Why we don’t do Listed / Public Equity

Technological, Operational and other limitations

Numerous crypto-startups have moved to put publicly traded securities on the blockchain. In this piece, we’ll discuss the challenges in doing so, the pitfalls numerous crypto-startups are ignoring, and highlight companies that are developing solutions that address these issues.

1. Blockchains are not fast enough

With confirmation times in the seconds rather than microseconds, its puzzling that this is the focus area of numerous crypto-startups.

Almost half of listed equity trading today is High Frequency Trading (HFT). Where traders set-up their operations as close to the exchange as possible, to reduce latency. That is how important a low latency / high speed connection is to their operating models.

US HFT volumes as a percentage of total have stabilized around the ~50% mark over the last five years

While HFT activity as a percentage of total has started to fall over the last five years, it still constitutes a good chunk (~50%) of total volumes.

For context, Ethereum’s confirmation times are competing with Nasdaq’s low latency of < 40 microseconds.

2. Public Blockchains are… Public

Quick example, Alice wants to buy 1,000,000 shares in AAPL — the share price is US$ 200 at the time.

1. Alice executes this trade, broadcasting it the Ethereum network with a gas limit of 42,000.
2. Bob sees this transaction before it gets committed to a block, and executes a trade for 100,000 shares in AAPL. He sets his gas limit at 126,000.
3. Bob’s transaction gets committed at the price of US$ 200.00.
4. Alice’s transaction gets committed at a higher price.
5. The price of the AAPL share goes up thanks to Alice’s sizable purchase.
6. Bob sells his shares, benefiting from being aware of Alice’s transaction in advance of its commitment.

This is known as front-running.

Note, Bob could also just monitor the network and execute his trade off-chain, using one of the many non-blockchain platforms available. He could also collaborate with others on the network, etc. There are numerous ways he can exploit the fact that dissipation of information is uneven.

He could collaborate with other participants in the network to increase this information asymmetry.

This could be solved at the protocol / order-book level, with companies like AirSwap, but we would be redesigning the way trading / order books are executed. So this would be largely incompatible with legacy / off-chain systems.

3. Regulation in this space is unfavorable

While volumes on these platforms may remain low enough to qualify for licenses that are easier / less nuanced to obtain, listed equity is still a heavily regulated space and will be quite difficult to disrupt.

Generally, regulation has been increasingly favorable, with crypto-startups emerging across the globe, listed securities is not something that is likely to change overnight.

While blockchain regulation has been favorable, this is unlikely to spill into Capital Markets Regulation in the short / medium-term (under 4 years)

Potential Solutions

Significant work is being undertaken on both Ethereum and other protocols to increase speed, efficiency, cost and privacy of transactions. We’ll see these addressed gradually as the ecosystem gets built-out:

1. zk-SNARKS: More computationally efficient zero knowledge proofs will help implement private trades
2. Side-chains / State Channels: Off-chain solutions provide potential workarounds, but these require reliance on a trusted party, i.e. do not capitalize on the main benefits of blockchain technology / no different to existing off-chain solutions

Conclusion

That being said, we still do believe there is value in trading listed equities on-chain — i.e. trustless transactions can facilitate seamless settlement, trading and clearance. In addition, smart netting mechanisms, enforced by Distributed Ledger Technology, could heavily reduce the cost base of clearing offices.

However, adoption / implementation is likely to happen through an incumbent player (securities exchange, settlement and clearing house, regulator, etc.), fully supported by Capital Markets regulators / watch-dogs.

The underlying securities will be represented by tokens in the back-end, and brokerages, trading platforms and other players will continue to operate as they do today. This hybrid model will facilitate faster and private trading, while simultaneously leveraging blockchain technology to deliver lower settlement and clearing costs.

We find it extremely unlikely that a new entrant with a limited track-record and experimental technology, will be able to disrupt a highly political industry. Not yet at least.

That’s why we don’t do listed equity.

Jibrel provides traditional financial assets such as currencies, commodities, debt instruments and securities, as standard ERC-20 tokens, on the Ethereum blockchain. Jibrel is a Jibrel AG initiative. Jibrel AG is registered in Zug, Switzerland, Qubist Labs Inc is a software development company based out of New York, US.