How R3 gets blockchain projects done
- Future of Finance
- Oct 16, 2023
- 32 min read
Updated: Jul 10
A Future of Finance interview with Co-founders of R3, Chief Technology Officer Richard Brown and Chief Strategy Officer Todd Mcdonald.
R3 first came to public attention in 2015 when a group of major financial institutions and technology vendors backed the company to work out how blockchain technologies could be applied to regulated financial markets. More than six years on, R3 is the established enterprise software company behind a host of live and soon-to-be-live blockchain-based networks across multiple asset classes. In that time, its founders have learned a great deal about how regulated financial institutions think about and adopt blockchain technology, the balance that must be struck between competition and collaboration, the importance of inter-operability between networks and how to build a business case within a major financial institution. Dominic Hobson, co-founder of Future of Finance spoke to two of the founders of R3, Chief Technology Officer Richard Brown and Chief Strategy Officer Todd Mcdonald, about their experience and their expectations for the future.
Transcript
00:15 Dominic Hobson Hello, everyone. I’m Dominic Hobson, co-founder of Future of Finance. My guests today are Richard Brown, Chief Technology Officer at R3, and Todd McDonald, Chief Strategy Officer at R3. Our subjects will include the evolution of blockchain technology, its some ways unexpected adoption by the regulated markets, whether collaboration accelerates progress or slows it down, the importance of interoperability and how to build a business case for investing in change. Richard and Todd, thanks very much for joining us.
00:48 Todd Mcdonald Thank you for having us, Dominic. And it’s also it’s a pleasure to be shoulder to shoulder with Richard. We’re normally not in the same office, so Richard is visiting us in New York this week and so we’re excited to be able to do this interview together.
01:01 Richard Brown Yeah, thanks for having us. Looking forward to it.
01:03 Dominic Hobson Well, I’m delighted that were able to bring you together for this.
01:07 Todd Mcdonald Exactly.
01:09 Dominic Hobson As I indicated in my opening remarks, blockchain technology evolves. It was originally developed as a direct response to the failures of the existing financial system. That is to say, these layers of intermediaries connected by these antiquated processes that require all these endless and successive reconciliations of data between the various parties to a transaction. That in turn imposes very high and often opaque transaction costs, but also capital and liquidity costs on movements of value in the markets. In other words, blockchain technology always understood right from the outset that the chief problem in institutional finance, as it had evolved to that point, lay not within financial firms, but actually between them – all those reconciliations I referred to. So here we are now, more than a decade on, how does enterprise blockchain technology measure up against that original blockchain vision of peer to peer trading, automation of workflows, value transfers recorded in these transparent shared ledgers? Where have we got to?
02:19 Richard BrownI’ve actually been pretty pleased by how far we’ve got. I mean, we’ve got nowhere near where I thought and think we can get to, but ten years on, from, if you like, the idea of applying blockchain tech to finance was first mooted. We now see it deployed, whether it’s for workflow, like market level workflow optimization in Italy with the Spunta project, being used to speed up the processing of pensions in Australia, something I never would have thought of. And then announcements and deployments by the Swiss Stock Exchange, DTCC, Euroclear and others. And then its use in some early-stage central bank digital currency projects such as in the UAE. So I’ve been really pleased by how it’s been deployed. But perhaps one thing, if we go back, you said blockchain was mooted as a solution to all these problems, and in the enterprise space that’s true. But I think what people miss is that wasn’t why the original blockchains or the public ones were first introduced and invented. If you look at, say, if you go back to the original Bitcoin white paper, it’s not written in these terms, but it’s strongly implied that what they were trying to build were new censorship resistant networks, a new ability to hold value and transfer it between parties without anybody being able to stop you, or not necessarily know that even that you’ve done it. And so they work the way they do to solve that problem. The inside, if you like, or the segue from that world to the institutional world was to say, well, hang on, these networks look quite interesting. They’ve been designed to solve one problem, censorship, resistance, unstoppable movement of value and to do that, they have the following properties. These are networks that are deployed at the level of a whole market. Everybody who’s connected to them sees the same thing, or at least the things they’re allowed to see are the same as everybody else’s. There’s no reconciliation, everything’s always in sync. And so the thought process was, well, if I had one of those, what else could I use it for? And that was then the stepping stone to the application of that type of technology to the regulated financial markets, for interfirm workflow, for the secure, reliable sharing of data, and for the modelling and digitization of assets. So there’s a lot further to go, but I’ve been really pleased by how far we’ve got so far.
