Emergence of Blockchain in Banking and FinTech: New...

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Presenting a live 90-minute webinar with interactive Q&A

Emergence of Blockchain in Banking and

FinTech: New Applications and Issues for Counsel Leveraging DLT Platforms for Recordkeeping, Payments,

KYC and More; Concerns With Regulation, Privacy, Adaptation

Today’s faculty features:

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

TUESDAY, SEPTEMBER 12, 2017

Ralph F. (Chip) MacDonald, III, Partner, Jones Day, Atlanta

Stephen J. Obie, Partner, Jones Day, Washington, D.C. & New York

Ralph A. Daiuto, Jr., Chief Operating Officer and General Counsel, t0.com, New York

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Emergence of Blockchain in Banking and FinTech

5

Faculty

6

Dzmitry Maroz, Senior Manager, Deloitte Advisory | US

Dzmitry, senior manager in Deloitte & Touche LLP, has over 15 years of experience designing and developing

financial technology solutions. Dzmitry has actively participated in the development of the loan market’s FpML

standard and is a Deloitte Advisory Blockchain Fellow.

Ralph A. Daiuto, Jr., Chief Operating Officer and General Counsel, tZERO.com, New York

Ralph is an accomplished attorney and business leader with over two decades of experience in the securities

industry, establishing and managing several broker-dealers and innovative technology companies and overseeing

their daily operation, including legal, compliance, and regulatory matters. tZERO, a fintech subsidiary of publicly-

traded Overstock.com, is a world pioneer developer of Blockchain based technology. Ralph is also the General

Counsel of SpeedRoute, LLC and PRO Securities, LLC, both broker-dealers registered with FINRA & SIPC.

Ralph F. (Chip) MacDonald, III, Partner, Jones Day, Atlanta

Chip's practice emphasizes securities, mergers and acquisitions, corporate governance, financial institutions

(including REITs, investment managers, and broker-dealers), and financial products. He is a frequent speaker and

author on matters related to financial and investment services and products.

Stephen J. Obie, Partner, Jones Day, New York & Washington, D.C.

Steve advises multinational corporations and individuals on U.S. securities and commodities law compliance. He

led the team that obtained the first ever effective registration statement that contemplates a public offering utilizing

blockchain technology.

Blockchain/DLT overload?

7

What we will cover • What terms will we use?

• What is Blockchain?

• What problems does Blockchain aim to solve and its

advantages?

• Blockchain vs.Bitcoin

• How Blockchain transactions work

• Blockchain in action

• What are some of the challenges to implementation?

• Questions and contact information

8

What terms will we use? • Distributed Ledger – shared/consensus record

simultaneously maintained and auditable by its participants

• Blocks – encrypted transaction record that, once validated, is

built upon to create a chronological chain which constitutes

the entire history

• Hash function – a one way function that maps/represents

data in a Block as data of a fixed size

• Hash value – the value created by a hash function that can

be used to substantiate transactions

• Smart Contract – computer code of terms and conditions

that lead to self-executing transactions

•

9

What terms will we use? • Immutable – Data can only be appended to the

Blockchain but cannot be edited or deleted

• Timestamped – Transactions on the Blockchain are

time stamped, making it useful for tracking and verifying

information

• Encrypted – Encryption is used to protect information

stored on the network and make it tamper-proof

• Consensus-based verification – Transactions must be

verified and agreed upon as valid, by majority of the

network to avoid malicious activities in the network

10

Centralized System

11

Central intermediary

A central intermediary (e.g., a bank, government

agency) transfers actual value between two parties

Separate ledgers

All parties involved in a transaction maintain a

separate ledger with central intermediary often

used as the final authority on correct version of the

ledger

Single point of failure

When a party loses its database and does not have

a backup, information is lost

Typical examples of centralized databases

are relational databases we are all familiar with.

When Financial Institution A buys an asset from

Financial Institution B, both parties A and B will have

separate records of their transaction in their

separate databases

Decentralized System

12

Think of a group of friends sharing a ledger.

Each person in this group has their own copy

of the ledger where they record every new

transaction among group participants. Each person

in the group independently verifies every new

transaction before recording it into the ledger.

•Digitally distributed

•Immutable

•Timestamped

•Encrypted

•Consensus-based verification

Distributed Ledger

13

• Centralized databases have one authoritative copy of a ledger maintained by a trusted party such as a central bank

• Blockchains are decentralized databases where a ledger is stored by all users on a common network

Date Person Amount

2016-01-05 Dan 40

2016-01-11 Laura 29

2016-01-15 Jen 82

2016-01-28 Dan 17

2016-02-02 Jack 21

2016-02-05 Laura 42

2016-02-11 Jen 8

Dan

Jack

Jen

Laura

Bank Ledger

What is Blockchain?

