James Angel compares bitcoin to MySpace, the social network that paved the way for far more influential services like Facebook and Twitter.
Today's bitcoin digital currency, says Angel, a professor of finance at Georgetown University, is too flawed to replace existing currencies. But the basic ideas underpinning the technology, he believes, can significantly change how the financial world operates. This is already starting to happen.
As it revealed over the weekend, Nasdaq OMX---the company behind the Nasdaq stock exchange---is testing a system that uses bitcoin technology to oversee stock trades on a separate market solely for private companies. Brad Peterson, who leads technology efforts at Nasdaq OMX, says the test will happen on the Nasdaq Private Market, which launched early last year, giving companies a way of better managing their shares before an IPO. In short, Nasdaq will handle the market's trades using technology based on the bitcoin "blockchain," the online public ledger that tracks ownership of the digital currency via machines spread across the Internet.
Angel calls the project "the perfect application for the blockchain." Today, pre-IPO companies track their stock sales and trades using ad hoc technology like computer spreadsheets. The blockchain can streamline private trading, and give pre-IPO companies a more reliable way of auditing trades in their stock. "CEOs often ask us: 'Why can't I know immediately who owns my stock and who trades my stock?'" Peterson says. "That's a fair question."
With companies waiting longer to offer an IPO---and seeking new ways of giving employees added liquidity before going public---Nasdaq's system could serve a growing need. Perhaps more importantly, the project could spark the use of bitcoin technology as a way of refining public stock markets as well. Today's public markets are woefully inefficient, taking up to three days to settle trades, and the blockchain could help change this.
Peterson believes it will. When asked if the company's work with the blockchain in the private market could lead to something similar in the public market, he doesn't hesitate. "Yes," he says, "we think so." And he's in a position to help make this happen. Nasdaq not only runs the Nasdaq stock market. It operates eight other stock markets in Europe, and it provides technology for countless others.
Peterson isn't the only one who believes the blockchain ultimately can remake public stock markets. Big-name online retailer Overstock.com, a public company, is building bitcoin-based technology that it hopes to use as a means of issuing its stock online. (Late last month, it filed a prospectus with the Securities and Exchange Commission in an effort to win regulatory approval for its plan). And open source projects like Counterparty are exploring the same basic idea.
Angel refers to this concept as "the stockchain," and like Peterson, he sees Nasdaq's private market technology as a stepping stone to a blockchain-based public market. "This is the type of application that makes a good test case," he says.
Nasdaq already has built a prototype using what's called the Open Assets Protocol. Essentially, this is a way of "coloring" bitcoin transactions so they represent an asset other than a bitcoin (such as a stock trade). The prototype runs atop bitcoin's existing network of machines, and Peterson says Nasdaq will start experimenting with outside private companies "right away."
Angel warns, however, that there are many challenges to overcome before this kind of thing can succeed, particularly on the public stock market. Nasdaq and other exchanges must hone the ideas that underpin the blockchain before it can thrive in the face of what Angel calls the "incredible conservatism" that characterizes Wall Street. Most notably, he warns that the technology must balance the open nature of the blockchain with the need for privacy. A chief benefit of the blockchain is it tracks all transactions on a ledger anyone can view at any time. But as Angel notes, many investors prefer to keep transactions private. A bitcoin-based stock system will need a way of keeping transactions public while hiding the identity of individual investors.
Peterson says Nasdaq already offers such privacy tools. "It's similar to the way a bitcoin wallet works today," he says. "We can give the company and the people a view into their private transactions, but they can’t see other companies' transactions." That said, researchers have shown that even if you hide behind anonymous addresses, there are ways of determining who you are.
This is often the tension in the world of bitcoin. And it's a key reason the technology is still used relatively rarely as a digital currency. But at the same time, public stock markets could very much benefit from the technology bitcoin provides. Today, stock trades are overseen by an organization called the Depository Trust & Clearing Corporation or DTCC, a privately controlled middleman that works under a system where trades need not be settled for three days. "The DTCC is really 1970s technology with 2000s hardware," Angel says. "That's why it still takes three bleeping days to settle a trade."
For Overstock.com CEO Patrick Byrne, such middlemen create loopholes that can be exploited by investors. He aims to close them with his blockchain project. Angel believes that even if Overstock's plan receives SEC approval, the company will have difficulty moving investors in its bitcoin-inspired platform. Investors in public companies like Overstock are too married to the old way of doing things, he says. They already juggle their Overstock shares through other parties and technologies.
But Nasdaq may have an easier path to success. When investing in brand-new company whose stock is only available in the private market, Angel explains, investors are more likely to give the technology a try. "The private market can go from quill pins and parchment into the 21st century," he says. And if it's successful, perhaps then the public market will follow.
Peterson sees a direct path to the public markets. Companies that use the blockchain in the private market will be more likely to use it in the public market, he says. And though there is enormous inertia to overcome among US investors, he adds, that inertia isn't there in the developing world. "We may see countries jump straight to the blockchain," he says.