04:35 Todd Mcdonald And maybe just to add to that, I think when we started R3, we were trying to bring these innovations to the existing market. So my background was in OTC markets and FX and rates, and it was using that as an inspiration. Right? So the way that I think it’s important to be able to apply technology to how markets would like to work. So you mentioned, Dominic, around more peer to peer. You know, markets are quite peer to peer today. A lot of markets are. So how can we map to that in a way that makes sense, especially for large regulated financial institutions that are part of those markets, but do it in a way where we are leveraging the things like intercompany workflows and the ability to know that an execution can also be a trade settlement? How can we bring some of this together to collapse some of the front, middle and back-office process that we’ve all lived with in our careers? And then I think looking forward where we’re starting to see now is kind of coming back around again to the original promise of what crypto was looking at, which is creating digital value that can move around the globe. Now, once we’re starting to see this installed base of a foundation of, hopefully a new digital capital market and a real pickup in okay, can we actually then pick this back up and see how we can tokenize assets in value and currency and have it operate in a way where these regulated financial institutions can leverage it? And also, participants can be part of these networks where they know that they’re getting into benefit without introducing new risks. So I think that’s what is exciting me for where we’ve gone today and also a little bit of where we potentially can get to in the next couple of years.
06:31 Dominic Hobson As you’ve both said, in your different ways. It’s surprising in a way that the traditional regulated markets picked up these cryptocurrency methodologies and asked themselves the question how can we apply these methods to problems or issues that we have in our own markets? And they’ve been quite inventive at that – tokenization, which you just mentioned, Todd, is the most obvious instance of that. But it seems to me the fact there is instances, in other words, more than one instance of these technologies being applied by regulated firms, perhaps those silos in the traditional markets are now starting to reproduce themselves in the tokenized world. Whereas the cryptocurrency markets – the cryptocurrency world – is entirely comfortable with a single operating model for every type of asset, every type of activity. Do you worry that the regulated markets are in some ways foregoing – and they might be foregoing it inadvertently as well as advertently. Are the regulated markets foregoing the benefits of having what you might call a single programmable platform, a single design? Do you ever worry about that?
07:44 Todd Mcdonald Maybe I’ll start. Whether markets need a single design or a single sort of unified ledger. Potentially that’s maybe mistaking what a solution can be versus what problem we’re trying to solve. Right? So can we get to what that is trying to achieve in a different way? I think it is important though, Dominic, there is a risk currently that we may be sort of repeating the sins of the past. There is a risk that because of potentially the challenges in implementing this type of technology within regulated markets, we do recreate silos and in effect potentially create new forms of value in a digitized format that are islands that are not able to be accessed or mobilized or used as collateral. That’s definitely a risk. I think we’re going to talk a little bit more about potentially what we’re working on, what the industry potentially hopefully can work on to avoid that. But I think taking the, I guess the crypto model of saying, here is a set of sort of short set of rules or parameters that everyone must agree to. And then once we agree to that, step two is we all can harmoniously come onto one ledger, is a difficult one. Instead, can we look at how markets operate today, which is a mix of listed and OTC markets, a mix of different ways that business gets done today and it’s really a network of regulated networks that is stitched together by lots of intermediaries and lots of plumbing. So how do we improve that as opposed to try and in effect force everyone into a single network to rule them all? But I know Richard, you have direct experience in how this has worked within R3 and within the industry.
09:40 Richard Brown Quite. And I guess I’m one of those who I guess for several years I beat my head against the wall trying to force customers to put everything on the same network. And eventually one has to accept that when the market tells you something several times, maybe the market’s the one that’s right and you’re the one that’s wrong. But why did I and others think that the regulated markets would follow the same path as the public networks? Well, I don’t think it was a mad thing to expect. And the fact they haven’t has caused benefit, given them benefits, but also caused some issues. So if I make it concrete, just take an example of one of the public networks. So cryptocurrency network Ethereum. There’s one Ethereum Mainnet, as they call it. Yes, there are forks, there are other platforms, but if somebody says they’re deploying an asset onto Ethereum, everybody knows what you mean. It’s one large network with lots of different assets and smart contracts and DeFi protocols and all the rest deployed onto it. And it has some benefits for those in that permissionless world who do so. Because if you trade an asset, one asset for another in one contract, it can pop out and then you can use it in a different context somewhere else. It’s like they’re one big integrated pool of liquidity in some ways. But in order to do that, everybody on that network has to conform to a set of non-negotiable rules. Everybody has to agree what version of the software they’re going to use. It’s implicit rather than explicit, but there’s very specific governance that applies. There’s a whole bunch of unstated, unless you’re into the details, into the technical details, unstated rules that everybody follows, you move to the regulated world that’s really hard to sell because each of these regulated institutions is in a specific geography, in a specific jurisdiction. They’ve got their own regulators, they’ve got their own business models, they’ve got shareholders or other people on their boards driving a particular timeline. They don’t have the ability to be anywhere near as accommodative to that shared governance. And so perhaps in hindsight, it’s no surprise that each of these networks, to a large extent, has evolved separately. There’s a separate network for each asset class or for each application. It’s allowed us to get things deployed quicker than would otherwise have been the case. But it does then create the question of how do you integrate them together and how can they interoperate? But it is exactly, as you say, one of those situations where what we thought would happen turned out not to be what did happen? You get one benefit and then some of the things that aren’t quite right, you then come and fix.
