Last December, HSBC and Wells Fargo announced they would start using a blockchain-based platform that builds on HSBC’s FX Everywhere to settle bilateral foreign exchange transactions. By that stage, HSBC had already used the solution to settle $2.5 trillion in trades within the HSBC group. The platform runs on Baton Systems distributed ledger technology (DLT), and FX settlements is just one of its post-trade solutions.
Baton Systems has big ambitions for its network as a decentralized financial market infrastructure (dFMI), and it’s already making considerable progress by processing an average of $15 to $20 billion in transactions daily, which is growing rapidly.
That figure includes another of Baton’s solutions, Core Collateral, that’s used to manage margins for exchange-traded and cleared FX derivatives. Users include JP Morgan and Citi, and the platform is linked to eleven CCPs, including ICE Clear Europe, LCH, CME, Eurex and SGX.
According to Baton Systems’ CEO Arjun Jayaram more than 40% of the global margins for cleared bank derivatives move via Baton’s Core Collateral platform.
And it’s just getting started. A top ten bank is being onboarded to a third solution, Core Payments, for netted settlements.
Decentralized post trade rails
Jayaram’s vision is that Baton is building the post trade rails for the capital market of 2030. And on top of these rails is a variety of smart contract-based workflows – FX, collateral, netted payments and others.
“If you think about wholesale payments, there are no rails,” said Jayaram. “What you have instead are venues, like the DTCC, Euroclear, CLS. And then you have counterparties. You have large exchanges like CME, Eurex, LCH (LSE’s London Clearing House). This is how assets are settled.”
Instead, each of the participants has its own node on the network in a decentralized world. When asked how Baton’s network might compare to existing infrastructures, the CEO described it as something like a Visa plus a SWIFT. But in order for this ‘DeFi’ structure to take off, he believes it needs to be incredibly easy to have a node.
“You can trade in microseconds, but you can’t settle like that,” said Jayaram. “You should be able to have a node. You should be able to mobilize your assets on demand, settle on demand with other people.”
Market structure frictions
One challenge in achieving decentralization is the market structure issue relating to central bank accounts. Baton Systems does not want to become a bank, but at some stage, it might need a central bank account.
Today central banks only allow accounts to be held by banks in their jurisdiction. Hence, for a bank to transact in another jurisdiction, it has to use an intermediary, which adds friction compared to a decentralized P2P solution. It’s an issue that’s been recognized if central bank digital currencies (CBDCs) are to be used for wholesale cross border payments.
But it’s not just a jurisdiction issue. It’s also the fact that only banks can have central bank accounts. Large central counterparties are not banks, and in a decentralized world, it would be ideal for them to hold central bank accounts. Baton Systems might also want one in the future. However, for now, it’s chosen not to apply for a UK omnibus account.
How to regulate a dFMI?
A second issue is how to deal with an infrastructure like Baton Core from a regulatory perspective? It’s not a Visa or Mastercard. And it’s not a bank. A key difference is it’s decentralized. The Baton CEO is engaged in frequent discussions with regulators and believes the regulatory landscape is likely to change in the next two to three years. He wants Baton to be ready.
That’s one of the reasons behind the funding round on which Baton’s working. In 2019 and early 2020, it raised a $17 million Series A from venture capital firms. This contrasts with many peers who have secured significant strategic funding, which we can expect to see in the Series B. Given the transaction volumes, Baton has managed to use its capital efficiently. Other capital markets DLT startups have raised significantly more, such as Digital Asset ($307m), Axoni ($90m), and Symbiont ($37m, understated), according to Crunchbase.
A different approach
While public blockchains tend to focus primarily on transactions, one of the things Baton has in common with these capital market providers is a focus on workflow. However, some other solutions use tokens, but Baton does not. Nor is Baton’s platform a blockchain. Baton Core is a proprietary distributed ledger technology (DLT) with smart contracts for distributed workflows.
“I’m not selling a DLT platform. I’m selling extremely powerful market infrastructure rails and distributed workflows on top of it,” said Jayaram. “It just so happens it’s on a distributed ledger technology which makes it very powerful and very extensible because there’s no central party there.”
“What makes it really unique is that we interoperate with the real world. We interoperate with the exchanges, nostro accounts, custody banks, CSDs where the assets are held and eventually CBDCs, digital assets and that whole spectrum of assets.”
The platform also links to the core systems of a bank, including security systems, payment gateways, and post-trade systems such as Eurex or Calypso. “That is something that, as far we’re aware, no blockchain does,” said Jayaram.
Until recently, Baton’s primary target was the top 15 global banks. Now it’s expanding its reach in banks and solution offerings.
Make no mistake Baton’s CEO has a clear vision of where he wants to get to. “The power of our technology will be truly seen when we start to move a trillion dollars of asset values a day,” he said.