The transformational potential behind the popular cryptocurrency bitcoin continues to draw the interest of traditional financial institutions looking to ready their core businesses for a wave of new financial technology. The aspect of bitcoin that appears to be of the greatest interest to financial services organizations is not the currency itself, but the underlying blockchain technology. This technology is what enables the integrity of trading systems without a central authority.
On October 30, 2014, Goldman Sachs filed a patent application titled “Cryptographic Currency for Securities Settlement”, which claimed priority to an earlier provisional patent application filed in May 15, 2014. The patent application was recently published by the US Patent and Trademark Office on November 19, 2015 as US Patent Application Publication No. 20150332395 (the “395 Application”). The 395 Application refers to a securities settlement system that leverages a distributed ledger and cryptographic protocols to provide for the secure, near instantaneous settlement of securities trades.
The current settlement system requires an interval of time between the execution of a trade and the actual delivery of a security or interest in securities to the purchaser. Clearing houses like the Canadian Depository for Securities (“CDS”) mitigate the risk that exists between the time of payment and the actual transfer of ownership.
The 395 Application provides for a new cryptographic currency called a SETLcoin to facilitate the exchange of assets, such as securities, cash, or other cryptocurrencies. Like other cryptocurrencies, the exchanges are enabled by reference to a distributed ledger derived from a peer-to-peer network of nodes that secure the ledger by publicly replicating it and thus making it nearly impossible for a fraudster to tamper with. According to the 395 Application, each participant would possess a digital wallet capable of proposing a transaction that would modify the public ledger to reflect the change in ownership of an asset acquired from, or exchanged with another wallet. These proposals (in SETLcoin language, “Exchange Transaction Messages”) would be checked against the multiplicity of nodes on the network to confirm the sender actually has the asset it is purporting to exchange. The Exchange Transaction Message embeds two important pieces of identifying information—an address based on the recipient’s public key, which is shared across the network and used to identify the recipient, and a signature based on the sender’s private key, a secret key mathematically linked to the public key that acts as a secure password through which a person may prove ownership of an asset on the public ledger. If the Exchange Transaction Message contains authentic and verified ownership information, the ledger is modified, presumably by a computation intensive, one-way algorithm as is the case for other cryptographic currencies. This transaction protocol is essentially the same as other established cryptocurrencies.
SETLcoin, however, differs from traditional cryptocurrencies in at least one very important manner: a SETLcoin can describe a particular exchangeable security or other asset. The 395 Application calls for the use of a “Positional Item inside Cryptographic currency” (“PIC”) that provides a common identifier code shared across the peer-to-peer network to represent a particular type of asset. A PIC can be supplemented by a “position”, which represents a quantity of the asset described by the PIC.
In order to make use of the PIC, SETLcoin offers a further twist on traditional distributed ledger cryptocurrencies: the use of authoritative entities that may designate, issue, authenticate, and destroy PICs. In the example described in the 395 Application , the inventors describe how an authoritative entity in the network, such as IBM (or, equally, an underwriter, regulator, or government treasury), could designate different classes of securities through PICs such as PIC IBM-B, (IBM bonds) or PIC IBM-S (IBM shares). These notations could be based on ticker symbols, abbreviations, security names, etc. Each issuer would use its private key to digitally sign each SETLcoin it issued in order to positively identify it when it is entered into the network ledger. This use of a hash based on the issuer’s own private key would provide a verification mechanism that could be supplemented by a counter-verifying validation by a trusted third party entity (for example the Ontario Securities Commission). Once registered on the distributed ledger, traditional methods of verifying the chain of past ownership could be used to trace the SETLcoin back to the issuer.
In order to provide for certainty in securities trades, the 395 Application also contemplates the use of a commitment protocol in the form of a distributed algorithm that checks to ensure two traders are prepared to perform their respective parts of the exchange. Certainty can be generated through the use of a multiplicity of nodes to confirm commitment by both parties, or through the use of a third party or exchange server that maintains a transactional queue.
The concepts and technologies described in the 395 Application represent the kind of thinking that could potentially disrupt entire industries by disintermediating anyone in the business of selling “trust”. The near instantaneous nature of trading and the verifiable certainty provided by a single, open and transparent ledger could seriously reshape the role of clearing houses like CDS and the necessity of systems like the large value transfer system. Both the Nasdaq stock market and the London Stock Exchange are already exploring the use of blockchain technology in their operations. These innovations are not constrained to the world of finance, and Goldman Sachs is not alone in its attempts to apply cryptocurrency technology to other walks of life. It is likely that there will be a strong first-mover advantage for innovative businesses who are capable of developing a blockchain network. The strength and usefulness of a distributed ledger depends on its capability to attract a multiplicity of users or nodes to verify and build on the ledger. The greater the number of nodes on the network, the greater the computational power, and the greater the security of the ledger.
If Goldman Sachs is able to obtain a patent (or a family of patents) protecting these transformative concepts and technologies, it may be able to assert control over the use of these concepts in new trading platforms through such patent rights. Goldman may be able to use these patent rights to maintain market exclusivity over its own trading platform and/or monetize these rights by extracting royalties from other platforms using these technologies. However, it is worth noting that other players, including Bank of America, are actively pursuing their own patent applications in this space. It’s another reminder that patent rights over transformative, ground-breaking foundation technologies can be very valuable, whether or not the companies actually commercialize the technologies themselves. As financial service organizations ramp up their technology development in this evolving area, patents will proliferate. As a consequence, it will become increasingly difficult for later entrants to carve a space for themselves without a robust intellectual property strategy.