12:10 Dominic Hobson The naturalistic fallacy was passing through my mind there. As you said, Richard, what did happen isn’t what we expected to happen. And of course, what happens isn’t necessarily what ought to happen. You know, Todd you put it another way, the market kept giving me this message and eventually I had to stop trying to tell them the answer. I don’t know whether markets are like customers and the market is always right. Somehow I doubt it. And the reason I’m having these slightly dark thoughts is because it occurs to me that maybe the market or the institutions in the market don’t actually want that single set of rules, that interoperability between different networks. Because if we look at what’s happening in the token markets, we find individual banks are building individual tokenization engines in-house, hoping to keep their existing business. We see exchanges doing very similar things, building these competing token platforms, albeit without really any tokens being issued onto them, but certainly keeping themselves in that game. You’ve got all these tokenization projects which are taking place inside individual asset classes, in bonds, in private equity, in real estate and so on, or in different financial functions, in payments, securities financing, stock loan, whatever it is. So it’s a very fragmented marketplace when you look at the regulated capital markets. And so the point where R3 began as a collaborative venture has given way now to this dozens of competing subscale projects. My dark thought is there a risk here that institutions are again inadvertently or vertically trying to build, like the Internet pioneers did before them, like AOL did back in the 1990s, a set of walled gardens? So to put my question plainly, is that resistance to that single set of rules, that unified ledger, that single programmable platform, is it actually deliberate or is it just a political fallout of the reality of these marketplaces? What was going to happen?
14:20 Todd Mcdonald I feel pretty passionate about this one. Let me get started and maybe Dominic, I am a hopeless optimist here, but if you think about maybe use it as an example. So the work that SIX Exchange embarked on with digital exchange SDX, they very specifically are looking to create a digital end to end digital infrastructure for the Swiss financial system. And in working with them, they were very specifically looking to obviously have control of their roadmap, control of how they stand up this infrastructure and how it integrates into their existing ecosystem. At the same time, and they’ve been very specific and very public about this, they are looking for the largest reach that they could have for their members, for the largest reach into other markets, and also to allow for those that are seeking investment and seeking funding to be able to access into the ecosystem that they’re building. So it’s really not about one or the other control versus interoperable reach. They’re looking to find that efficient frontier between the two. So it’s always been the case that there is a desire for there to be more access to these products, more access to these pools of liquidity. I think that we have seen very strong desire for that. You are correct that within tokenization there have started to be some efforts of independent efforts. But what I have observed, and in particular over the last year, is a realization by those that have invested already and those that are looking to provide services that this is potentially not the right path. That how can we try and bring this back into a network of regulated networks so that we can get the benefits of liquidity and get the benefits of the new infrastructure that is being provided by some of these participants? So I think where you’re going to start to see and I would point out at Sibos recently, there was a paper that was released by DTCC Euroclear and Clearstream, and the folks at SDX were very supportive of the paper as well, which is saying we as an industry and in particular market infrastructure, has an incredible role to play to be a foundation for a regulated tokenized future. So that I think is the opportunity to try. And now that we are starting to see these capabilities being built up and seeing things like SDX, which is an end to end digital exchange where you can issue a digital bond and have it settle in central bank digital currency with the Swiss National Bank. Having that be part of a wider network of regulated networks is something that the industry, I think, wants. They’re not trying to fight that. We just all have to work together to try and increase the chances of that being a reality.
