Responsible Innovation in Financial Markets: Observations from the Trenches, Part I
Editor’s note: Manoj Ramia is Digital Asset’s General Counsel
Sometimes the headlines about financial innovation don’t tell the whole story. Sometimes, in fact, the financial innovation that grabs the headlines—in both good times and bad—isn’t the innovation that actually matters. The global financial system is inordinately complex. No “one big thing” is going to change everything, especially overnight. Rather, what actually matters are the many incremental, behind-the-scenes changes—changes that are perhaps superficially boring and seem individually insignificant but that can, over time, accumulate and make a meaningful difference. This is how real financial innovation happens. And this is how responsible financial innovation happens. This is innovation that solves real problems faced today by market participants, and that does so within regulatory guardrails that ensure a safe, sound, and fair financial system.
Digital Asset is enabling this responsible innovation with its Daml and Canton technologies, which are being used in production deployments by major market participants including Deutsche Börse, Goldman Sachs, and Broadridge. No other blockchain technology is in such wide use in production systems at major financial institutions.
Cynicism about financial innovation is justified. From the 2008 Global Financial Crisis to crypto, once-heralded “innovations” turned out to just be new ways to repeat the mistakes of financial history. The recent fraud and contagion plaguing the crypto sector have been particularly striking. Trillions of dollars of value were conjured up and subsequently destroyed, hurting retail investors misled by lofty promises. And all because a compelling, creative idea developed into an ideology. Rather than trying to solve real problems in the financial system, crypto “innovators” clung to their beliefs, tried to bend reality to their will, ignored the lessons of history, and failed spectacularly.
While the crypto sector has been going through increasingly destructive cycles, and its underlying ideology is proving to be hollow, real innovation has been happening outside of the spotlight. Rather than trying to impose an ideology, the focus of this innovation has been on testing ideas against reality to solve real problems. Rather than trying to replace the financial system we have today, the focus of this innovation has been on trying to improve it.
Driving this innovation is blockchain technology—innovative infrastructure that shouldn’t be confused with the speculative asset classes created by crypto. And just as importantly, we shouldn’t think of blockchain as some monolithic panacea to all the ills of the financial system but instead as a useful tool that can help solve some (not all) of the problems in today’s financial system.
To understand why blockchain is useful, it’s important to remember that at the core of the financial system are ledgers—the record of the assets held by financial institutions and the parties that own those assets. The fundamental innovation enabled by blockchain technology is the ability for market participants to work from a shared ledger, rather than—as is the case today—each market participant having its own ledger. The obvious benefit of having a shared ledger is the efficiency gained by no longer having to reconcile transaction data among many individual ledgers.
And blockchain technology enables an arguably more important innovation: the ability to rethink how value is transferred. Today, because an asset is represented on multiple, disparate ledgers, any transfer of that asset happens through manual processes prone to error, creating inefficiencies and settlement risk. But when an asset is instead represented in code using “smart contracts” on a blockchain-based shared ledger—this is what it means for an asset to be “tokenized”—the asset is no longer a static record, but rather becomes dynamic. The rules underlying any transfers of the asset can then be specified in the code representing the asset, making the asset “programmable.” This can eliminate inefficiencies and reduce settlement risk. Moreover, with the rules for transfer now specified within the record of the asset, complex workflows involving multiple assets can easily be created; in other words, the workflows become “composable.”
Regulators, while rightly skeptical of crypto, have recognized the benefits of blockchain technology. For example, Michael Hsu, Acting United States Comptroller of the Currency, has said, “Programmability, composability, and tokenization hold promise” and that “Blockchain development can be credited with bringing these ideas to the fore.” The Bank of International Settlements echoed this, saying, “programmability, composability, and tokenization [can] foster a vibrant monetary system.”
But not all blockchain technologies are the same. Digital Asset’s Daml and Canton technologies have unmatched privacy and data control capabilities that make them unique in their ability to deliver the benefits of blockchain.
Daml is a smart contract language that enables the development of blockchain applications that model transactions in the context of rights and obligations while enabling granular control over data. This preserves privacy and makes it well-suited for financial workflows. With Daml, a developer can specify different privacy rules for each unit of data in a transaction that is handled in that application. And using a set of Daml libraries we call Daml Finance, assets can easily be tokenized and made programmable while meeting the privacy requirements of the financial system. Daml applications fully realize these privacy capabilities by running on a Canton blockchain.
Canton (its name refers to Switzerland’s cantonal, federalist governance structure) is a blockchain technology that takes a unique approach to creating a shared ledger. While most blockchains today replicate the entire ledger across parties on a network, with Canton, each user of a Daml application maintains a ledger of only the data it is permissioned to see by that Daml application. The Canton protocol ensures that this data is valid and current. As a result, everyone works from a shared ledger without being in possession of the entire shared ledger and without that shared ledger actually existing; each user is only in possession of its portion of the shared ledger. This provides privacy as well as scalability and performance. And users of Daml applications can connect their Canton ledger to multiple Daml applications (subject to each application’s privacy rules), creating an interconnected network of Daml applications and enabling composability and the innovation benefits of network effects.
These capabilities of Daml and Canton together make them a viable blockchain solution for financial markets. This is why no other blockchain technology is in such wide use in production systems at major financial institutions.
Stay tuned for part two of our Responsible Innovation blog series, where we share what we’ve learned from helping major market participants deploy blockchain solutions for production use and discuss how Daml and Canton are solving real problems and fostering responsible innovation in financial markets.