New & Noteworthy

Implementing Derivatives Clearing on Distributed Ledger Technology Platforms

Colin Platt, Peter Csoka, and Massimo Morini take a measured approach in their evaluation of the impact that DLT can have on central counterparties (CCPs).  They provide historical context of CCPs and discuss their importance for markets, the challenges in modern clearing, opportunities for DLT to improve clearing, the different CCP processes that may be best suited on-ledger and off-ledger, and conclude with a discussion of business and strategic considerations.

R3 Public Research

Private Research

Click each title below to read the abstracts for the private papers.

Foundations of DLT: Asset Modelling

This whitepaper considers the support of financial assets on distributed ledgers and evaluates how the asset lifecycle for different assets could be managed through smart contracts.  The paper uses two specific asset types—bonds and FX—as a proxy for much of the behavior of other asset types.  The paper concludes that there is a great opportunity in the post-trade space, with DLT as a potential catalyst for a fundamental re-engineering of post-trade business and technical architectures.

Foundations of DLT: Cash

This whitepaper extensively researches the subtly complex subject of money and its representation on distributed ledgers. It summarizes business and technical questions related to money and money-related use-cases on distributed ledgers.  The paper also explores the lessons learned from cryptocurrencies, evaluates some of their shortcomings, and outlines practical considerations for money representation, particularly with Central Bank-issued Digital Currencies (CBDCs).

Foundation of DLT: Industry Business Case

This whitepaper examines the business case for DLT in financial services, provides a realistic view of the potential benefits and challenges, evaluates the impact on market participants and surveys the ways that banks could adopt the technology.  As the potential use-cases and (occasionally speculative) benefits of DLT have been well documented, the paper instead discusses the technical and operational challenges banks may face in implementing the technology, the need to think strategically in constructing a viable business case, and the costs banks would incur.

Foundations of DLT: Ledger Constructs and Consensus

This whitepaper assesses the fundamental differences in the ways that existing DLT solutions are constructed and the consensus models they use. Specifically, the paper identifies three core models of construction: “balance-style”, “receipt-style” and “UTXO-style”, ultimately concluding that the UTXO-style model is most advantageous for financial services use-cases in terms of supporting scalability and preserving privacy. In examining the different consensus models, the authors consider the elements of transaction validity and transaction uniqueness, determining that privacy requirements will likely influence the consensus model the industry adopts.

Foundations of DLT: Legal and Dispute Resolution Frameworks

This whitepaper presents a view of the legal frameworks surrounding distributed ledger technology and, in particular, the legal enforceability of smart contracts and the mechanisms for dispute resolution. The paper considers these topics from an architectural perspective, raising questions and considerations to be opined on by the legal community. While the framework of smart contracts will likely depend on the business model of the network and the willingness of regulators and market participants, the authors propose that, in the short term, there will likely be overarching user agreements for use of the platform (with a hierarchy of trading agreements) and that lower-level agreements will use Ricardian Contract legal prose.

Foundations of DLT: Interoperability

This whitepaper attempts to bring the concept of interoperability into a coherent framework.  Given the parallel activity across different platforms, firms are concerned that experiments could add to fragmentation, cost and risk. The challenge of interoperability between ledgers and the existing world has led the authors to propose an ecosystem of ledgers that can interoperate seamlessly both within themselves and more broadly, with other distributed ledger platforms.

Foundations of DLT: Smart Contracts

This paper develops some core concepts for smart contracts and their use in financial services. It defines a smart contract, an agreement whose execution is both automatable and enforceable, and addresses fundamental topics including the implementation, evolution and value of smart contracts as well as potential impediments to adoption. The paper proposes that, while it is uncertain how smart contracts will first be adopted, we are reaching the stage where they can be developed for financial services and will have significant benefits for the industry.

Foundations of DLT: Identity

This whitepaper researches in detail the complexities of identity within financial services. The authors conclude that distributed ledgers, which ensure cryptographic securing of records, are a natural place to look for new solutions. Due to the power of smart contracts and the power of the DLT community, the paper reflects hope that new infrastructures can be built that provide better barriers against bad actors and an enhanced customer experience.

Foundations of DLT: Non-functional Considerations

This whitepaper explores non-functional considerations as they pertain to the debate on distributed ledger platforms and smart contracts and their application to financial services. The paper introduces some of the non-functional barriers to adoption that must be overcome including scalability and performance, security and privacy, availability and recovery, the ability to support change and how governance will work. These areas will need to be addressed before deployment of large-scale financial service networks utilizing DLT at the core of banks’ infrastructures.

Foundations of DLT: Collateral, Valuations & Risk Management

This whitepaper evaluates the application of distributed ledger technology to collateral management through a “business” lens.  The paper proposes a theoretical model for how DLT could automate variation margin and initial margin calculations.  The whitepaper also explains how the principles can be applied broadly across the cleared derivatives world.