17:33 Richard Brown The only thing I’d add to that is … completely agree Todd’s recurrent mantra about networks or regulated networks. Of course, that same terminology can be used – network of networks – can be used to define the Internet. The Internet is not a single network. It is a collection of networks that connect together. They peer with each other, peer to peer through peering agreements where each network agrees with whom they’re going to connect. And there’s a set of standards that facilitate it. So it creates the illusion of a single global network where anyone can connect to anybody else. But in reality it’s implemented as a very large number of separate networks, sometimes on different technologies that have been assembled into a network of networks. And we’re seeing the same thing happen in the digital asset space as well, I think.
18:20 Dominic Hobson I’m interested, Richard, you bring up that question of standards, which strikes me on the face of it as being very much a second best to that unified ledger, that single design which were talking about earlier. But the fact is we have these multiple networks that need to be connected in some way and standards are of course the old world solution to linking those networks up and they can obviously contribute to interoperability. But I sometimes get depressed when I hear about standards because I look at the history of it. You’ve got Fix in the front office, you’ve got Swift in the back office and they don’t collaborate with each other. You’ve got the payments industry transitioning to ISO 20022 and the securities industry saying, well, we’ll transition to ISO 20022 if you can make it look like ISO 15 two and the FX and money market saying we’re never going to go there, thanks very much. And then you’ve got all these competing standards which are proliferating not just in the traditional markets, but actually in the blockchain markets as well to try and enable interoperability between the different layer one blockchain protocols. So the history of what’s going on here strikes me that it’s actually very challenging to get regulated firms to agree to communicate, quite apart from the fact this is in some ways a huge defeat for blockchain technology to be even having this discussion. But it’s very difficult to get the participants in a marketplace, whether they’re on a blockchain network or something else, to actually collaborate enough to adopt common standards to enable those data exchanges to take place. So my question is what part are standards now playing in your own thinking at R3 about the way these markets, blockchain based markets, are going to evolve? Do you see them as very important or as a transitional stage?
20:11 Richard Brown Had I been answering that question, say five or ten years ago, I would have said transitional stage. But I think it was the old me that was wrong rather than the present me. And to see why, you make the point about the whole 15022/20022 sort of like the time it’s taken to do that transition. But of course that’s the key point. The standard provides, if you like, a buffering point or an impedance matching point that allows different organizations to move at different speeds and yet nevertheless be able to collaborate and communicate. If we look at the public cryptocurrency networks, there are some examples of projects being successfully deployed on the same network. I think the Ethereum Mainnet is an example of that, but it’s just one of many networks. So even that technology success is not dominant. There are other networks with which it has to connect and because you’ve got so much happening on one network, you hit performance issues, so then they have to go to layer two and things like that. And it is not a given that approach is always superior. So if we look at the Bitcoin network, people don’t talk about Bitcoin as much these days. It used to be utterly dominant. One of the reasons I would argue that people don’t talk about it too much is that network and that community has in effect and I’ll probably get loads of abuse now, but has in effect atrophied because it was so hard to agree amongst that community on a set of steps that everybody could get behind to upgrade the network. And so the network protocol didn’t evolve and a lot of the traffic and a lot of the value moved elsewhere. So there is a flip side to having everybody follow the same protocol and follow all the same standards, which is everybody has to move at once. So you then have the problem that those who want to move fast and innovate have to wait for people to catch up before they can. You have people who are perfectly happy, stable, they’ve got a viable business model that doesn’t need to upgrade, who are suddenly told they have to upgrade if they want to stay on the network. And you end up with this very difficult political process of keeping everybody on the same place, on the same page. And in an environment where innovation is happening rapidly, that gets even harder. The alternative is to say, actually let each project, let each network progress and act at its own speed and then we’ll talk about how they can connect, which is where interoperability comes in. So it’s an enabler of that multi speed approach rather than downside. I didn’t see that in the early days. It took several years of working on this before I realized the benefits that these standards provide.
22:36 Dominic Hobson Todd used the phrase working together to solve problems. You, Richard, have just talked about keeping people on the same page and I think there is, at least publicly, a growing appetite in the security industry in particular, to collaborate. It was a theme chosen by Swift for Sibos this year. It was a theme at the Issa event back in the spring. And the thinking behind that is pretty clear. When you’re in bearish markets, collaborating can appear to cut the costs, cut the risks of automating processes, digitalizing processes, digitizing data. And so it might even perhaps create some new opportunities, certainly for new entrants, if it lowers the barriers to entry, for people to compete in a marketplace and lower the cost even for incumbents of producing the digital data their various AI machines are going to consume. So the case for greater collaboration, for working together, for being on the same page is pretty clear. But I wonder, as you’ve just indicated, Richard, that your views about this have changed somewhat. But as you look back over the history of collaboration and indeed non-collaboration in the Bitcoin case you referred to, in the blockchain industry, where do you think the balance now lies between collaboration on the one hand, competition on the other, in the established capital markets of today?