14

What is Blockchain?

• A type of distributed ledger technology (“DLT”)

• It is a collection of technologies that allows information sharing between users on a network (e.g., public-private key encryption)

• A Blockchain is a shared list of sequential records called “Blocks”

• Each Block contains a validated record/data and a link to the previous Block

• Blocks are linked together into a “Blockchain” where changing or removing a Block may “invalidate” others within the chain

• The chain may then be “revalidated” by the user making the change and others (consensus)

• Consensus creates consistency and reliability in recordkeeping

• Blockchains can be shared publicly or privately with selected users – internet versus an intranet

15

Advantages of Blockchain

16

2. No intermediary - Disintermediation Blockchain technology is based on cryptographic proof instead of

trust, allowing any two parties to transact directly with each other,

without the need for a trusted third party.

3. Distributed ledger – Audit trail The peer-to-peer distributed network records a public history of

transactions. Blockchain is distributed and highly available. The

Blockchain does not typically preserve the identities of the parties nor

the transaction data, only the proof of the transaction existence.

5. Immutability – Audit trail The daisy-chained cryptographic framework prevents

past blocks from being altered.

4. Irreversibility – Audit trail The Blockchain contains certain and verifiable records of every single

transaction ever made. This helps prevent double spending, fraud,

abuse and manipulation of transactions.

1. Near real time - Efficiency Blockchain enables the near real time settlement of recorded

transactions, removing friction and reducing risk.

1. Near Real

time

2. No

intermediary

4.

Irreversibility

3.

Distributed

ledger

Blockchain

“The Internet of

Value”

5.

Immutability

Blockchain vs. Bitcoin

17

While Bitcoin is still the most well known

implementation of Blockchain technology

it is important to remember that the two are

not synonymous. Blockchain technology has

many potential applications outside of

Bitcoin.

• Leading digital currency • Has existing ecosystem with

numerous consumer-facing applications

• Industry adoption with institutional participation

• Distributed ledger, which means it is copied to all participants on the network.

• Applications often extend beyond financial use cases

Blockchain Bitcoin

How Blockchain transactions work

18

Transaction is initiated

Transaction is placed into a

queue

Transaction is verified and placed into a

block.

Nodes verify transactions

Valid blocks are added to

the ledger

All blocks are

linked to each

other

1 2 3 4 5 6

Blockchain transaction

19

Two parties exchange data; this

could represent money, contracts,

deeds, medical records, customer

details, or any other asset that can

be described in digital form.


1 A simple example is Person A

buying a product from Person B

for 10 dollars. When transaction is

submitted to the Blockchain, each party is

represented by their public key – identifier

that is unique to each participant.

Person A

03c6691ebdd1613

63457e3c73a8ed4

4186536cf9

Person B

6025f94596c2445f

0a776d9bac92982

9de3


20

Depending on the network’s parameters, the transaction is either verified

instantly or transcribed into a secured record and placed in a queue of pending

transactions. In this case, nodes—the computers or servers in the network—

determine if the transactions are valid based on a set of rules the network has

agreed to

Transaction is

initiated

Transaction is placed

into a queue

1 2

In this step, we simply confirm that transaction is

properly formatted and has all the necessary

attributes. It is similar to verifying a check before

depositing it. Before we can process the check

we need to confirm that all required data is there

– date, amount, payee and payer.


Each block is encrypted using an algorithm agreed upon by the

network. A block contains a header, a reference to the previous

block’s hash, and information that is being recorded to the

Blockchain. The sequence of linked blocks creates a secure,

unique signature.

Block 1 Block 2 ?



queue


block

1 2 3

In this step transactions are

added to a block and encrypted.

Block is now ready to be validated

and confirmed by the miners/verifiers

21

Blockchain transaction Transaction is initiated


queue


block

1 2 3

22

If we go back to our example of

friends sharing a ledger, you can

think of mining as a competition

of who can verify new transaction first.

Every time new transaction is announced,

friends compete against each other to

verify if transaction is valid. First person to

confirm new transaction informs everyone

else and asks them to confirm their result. • A process that allows anyone to verify transactions

• Miners sometimes ‘earn’ money for their verification

services

• Process is made intentionally difficult in open systems to

prevent cheating (proof of work)

• Proof of work is only relevant to open systems like Bitcoin

Mining explained


23

Blocks must first be validated to be added to the Blockchain using

consensus or other agreed upon validation method. If a block does

not meet validation requirements, it is rejected by the network and

discarded from transaction queue

Block 3 Block 1 Block 2



queue

Transaction is

verified and

placed into a

block


1 2 3 4


When a block is validated, the miners that solved the puzzle are

rewarded and the block is added to the Blockchain.