Foundations of DLT: Oracles

This whitepaper defines an oracle, an authoritative source of data, and explores 6 key uses of oracles, including retrieving reference data and signing data within a transaction. The paper provides a set of considerations for these uses and also explores the different subscription patterns that oracles may provide and users of oracles may adopt. The paper also distinguishes between oracles and smart contracts, while acknowledging that there could be an overlap in the roles they perform. Finally, the paper explains the implications of oracles on existing business models.

R3 Reports

Click each title below to read the abstracts for the private papers.

The Myth of Easy Interoperability

Legacy information technology (IT) systems in financial institutions today are a patchwork of layered solutions. Maintaining data quality, reconciling trades, and exchanging assets between relevant parties in this environment is expensive, slow and complex. Distributed ledger technology (DLT) offers a potential solution. Given the costs of integration and interoperability, this paper makes the case that DLT product competition at the application level is more critical than competition at the platform or “full stack” level. By encouraging competition at the right level, and by building an ecosystem on top of a manageable number of underlying platforms, financial institutions can benefit from network effects and use the technology to address historical IT complications.

Two Sides to Every Coin: An examination of Initial Coin Offerings

George Calle’s overview of initial coin offerings (ICOs) provides groundwork for how entrepreneurs, innovators and regulators can encourage legitimate ventures in the future. He begins by explaining how they are structured by focusing on new features and risks associated with these offerings. He also explores how ICOs may be evaluated by regulators and points out which laws are applicable.

Evolution in Cash and Payments

JP Koning provides a concise summary of central bank retail and wholesale payments, international correspondent banking, and traditional remittance providers.  He first explains the incumbent systems for each of these types of payments, then describes the emerging competition across the payments ecosystem, and concludes with the potential implications for banks.  The paper is an accessible introduction to new payments technology across DLT and non-DLT solutions.

Top Ten Obstacles Along Distributed Ledgers’ Path To Adoption

Sarah Meiklejohn provides an analysis of the different areas where DLT platforms (both public and private) will require technical improvement before they can be broadly adopted.  Sarah discusses issues such as governance, interoperability, scalability, privacy, and usability, and details the potential and developing solutions that are designed to address each.

How the ICO and OCO Ecosystem Works at a High Level

Tim Swanson explains token crowdsales, a funding tool that companies use to generate capital by issuing and selling a native cryptocurrency. The paper discusses how offerings are commonly structured, the risks connected to the fundraising method, and provides examples of fraud. Many of the points made in the paper are also broadly applicable to cryptocurrencies.

Ethereum: Platform Review

Vitalik Buterin discusses the opportunities and challenges for private and consortium blockchains.  He provides context for the development of Ethereum, touches on potential interactions between public and private blockchains, and discusses the topics of security, scalability, efficiency, privacy, and purity.  Vitalik provides key recommendations on each of these themes.

Give Commercial Banks Some Credit

In this R3 Research brief, Kevin Rutter gives an introduction to commercial bank money and briefly discusses some advantages and disadvantages of the current credit creation system.  Then he evaluates both cryptocurrencies and central bank-issued digital currencies (CBDC) regimes and their potential to alter the amount of commercial bank money.  He argues that the introduction of a CBDC by a central bank would need to be mindful of the potential impact on credit and loaning activity.  He states that the distribution of a CBDC could either be an expansionary or contractionary monetary policy decision and argues that initial implementations in advanced economies will likely aim be “neutral” by leaving the monetary supply as close to unchanged as possible.

Bridging The Gap Between Investment Banking Architecture And Distributed Ledgers

Martin Walker argues that a pragmatic, hybrid approach is necessary for the adoption of DLT in capital markets, by applying DLT alongside more established technologies (adapted in new ways).  The paper discusses the difficulties of trade processing, the limits of centralization and opportunities for DLT, and the barriers to “Ledger Nirvana.”  Martin concludes that a hybrid approach would make it easier for production-quality DLT solutions to meet the banking sector’s strict requirements regarding procurement, security and data privacy.

Application and Impact of the European General Data Protection Regulation on Ethereum-Based Blockchains

Jana Moser assesses if and how the European General Data Protection Regulation (GDPR) applies to private and consortium Ethereum-based blockchains.  The paper describes the main obligations and requirements under the GDPR that are relevant to companies that use Ethereum, such as the right to erasure and the right to be forgotten, data processing agreements, data transfer, and data protection impact assessment obligations.

Insurance: How DLT Can Help the Industry Evolve

In this insurance series, Todd Bault first defines insurance quantumization and explains how fiat currency (a CBDC) on distributed ledgers will be “the killer app” for insurance.  The second part describes how state management could be the disruption that finally cracks insurance, and that DLT is the “right” tool to facilitate that paradigm. Last, Todd concludes that Corda could be that future operating system for insurance in such a state-based world.