24:07 Todd Mcdonald So it does come back to incentives always. And what are market participants incentivized to focus on today? We are living in a different world. The cost of capital has changed dramatically over the last two years and I think that aligns quite well with, I think this theme of collaboration or this theme of better connectedness of these pools of liquidity. Participants are incredibly focused on the topic of collateral. Where am I pre-funding certain venues? How can I get a better use of out of the funding that I have put forward? Because the costs are dramatically different than they were two to three years ago. So I think that’s a very big driver on the incentivising [of] market participants to try and figure out novel ways to have better collateral mobility. And if you look at not just what’s happening within, say, the enterprise blockchain space, across market infrastructure, but you look across the other market sort of structure and technology moves over the last year or two, it’s very specifically targeted at how can we improve knowledge of where my collateral resides? How do I understand how I can leverage that collateral? This is across capital markets, payments. This is a huge theme, and I think it’s really going to help accelerate, because if you think of it differently, R3 was founded with potentially a naive notion that large numbers of global investment banks would want to collaborate together to try and bring something forward. That can hold true if you align incentives enough, they’ll never be perfectly aligned, but there has to be enough alignment there. And I think the current environment actually does help quite a bit with continued collaboration. Not an altruistic one, but a really self-interested one for the participants. So I think it’s very helpful.
26:18 Dominic Hobson Incentives is a powerful point, and you’ve explained very clearly, Todd, about how more efficient mobilization of collateral can lower the cost of funding a bank, particularly in a high interest rate environment like today. And this has been my experience talking to established financial institutions about their adoption of blockchain. Efficiency has been a very big part of that right from the beginning, and it’s been a big part of the collaborative projects they’ve worked on. And many of the projects which I have tracked over the last few years were measured largely by the cost savings they would ostensibly or actually generate, particularly on the operational side of the business, which to some extent meant the industry ignored the savings which you’ve just referred to. Those savings can be generated by blockchain technology between firms. Those firms are kind of focused on how much money is this going to save us internally? And they’ve taken a long time, I think, to reach the point that you’ve been talking about, Todd, but you can get the benefits of that increased collateral liquidity, the capital savings, the savings in the funding of the bank. And as recently as this year, the DLT in the Real World Survey, which Barney Nelson runs in conjunction with Issa, said that found that only 13%, like one in eight of the blockchain projects, the members, the respondents to that survey were involved with that. That’s just investment banks. Were actually focused on liquidity. When you talk to custodian banks, it was like 9% of them. The exchanges and CSDS, it was 6%. The asset managers, it was 0%. So they’ve still got quite a long way to go to wake up to the liquidity benefits of engaging with blockchain networks. And I know Todd, you’ve described yourself as a kind of inveterate optimist here. Am I sounding too pessimistic here? And have a lot of things … do you detect real momentum now among established financial institutions to start garnering the benefits of greater efficiency between financial institutions? Getting collateral being an obvious starting point because it’s scattered in lots of banks and CSDS all over the planet.
28.39 Todd Mcdonald Dominic, I’m happy to provide my Positivity therapy to you after this. So maybe this is a good time to talk about an example, one project that we’ve worked with for a while. And then maybe, Richard, you can talk about how we’re looking to leverage interoperability to help move that forward. So, I guess, Dominic, this has been a theme, maybe a little bit of an undercurrent of a theme around balance sheet and how you can optimize it. But High Quality Liquid Asset Exchange (HQLAx) has been around for a while and we were very proud to be able to support them early days, even with office space and obviously on the technology side and we’re incredibly proud with what that team has accomplished. And what they’re trying to do is to use this technology so that firms can swap baskets of securities amongst them to better optimize what high quality liquid assets they hold on balance sheet. And so it is a great example of a market need, the ability to do it with new technology while still integrated into existing systems. So leveraging working with underlying custodians like Clearstream and Euroclear and others to make it as easy as possible for financial institutions to leverage this benefit. And this was obviously an acute need for European banks initially. But increasingly more and more banks are having, and I would say corporates are going to be having a similar need for the ability to initially have collateral swaps happen. So I tokenize the basket of securities, I swap that token, give it from me to you and it is recognized as being transferred from my balance sheet to yours. And there’s a lot of underlying magic there where we can change the contents of the underlying basket without having to recall the token. All the goodness of having an integrated distributed ledger plugged in underneath that fits within existing systems What they are looking to do and what others are in the conversations that I’ve been increasingly having is how can we build and chunk up from that to unlock further things like stock lending and repo. And so one of the ways they need to be able to offer that to their clients is how can we settle or exchange this token that represents a basket of securities? How can we exchange that for something that represents actual value, like within a repo agreement?
