“… the opportunities we can envision blockchain providing stand to benefit not only our clients, but the broader global capital markets.” — Bob Greifeld, Nasdaq Chief Executive
Dole Foods, a California agricultural producer, was sued by its shareholders for ‘sandbagging’ when going private in 2013[i]. The Delaware courts determined that shareholders should be compensated for $2.74 per share. Despite only having 36,793,758 shares outstanding, the company received reimbursement requests from the holders of 49,164,415 shares. Where did the 12,370,657 new shares appear from? In the days leading up to the sale, shares continued to be exchanged and ‘shorted’, and since there was a lag between the execution of the transaction and the transfer of share ownership, multiple parties could claim to hold the shares simultaneously. Nobody, including the judges in the subsequent lawsuit, could determine who actually owned the company’s stock at the precise moment that counted. Ultimately, the excess claims were settled out-of-court between Dole, the Depository Trust Committee and the brokers.
The Dole Foods case demonstrates the limitations of current securities exchanges. The problem was that within the complex supply chain of stock transfers, duplication of ownership was possible. Blockchain technology could solve this issue, as well as improve cost profile, security, and transparency. Nasdaq is threatened by these shifts, and is aiming to capitalize on them.
Blockchain and Securities Supply Chain
Although a stock transaction can be completed within microseconds, the settlement — transfer of ownership of the stock — can take “as long as a week”[ii], and involves a supply chain with a series of counterparties outside the exchange, including brokers, depositories and custodians.
Blockchain technology could cut out the need for many of these intermediaries[iii]. The blockchain is a distributed ledger that allows for trustless, immutable and transparent tracking of digital asset ownership. Crucial to blockchain technology’s potential in exchanging securities are ‘smart contracts’, programs that combine the transfer of ownership with the transfer of value. That is, a blockchain-based network will only move money once the equivalent service (for example, the owner of a security being updated in the ledger) is completed. This ‘trustless’ attribute — where buyers and sellers no longer need escrow-like services to hold materials in the short-term — it is argued[iv], cuts out the need for ‘middlemen’ in digital asset supply chains, and this is a significant concern for Nasdaq.
Nasdaq’s Response: The World Is Not Enough?
Nasdaq has made several moves to capitalize on these opportunities. First, operationally, they hired a Vice President of Blockchain Strategy and advertised for blockchain developer roles[v]. Second, they are building new business models around blockchain. In late 2015, they created a new share ownership system for a private company, Chain.com[vi]. Paper share certificates were replaced by digital certificates, built on a private blockchain. By creating a blockchain-based trading platform for non-cryptoassets, this could establish Nasdaq as the blockchain-trading market leader. Third, they are integrating blockchain into their core business model. In 2016 they investigated the use of blockchain for shareholder proxy voting[vii], and most recently in November 2017 they created an exchange traded fund-like blockchain Smart Beta product[viii].
Although the most responsive of the stock exchanges to the threats and opportunities of blockchain, Nasdaq could still be doing more. First, they could invest in more blockchain startups or cryptoassets. This would provide a hedge against the growth of blockchain. Second, they could start a cryptoasset retail trading platform, to compete with Coinbase, Bitfinex, and others. This would allow them to capitalize on the potential for crypto-based protocols that will not need to IPO in the future. Finally, Nasdaq could expedite the shift to blockchain-based systems by encouraging publicly listed companies to open up their share registers to the blockchain. This would ensure that Nasdaq were right at the center of the approaching shift.
As with elsewhere in the blockchain space, many questions remain unanswered. Will blockchain-based solutions permeate the market? If they do, will an incumbent like Nasdaq be in a position to dominate, or will an innovative startup without Nasdaq’s institutional baggage be better positioned to do so? Perhaps most importantly of all, does the ‘blockchain revolution’ have substance, or is it, as Jamie Dimon described bitcoin, “a fraud”[ix]?
[i] Levine, Matt, Dole Food Had Too Many Shares (2017). Bloomberg News. https://www.bloomberg.com/view/articles/2017-02-17/dole-food-had-too-many-shares
[ii] Iansiti, Marco and Lakhani, Karim R., The Truth About Blockchain (2017). Harvard Business Review. https://hbr.org/2017/01/the-truth-about-blockchain.
[iv] Lee, Larissa, New Kids on the Blockchain: How Bitcoin’s Technology Could Reinvent the Stock Market (2016). Hastings Business Law Journal.
[v] Buntinx, JP, NASDAQ Is Hiring A Blockchain Developer For Their Linq Project (2016). The Merkle. https://themerkle.com/nasdaq-is-hiring-a-blockchain-developer-for-their-linq-project/.
[vi] Nasdaq, Nasdaq Linq Enables First-Ever Private Securities Issuance Documented With Blockchain Technology (2015). http://ir.nasdaq.com/releasedetail.cfm?releaseid=948326.
[vii] Rizzo, Pete, Nasdaq to Launch Blockchain Voting Trial for Estonian Stock Market. Coindesk. https://www.coindesk.com/nasdaq-shareholder-voting-estonia-blockchain/
[viii] Chaparro, Frank, There could soon be a new way to bet on the rise of blockchain (2017). Business Insider. http://www.businessinsider.com/blockchain-index-nasdaq-reality-shares-2017-11
[ix] Noonan, Laura, JP Morgan’s Jamie Dimon calls bitcoin ‘a fraud’, ‘worse than tulip bulbs’ (2017). The Financial Times.