Background
Blockchain Trading
Model
Non-Transparent I
Transparent
Non-Transparent II
Market Design of Trading with Blockchain Technology
Katya Malinova and Andreas Park
P2P Financial Systems 2016
London, UK
Summary
Background
Blockchain Trading
Model
Non-Transparent I
Transparent
Non-Transparent II
The Buzzword in the Financial Press since mid-2015
Background
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Summary
Background
Blockchain Trading
Model
Non-Transparent I
Transparent
Non-Transparent II
The Buzzword in the Financial Press since mid-2015
Background
Summary
Background
Blockchain Trading
Model
Non-Transparent I
Transparent
Non-Transparent II
Why is Blockchain Important? What can it do?
An Analogy
• World Wide Web:
• frictionless transfer of information
• Blockchain:
• frictionless transfer of value
• Economic Implications:
• peer-to-peer transfer of value possible → no need for “trusted third party”
Summary
Background
Blockchain Trading
Model
Non-Transparent I
Transparent
Non-Transparent II
What is Blockchain and why is it interesting?
Securities Trading Today
Verifies that
Trader has money to buy
Broker 2
Exchange
- keeps book
- displays limit order
- facilitates match of
Buy and sell
Verifies that
Trader has stock
to sell
Broker 1
Trader sends
MKT buy order
Trader posted
Limit sell
DTCC/CDS
(Register holder; could
be aggregated at broker
level):
End of day clearing &
settlement
Broadridge
Maintains list of
Beneficiary owner
Summary
Background
Blockchain Trading
Model
Non-Transparent I
Transparent
Non-Transparent II
What is Blockchain and why is it interesting?
Transfer of value with Blockchain
Stock 3
Pk6543
Money coin
Pk5432
Makes offer to buy
Pk5432
Pk6543
Agrees to buy
Summary
Background
Blockchain Trading
Model
Non-Transparent I
Transparent
Non-Transparent II
Summary
Design choice: Permissionless vs. Permissioned Blackchain
Public Blockchain
Private Blockchain
=> distributed network
=> select/limited number of network nodes
Features:
- open access
- irreversible blocks
- public info of ownership (by public key)
Features:
- filtered access
- blocks can be changed
- ownership info may be public or private
Background
Blockchain Trading
Model
Non-Transparent I
Transparent
Non-Transparent II
Information Environment Today vs. Distributed Ledger
Ownership Information
Current World
Blockchain
Broker A
Acc A123
Acc A3214
Broker B
Acc B432
Acc B123
Acc B654
Pk234
Pk123
Pk321
Broker
Acc 3421
Broker A, Acc A123
PK123
Privacy
is a
choice
Investor
Investor
Broker B, Acc B123
PK321
Summary
Background
Blockchain Trading
Model
Non-Transparent I
Transparent
Non-Transparent II
Summary
Information Environment Today vs. Distributed Ledger
• Blockchain
•
= “distributed ledger of all transactions of an electronic item”
Easiest way to think about it: a single, distributed database of past transactions for
an item.
• Past transactions ≈ current ownership
• transactions are identifiable by public keys → derive holdings
• public keys/IDs are collections of numbers and letter → not directly identify a
person/entity.
• people/entities can choose to reveal identity or be known in permissioned network
• can achieve anonymity by using multiple IDs
→ hard to achieve in, e.g., OTC markets.
• → privacy is a choice.
• Main observations that motivate the paper: technology enables
• transparency of holdings
• and peer-to-peer trading.
Background
Blockchain Trading
Model
Non-Transparent I
Transparent
Non-Transparent II
Our Paper: Two market types
Possible Markets
Intermediated
market maker
absorbs orders at
a cost
Peer to peer
contact other traders
probabilistic fill
complexity cost
Summary
Background
Blockchain Trading
Model
Non-Transparent I
Transparent
Non-Transparent II
Summary
Model Ingredients
• Normally distributed asset. No private information about asset value.
• Two large institutional investors, of the same size, one of whom will be
hit with a liquidity shock.
• Continuum of small investors, trade small amounts with some probability.
• CARA intermediaries, willing to take on position (but expensive).
• Complexity cost of trading peer-to-peer.
Background
Blockchain Trading
Model
Non-Transparent I
Transparent
Non-Transparent II
Setting I: Non-transparent Concentrated Ownership
One owner - one key
Peer to peer 1:
Ownership: one owner, one key
=> concentrate all holdings
under one PK
Visibility: NO
Investor
Large investor,
but invisible!
Summary
Background
Blockchain Trading
Model
Non-Transparent I
Transparent
Non-Transparent II
Summary
Results: Relative to Benchmark with all trading through the
intermediaries
1. Large investors split their large trade between small investors and the
intermediaries.
2. Payoffs for large investors are higher (because of lower intermediation
cost).
