Infographic: The Blockchain Could Change the Backbone of the Stock Market
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The Blockchain Could Change the Backbone of the Stock Market

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Where the Blockchain Meets the Stock Market

Modern technology enables stock markets to be faster and more complex than ever.

But while the speed of order executions are infinitely more impressive across the board, the conceptual backbone behind the stock market itself hasn’t changed much. In fact, the model we use today for settling trades and ensuring proper share ownership is still based on the one initially created in the 17th Century.

A Decentralization of Equities?

Today’s infographic comes to us from Equibit, and it envisions what a decentralized securities platform could look like.

In such a paradigm, the settlement of trades would not occur through centralized transfer agents, but instead through a blockchain with this feature “built in”.

The application of blockchain technology could take the modernization of the stock market one step further. Instead of technology being used simply to speed up more complex transactions, the blockchain could change how the plumbing behind the system works to mitigate current risks and problems.

But to understand how transformative this idea is, we need to look at the history behind the current model first.

The Roots of the Modern Market

The roots of the modern stock market can be traced back to Amsterdam in the year 1602, when the Dutch East India Company became the world’s first “publicly traded” company.

Trade missions to the West Indies were risky and expensive – so shares and bonds in the company were initially sold to a large pool of interested investors to spread the risk. In turn, backers of the company received a guarantee of some future share of profits.

As investors began speculating about the prospects of the Dutch East India Company, a secondary market quickly developed for these securities. People bought and sold stock in high volumes, and a central registrar tracked the transfer of shares between parties.

The Backbone of Today’s Market

Over 400 years later, the stock market is not that much different from the earliest exchange found in Amsterdam.

Modern computing and the internet have sped up transactions so they can be executed in milliseconds, but the conceptual backbone of the market hasn’t changed at all.

Stock Transfer Agents are the centralized registrars in the background that track share ownership for issuers and the stock market. They are a third party that will cancel the share certificate for the investor that sold the shares, and substitute the new owner’s name on the official master shareholder listing.

There are over 130 stock transfer agents in the USA and Canada, maintaining the records of more than 100 million shareholders on behalf of over 15,000 issuers.

New Technology, Old Model

While modern stock transfer agents use today’s technology, the same old model persists – and it creates multiple industry problems:

Centralized and expensive

  • Depositories and transfer agents are a single point of failure
  • Registration, transfer, distribution, scrutineering, courier fees
  • The more widely held, the higher the administration costs

Limited Transparency

  • Information asymmetry leads to market advantages
  • Forged securities still a concern
  • Counterparty risk is systemic

Furthermore, legal ownership rests with transfer agents in most jurisdictions. Investors actually do not have title.

At the same time, the industry is huge – just one company, The Depository Trust & Clearing Corporation (DTCC) is the highest financial value processor in the world with $1.6 quadrillion in transactions in 2016.

The Problem With Centralization

During the Financial Crisis, the problems of increased centralization and limited transparency reared their ugly head.

Companies like Lehman Brothers and MF Global self-destructed – and nobody knew what kind of assets they had off their balance sheets.

If an accurate [blockchain] record of all of Lehman’s transactions had been available in 2008, then Lehman’s prudential regulators could have used data mining tools, smart contracts and other analytical applications to recognize anomalies. Regulators could have reacted sooner to Lehman’s deteriorating creditworthiness.

– J. Christopher Giancarlo, Commodity Futures Trading Commission

This lack of clarity and risk helped drive hysteria, ultimately exacerbating the extent of the crisis. Because no one could quantify the risks, investors liquidated their assets. More selling meant even less liquidity.

Enter the Blockchain

Instead of putting all stock transactions through a centralized hub, the blockchain can be used to directly transfer share ownership between investors.

Here’s how a decentralized securities platform could work:

  1. Somebody decides to transfer a security.
  2. The transaction is broadcast to a P2P network consisting of computers known as nodes.
  3. The network of nodes validates the transaction and user’s status using known algorithms. A valid transaction will transfer the title of the security.
  4. Once verified, the transaction is combined with other transactions to create a new block of data for the ledger and thus completing the transaction.

In other words, stock exchanges could run using a blockchain under the hood, with no longer any need for a centralized settlement or transfer of share certificates.

This is cheaper, faster, reduces risks, and more secure. It also would be fully transparent.

Even better, such a platform could also serve as the base for other value adds – and fully transform the way we think about equity markets.

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Visualized: FTX’s Leaked Balance Sheet

As Sam Bankman-Fried’s crypto exchange FTX files for bankruptcy, this graphic visualizes FTX’s balance sheet leaked by the Financial Times.

