Digitizing Derivatives: Digital Bytes Podcast

Digitizing Derivatives: Digital Bytes Podcast features Richard Baker of Tokenovate

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On September 8, the Digital Bytes Podcast with James & Johnny featured Richard Baker, CEO of Tokenovate, as their guest.

With the title of “How Maturing Blockchains Can Speed Up Settlement and Improve Collateral Management,” you might be thinking, what the heck does that mean?! I most certainly did. However, host Johnny and Baker both did an amazing job breaking down the subject matter so the podcast’s broad audience, ranging from techies to Johnny’s mom, would find value in listening.

The episode kicked off with Baker’s background.

Baker is a trained electronics engineer who was involved in the first phase of the internet. He founded Clear Trade Exchange in 2009, a futures market for commodities orientated around the dry bulk shipping market. Around 2015, Baker started looking into blockchain tech as a possible solution for settlement and clearing in a more efficient way, but the tech was not ready yet.

Baker sold Clear Trade Exchange in 2016, but his interest in blockchain tech remained strong, with a focus on the original Bitcoin protocol in particular.

“As a technologist, it is a protocol first, a blockchain second, and a token a distant, distant, distant third,” said Baker.

In an effort to clarify the more techy terms for less familiar listeners, Johnny asked Baker to define “protocols” and “tokens.”

Baker used the example of a laptop automatically connecting with a wifi network as a “protocol.”

“In the background, it undertakes a set of logical functions, establishes connectivity, exchanges messages, and sets up permissions structures,” he explained.

When we talk about blockchain protocols, we’re still talking about establishing the foundations of modern infrastructure.

It’s an exchange of value and trust.

According to Baker, a blockchain is one single instance of a common database that everyone sees at the same time; it is a common consensus layer.

“[A common consensus layer] is the most significant thing a blockchain brings to the world, certainly financial services,” he said.

Tokens” are digital forms of underlying assets such as cash, property, or bonds.

Next, Baker explained the origin of the name of his company, “Tokenovate.”

“In a world of derivative trading, the common legal activity that happens in a derivative is that you’re novating the legal responsibility, the obligations of a contract often. You novate your trade into the clearing house,” Baker said.

“One part of our name is novation because I’m undertaking the function of novation through the concept of tokenizing an asset and tokenizing the trade,” he added.

Johnny followed up by commenting on what huge asset class derivatives are and how bringing in blockchain will make trades more efficient and cheaper.

“It’s huge,” Baker agreed.

“A derivative is used across every asset class that’s traded in the world, so whether we’re talking about interest rates, or fixed income or bonds or credit or commodities—all of those underlying fundamental assets have been complemented with some form of a futures contract or forward contract or swap product that is exchanging value or giving a hedging solution,” he explained.

“Derivatives are a very, very important part of our financial services backbone; they help actors come in and out of the market on a daily basis,” he added.

“We are really passionate about helping those industries reduce cost but significantly become a lot more efficient through digitization of the workflows,” he said.

In order to make the process more efficient, Tokenovate collaborated with the International Swaps and Derivatives Association (ISDA) 18 months ago to take ISDA in its digital form, so it’s now expressed in code.

“At Tokenovate, we take that code as an expression of a logic system. It’s a set of conditional logic outputs- it says, in the event that this happens, do the following things,” Baker explained.

“We take that logic system, and we now deploy it into smart contracts,” he said.

“It’s using a scripting language to write a series of smart contracts, and each of those smart contracts is a micro-small event, and we write that event as it happens to a blockchain,” Baker added.

While the initial trade may be “sexier,” Baker pointed out that maintaining the trade over its lifetime is the more challenging and painful part of derivatives.

“That’s what Tokenovate specializes in; we help digitize the lifecycle of the trade to ensure that its economic and its legal expectations are fulfilled digitally,” said Baker.

When asked where he sees the largest opportunity for Tokenovate, Baker prefaced his response with how he thinks the future of global finance markets is being rebuilt. What has been known as traditional financial market infrastructure is becoming distributed financial market infrastructure.

“We are a modern technology company participating in that broader transformation,” he said.

The area of collateral management and settlement is a big focus of Tokenovate. There is a lot of operational dwell time caught up in this process, and there is a big opportunity to compress and digitize everything in that layer.

How assets can be expressed in digital form is also a significant focus of Tokenovate. Baker described their technique of being able to represent an underlying asset for collateral purposes as a digital twin and codifying in the digital twin the very detailed attributes of the underlying asset. By doing this, the settlement process and the trade that goes with that becomes automated.

Finally, as new asset classes are on the rise, Baker said they should not come to market in traditional ways, and this is where Tokenovate comes in. The voluntary carbon credit market is a perfect example of one of these new asset classes.

“It should be a digital-first asset class and should not be subject to a historical way of working,” Baker said.

In conclusion, Johnny recognized the brilliance behind Tokenovate and what it will bring to the derivatives market. He pointed out not enough people are talking about the importance of derivatives, and Baker agreed wholeheartedly.

“Whether as day-to-day consumers, thinking about it or not, every product we purchase and everything we interact with ultimately has a derivative trying to help out its price and its supply,” Baker said.

Watch: CoinGeek TV with Tokenovate’s Richard Baker & John Anderson

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