With a population of just under a million, the small state of Delaware is nevertheless a behemoth when it comes to corporate finance law. The state carries the distinction of having the most well-developed body of corporate law in the country. As a result, two-thirds of Fortune 500 companies are incorporated there and it is also where 85% of initial public offerings choose to domicile.
That is why a pilot program testing blockchain technology underway in Delaware could be a game-changer for Wall Street, according to speakers at a recent event hosted by the Mack Institute for Innovation Managementand the Penn Wharton Public Policy Initiative. The Delaware Blockchain Initiative is applying the technology to its public archives to store, distribute, encrypt and sunset documents. Later, the blockchain could be used for notice-of-lien filings, share issuances and other official actions.
“Delaware is such an important state. It is the state where the foundational infrastructure of finance in the United States happens,” said Caitlin Long, president of blockchain startup Symbiont, the state’s partner in the program. When Delaware makes regulatory changes, “it’s going to have a big impact on the whole corporate industry and therefore on all of Wall Street.”
Wall Street, in particular, is due for a technology makeover. While financial institutions have adopted the latest consumer-facing applications — such as banking apps on smartphones — much of the back office processes remain mired in outdated systems. There is an “unbelievable lack of technological adoption in the financial services industry,” said Long, a 22-year Wall Street veteran who has worked at Morgan Stanley and Credit Suisse. “You would be appalled at how much is still in paper form and how a lot of technology stacks of financial institutions are still running on [outdated programming language] Cobol. It’s really shocking.”
The step Delaware is taking could eventually lead to a much more efficient Wall Street, where settlements of trades and other processes would happen instantaneously and record-keeping will not only be easier but also more accurate. “This technology really is a game changer to massively simplify and streamline what’s going on in the financial sector,” Long said. “There’s no reason why we can’t settle securities transactions instantaneously. And this is the technology that I think will get us there.”
“Delaware is such an important state. It is the state where the foundational infrastructure of finance in the United States happens.”–Caitlin Long
Not a Bitcoin World After All
Blockchain technology came about when a mysterious entity named Satoshi Nakamoto designed the first cryptocurrency in 2008, the bitcoin. But what many don’t know is that “there is actually nothing new about bitcoin. It was just a combination of technologies that had never been combined that way before,” Long said. The technology underpinning bitcoin is the blockchain — a distributed ledger that uses smart contracts.
As a distributed ledger, or database, the blockchain keeps a growing record of data called blocks in a system that gives multiple users access. They share a single, immutable record of transactions that parties trust as valid. But “distributed systems have been around since the late 1980s,” Long said, citing Netflix and Google Docs as examples. “If you’ve ever worked on Google Docs you can see who’s editing in real time and you can have multiple people seeing the same thing at the same time.” Users can also see who made the changes in the database. (Bitcoin is a particular token that tracks balances on a blockchain.)
What makes the blockchain different from Google Docs is the lack of a central authority. Many ledgers may look like a blockchain, but in reality they are centralized databases on a network. While that may be good enough for many companies, it’s not a blockchain. “The characteristic that we think is really important … is decentralization,” Long said. Symbiont provides the software and management of Delaware’s blockchain program but it cannot look at or access the data. “We run the on ramps and off ramps. We update the software. That’s it. The entire network is peer-to-peer,” she said. “There isn’t anyone who owns it.”
Smart contracts are also not new. Long said that anyone who has ever used online bill payments is actually using smart contracts — they are set to automatically make regular payments, say, on the 30th day of every month. Add cryptography — which secures the data and the network — to the layer of smart contracts and distributed systems, and one begins to see Nakamoto’s ingenuity.
“That combination [of existing technologies and using them in a new way] is what caused this incredible flourishing of technology and opportunity to streamline the plumbing of the financial sector in the U.S.,” Long said. “When you’re combining smart contracts and a distributed ledger, you’re automating work flows and you’re massively simplifying the underlying plumbing of Wall Street.” Software can clear and settle transactions, for example, eliminating middlemen to speed up transactions and cut costs.
Benefits of the Blockchain
When bitcoin first came about, excitement swirled around cryptocurrencies. But attention shifted to the blockchain after it became increasingly evident that digital currencies face a tough challenge from regulators, and market adoption also would not be easy. “The market evolved as it became clear that cryptocurrencies, at least in the developed world, are not likely to have a big impact on the financial sector,” Long said.
The blockchain, however, is another matter. “This is so much more than bitcoin,” Long said. After speaking at a 2014 event for corporate treasurers about the technology, she said the audience immediately understood the blockchain’s potential to streamline corporate processes. “These big companies have about 2,000 accounts around the world,” Long said. “You can imagine the reconciliation they have to do.”
For example, Long said it takes Seagate Technology six days to move cash between its Thailand subsidiary and the U.S. The blockchain can substantially speed up this process. “Immediately, the corporate treasurers understood there’s something really big here and this can really help free up working capital [and] help reduce a lot of operational risk in the securities industry.”
The blockchain can be permissioned — only approved users are given access — or permissionless, which is open to the public. Long said it is difficult for financial institutions to use public blockchains because they have to comply with anti-money laundering and other laws. “They need to know who’s on the other side of the transaction. By definition, in a permissionless platform, you don’t know who’s on the other side,” Long said.
The Delaware Pilot
In Delaware, one immediate application of the blockchain is that incorporation and share issuance could be executed at once. Currently, these are two separate steps. “If you think about it, that doesn’t make sense. A corporation is a company that issues shares to its investors,” Long said. “These two things really can’t be separated if you think about it conceptually. And yet, that’s exactly what the process is in every state. So, by being able to register on a distributed ledger on a blockchain, the process of incorporation and issuing shares will happen automatically.”
“There’s no reason why we can’t settle securities transactions instantaneously. And this is the technology that I think will get us there.”–Caitlin Long
Andrea Tinianow, director of the Delaware Blockchain Initiative, said the state began exploring the technology after some companies asked if they could issue shares on a blockchain. While the state does allow the issuance of uncertified shares, legislation is pending that would specifically permit the registration of common shares using blockchain technology, she said.
This “small change to Delaware corporate law, if enacted, could facilitate a major simplification of the plumbing of the financial system,” Tinianow and Long wrote in a March 2017 piece for Harvard Law School. Delaware’s blockchain program “will allow for the application of distributed ledger technology to many of the private sector’s most basic and critical legal documents, which companies currently file with the [state].”
When a new company incorporates in Delaware using shares issued on a blockchain, the state would transfer the authorized shares directly to the firm. In doing so, it establishes a record of the shares and the blockchain keeps track of them, they wrote. Today, it is not unusual to find mistakes in the record-keeping of shares, which then needs to be corrected through more filings and audits. The blockchain is expected to solve this problem.
Delaware is not the only state looking to allow blockchain technology. At least eight states reportedly have pending legislation about it in some form: Vermont, Arizona, Maine, Nevada, Hawaii, Illinois, North Dakota and California. “Delaware was the first,” Tinianow said at the event. “I think other states are going to come on … [in] a handful of years. Not decades.”
Long sees the financial services sector will be “just software” within 20 years. “Twenty years is probably not that long when you think about it. It sounds like a long time from a technology adoption cycle [viewpoint], but it’s just such a vast industry and there’s so much work that has to get done to adopt it. And it has to be done in the network. So it is going to take time.”