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Visualizing FTX’s Balance Sheet Before Bankruptcy

In a difficult year for the crypto space that has been full of hacks, failing funds, and decentralized stablecoins going to zero, nothing has compared to FTX and Sam Bankman-Fried’s (SBF) rapid implosion.

After an astronomical rise in the crypto space over the past three years, crypto exchange FTX and its founder and CEO SBF have come crashing back down to earth, largely unraveled by their misuse of customer funds and illicit relationship with trading firm Alameda Research.

This graphic visualizes FTX’s leaked balance sheet dated to November 10th, and published by the Financial Times on November 12th. The spreadsheet shows nearly $9 billion in liabilities and not nearly enough illiquid cryptocurrency assets to cover the hole.

How did FTX wind up in this position?

How FTX’s Bankruptcy Unfolded

FTX’s eventual bankruptcy was sparked by a report on November 2nd by CoinDesk citing Alameda Research’s balance sheet. The article reported Alameda’s assets to be $14.6 billion, including $3.66 billion worth of unlocked FTT and $2.16 billion of FTT collateral.

With more than one-third of Alameda’s assets tied up in FTX’s exchange token FTT (including loans backed by the token), eyebrows were raised among the crypto community.

Four days later on November 6th, Alameda Research’s CEO, Caroline Ellison, and Sam Bankman-Fried addressed the CoinDesk story as unfounded rumors. However, on the same day, Binance CEO Changpeng Zhao (CZ) announced that Binance had decided to liquidate all remaining FTT on their books, kicking off a -7.6% decline in the FTT token on the day.

Back and Forth with Binance’s CZ

While Ellison publicly offered to buy CZ’s FTT directly “over the counter” to avoid further price declines and SBF claimed in a now-deleted tweet that “FTX is fine. Assets are fine.”, FTX users were withdrawing their funds from the exchange.

Less than 24 hours later on November 7th, both SBF and CZ tweeted that Binance had signed a non-binding letter of intent for the acquisition of FTX, pending due diligence.

The next day, the acquisition fell apart as Binance cited corporate due diligence, leaving SBF to face a multi-directional liquidity crunch of users withdrawing funds and rapidly declining token prices that made up large amounts of FTX and Alameda’s assets and collateral for loans.

FTX’s Liabilities and Largely Illiquid Assets

In the final days before declaring bankruptcy, FTX CEO Sam Bankman-Fried attempted a final fundraising in order restore stability while billions in user funds were being withdrawn from his exchange.

The balance sheet he sent around to prospective investors was leaked by the Financial Times, and reveals the exchange had nearly $9 billion in liabilities while only having just over $1 billion in liquid assets. Alongside the liquid assets were $5.4 billion in assets labeled as “less liquid” and $3.2 billion labeled as “illiquid”.

When examining the assets listed, FTX’s accounting appears to be poorly done at best, and fraudulently deceptive at worst.

Of those “less liquid” assets, many of the largest sums were in assets like FTX’s own exchange token and cryptocurrencies of the Solana ecosystem, which were heavily supported by FTX and Sam Bankman-Fried. On top of this, for many of these coins the liquidity simply wouldn’t have been there if FTX had attempted to redeem these cryptocurrencies for U.S. dollars or stablecoin equivalents.

While the liquid and less liquid assets on the balance sheet amounted to $6.3 billion (still not enough to equal the $8.9 billion in liabilities), many of these “less liquid” assets may as well have been completely illiquid.

Relationship with Alameda Research

When looking at FTX’s financials in isolation, it’s impossible to understand how one of crypto’s largest exchanges ended up with such a lopsided and illiquid balance sheet. Many of the still unfolding details lie in the exchange’s relationship with SBF’s previous venture that he founded, trading firm Alameda Research.

Founded by SBF in 2017, Alameda Research primarily operated as a delta-neutral (a term that describes trading strategies like market making and arbitrage that attempt to avoid taking directional risk) trading firm. In the summer of 2021, SBF stepped down from Alameda Research to focus on FTX, however his influence and connection with the firm was still deeply ingrained.

A report from the Wall Street Journal cites how Alameda was able to amass crypto tokens ahead of their announced public FTX listings, which were often catalysts in price surges. Alongside this, a Reuters story has revealed how SBF secretly moved $10 billion in funds to Alameda, using a bookkeeping “back door” to avoid internal scrutiny at FTX.

While SBF responded to the Reuters story by saying they “had confusing internal labeling and misread it,” there are few doubts that this murky relationship between Alameda Research and FTX was a fatal one for the former billionaire’s empire.

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