Citi, Goldman Sachs Conduct First Blockchain Equity Swap On Ethereum-Inspired Platform
On Tuesday, January 28, 2020, Citigroup and Goldman Sachs quietly conducted what some will consider a historic transaction: the first equity swap on a new blockchain built using tools originally designed for ethereum. While this first transaction, a total return swap in which one bank agreed to make a payment based on the returns of an underlying asset, and the other based on a set rate, involved only the two counterparties, another 13 are waiting in the rafters. Unlike more traditional equity swaps, which have to be constantly updated for countless variables, including end-of-day market prices, corporate actions like stock splits or dividend payments, and variable interest rates, the new equity swaps platform, powered by venture-backed blockchain startup Axoni’s technology, assures that every counterparty in every swap is seeing, and using, the same data. With trillions of dollars in equity swaps being conducted around the world last year, financial giants like Citi and Goldman Sachs have to employ small armies to constantly check—and cross-check—every step of the process until the swap comes to maturity, sometimes months later. When things go wrong, when the numbers at one bank don’t match the numbers at another, those armies can lose days of work and millions of dollars on each transaction. “When there is a break, and it could be something as silly as keying the wrong payment dates and accruing interest differently, each party has to go back into their data sets and spend hours or days digging through huge, huge chunks of data,” says Greg Schvey, 33, Axoni cofounder and CEO. “And now we can show you that instantly and in a way that both parties have full visibility into.”
To pull off this state of continual reconciliation, Citi integrated its existing back-office infrastructure directly with a distributed application (or “dapp”) built on top of Axoni’s Axcore blockchain, customized to reconcile any number of equity swaps, not just the total return the bank executed with Goldman Sachs, according to Puneet Singhvi, Citi’s head of finance market infrastructure and blockchain lead. Unlike many other enterprise implementations of blockchain, where the software that helps the counterparties instantly agree on a transaction life cycle (called a node) is run by cloud computing power, Citi opted to run its nodes on the premises at one of its physical offices. Similar to bitcoin, in order for the transactions to stay in a constant state of reconciliation, each counterparty also has to run its own node. Even Axoni runs specialized nodes that work with the other nodes to help the broader network reach consensus. The Axoni nodes, however, are partitioned off from the actual transaction data, giving each company valuable ownership of its own data.
Unlike bitcoin, where anyone can run a node and consensus is reached through a process called mining that also generates new cryptocurrency, only invited, or known counterparties can participate in Axoni’s equity swaps platform, with each of the other 13 financial institutions in the pipeline expected to run multiple nodes. No cryptocurrency is required, but also the network is less decentralized than bitcoin and other public blockchains. At the time of launch, more than ten nodes were running.
At the moment, equity swaps traders on the platform are expected to comply with existing regulatory obligations around each transaction, but in the future regulators themselves could be granted access to a unique regulatory node that grants direct access to transactions in certain circumstances, further reducing compliance paperwork, and removing the need for the expensive employees and organizations that process that paperwork.
In the current model where each counterparty in a trade manages its own records, disagreements related to swaps and derivatives take teams of experts at least an hour to resolve in 70% of all transactions, according to a quarterly report published last month by the International Swaps and Derivatives Association (ISDA), and more than a day to reconcile in 15% of all transactions. That adds up to as much as $1 million in losses in a third of all disputes over data. In 2% of disagreements, losses range from $1 million to $2 million per transaction, a massive chunk of the investment returns.
“If you look at most of the large dealers, they’ll have hundreds of people in their confirmations group and reconciliations group,” says Schvey. “These are massive operational teams, spending a huge amount of their time just figuring out where things went wrong.” “What you’re really replacing,” says Singhvi, “is phone calls, Excel spreadsheets, emails, etc. If you have disputes, the sooner and constantly concerned you are, the less risk you have from an operational and financial perspective.”
However, the ISDA report also warned that uncertainty about exactly where the data on a distributed ledger is domiciled is making it unclear which regulatory jurisdiction applies, and could hamper broad adoption. As a possible solution, ISDA last month coauthored a paper with distributed ledger startup R3 and others recommending that users of a distributed ledger should agree to be bound by a “common law of the platform.” To help with the process, called the Common Domain Model for equities, Axoni shared its equity swaps data model and trade template with ISDA and is working with other members of a working group to help standardize the distributed ledger process.
“Through this, you’re creating a level of standardization across the industry on terms so each entity, which might have their own internal data structures, now could actually enable consistency across that, further driving efficiency,” says Singhvi. At stake is a total of $3.142 trillion in swaps and forwards globally as of December 2019, according to data provided by global central banks to the Bank of International Settlements, based in Basel, Switzerland.
The history of the unnamed equity swaps platform goes back to November 2017, when Citi joined other investors in Axoni including, Goldman Sachs, JPMorgan and Thomson Reuters to test a pilot version of the Axcore blockchain. Axcore is a permissioned blockchain, meaning not anyone can build on it, developed by Forbes Fintech 50 alum Axoni and based in New York. After raising a total of $36 million, the company, valued at $171 million, according to Pitchbook, built the equity swaps platform on top of Axcore, for which it owns the intellectual property, and then leases access to users for an undisclosed amount.
Unlike the public ethereum blockchain, which reaches consensus by using a global network of computers, Axcore was built from the ground up to let counterparties who already know each other do business with fewer middlemen. While Axoni stops short of calling the current implementation of Axcore a “fork,” or copy, of ethereum, the company partnered with blockchain developer startup Truffle in April 2019 and is currently using an enhanced version of the company’s tools, originally designed for the public ethereum blockchain, to move $10 trillion from the Depository Trust and Clearing Corp.’s trade information warehouse to Axcore and to build the new equity swaps platform. Now that the platform has successfully conducted its first swap, Axoni will soon begin activating other nodes on Axcore managed by additional clients.
“The ability to have synchronous, peer-to-peer processing of data between institutions and have databases natively speaking to each other is just a huge, huge first step toward the future that I think a lot of people have been looking for in capital markets infrastructure,” says Schvey. “And for these huge firms that we’re working with—and then I’d argue for probably most of the world— this is a pretty substantial advancement toward that path.”