Digitisation at CME: What Does it Mean?

Galen Stops sat down at Consensus 2017 with Sandra Ro, executive director and head of digitisation at CME, to talk about the nascent technologies the exchange group is exploring and how they could improve the way that assets are traded.

Broadly
speaking, CME Group’s “digitisation” effort can be divided up into two distinct
categories. One is related to how blockchain, or distributed ledger technology
(DLT), can replace or improve core infrastructure in financial markets.

Discussions
around this technology inevitably involve clearing members and clients already
connected to the exchange, and the more core that the infrastructure being
looked at is, the longer it will take for an effective solution to be
implemented in its place.

“When we
think about blockchain and DLT, they are fundamentally removing frictions,
which increases efficiency and transparency and in turn should convert to
operational cost reduction and cost reduction in general,” says Ro.

However,
she is quick to add the caveat that investment is required by industry
participants in order to reach a point where the benefits of this technology
scales out and therefore this side of the digitisation effort is likely to
remain a work in progress for some time.

Given the
amount of media attention and industry hype around DLT over the past 18 months,
it seems likely that this part of the digitisation effort will probably sound
familiar to anyone working in financial services. What they might not be as
familiar with is the other side of CME’s digitisation initiative, which focuses
on the evolution of digital assets as a new asset class.

Interestingly,
in addition to focusing on the “pure” crypto assets, such as bitcoin and ether,
that have their own technology networks or blockchains underpinning them, the
CME is also looking at the “digital tokenisation” of physical assets.

To this
end, CME and The Royal Mint – a 1,000-year-old institution owned by HM Treasury
in the UK – announced plans in November 2016 to launch a digitised gold
offering called Royal Mint Gold (RMG). 

“This is
about creating a digital spot market,” explains Ro. “One RMG is equal to one
gram of fine gold, so an institution that would like to invest in gold will be
able to instead buy RMGs and know that they have physical gold sitting in The
Royal Mint vault in Wales. This means that there are no loans and no re-hypothication,
the gold is sitting there and The Royal Mint will exchange it for RMGs, if
investors require the physical asset.”

She adds:
“What does that do? A digital gold product removes challenges and allows
institutional investors to more easily trade, execute and settle.”

The Royal
Mint will be the sole issuer of RMGs and the CME will then provide the infrastructure
that will enable investors in this digital asset to trade it.

“It’s going
to be very simple to start with, it’s buys and sells on a screen for RMG
against euro, the US dollar and sterling. On the front end there will be
pricing transparency via a central limit order book, which people are used to
using. On the back end there will be a ledger system that the network – not CME
and not The Royal Mint – will use to record the transactions, and therefore
firms’ ownership of RMG,” says Ro.

This distributed
network that will be responsible for confirming transactions will have to be
permissioned into the network as validators by The Royal Mint. In other words,
this is not a public, permissionless ledger model, such as is utilised by
bitcoin, but a private, permissioned ledger structure similar to those being
touted by DLT vendors in the capital markets space.

Despite
this though, the company released the source code – Prova chain – underpinning
the network in order to garner feedback from the community of users about how
it can be improved. 

“Even
though we’ve open sourced the blockchain, this should not be confused with the
fact that that this is a private, permissioned ledger. To trade or to be a
validator, investors will need to be brought into the network,” says Ro.

CME and The
Royal Mint are not yet willing to disclose how many validators will be on this
network, but Ro says that this, and more technical details, will be forthcoming
in the future.

On the
digital infrastructure side, the CME will offer a cold storage solution to
ensure that investors are confident that their RMGs are being held securely.

Talking
about the future of tokenising physical assets, Ro is at pains to stress that
this is still very much an emerging use case for the technology.

“It’s still
pretty early days, but I think it will get very interesting if the industry
develops tokens that represent bushels of wheat or barrels of oil, physical
items that firms will actually want delivery of. If you have the digital
version of these physical assets, it could be very different from a crypto
asset world, where we’re talking about technology networks under-pinning these
tokens,” she adds.

Galen@profit-loss.com

Twitter @Galen_Stops

Twitter @Profit_and_Loss

Colin Lambert

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