OPINION: Blockchain’s Liquidity Problem09.09.2016
If U.S. equity market structure weren’t complex enough, T0, a subsidiary of online retailer Overstock.com, plans to launch a blockchain-based alternative trading system by year-end that will introduce further complexity.
Unlike existing the ATS platforms and self-regulatory organizations, T0’s platform will not submit matched trades to the National Securities Clearing Corp. for a T+3, soon to be T+2, settlement. Instead, the platform will validate and verify the trades by writing each completed trade to its proprietary blockchain.
According to T0, the entire process should take no longer than 10 minutes depending on where the trade lands in the queue.
To prime the pump for this proof-of-concept trading system, Overstock will issue a yet undetermined amount new shares that will be available to current shareholders either as standard shares or blockchain-based shares.
Once T0 launches trading on the ATS, there will be two separate markets for Overstock.com’s stock, the approximately 25 million outstanding shares that trade on the equities exchanges and a smaller amount that only will trade on the blockchain ATS.
Although trades in both sets of shares will be printed to the consolidated tape, there doesn’t seem to be any fungibility between the shares. There’s no mechanism to move a blockchain-registered share to the NSCC or vice versa.
This bifurcated market certainly will make attracting liquidity to the new ATS even more challenging. As an ATS, it doesn’t have a protected quote like an exchange that can rely on mandated onward routing by other market centers when it has the National Best Bid and Offer.
Initial liquidity might come from blockchain and cyber-currency enthusiasts, but attracting institutional flow is going to be the classic chicken-and-egg dilemma for the new trading platform.
Would institutional investors prefer trading in a more illiquid issue that settles the same day or an issue that takes longer to settle but from which it is easier to enter and exit a position?
Also, trading on the new ATS will involve creating a new account with T0’s soon to be named broker-dealer partner.
How many institutional investors will go through the effort of setting up another sell-side relationship to trade a single issue?
T0 has stated that it plans to support trading in other stocks in the future. But for that to happen, each company would have to issue new shares that trade in a blockchain environment just like Overstock.com.
It might be attractive for firms that are making their IPOs. But for listed companies, it would be a difficult sales pitch in this age of stock-repurchase programs.
On the other hand, a blockchain-based trading venue can offer other things to institutional investors that SROs cannot. There is no way to naked short sell on a blockchain. Traders must possess the shares before they can sell the issues, which solves one common complaint against the exchange-traded environment.
Blockchain-based systems also introduce a considerable amount of latency between the trade match and settlement, up to several minutes, which would tie high-frequency trading strategies in knots compared to the SROs.
Corporations might prefer keeping their stocks out of the hands of high-frequency traders, but would they accept the price of repurchasing shares only to re-issue them in a blockchain environment to achieve it? Only time will tell.
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