Tapping opportunity with blockchain: Q&A with Nick Cafaro

 
Blockchain’s vast potential is regularly discussed. However, its pick-up across most industries in Canada has been slow. What steps do you think need to be taken to promote more widespread adoption?

I think the primary obstacle is a clear use case where people understand how to either increase revenue or reduce costs. What has happened to date is the implementation of blockchain solutions without clear objectives, or an implementation for the sake of using blockchain technology. Unfortunately, these implementations have been rather costly, particularly in the enterprise sections, whilst the benefits have been rather small compared to the potential.

Blockchains are not magic. They are a technology solution and their impact, like other technology solutions, should be measured on their impact to cost structures. For example, the internet reduced the cost of search to near zero. You don’t go thumbing through a catalogue or encyclopedia anymore to find something—you type your question into Google and get an answer for free.

So, what are blockchains in this context? Well, you might have heard them referred to as “trust machines”, and what this means is you can trust the data stored in that blockchain. In certain circumstances, like financial transactions, this is quite useful because it means the involved parties don’t have to keep a copy of their side of the transaction. Why does this matter? Because if we each have to maintain our own copy, then we also have to agree that each of our copies is correct, and this process of reconciliation can be a costly business process. Blockchains as a technology solution can reduce the cost of reconciliation to near zero. Unfortunately, the problem with the cost of reconciliation is that it is difficult to fully measure because it consists largely of people, excel and legacy reporting systems, which are not easily accounted for.

So, when you’re thinking in terms of the benefits in cost reductions, it’s difficult for decision-makers to intuitively see those saved costs, which, in turn, makes it difficult to convince them to adopt the technology, especially given the poor early returns.

I think as the market matures, the product will become more usable and the revenue models become clearer, the benefits will become more tangible, and therefore investment decisions easier to make; then hopefully confidence in the technology starts to happen and adoption ensues.

What advice would you give to developers who are building in this space?

Make sure that you really understand the problem you're solving for. It’s not about just saying, hey, use this technology for the technology’s sake. It’s a bit of a cliche, but you have to solve problems.

It's as simple as that. People use things because they have a job that needs to be done, and the technology can do it.

For example, I needed a coffee this morning. I have a coffee cup. There’s a sleeve on it so I don't burn myself. So, the job of the sleeve is to make sure my fingers don't burn when I'm driving away in my car. And that’s what developers need to think about—that they are solving a problem for a customer. That is absolutely number one.

And the second thing I would say is to consider the regulatory and legal environment that the problem you are trying to solve exists in. You can’t just go and make an exchange to trade securities. That kind of app falls under the securities industry, which is one of the most regulated industries in the world. Most of the use cases for blockchain will touch industries that are heavily regulated with very defined legal parameters for operating within the boundaries dictated by local jurisdictions.

What opportunities does blockchain present to corporations around governance and compliance?

This is probably a bit further off, but my hope is that one day decisions in the boardroom eventually get recorded directly on the blockchain. For example, a resolution announcing a dividend could be recorded on the blockchain. Once the dividend is inputted into the corporate governance system, it gets recorded on the blockchain, and the dividends automatically get paid to the investors directly.

 
Currently, decisions made at the board level are delegated via the management team, who are entrusted to input this information into management systems, and then an auditor may be hired to provide an audit report.

If policies are implemented using a technology where the underlying data cannot be altered, and therefore actions taken by managers must be in compliance with those policies in order to be executed, then there will be a much better risk and control framework that's fully transparent to the board. And I think it is in the areas of poor performance or mismanagement or fraud that we'll start to see better outcomes, as things will be very visible to the board. Obviously, this information would not be put on a public blockchain. There are lots of private solutions where the technology is still the same underlying blockchain technology that is much harder to alter.

How have you seen the crypto and blockchain industry change over the years?

In the past, crypto was primarily seen as being used for illegal reasons, such as tax evasion or money laundering purposes. Now, it is viewed by the majority of people as a very real, and above -board, asset class.

For blockchain, there is now a focus on how we get this technology into a much more enterprise-friendly environment in a way that is compliant with regulation.

What emerging use cases are you most excited about?

This is under the banner of tokenizing real-world assets. I think we are getting really close to mainstream fractionalized real estate. I can see it, and its regulatory path, and it is exciting.

Then there are NFTs. Aside from all of the recent craze, NFTs are really another type of gated access where artists can sell them in return for access to exclusive tickets or content.

You can also take NFTs one step further, where you can use them to represent a company’s invoices. If you tokenize invoices, you can really start to improve both working capital and small business lending. And, while we aren’t there yet, the first industry leader to figure this out will really position themselves well—and they are going to be in that position for a long time because they will create a durable working capital advantage, which will be very difficult to overcome.

What are the biggest misconceptions about the industry?

That it is Wild West cowboys who perform speculative gambling. And yeah, sure, there are those sorts of actors within the industry, but they exist everywhere. I think it’s definitely unfair because most people in the industry want to figure out a way to ensure everything is being done in a regulated fashion.

Blockchain has been built specifically to take on regulated assets, but what new financial assets have you seen, or would like to see, emerge?

There’s been a lot of research done on the notion that a token represents some hybrid property type, where in its early infancy, it's a security, and then later on, it becomes something else that perhaps doesn't exist in law today. So that could be a new thing.

We have had securities for a long time, but we don’t have securities that make daily payments or micro-payments or anything of that sort. If you invest in a project and want to get paid a daily dividend, that will not work with the traditional financial infrastructure we have today—as it will be too costly and the project economics won’t work. This kind of financial asset would be an interesting yield product because people could go in for a very short period, collect yield and then get out versus holding the asset for a long time before receiving distributions. I think that’s something that would make project financing a lot easier.

And on the consumer side, let’s say with mortgages, people could make mortgage payments daily. Allowing people to pay a little bit off their principal every day would really lower the amount of interest they pay, and cut into their amortization.

What are your thoughts on blockchain and digital money legislation in Canada?

I think we have a good start. Is everything really a security? No. So, I think that’s one of the things that probably is a little bit more conservative than folks would like because I think there are still undefined features about what types of entities can do what type of activity.

The other thing that would be quite helpful is clear guidelines from OSFI, who probably need some laws to enable them to do this. But if the liquidity treatment of crypto assets on a financial institution’s balance sheet was not overly punitive like current proposals (i.e., 100% haircut), then this would spur financial institutions to support the industry, and mainstream adoption would follow.

What is your 10-year forecast for the blockchain industry?

I think there will be two things. One, large industry players will replace their legacy technology with blockchain technology, maybe not the whole stack but at least one vertical.

I think that the barriers to entry for financial intermediaries will remain high, but we will start to slowly see the formation of networks built up from smaller players. Part of this will result in payment networks being added at a much lower cost, with smaller banks or fintechs emerging to provide that gateway and that service. On top of that, we will see the dealmakers at large institutions leave to run their own businesses while being able to access sufficient capital through these networks. They won’t be super large, but they will at least have some capital formation on these smaller networks. Blockchains can allow that to happen safely, securely, and in a regulated way. People will be able to efficiently pool capital for specific purposes in a much more efficient, cost-effective manner.

Nick Cafaro is the Head of Product at the Polymesh Association and oversees the development of new products and solutions on Polymesh.

Prior to his involvement with Polymesh, Nick spent 15 years in financial services with Canada’s three largest banks, working everywhere from commercial and retail banking to wealth management and global asset management.

Nick has spent the last 4 years in the blockchain industry working on Substrate and Cardano protocols. He’s been involved with Polymesh since its early days of development and a key contributor to many of its core features.