The Australian Stock Exchange (ASX) made a big splash recently announcing the cancellation of their blockchain project after spending—and writing off—$165 million. While this sounds disastrous for blockchain technology, it is actually a cautionary tale since the blockchain project of ASX is based on Ethereum.
We have been saying this for over three years: public blockchains for securities and derivatives is a bad idea. In fact, Vitalik Buterin, one of the principal developers of Ethereum, himself noted back on May 19, 2016 that “…the weaker argument, that for high-value assets the economic security margin of public blockchains is too low, is entirely correct and depending on the use case is a completely valid reason for financial institutions to explore private and consortium chains.” He was alluding to various versions of the settlement finality problem that he describes in that blog. From the subsequent failures of the ICO and the STO initiatives, it appears that very few of those developers read Vitalik’s article or understood it.
In ASX’s case, it appears that their blockchain is based on VMWare’s DLT, which is itself built on Ethereum and apparently addresses the limitations of Ethereum. The VMWare blockchain team had to go through (and probably continue to go through) considerable engineering to extend Ethereum’s functionality to make it useful for enterprise chains. Enhancements include a privacy SDK, governance, and scalability. The amount of work necessary to make Ethereum play nicely with securities is a bit like trying to convert a Ferrari into a cruise ship. It can be done, but why not start with a decent boat instead?
There are two main reasons why public blockchains are not best suited for financial securities. The first reason stems from a massive confusion about the nature of non-payment financial instruments, such as securities, derivatives, and asset-backed digital securities (such as NFTs). These financial instruments (the securities) are not bearer instruments. Transactions involving them are subject to corporate law and securities law. While some of these laws may seem onerous, they are there for good reasons that evolved with several hundred years of experience. Mainly, these laws ensure that transactions are subject to the judicial doctrine of contract law. Entities (companies or individuals) who act as intermediaries in these transactions provide valuable services, chiefly that of assuming counterparty risk. For this reason, the participants in transactions involving non-bearer instruments are either the principals or intermediaries who have fiduciary responsibilities. To put it simply, an ostrich farmer in Kenya has no business validating a securities transaction between a seller in Kansas City, KS, and a buyer in Los Angeles, CA.
This is, or should be, a powerful deterrent for using unverified participants (as in a public blockchain) to validate securities-based transactions.
The second reason why public blockchains are unsuited for such financial transactions is due to technical limitations of public blockchains. Scalability, recourse, recovery, privacy, and safety become paramount. Can a public blockchain provide all that? Yes, but at what cost, when there are permissioned blockchains available for such a use case?
To put it another way, the first reason says,”Don’t let a drunk drive a Ferrari.” The second reason says, “Don’t try to modify a Ferrari into a cruise ship when there is a cruise ship readily available to use.”
At KoreChain, we come from a multi-decade background in the financial industry, as executives, entrepreneurs, and traders ourselves. We are painfully aware of the issues in the existing legacy technologies. We also realize that regulation can be onerous even when well-intentioned. Our concern was not to waste time re-engineering Ethereum or any other public chain for that matter, but instead to focus on solving the business problem. Addressing the friction in the private capital markets was more important than going on a technology goose chase and attempting to shoe-horn a public blockchain for a very different purpose.
For this reason, we built the KoreChain on a solid base of an enterprise-ready, industrial-strength permissioned blockchain. We focused on the business architecture and design of the blockchain application.
None of this is a polemic against Ethereum itself, which is an ambitious technology that brought awareness to the power of smart contracts. It’s just not the right tool for this particular job.