Block 1 Block 2 Block 3



queue

Transaction is

verified and

placed into a

block


1 2 3 4


the ledger

5

24


25

The block is added to the Blockchain is distributed through the network. Each node adds

the block to the majority chain, the network’s immutable and auditable Blockchain. Once

the block is added to the chain, each participant on the network has the same copy of the

ledger



queue

Transaction is

verified and

placed into a

block


1 2 3 4


the ledger

5

All blocks are

linked to each

other

6

Each block in the Blockchain references previous

block. With every new block, Blockchain

becomes more tamper-proof.

Blockchain in action

• Blockchain is being used today

• Bitcoin

• Everledger

• Transfer and custody of physical assets

• Issuance and transfer of securities

26

Blockchain in action (tØ)

27

• Overstock preferred offering using Blockchain

• Eliminates T+3 and DTC, now T0

• Track and confirm shares, holders, and transactions

Application to securities transactions

28

• Proof datasets/distributed ledger created hourly

Blockchain in action

29

Smart contracts

Electronic contracts with transfer of

ownership provisions coded into

the contract itself. Both tamper-

proof and self-executing, without

the need for trusted third-parties.

Intellectual property

Encrypted and time stamped

documents stored on the

blockchain can be used to

document ownership of IP without

revealing the information it

contains.

Medical records

Patients can hold the

private key used to encrypt

their medical data, using

public keys to share

selected information with

doctors only when desired

Foreign exchange

The ability to securely clear and

settle transactions bilaterally

using the blockchain opens the

FX market to non-bank market

makers, tightening spreads and

lowering transaction costs

Transfer of property

Fractional bitcoins marked with

certain properties, also known as

colored coins, are use to represent

digital or physical assets such as a

house or a car.

Identity management

A cryptographic distributed

network could be used to verify

people’s identities, such as

passports, social security

numbers, tax id numbers and

driver’s licenses

Lower transaction costs

Increased information

sharing

Elimination of requirement

for trusted third-party

intermediaries

IMPACTS

Potential FinTech Opportunities

Blockchain Startups

Bitcoin Startups

Hybrid Startups

• Focus on digitizing assets, improving anti-counterfeit measures, and digitalizing transfers of company equity and ownership

• Focus on payments, exchanges, trading, and other uses of digital currency

• Focusing on both of the above

Applications to KYC

• Banks & Institutions perform KYC individually and upload information Currently

• Creation of central customer registry with each customer having a unique identification number

Blockchain Potential

• Remove KYC duplication efforts

• Allows distribution of encrypted updates to client details

• Provide historical record of client documents and compliance activities

Benefits

Land registration

Identity management

Foreign exchange, money transfer, securities transactions

Medical records Voting Smart Contracts

Dealing with Real World Assets

33

Securities

Funds

Funds

Funds

Funds

Mortgage Loans

Investors

Mortgage Loans

Mortgage

Loans

Loan Originator/Seller

Depositor/Sponsor

Contract

Borrowers/Mortgagors

P&I

Master Servicer/Servicer

Trustee

Trust (Loans & Foreclosed

Properties)

Custodian

Paying Agent

P&I

P&I

Application to securitizations

P&I

(Principal & Interest)

Contract

Contract Contract

Red =

Payment

Blue =

Contract

34 The future of financial infrastructure, WEF (August 2016)

Application to payments

35 The future of financial infrastructure, WEF (August 2016)

Application to payments

Blockchain and the Gramm-Leach-Bliley Act

• The Privacy Rule

• Limits the means of disclosure of non-public personal information about a consumer to non-affiliated third parties

• Requires the disclosure to consumers of certain privacy policies and practices regarding the same

• Must provide consumers with the ability to opt-out of the disclosure

• The Safeguards Rule

• Compliance with regulatory standards relating to administrative, technical, and physical safeguards of consumer records and information

• Appropriate due diligence on third-party service providers

36

Blockchain and the Gramm-Leach-Bliley Act

• Blockchain can help

• Track information sharing with third-parties,

disclosures to consumers, and opt-outs

• Compliance with standards through encrypted

Blockchain/DLT and private network

• GLBA, FCRA, and the SEC's "Regulation S-P" all

require personal financial data to be redactable

• BUT, might be difficult on an immutable platform

37

38

Smart Contracts

Smart contracts are computer protocols that

execute transactions when a set of pre-

determined conditions are met. These

electronic contracts are tamper-proof and self-

executing, without the need for trusted third

parties

39

• Smart Contracts build off of Blockchain, like macros to an Excel file

• Automated contracts

• Working with real-world assets, when a pre-programmed condition is triggered the smart contract executes the corresponding contractual clause (life insurance payout upon death)

Dealing with Real World Assets Smart Contracts

A smart contract between a bank and a car buyer provides legal ownership to the buyer as long as the person makes loan payments to the bank.

