Like many people a few years ago, I had been hearing about cryptocurrency for some time, but largely dismissed it probably because it was something I really couldn’t get my head around. But in 2016 I heard the word “blockchain” mentioned for the first time, and that piqued my interest enough to Google it to find out what it was. I learned that blockchain and distributed ledger technology can take many forms and have many uses, and that it underpins exciting changes in numerous business practices throughout the world – and most importantly that there was an expansive world of blockchain beyond mere cryptocurrency. But as someone who largely views the business world through a structured finance filter, my “genesis thought” after reading perhaps only one or two paragraphs about this so-called blockchain technology was, wow, this could run securitization transactions. That same day, I dove into LinkedIn to find others talking about blockchain and so I began networking, and within a few months I was speaking on a blockchain panel at the Structured Finance Industry Group’s annual conference in Las Vegas.

Science fiction

At that conference in February 2017, I painted a “science fiction” version of what securitization transactions could look like in a future world supported by blockchain technology including digital title to assets, digital securities, and the ability to move fiat currency digitally and instantaneously. Using auto loans as an example, it went like this: an individual agrees on the price for a car at the dealership lot, scans the vehicle identification number with a phone app, selects a loan amount if needed, and provides insurance and other personal information before hitting “submit.” The dealer is pinged and clicks “accept.” Then, perhaps in a few seconds or minutes, the car is titled and insured in the buyer’s name, a loan is underwritten and has been funded instantly by a type of autonomous variable funding note or securitization structure “living” on a blockchain with investors on the other end of it. Funds are pulled from participating investors’ wallets and pushed through the system, the dealer’s floorplan line is paid down, and the profit from the sale is deposited to the dealer. Perhaps the phone now operates the vehicle’s “smart locks” to enter and start the car and its digital license plate lights up to reflect its registration – all with little to no human involvement.

The future comes in steps

We Earthlings did not fly to the moon without first learning to fly across a field. That’s because change and achievement are generally multi-step processes, and this especially holds true in the financial markets. I can recall modelling my first term asset-backed securities deals in a somewhat nascent industry using Lotus 123, and experiencing the “big deal” of adopting both Windows and Excel. We used formulas found in Fabozzi’s handbooks to create and model pricing formulas and prepayment speeds. In multi-class sequential-pay structures we quickly learned the value of the @if function in our models for allocating principal to tranches, these functions often nested together in formulas that would span the entire width of the screen. We fought circular references, the enemy of any spreadsheet user. We were always wrong until we eventually got it right, and hundreds of millions of dollars were at issue in these transactions.

Enter distributed ledger technology – i.e. “Shared Math”

Today, much of the financial markets still revolve around parties to transactions reconciling information every month, month in and month out, often on Excel spreadsheets. In many cases, one party puts together a spreadsheet for another, who takes that information and puts it into its own. Analysts of counterparties have conversations that sound like this, “my spreadsheet says I get X and yours says I get Y. Well, I think you accidentally hard-coded cell F64. But you didn’t update the LIBOR rate. What do you have in the sub-total in G98? Okay, got it, my bad, talk to you next month.” Think of the number of parties doing the same math each month to “tie out” cash flows in a term asset-backed transaction that may endure for years and have dozens of investors. What if all parties to a transaction had connectivity into the same ledger instead of each having their own? What if a “smart contract” was coded that automated the business terms of a transaction (in the parlance of securitization these business terms are known as the “payment waterfall”)? What if the parties that mattered were all “nodes” on a distributed ledger or private blockchain – the issuers, servicers, investors, rating agencies? Portfolio collections systems could feed data to the smart contracts, principal and interest calculations could be calculated, and trigger calculations and many other servicer reporting or performance calculations could be automated. This connectivity could be created between parties to virtually any capital markets transaction, especially beneficial in math-heavy transactions found in securitization or even warehouse lending – where it is the performance and thereby cash flows generated by a pool of assets that drives monthly flows of money.

What we can do today

I think the first step to implementing blockchain or distributed ledgers to benefit the securitization process is to simply show that a transaction’s data and calculations can be run and automated on a distributed ledger, even in our “paper world.” We can use blockchain’s connectivity and consensus mechanisms to provide trust, provide automation and efficiency, immutability, and eliminate or reduce human error. I do believe there is a future for digital title to assets, digital securities, and digital currency, but a tremendous amount of infrastructure needs to be put in place to support that. Some blockchain advocates in the space are trying to do everything at once, they believe the future is now. But this “all-now” paradigm is proving too big of a leap for many incumbent players, especially at the institutional level, and adoption of blockchain in securitization has been stymied. I believe we should only provide the market with what it is ready for, and implement a foundational structure for simply reporting and managing data as described. I say, let’s start by flying across the field before we shoot for the moon.

Gary Miller heads U.S. operations for Intain Fintech, an artificial intelligence and blockchain technology solutions provider focused on the financial services sector, including securitization.