31:10 Richard Brown Yeah. And this ties several things together. Exactly as Todd says on HQLAx, there are these digital collateral receipts. And you can exchange them delivery versus delivery, sort of basket versus basket. So next question. As Todd says, what happens if you want to exchange one of these baskets for cash? Well, right now there is no cash token on the HQLAx ledger. But there is a parallel project on a different technology, as it happens, called Fnality, which you can think of as providing as close to CBDC as you can get without it having been directly issued by the central bank, let’s call it synthetic CBDC, and that could provide the cash leg. So immediately we’ve got an example of two networks that if we could bring them together, we could achieve this DvP and unlock things like repo. Now, one question might be, well, why on earth are they on different technologies? But if we then think through what it has taken to get each of these projects to the point where they’re live or about to go live. In the HQLAx case, so there’s the linkages to Clearstream and others, there’s the rulebook associated with that. There’s a legal opinion about balance sheet treatment on the HQLA side and then on the Fnality side, this is regulated, I suspect, as a financial market infrastructure, it has its own rulebook. There’s the question of domicile. The interface between technology, business model and regulation is subtle. And it’s different for each of them. The idea that they would have to have coordinated to choose the same technology, the same rulebook, the same governance, we’d still be talking about maybe they’ll go live in several years. Because they were able to run at their own pace, they were able to go much faster. And so the interesting thing to me was last year, this is now history, those two organizations, they wanted to do this DvP, and because of the way the platforms work, they were able to implement a protocol that worked bilaterally. They didn’t need to engage R3, they didn’t need to go through a standards body in the first instance. They were just able to make it work. But the interesting thing is, at least one of the interesting things to me, is why did they have to build one themselves rather than use an off the shelf standard? And the answer is, because of these points I just made, that there are two different rulebooks that have to be reconciled. There are questions about well, how does the technology – so the technical protocol, what does that do under certain legal situations? If there’s a bankruptcy on one side, what happens if assets are held immobilized in a lock and interest is paid? Who gets it? The pure technical protocols hadn’t engaged with those questions and so couldn’t be used. And so they directly worked with their lawyers and their technologists and produced a protocol that worked. And then the final point to this is, of course, is Todd’s point about incentives is they don’t want to have to then maintain that in perpetuity. So that then creates the incentive to work through a standard organization openly. R3 and our partners at Adhara are working with all these groups to say what has been learnt from this experience? Can we turn this into an open standard so that the cost of maintaining it is borne by everybody rather than just one firm? But they didn’t begin with a sort of just like an abstract academic desire to do interoperability. It was a really sort of like hard-headed need to bring these two networks together. The lawyers, the technologists, the business people figured out what was needed and then the incentives kick in to say we want this to be an open standard so we can share the cost and get the benefit rather than just doing it for the sake of it or because somehow we believe open is inherently good.
34:35 Dominic Hobson Okay, I get that open standards can emerge from normal market processes. People have financial, material incentives to generate these things to solve real problems. It prompts a thought in my mind though about public versus private networks. I suspect we’d had this conversation a few years ago we would have been talking entirely about private networks because people wanted to be confident who the counterparty might be on the other side. And I now detect that debate is shifting back in favour of public networks. And if networks are public, it’s a reasonable assumption that will enable liquidity to grow a lot faster than by trying to create lots of private networks which must somehow be made interoperable. And I do, as I say, detect this institutional willingness to use public networks. An OMFIF survey last year really surprised me where it found these major supranational bond issuers. A clear majority said yeah, we’re fine with issuing bonds onto public Ethereum networks, that’s okay with us. And again, that DLT in the Real World survey which I referred to a few minutes ago also records that majorities of respondents are very comfortable with public blockchains across almost every asset class. So my question is do you detect a similar shift of sentiment away from yes, we must be private, towards yep, we’re okay with public? And if you do, do you think that’s going to accelerate, as I assume you will agree with me, liquidity and interoperability between networks?