An external trigger in the shape of a late payment will automatically block use of the car by black-box engine communication.

In case the buyer fails to make up the payment default, the smart contract automatically returns the legal ownership of the car to the bank.

The processes are transparent, absolutely clear, and automatically executed.

40

Dealing with Real World Assets

41

Smart Contracts

Decentralized System

• Self-executing automated contracts provide high-level of

guarantee of fulfillment at low costs

• Build on the strengths of the Blockchain technology (i.e.,

unbiased, programmable, immutable, and immediate)

Time Locked Service

Assets are put on hold based on

contractual terms for a specified

period of time

Types of Smart

Contracts

Examples of

Potential

Applications • Payback schedule built into • Claims payout based on

loan contracts, executed

automatically based on

interest rate feeds

Traditional Contracts Blockchain Smart Contracts

Contract Creation

Programmed

Smart Contracts

Fulfilment

Peer-to-Peer Third Party

Contract Creation

• Trade-off exists between the level of guarantee of fulfillment

and transaction costs / speed

• The degree of reliance and efficiency is dependent on third-

party intermediaries’ capabilities

Third-party Service

Utilizes a trusted third-party

information feed to trigger

contractual payouts

Escrow Service

A trusted third-party helps

mediate the execution of the

contract

Banking Insurance

trusted data feed (e.g. for

crop insurance using

weather data)

Real Estate

• Immediate property deeds

transfer tied to settlement

of funds

Capital Markets

• Automated execution, clearing

and settlement of financial

derivatives

• Program protocols to execute transactions when a set of pre-

determined conditions are met. These electronic contracts are

tamper-proof and self-executing, without the need for trusted third

parties.

What are some of the challenges to implementation?

• Blockchain will NOT happen overnight

• But it is coming…

• “Nearly nine out of 10 senior executives in financial

services and information technology believe that

blockchains will be used on a daily basis in the

finance industry by 2026”

42

Practical

• Translation to different business functions

• Adoption by major market players

• Cost of systems & implementation

• Integration into risk management framework

• Talent acquisition and development

Technological

• Cyber security

• Systems acquisition & licensing

• Replacement of legacy systems

• Interoperability with internal & external users

• Data storage requirements

Regulatory/Legal

• Cyber security standards & compliance

• Regulatory recognition or rules

• Nature of the asset (property v. personal rights; documentary intangibles; possession, delivery or ownership)

• Courts differing views on the nature of the asset and enforceability of agreements.

43



44

• Governing Law?

• Place of performance?

• Nature of asset transferred? Jurisdictional

• Enforceability

• Technology or design failure

• Performance Liability

• In or out of regulation?

• Reporting

• The rise of ICOs and issues with securities laws Regulated Products

• Ensuring compliance with state and federal regulations

• Data and verification breaches?

Cybersecurity & Data Privacy

• Patent acquisition

• Patent litigation

• Open source Intellectual Property

Legislation/Licensure

45

Arizona Delaware

New Mexico

New York

Vermont Washington

Financial Regulators

• Federal Reserve

• Distributed ledger technology in payments, clearing,

and settlement

• OCC

• FinTech Charter

• CFTC

• SEC

• FINRA

46

More regulation and legislation is coming…

47

Questions?

48

Thank You!

• Dzmitry Maroz

– (212) 436-2442

– [email protected]

• Ralph Daiuto, Jr.

– (347)694-7816


• Chip MacDonald

– (404) 581-8622


• Steve Obie

– (212) 326-3773


49

50

Law/regulation is stated as of September 2017, is intended as general

guidance only and should not be relied on in respect to any specific

matter. Views expressed are those of the individual presenters and

not those of Jones Day or their respective clients.

51

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investment, legal, tax, or other professional advice or services. This presentation and panel discussion are not substitutes for such professional advice or services, nor

should they be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your

business, you should consult a qualified professional advisor. Deloitte shall not be responsible for any loss sustained by any person who relies on this presentation

and panel discussion.

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