Yesterday morning, New York time, a company called Clique Fund used the bitcoin blockchain to borrow $10 million in stock.
Bitcoin is the world’s most popular digital currency, and the blockchain is the vast online ledger that underpins bitcoin, tabulating transactions using thousands of independent machines spread across the globe. But the blockchain can oversee more than just the exchange of money. It can also oversee the exchange of, well, anything that holds value. That includes stock and other financial securities.
Through a new operation it calls TØ.com, online retailer Overstock.com and its freethinking CEO, Patrick Byrne, have built a system for issuing, buying, selling, and even borrowing stocks and bonds on the blockchain. On Tuesday morning, Clique Fund, a hedge fund based in New York City, used this system to borrow shares in the 30 stocks that make up the Dow Jones Industrial Average.
A New Way to Trade
Previously, TØ.com, an Overstock subsidiary, had used the system to issue a private bond to Byrne himself. Later, it issued a mostly symbolic bond to an outside company called FNY Capital. But the Clique Fund transaction is more than just a symbol. “This is a real trade,” says John Tabacco, who founded TØ together with Byrne.
According to Tabacco, TØ has been facilitating stock loans for the past two weeks, with five different customers borrowing stock, including Clique Fund. Tuesday’s transaction is the largest to date. “We’re starting to get critical mass—institutional-sized trades,” he says.
New Tech to Renew Markets
The transaction spearheads a much larger movement towards systems that use the blockchain and related technologies to facilitate financial trades. Startups such as Symbiont are working on similar systems, as is the company behind the Nasdaq stock exchange. At the moment, Nasdaq is building a system that will use the blockchain to oversee trades in private companies. But it believes that the technology can also be applied to the public stock markets.
The promise of the blockchain is that it can streamline the trading process, providing a more reliable record of who owns what and when, while removing at least some of the middlemen who bog down today’s markets. In particular, Byrne sees the technology as a way of closing the sort of well-documented market loophole—so-called “naked short selling”—that has plagued the Overstock.com in the past.
The way the market works today, stock trades can take up to three days to settle, and this largely happens behind closed doors. In the mid-2000s, this allowed hedge funds and other to short sell stock that hadn’t really been borrowed—-aka naked short selling. Though this loophole has now been closed, similar issues continue to plague the market. In moving transactions onto an online system, Byrne believes, we can remove these loopholes by settling stock trades immediately, and in a more transparent way. TØ is called TØ because it aims to settle trades with zero delay.
Overstock and TØ believe this system could particularly benefit the stock loan market, which is controlled by a select group of middlemen, including prime brokers such as Goldman Sachs and Morgan Stanley, as well as “agent lenders” such as BNY Mellon and State Street. To a certain extent, TØ’s system can cut out these middlemen and reduce the cost of stock borrowing.
Basically, organizations that want to make some extra money loaning out stock—such as pension funds—can offer up this stock through the TØ system. The system uses the blockchain to attach digital tokens to each share, and then, hedge funds and other traders can bid for these “pre-borrow asset tokens,” which provide the right to borrow the share. Using these tokens, stock holders can closely track each transaction involving their loaned stock.
Opening the System
That’s no small thing. Stock loans are an enormous part of the worldwide financial system. In borrowing stock, traders can short sell (sell the borrowed stock and reap the profit when the price goes down) or they can hedge other trades. The global stock market spans about $101 trillion in financial securities, and according to research from DataLend, about $1.7 trillion is out on loan at any given moment. That figure tops $954 billion in the U.S. alone.
Josh Galper, who runs a financial consulting firm, Finadium, that closely tracks stock loans, applauds the TØ system but questions how big its audience will be. The existing players, including the prime brokers, will be difficult to unseat. “It’s good news for them—and a very interesting experiment,” he says.
At the same time, Overstock and TØ are also aiming to remake the public stock market as a whole. Their system provides a way for companies to issue stock, and it’s seeking SEC approval to do so publicly. As it waits for an SEC greenlight, TØ has shown that the system can be used to issue private bonds—similar to what Nasdaq is trying to do with its Nasdaq Private Market system.
Though the system now uses the bitcoin blockchain, Overstock has experimented with other technologies that mimic the blockchain, and the system may move to these technologies in the future. The blockchain may not operate fast enough for real-time trades on the public stock market. But the idea will hold up just fine.
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