R3

R3 is an alliance of the world’s largest insitutions, with a mission to realise the benefits of distributed ledger technology.


Financial Grade Ledger Global Collaborative Lab

Distributed Ledgers at a Glance

Distributed ledgers are records of consensus with a cryptographic audit trail maintained and validated by several separate nodes.

When there are multiple parties trying to submit information to the network, distributed ledgers leverage a consensus mechanism to validate transactions.

When a transaction is added to the ledger, the network is almost-instantly privy to this new version. Distributed ledgers also leave behind a cryptographically assured audit trail and timestamp.

All parties in the network keep a copy of the ledger.

The Promise of Distributed Ledgers

Distributed ledgers are a type of software maintained by a network of nodes which can validate, register and track complex transactions in a dynamic fashion.

In capital markets, this type of process sits in the back office, where decades-old systems based on data reconciliation processes drive a multi-trillion dollar industry.

Benefits of Distributed Ledgers in Capital Markets

Many of the software solutions in back office functions are decades old and rely on reconciliation among separately maintained databases to register, track, and account for transactions.

This introduces substantial risk from human error and insufficient liquidity.

In the R3 model, the transactions validated by the network would be registered in one ledger.

This property would allow financial firms to track and manage risk more dynamically as the transaction data would sit in one place held among legally culpable actors

Legal entities and auditing functions at a bank would benefit from a cryptographically assured record of transactions.

The creation of an authoritative system of record securely shared among firms would change the economics of our current financial system, reducing costs while increasing security

Impact to the Ecosystem

Distributed ledger/blockchain technology has benefits across the trade life cycle, while simultaneously offering a new paradigm for bank interconnectedness which will collectively reduce risk.

The adoption of distributed ledgers reflects frustration with a disintermediated banking system.

Current State

Highly fragmented
Transactions take days to confirm and validate
Liquidity risk is pervasive
Regulatory reporting is tedious and suffers from human error

Future State

Unified by one ledger
Transactions validated in near-real time
Regulators can use the cryptographically assured audit trail made by the ledger passively

Bottom Line Impact

The benefits of distributed ledger technology are both financial and operational.

From a balance sheet perspective, centralizing databases and eliminating steps in the clearing process would obviate the need for old systems, reducing operational risk from capital requirements.

Not all potential benefits need to be derived from back office functions though:

New OTC derivatives products can cost over $20 mn and weeks of work
Collateral management processes can absorb the time of high-paid workers

From a risk-management perspective, a distributed ledger solution would make the work of middle office practitioners substantially easier. A number of benefits can be derived in the short and long term:

Decreased settlement times yield decreased balance sheet risk, freeing capital
Regulatory compliance would be substantially easier with a cryptographically assured audit trail maintained by reputable actors

Use Cases

Distributed ledgers are able to account for complex and decentralized products with ease. They can bring order and standardization to processes which are driven by fragmented standards. Candidates for this type of augmentation are activities such as issuing letters of credit, managing collateral, creating swap agreements and settling loans.

Complex transactions will leverage smart contracts, event-driven code which can transfer value in a distributed ledger:

Smart contracts act as a wrapper on a bigger distributed ledger, providing more granularity and terms to be evaluated by the network
New standards for creating agreements must replicate existing logic.
The process of adopting this as a new paradigm will require extensive testing.

Institutions

FX Settlement
Trade reconciliation
Transparent Valuations
Cross Border Payments
Credit Efficiency
Loan Settlement
OTC Derivatives Clearing
Collateral Management

Regulators

Compliance Reporting
Risk Visualization
Basel III Compliance
Client Fund Transparency
Know Your Customer/Anti- Money Laundering
Trade Reporting

Operations

Client Onboarding
Intracompany Settlement
Normalize Reference Data
Timestamping
Account Portability
Broker Fraud Identification
Securities Agreements as Smart Contracts

Individuals

Crowdfunding
Virtual Identity
Credit Scoring
Cross Border Remittance
Vault/Escrow Services
Customer Deposit Cost
Peer-to-Peer Lending
Show Repurchase Agreement Example

Repurchase Agreement Example (REPO)

Repurchase Agreements (”Repos”) are a popular way to finance short term positions by creating a collateralized loan. In a Repo transaction there is a base asset and a subsequent agreement (REPO) that reassigns the cash flows without changing the ultimate beneficial owner. Repos have a set timeline and rate, which makes them a very good candidate for simplification through distributed ledgers. At present, there are two main ways to settle repos: triparty and “delivery vs payment” (DVP). Triparty settlement involves an agent beyond the buyer and seller to manage collateral. In a smart contract-enabled distributed ledger, the smart contract can verify liquidity, as well as assume and transfer ownership of the security upon reaching the contract’s term.

Start
Scenario A
Scenario B

LEGEND

Smart Contract
Code which manages the transaction
Cash
Pledged to the transaction by the Dealer
Asset
Pledged to the transaction by the Hedge Fund

Hedge Fund sells a security to Dealer with a commitment to repurchase at a future date. Hedge Fund creates a smart contract to replicate this agreement. After testing, Dealer consents to the code and pledges cash, which is transferred to Hedge Fund through contract terms, while the contract itself assumes ownership of the asset.

The end of term will trigger execution of the smart contract agreement. At this point, one of two scenarios will unfold: either the cash agreement will be paid in full from Hedge Fund’s account, triggering the assignment of the security from escrow (a) or Hedge Fund will show insufficient funds to pay Dealer, reassigning the security permanently to Dealer (b).

R3’s Global Collaborative Laboratory


A focal point for innovation

Evaluation Framework

Transparent, scientific, rigorous, outcome-oriented metrics for success

Real-time Engagement

Truly unique forum for collaboration with peers and market participants

Thought Leadership

Tailored, empirical, proprietary research for learning and development

IP Structure

Thoughtful IP structure to accelerate collaboration and drive outcomes

Hybrid Engagement

High-touch client engagement paired with digital content delivery platform

Results & Insights

Impartial experiment results to drive identification of commercial opportunities

Recent Successes in the Lab

Project Zero - 11 banks on Ethereum exchanging value via "Ether", the native cryptocurrency.

Project One - 42 banks on Ethereum with a basic smart contract implementation.

Project Genesis - 40 banks on Ethereum, Eris, Chain, Intel and IBM with a cosistent commercial paper business logic coded in smart contract form.

Lab Benefits

Quantitative feedback on the potential for various use cases.

Exposure to the R3 Global Collaborative Lab and distributed ledger technology.

Ability to conduct PoC across market segments across the financial “supply chain”.

Potential for learnings to be shared across membership.

Essential Reading


Blogs

The R3 Blog, the blog of our team at R3

Gendal.me, the blog of our CTO, Richard Gendal Brown

Ofnumbers.com, the blog of our Head of Research, Tim Swanson

Fifth Moment, the blog of one of our Product Developers, Ayoub Naciri