Overstock CEO Patrick Byrne brought new attention to potential applications for blockchain technology on Wall Street earlier this week when his company’s long-awaited blockchain trading platform debuted at Nasdaq’s New York headquarters on Tuesday.
The unveiling of tØ, covered by news outlets including Wired and The Wall Street Journal, was broadly focused on appealing to attendees with expansive rhetoric and a sweeping vision for how trading could be improved with blockchain technology while leaving some questions as to the market strategy and technical design of its products.
In a new interview, tØ co-founder John Tabacco opened up about the company’s offerings and its working relationship with the Industrial and Commercial Bank of China’s (ICBC) US capital markets division. At launch, he explained that tØ offers a private equities trading platform and a “preborrow assured token”, with the goal of opening up its public equities trading platform pending regulatory approval.
Tabacco suggested more information on the collaboration with ICBC, the world’s largest bank by total market cap, would potentially be forthcoming, but added new details to the record on this development:
“ICBC is being very cooperative. They’re some of the brightest and most innovative minds, and they’re helping and assisting us as a correspondent clearing firm to have all the parts of our system automated and demonstrable for the regulators.”
Tabacco explained that tØ is using the blockchain and its in-house matching engine to transact “digitized representations of existing legacy securities”.
“We’ve married the traditional legacy systems for public securities to the crypto ledger and what we’ve done is automate a process where we can preborrow shares and know they are in our custody. They’re untouchable to anyone else, and once we know they’re in our custody, we will issue digital representations of that in the form of a token.”
Each token, he continued, equals 100 shares of a security that he emphasized would allow “real-time price discovery” upon wider use. Today, Tabacco said tØ’s platform can borrow, segregate and create digital representations of shares.
Tabacco notably has a long and controversial history in securities lending, having been an outspoken critic of traditional practices in the industry in the wake of the 2007–2008 financial crisis. Further, he has taken sometimes extreme means to voice his beliefs, starting an anti-Occupy Wall Street protest in 2011.
He perhaps best known, however, as the founder and CEO of Locatestock, an electronic platform for trading securities lending that sought to help users locate legal traders, experience he suggested makes him well-placed to help carry out Byrne’s vision for the platform.
To date, tØ’s private equities trading platform is the company’s most active proof of concept, as it recently faciliated the issuance of a $5m “cryptobond” to New York trading firm FNY Managed Accounts.
Tabacco explained the company’s private and public securities platforms as “similar products with significantly different regulatory hurdles”. Overall, he framed this initiative as comparable to an effort launched by Nasdaq to use the blockchain in its Nasdaq Private Market, an exchange for pre-IPO company shares.
“We’re trying to address an area of the market that is underserved if not unserved, in that private securities and people who invest in VC securities. They make an investment into a Series A round or Series B round with the hope of a public offering or otherwise that will offer liquidity and an exit,” he explained.
He acknowledged that the product is also similar to one formerly offered by New York-based SecondMarket, which prior to 2011 had offered a pre-IPO securities marketplace. SecondMarket was notably founded by Barry Silbert, who has since become one of the most active venture capital investors in the bitcoin and blockchain industry.
“I think SecondMarket was a fantastic innovation,” Tabacco added. “What we’re doing at tØ is like SecondMarket 3.0.”
Building a private market
Tabacco declined to elaborate further on how tØ would seek to bring liquidity to its private market, a challenge SecondMarket cited in its decision to terminate its pre-IPO market. He did, however, explain how the pipeline for shares issuance is expected to work at scale.
“What would happen is an issuer would come to us and contract with us to put together their offering documents, and we have broker-dealers who we’ve engaged for strategic relationships who can handle the subscription process KYC/AML,” he said. “The broker-dealer would handle the subscription process to see if they’re a qualified buyer and institutional investor.”
Tabacco further cited its strategic relationships with FNY and brokerage-as-a-service provider DriveWealth as ones that would help drive interested participants to the new service and ensure participants are eligible to invest using its platform.
Public securities market
Tabacco suggested that the path toward the launch of a public version of this platform was less clear, but spoke at length about Byrne’s vision for the system.
“Patrick feels that retail investors are not fairly treated in the current capital market system,” he said. “There are multiple layers of intermediaries that add friction and cost.”
He explained that this version of the product would “push past limits” imposed on its private equities market, allowing a new class of investors the “transparency and efficiency” of its blockchain-based platform.
At issue is how regulatory agencies will allow consumers to engage with the platform, though Tabacco suggested the firm’s legal efforts, spearheaded by Jones Day and Perkins Coie, were making headway on this goal.
“The US Securities and Exchange Commission (SEC) has been working with us and they’re aware this is a novel idea and they want to know more about it. We’ve been granular in our explanations to them we want to make sure that the regulators regulate what they feel needs to be regulated,” he said. “We want to open tØ up to all investors.”
Preborrow assured token
In Byrne’s speech, a particular emphasis was placed on the company’s preborrow assured token, which was unveiled at the Tuesday event.
Building on this idea, Tabacco spoke out about a lack of transparency in the securities lending space, relating the developments in this part of the industry in terms of the financial crisis. Ultimately, regulators banned all methods of short selling stock following the event, allowing the excepting when stock was “preborrowed”.
“In the old days, if you wanted to short a stock, you’d call up a friend at another firm and say I’m shorting this stock and in three days I may need you to deliver it over to me, and you had to have reasonable grounds that that person would make good on his progress,” he stated.
This reliance on verbal assurances, he suggested, meant in an instance where users defaulted on these products, many short sales were subsequently never settled.
Here, Tabacco reckoned that tØ would be able to solve a market inefficiency by taking the human element out of helping traders prove they are conducting short sales according to the rules.
“What the blockchain gives us is the opportunity to basically segregate shares on every trade date, lock them in a segregated account where we know no one has access and create a digital representation of that in 100 share units,” he remarked. “The blockchain allows us to sell a digital token, which were calling a preborrow assured token.”
Tabacco called his former venture Locatestock as a “1.0 version” of the preborrow assured token, which sought to use unique ID codes to establish records of such trading.
“I think today most firms have a rudimentary internal messaging system that allows them to communicate where they believe shares may be available, and who they’ve given reasonable representation that they can lend it to them,” he said, adding:
“The innovation here is mind-boggling to people who understand it. There is a tremendous gap thanks to the lack of transparency in pricing for securities lending liquidity.”
Tabacco suggested that, while a small innovation in the entire trading ecosystem, the impact of the use of the blockchain in this area would be beneficial to investors in pension plan and non-profit groups through endowments.
“Using blockchain technology, we can zeroing in on a place in the market where there is no transparency so the good folks from say, the New York teachers’ pension plan or city retirement system if their custodian chooses to lending securities,” he said.
TØ, he said, would “level the playing field” by allowing such entities to compete on the same plane as more established trading firms, who he says have better access to price discovery.
He said this might lead to better returns to those engaged in these types of trades.
“Many of the US pension plans have been seeking anyway possible to enhance their returns, and by giving them an opportunity for them to access 1,000% price discovery, Patrick feels that we’ve created a product that will be greatly, greatly received by the retirement systems of America,” he said, concluding:
“If they’re getting 40 cents and they should have got $10, this will have a significant impact.”
John Tabacco image via Overstock