36:19 Todd Mcdonald I think I’ll start. So there is often a debate that’s framed as a binary of say, public versus private and at least I can say what I’ve been observing over the last year there has been an increased focus on how can I or, as a user, how can I create an asset of value that is regulatable. That is really what I think participants are looking for. So implementation of say, an open public crypto network where anyone can join as a validator all the way to an extreme of say, existing systems. Today there are a lot of different options in between those two. But it really comes down to what is the need if you’re issuing a bond or if you are looking to have, say, tokenized deposit that represents a settlement asset, those tokenized assets, especially when they are, as the crypto people like to call real world assets even though using RWA for that acronym drives me insane. Those need to have the ability to be regulatable not just to please regulators, but so that issuers and investors can be able to leverage them in a way that is straightforward. So when we speak to buy side firms, when we speak to banks, that is really what they’re looking at. How can I take the benefit of tokenization and do it in a way where the things that I am either tokenizing or the things that I’m consuming that have been tokenized can be regulatable and fit into how I manage my entire book today? I think that’s the important aspect here and public private or public permissioned? Private or permissioned? I don’t know. To me it’s a bit more of a label thing.
38:13 Richard Brown Yeah, we’re very comfortable with interoperability with both. The work we’re doing doesn’t discriminate. One thing I’ve noticed is in terms of there’s always that I guess the economic concept revealed preferences, what people say and what they do. And you’re right, a lot of our clients and prospects talk about interoperability with public networks as something they care about, which is of course really important. You need to have that option. You need to know that’s going to be possible. In terms of what they actually do right now, the majority of them are deploying to private networks or to walled gardens within the public networks. But we’re un-opinionated on that. One of the advantages of the idea of a network of regulated networks is you can, for any given problem, choose the right platform, the right network for that problem, knowing that these things will interoperate, if you like, between the public and private world. A few years ago it felt something like a holy war because if you believed that all assets would be on one network you necessarily then had to have the debate well, is it your network versus a competitor’s? And then at the macro level, is it a public network versus a private network? The acceptance, realization and embrace of the idea of use the right tool for the job and then connect them means that becomes a lot less emotional than it used to be.
39:29 Dominic Hobson This is my penultimate question. We promised we would talk about building a business case. Now obviously to go back Todd’s example of more efficient use of collateral, it would be great if that took off. The incentive to … the business case would kind of make itself because your collateral everywhere would be usable anywhere. The cost of funding your bank would go down, your capital ratios would go down. It’s a clear business case. Yet I keep hearing stories of firms actually struggling internally to build business cases for investing in blockchain. And the kind of reasons you come up against are actually much less to do with, oh, well, it’s very difficult to generate the liquidity you’re talking about. It’s difficult to get the interoperability going. It’s very familiar issues like, well, we’ve got all these assets sitting on these different platforms, the systems don’t talk to each other, the law isn’t clear, the regulators haven’t pronounced on this. So I’m a bit uncertain about whether we can do it at all. How do we integrate this with our counterparties’ systems? Isn’t there a risk we might get locked into some particular blockchain technology? And then you’ve got dozens of other projects all over the bank looking for various forms of budget to support the ambitions of groups within that bank. For R3, as an enterprise blockchain provider, you must encounter these obstacles and concerns all the time. How do you overcome them? How do you allay those concerns, those excuses, those fears?
41:11 Richard Brown Hopefully this answer doesn’t come across as trite. But Dominic, you said something really interesting in the question around being able to make a business case for doing a blockchain project or words to that effect. And of course, that’s the warning sign of a prospect or client who’s looking for advice and help on doing that. Already you know that there’s a problem here that has to be addressed. Because you look at some of the standout successes and I always come back to the one in Italy, it’s close to my heart. But the Spunta project, it runs on Corda, it runs on a blockchain, but that isn’t where its value comes from. Or you don’t need to mention that in order to convey its value. Moving from a once a month manual reconciliation process to one that happens automatically every night between every branch of every bank in Italy, the value comes from the problem that was being solved and the reduction of risk or the reduction of cost, whatever it may be. So the underlying project has to have a rationale. And then for us, as often with our vendor hat on, it’s our job with our prospects to explain to them or to convince them that solving that problem which needs to have a standalone business case, solving that problem with our architecture rather than the competing one would be superior, either because it can be deployed more quickly or it would be for lower cost or it allows them to gain other benefits. But you’re absolutely right. If someone was looking for a business case to deploy a database, you would kind of look at them as if they were a bit odd. And you’re right, we still see that with blockchain. And those projects are absolutely, almost always, the ones that don’t succeed.