3. Price volatility is lower.
Note: Nothing in this setup requires Blockchain Tech — ITG’s POSIT Alert or
Algomi already facilitate anonymous peer-to-peer.
Background
Blockchain Trading
Model
Non-Transparent I
Transparent
Non-Transparent II
Setting II: Transparent Concentrated Ownership
One owner - one key
Peer to
Ownership: one
=> concentrate all
Visibility of
Investor
Direct trade
Between two
Large investors
peer 2:
owner, one key
holdings under one PK
ownership: YES
Summary
Background
Blockchain Trading
Model
Non-Transparent I
Transparent
Non-Transparent II
Summary
Results: Relative to Benchmark with all trading through the
intermediaries I
• Pros and Cons of Transparency:
(+) ability to locate/contact the other large trader
→ escape the complexity costs & rents by the risk-averse intermediaries.
(−) reveal info about the trading needs & may get “front-run” by the other trader.
• Modelling Mechanics of Front-Running:
(i) LT to LP: Buy quantity Q at price p̃?
(ii) LP buys Q from intermediary and moves the “public price” P ր to P + x.
(iii) LP to LT: “sell you Q at price ≫ p̃?”
Background
Blockchain Trading
Model
Non-Transparent I
Transparent
Non-Transparent II
Summary
Results: Relative to Benchmark with all trading through the
intermediaries II
• Observations:
• To avoid front-running, offer price concession (p̃ “high enough”)
• But: in single-shot setting, LP extracts all surplus from LT
• Repeated setting: front-running is punished in subsequent periods via “trigger
strategy” punishment:
• Deviation → large traders avoid each other; trade as in Setting I forever.
• Results:
1. In a repeated game, front-running can always be avoided.
• large traders trade only with each other.
• large traders share the cost savings.
2. For large enough discount factors (≈ frequent interactions), trading between large
traders at p = 0 is an equilibrium.
Background
Blockchain Trading
Model
Non-Transparent I
Transparent
Non-Transparent II
Setting III: Non-Transparent Dispersed Ownership
“One share - one key”
Peer to peer 3:
Ownership: one share, one key
=> disperse holdings over many PKs
Visibility of ownership: Yes, but no memory
Investor
Summary
Background
Blockchain Trading
Model
Non-Transparent I
Transparent
Non-Transparent II
Summary
Results: Relative to Benchmark with all trading through the
intermediaries I
• Idea: LT approaches continuum and trades with small and large investors.
• Observations for equilibrium where large trade with each other:
• Can be welfare enhancing relative to non-transparent, concentrated ownership (less
trade with intermediary).
• But: sometimes high price concession (which goes to small and large investors!) is
necessary which lowers payoff to large traders.
Background
Blockchain Trading
Model
Non-Transparent I
Transparent
Non-Transparent II
Summary
Results: Relative to Benchmark with all trading through the
intermediaries II
• Results:
1. Equilibrium with no front-running exists
• When the discount factor is large enough (frequent interactions).
• When the intermediated market is sufficiently liquid.
2. (Numerical): For small discount factors, the equilibrium with no front-running
where large traders accept each other’s offers does not exist.
• In equilibrium, the liquidity trader offers p = 0 to the continuum, and public keys of the
other large trader reject the offer.
• Welfare-reducing for large traders relative to Setting I because the low probability of
acceptance in the continuum leads to “over-trading” with the intermediaries.
Background
Blockchain Trading
Model
Non-Transparent I
Transparent
Non-Transparent II
Summary
Comparison of the three
1. Payoffs in peer-to-peer settings dominate pure intermediation.
2. Payoffs with transparent, concentrated ownership are highest.
3. Payoff ranking with non-transparent ownership depend on whether in
equilibrium large investors trade with each other.
(i) No? Payoffs with concentrated holdings are better.
(ii) Yes? For small price concession p, the payoffs in the setting with dispersed holdings
are better.
Background
Blockchain Trading
Model
Non-Transparent I
Transparent
Non-Transparent II
Summary
• Intrinsic Feature of Distributed Ledger: Information on holdings.
Q: How much transparency is desirable?
Q: What are there tradeoffs between anonymity and liquidity?
• Our paper: A framework for pros and cons of holdings transparency.
• Let’s start talking about market design with blockchain technology!
Summary
Background
Blockchain Trading
Model
Non-Transparent I
Transparent
Non-Transparent II
Summary
Why academics should care about trading with blockchain
securities
1. It an economically big question.
HFT (still the hot microstructure topic) annual revenue: $1.3B (TABB Group
estimate for 2014).
• IT cost savings from Blockchain for FI: $6B (Goldman), $20B (Santander).
• current post-trade and securities servicing fees are ≈$100B (Oliver Wyman).
•
2. The technological change can give rise to new market structures
•
Once-in-a-lifetime opportunity for reset and optimization of the organization and
regulation of trading.
3. Academic research can make important contributions to set up solid
market organization.