The Shared Operating Model: The Joint Back Office

Clark Thompson describes the potential for distributed ledger technology to provoke fundamental changes to current operating models in financial services.  Clark describes the potential for cost reduction and avoidance, the benefits of sharing non-competitive business capabilities, a business capability model, risk reduction and risk avoidance, shared service utilities and externalization, and business change activities.

The Cryptic Currencies: Cryptocurrency Markets in Context

Kevin Rutter compares retail foreign exchange (currency) markets with the growing but still nascent cryptocurrency markets.  He evaluates the two markets across topics such as regulation, market structure, liquidity, leverage and short selling and derivatives markets.  He also discusses the subtle ways that directional risk arises, putting exchanges and brokers (and as a result their customers) at financial risk, depending on whether they employ a principal or agency model.

Reusing Legacy Code Assets as an Accelerator for Smart Contract Development

Clark Thompson and Chris Verhoef propose an experiment that intends to explore legacy code renewal strategies that leverage existing code bases at financial institutions, instead of attempting to develop smart contracts “from scratch.”  Clark and Chris make the argument that reusing code assets will be a faster, cheaper and less risky path towards providing a rich functional catalog of smart contracts.  Further, this approach would use code built under existing regulatory compliance schemes and, as a result, may be less subject to increased regulatory scrutiny than entirely new development.

Comments on the Coin ETF

Tim Swanson colorfully and comprehensively evaluates the COIN ETF and describes many of the idiosyncrasies of bitcoin as an asset.  Tim discusses price manipulation risks, “The Winkdex,” facilitators for trade in the industry, out-of-band attacks, forks, and also discusses potential risks associated with unregulated exchanges and mining pools.

Defining the Identity Management Landscape

This paper defines identity management for financial actors and entities on a distributed or shared ledger, describes key terms and definitions, reviews challenges of identity systems and categorizes the relevant identity-related companies in the startup and utility landscape.

Vision Series: Cash and Payments

Kevin Rutter argues that successful  DLT  implementations in  the  next  3-5  years will likely not  aim  to  revive  fatigued foundational  debates  about  the  role  of  a  central  bank,  nor  revisit  the role of  credit  creation  or monetary  policy,  but will instead  look  for improvements  within  existing  economic  and  regulatory regimes.  He describes the different types of money using DLT, reviews some of the benefits of a Central Bank-issued Digital Currency (CBDC), mentions some limitations and obstacles in the road ahead, and discusses R3’s work in cash and payments.

Vision Series: Trade Lifecycle

Kevin Rutter explores the potential use of distributed ledger technology for modernizing post-trade architecture, by establishing a secure “source of truth” for asset ownership and lifecycle events between counterparties.  He discusses the benefits of mutualizing noncompetitive or “non-differentiating” services and processes along the trade lifecycle that are currently carried out independently by each counterparty or via the assistance of a third party.

Blockchains and Laws. Are They Compatible?

R3 and Baker McKenzie consider whether distributed ledger technology implementations adhere to laws that govern global financial institutions.  The paper discusses privacy concerns with the data sharing models of public broadcast-type blockchains in the context of regulated finance. The paper then explores the complex legal questions that can arise for distributed ledger network participants in different physical locations (by comparing single jurisdictions against multiple jurisdictions).  The piece concludes with a survey of global data protection law, and then specifically explores data protection laws in Europe and the UK, Singapore, Australia, and the US.

Leveraging Cooperative Development: Learnings From R3 Applied to Insurance

R3 and Celent Research evaluate the consortium model and the value of cooperative development amongst financial institutions, including insurance companies.  The paper discusses R3’s background, and the project delivery strategy for the consortium’s projects. Further, two R3 projects, one on identity management (KYC) and one on reference data are described in detail, and the paper explores how these project outputs are transferable to the insurance industry.

Digitizing the Insurance Value Chain

R3 and Norton Rose Fulbright examine how DLT can influence traditional insurance processes. The paper describes DLT and Corda, the significance of the technology to the insurance industry, example use-cases, a likely timeline for adoption, key legal and regulatory issues and other obstacles to widespread adoption.

Can Smart Contracts be Legally Binding Contracts?

R3 and Norton Rose Fulbright approach a range of issues in an attempt to come to a common understanding of smart contracts between industry stakeholders, lawyers and technologists.  The paper explores issues such as whether smart contracts are legally binding, potential enforcement problems, and dispute resolution mechanisms.

Blockchain KYC/AML Utilities for International Payments

The problem of derisking is embedded in the lack of transparency in the international payment ecosystem. DLT offers a potential solution – by embedding smart contracts into a KYC/AML utility for international payments, the process of due diligence could be faster, safer, and more transparent. The author, Neepa Patel, explores how such a utility might work and its implications for both regulators and banks.