42:40 Todd Mcdonald Yeah. Just fall in love with the problem. Right. And one other example I like to point out is where are there problems that a blockchain architecture can potentially uniquely solve? So an example is another company that works with us is Finteum, and they’re looking to address intraday FX swaps. So I left FX about 10-12 years ago. Intraday FX swaps didn’t even exist. It wasn’t a problem that banks thought they had until potentially regulators told them. They had that problem. But now, if you’re looking to manage that liquidity on an hourly basis, as opposed to doing tom next swaps or overnight swaps, the ability to bring settlement as close as possible to the execution and to reduce the amount of fails you have on getting actual delivery of currency into your nostro, that’s incredibly important. And so having a platform that can bring that together, where the execution and the settlement are as closely coupled as possible, is a real benefit and it’s a direct pain point for banks. So I think those are the types of examples that we have to stay focused on, because if as an industry we aren’t falling in love with the problem, but just trying to pedal the blockchain solution, that we will actually be on your corner of being the pessimist and not the optimist.
44:09 Dominic Hobson With my final question, I hope we can give everyone listening some idea of – we’ve touched on this how far we’ve come and where we’re all heading towards. You at R3 have a very clear vision of the future. It’s this open, this trusted, this enduring digital economy. My question is, what progress do you believe we’ve made towards that vision so far? And what are the problems, what are the obstacles that lie between where we are now and the realization of that vision in the near to medium term future?
44:49 Todd Mcdonald Obviously, potentially, as an optimist and an entrepreneur, always thinking that things will take less time than they do, I am incredibly excited that the marketplace is coming around to staying focused on where we can create new products and create new capabilities within tokenization. So we’ve talked a lot about tokenization of collateral and we haven’t touched at all on digital currency or Central Bank Digital Currency (CBDC), and a lot of the projects that we are working on quite feverishly here at R3. What we have seen is that I think initially there was potentially this concept that things would be completely peer to peer, things would be organized around a single network where everyone would all participants, buy side, sell side, intermediaries, would all join one sort of harmonious global network. Reality is always obviously going to be different. But if we look at where we are today, what excites me and what I think sets us up potentially for success in the near term is that, as you’ve mentioned, the banks have invested in this, but market infrastructure is investing and that’s incredibly important. FMIs, CSDs, central banks, having them put real money to work to implement this really new digital foundation for markets is incredibly powerful. The opportunity and risk will come in is how do the participants start to get involved? And not just the sell side, but increasingly the buy side and the longer tail of market participants. So I think that’s the opportunity that we have and I think what’s helpful is that it’s not just about cost reduction because in life things do come down to fear and greed and usually it is things that cost reduction is sort of like a fear of needing to save money. But if we can have an element of unlocking new markets, unlocking and creating sort of new securitization, be able to securitize cash flows in different ways, bring new product to market, that’s when you’re going to start to see people lean in. That’s when it’s not just going to be the banks looking to mutualize back offices. You’re going to start to see buy side and sell side and others really jump in with two feet on tokenization across the value spectrum. So I think that’s what’s setting us up to try and get to this vision that we have where value can move freely, but participants and businesses can have the faith that when they do interact in this world, that business can be done safely. So that is the balance that we are trying to strike and I think we can get there.
47:35 Richard Brown Yeah. Nothing to add to that. That’s the vision.
47:40 Dominic Hobson You don’t want to give us some final thoughts, Richard, on how far we have to go before the vision is realized?
47:48 Todd Mcdonald Well, he’s buffing his crystal ball here.
47:53 Richard Brown So maybe not about the future, but just on that question about how far we’ve come. Looking across not only the R3 projects, but our competitors or peers. There are live projects in multiple countries, multiple domains, multiple subcomponents of the financial industry and these projects are solving problems today and they’re alive and they’re growing. We’ve figured out how to connect these networks. So this problem we thought we had, which was these networks are isolated and therefore, in quotes, `they’re doing it wrong.’ We realized, no, we misunderstood the reality of how these things grow and we’re showing how to connect them together and the technology works. There’s been a lot of doubt about that in the past. So the technology works, these projects are delivering value and we figured out how to connect them. So all the pieces are in. So yeah, like Todd, I’m hugely optimistic.
48:42 Dominic Hobson Richard Brown and Todd McDonald, thank you very much for taking the time to share your knowledge, your experience and your ideas with the members of Future of Finance.
48.51 Richard Brown Thank you. Dominic, thank you.
