Discussions of Blockchain at conferences and cocktail parties range from the underlying technology to crypto-currency, Initial Coin Offerings (now being redefined as Token Revenue Events), to how the regulators will react to all of this.
To keep these blogs on point, we will limit our discussions to the three elements of Blockchain most relevant to Secondary Market Assets:
- Immutable Record– Blockchain creates a series of “blocks” of hash-marks that are linked together in a chain that makes it virtually impossible to modify the record after the fact. In our case, the meta data about each loan tape data element and each loan document in the loan file would be hashed and then “published” as an immutable record to a Blockchain. As you can imagine, making a 1,000 page “PDF blob” of an unaudited loan tape data, an “immutable record” would be of little value. Clearly, the Asset must be cleaned up before being published and the loan documents must be linked back to keep the file accessible.
- Distributed Ledger– Once the loan data and associated loan documents are immutable, it is published on a distributed ledger so that all interested parties can independently validate its accuracy and accept it as the “truth” for future transactions, audits and regulatory compliance. The distributed ledger is comprised of a network of Nodes to distribute the encrypted information about the loan data and loan file. By distributing the hashed and time stamped data across the network of Nodes, this evidence about the Asset is practically impossible to manipulate. Each Asset data element published to the blockchain is signed with private keys to provide immutability, in essence creating the ledger with additional security to only provide access to the Blockchain for users who need it. This makes Blockchain technology ideal for becoming the system of record for asset information. In the context of Secondary Market Assets, these Nodes could be operated by the key participants in a transaction; for instance, in an ABS deal, the Nodes could be controlled by the trustee, the investors, the issuer and the servicer.
- Smart Contracts– These contracts are prepared by attorneys but embed self-executing software code to manage routine processes required by legal deal documents. For example, the “if then” statement in the Indenture for an ABS deal that says: “If new month, then calculate the required cash distribution, withdraw funds from this account and deposit in the investors accounts, enter these transactions in the ledger and send a confirmation to each required party.” Smart Contracts for an ABS deal could, for instance, track ownership of beneficial interests in the Trust, payment and reporting by the Trust, and manage the Assets deposited into the Trust.
Let’s see the challenges to apply these three concepts to Blockchain solutions for Secondary Market Assets and how each can be solved.