clearmatics 

30 Creal C:uildford Street 

London, SEl Ol!S 

u nitC'd Kingdom 

FC'hrna ry :.n. 20 16 

i\ lr. Chris Kirkpatri ck 

Secretary 

Commodily F11t.11rC's Trading Commission 

l 151 21st. St. NW 

Washinglon , DC 20581 

Dear Mr. I<irkpatri ck: 

On behalf of Clearmatics, I would like to thank the Commissioner for inviting me to participa le in the 

Commodily Futures Trading Commission's Technology Advisory Co111111 ittee 1neeting on February 23, 

2016. 

Clearn1alics is a London-based led1nology compan.v working wilh fi n<1ncial institutiorn; to develop " Programmable Distributed Ledger" teclmolog.v t hat will dra1naticall.v impro\'e post-lrade trans parency and 

also cnnblr what. wr drscribe as .. Automation wit hont lnt.crmrdiat ion ". SprrifiC'a ll.\". onr trrhnology rnables t.he consort.ium members of a market. 11t ility to jointly maintain n golden record o f financial ll"<lgers 

and, most import.antly. to collectively perform the computations in\'olved in a mending t ha t ledger. 

In terms of ma rkets, we a re focused on Fixed Income. Currency and Commodities (-·FIC'C'.) asset classes, 

wit h a particular emphasis on their OTC derivatives. 

Some comme n ts abou t t e rmino logy 

It i:; popular today lo speak of "blockchain" technology in the context of fini:lncia l 1m.1rket.:;. in pcirt.icular 

its ci pplicauility to post-t rade. This is often qualified as "pcrmissioncd b lockd1ci in·' cd111 log~· t.o make 

clear t hat t he consensus model is based on authenticated and legall.v-aC"count able rnlidating nodes, and to 

to d istinguish it. from blorkcha ins likr JJitcoin or .Ethcrrnn1. whi('h arc' basr d on a modPI of 1w rmissionlrss 

consensus. 

I will instead use t he phrase " Distributed Ledger Tccl111ology", or "DLT" in place of " permissioned 

blockcha in ". T here is nothing wrong wit h the phrase " permissioned blockcha in ", it is just that neit her 

t he property of collating transact.ions into blocks, nor the property of chaining those blocks together via 

cryptographic hash a re essent ia l to creating an in11J1utable a nd distri lrnted ledger, su the terminology is 

a li ttl e quest.ion-begging a.bout i111plementa.tio11 deta ils. 

I also t hink it he lp:; to de 111ystify the ted111ology uy 1naking cbir t hat. we arc fin di ng powerful new 

a pplicat ions by comb ining tcrhnologirs t.hat, a rr actua lly w<'ll-rst a blishrd a nd wf'll-11ndrrst ood, namrl\·: 

• puulic key signciturc : 

• cryptographic hash functions: 

• virtualisation: 

• distributed rons<:>ns11s a lgorithms: 

• and prcr-lo-pccr net.working protornls. 

Some observations abou t t h e technology 

DLT is a rwt.work whC'rC' r\ r~· node on t.Jw nrtwork hns a loatl copy oft hr _qlobal statr of thr IC'dgrr. and 

a cons011s 11s algorithm insures t,hal earh nodc·s locnl copy is I hr samr as r \·rry ot h!'r node's lorn I copy. 

which is why we ran refe r t.o the collect.ion of s!:'pilrntr ledgrrs as a. si11g[P. . shared lPdger. 
Today every financial institution maintains its own system of ledgers, so in today's financial system it 

is fair to say that ledgers of ownership and obligations are already dist.rib11t.ed. But. in today's system, 

consensus on the global state who-owns-what and who-owes-what-to-whom is obtained by many iterations 

of reconciliation, which is usually labour intensive, expensive, and slow. 

DLT works differently. Each node on the network: 

1. 	 takes a set of settlement instruct.ions, applies them to the current state of the ledger and returns a 

new ledger state; 

2. 	 then the nodes follow a consensus algorithm to come to agreement. with each other on the new 

ledger state that each node computed independently. 

There has been much talk about how this second aspect. of DL'l' can improve post-trade. If you replace 

reconciliation with a consensus algorithm, you can obtain substantial operational efficiencies through 

automation, whilst reducing the time interval between trade and settlement, which releases capital and 

reduces counterparty risk. 

