaging, telephone, email or GUI. Additionally, there are two main methods of trade acceptance: single-sided trade submission and dual-sided.
- Single-sided is the process by which only one side is considered “confirmed,” therefore requiring the other counterparty to confirm the alleged trade. This is suited for any trade reporter that is also a counterparty to the trade, e.g. a principal dealer.
- Dual-sided is the process by which both sides are considered confirmed at entry. This is only allowed when both sides have authorized the trade reporter in advance to submit trades on their behalf. This is never allowed when the trade reporter is a counterparty. This is therefore perfectly suited for an agency broker.
Trades are gated
Different Platform Operators desire different styles of settlement, with different types of settlement schedules. For example, a Platform Operator may wish to settle all trades every day in batch at 4pm CST, with the ability to let trades roll over to the next day if a counterparty cannot deliver. Zero Hash can offer this level of customization in what it calls a “gate.” Trades are therefore gated, per platform, until certain settlement criteria are met. Once met, the trades are released for calculation and settlement. Trades may be gated until a certain time (scheduled settlement), until a certain net notional threshold is met (notional settlement), or trades may not be gated at all (instant settlement).
Obligations are calculated
Margin and settlement obligations are calculated by Zero Hash in its capacity as calculation agent. Each trade is passed through a system that determines movements that must occur for each transaction. This includes initial margin, variation margin, final settlement and more.
Movements are executed
Settlement obligations are pooled per participant and movements are executed. Settlements are initially completed off-chain within Zero Hash’s secure ledger infrastructure as a FinCEN-registered Money Service Business and money transmitter. Based on Platform Operator preference, trades may be allowed to roll across multiple settlement runs, to provide counterparties with a window to deliver into, or exit, a position.
Movements are prepared for on-chain settlement
Zero Hash uniquely offers a segregated wallet per participant, per coin. So the next stage of settlement involves the isolation of digital asset movements for delivery to the Zero Hash Digital Asset Vault. The Vault performs a number of reconciliation checks, and once complete, transactions are prepared for delivery to the blockchain.
Each transaction requires signatures from two of three private keys for on-chain settlement, plus manual review and approval by the Zero Hash Ops team. Once the transaction has received signatures and the required manual approval, the Digital Asset Vault then delivers the signed transaction to the blockchain for on-chain settlement. Once the blockchain network confirms the transactions, the process is complete and settlement finality has truly been achieved.
The digital asset market is rapidly evolving. We are bullish on the growth of lit exchanges that offer the ability to execute considerable size in a safe and secure venue, including our own market. However, we appreciate that exchange trading will never be the only form of execution that is utilized. Across the market, different matching protocols will evolve and co-exist. Models that are popular in the digital asset space today include phone-based execution, instant messaging, price streaming and RFQ. All of these models result in bilateral trades, generally of larger notional size. Our SAAS infrastructure is venue agnostic and compatible with any execution model, which makes it perfectly suited to solve the significant challenges that exist in the post-trade cycle today.
In other markets, settlement banks serve the back office role. But most settlement banks have not entered the digital asset space to the level that is needed, and hence there is a gap and a need to service the OTC community.
The digital asset space needs an institutional-grade settlement utility. The time for Zero Hash is now.