However, this narrative around the benefits of replacing reconciliation with consensus algorithm is silent 

on the the first aspect of DLT, which raises an important question: at what point in the post-trade 

lifccycle is an instruction generated and passed to DLT? 

The post-trade life-cycle is complicated. It differs from market-to-market, and there arc many process in 

between the contmctual event represented by a trade confirmation and the proprietary event of a trade's 

settlement. 

If DLT comes only at. the end of the lifecycle, then some other technology or technologies are automating 

the post-trade process up until that point. But given that the legal validity of a ledger entry makes 

reference to every step in the lifecycle, DLT could end up turning a distributed, industry-wide "golden 

record" into in an intermediated technology service, even if the DLT itself is a technology commons. 

This could have the rather paradoxical consequence of actually co11ce11trati11g rather than decentralizing 

post-trade intermediation. 

On the other hand, if DLT is introduced at the beginning and encompasses the entire post-trade lifccycle, 

then there is a very different. implication. Post-trade automation can he achieved through what we 

describe as Decentmlized Clearing Networks, or DCN's. DCN's are light-weight consortium entities 

whose members are the nodes on the network and consist of the main participants in the market that the 

DCN clears. In principle, this model can eliminate third-party intermediation entirely, replacing it with 

a platform model, one that enables third-party service provision, but the platform itself is governed by 

DCN members rather than a third-party intermediary. The market "owns'' the post-trade plumbing. 

Some DLT architectures, like those derived from the Ethereum codeuase, lend themselves to this second 

scenario because they are based 011 a model where ledger state tra11sitio11 is general purpose computation and arc capable of expressing the complex business logic involved in post-trade lifocycle. These 

architectures are "Programmable Distrihnt.ed Ledgers", or PDL's. 

Other architectures, like those adapting Bit.coin's UTXO model, an" much more likely t.o fit in the first 

scenario for the simple reason that these architectures cannot by themselves implement the complexities 

of post-trade processes in their model of limited-purpose ledger state transition. 

The OTC Derivatives Market 

One domai11 where the DCN model is most compelling is the OTC derivatives market, where we believe 

that PDL's are not only a transfonnative new infrastructure for the bi-lateral, uncleared OTC market, 

but also perhaps an alternative to Central Couuter Parties (CCP's) themselves. 

One of the most interesting aspects of PDL's is that it challenges 011r hackgro11n<l ass11mptions about what 

functions can only he performed through centralized int.ermediat ion. Consider the following functions 

performed by a CCP: 

• 	 performing contract valuation 

• 	settling variation margin payments 

• 	 calculating initial margin 

2 
• custody of initial margin and other loss-absorbing capital 

• novation and netting 

• managing close-out on default 

Clearmatics is currently working on proving how all of these functions can be performed on a DCN, that 

is, by a membership-governed network instead of a CCP. 

At their core, derivatives contracts are legal agreements with fully computable terms. They are, quite 

Jiterally, algorithms disguised in the legalese of IMA 's, CSA 's and contract specifications. Ignoring for 

the moment the role that CCP's play in assuming the performance of a derivatives contract to both sides 

of a trade, what CCP's in effect do is standardize and automate the aforementioned clearing functions 

by centralizing the computations in the CC P's technology silo. 

This solution is sensible when the alternative is that the counterparts to a trade perform the computations 

independently. This is because, until recently, there has been no obvious means of definitively reconciling 

complicated computations performed independently by two or more parties. Valuation disputes in the 

bi-lateral market are but one example of this difficulty. 

But we now have a model for performing computations collectively and coming to consensus 011 the correct 

results. With a PDL there is not only a golden record of collateral a11d variation margin movements, but 

also a golden record of all the computations involved in those movements. Everything is available 011 the 

ledger, with machine-readable audit.ability. 

We believe that one of the more profound implications of this technology will be the transformation and 

revival of OTC market places that are more transparent alternatives to markets that centralize post-trade 

intermediation. 

Clearing without the Central Counterpart 

The one function that a CCP performs that cannot be replicated by a DC.\" is that of guaranteeing both 

sides of a trade. It remai11s an una11swered questio11 whether this impressive concentration of cou11terparty 

risk at CCP's mitigates or amplifies systemic risk. But 11ow that technology is providing practical means 

of un-bundling the many functions performed by a CCP, it is perhaps worth re-visiting the question. 

Another potential systemic risk factor in the OTC derivatives market is the legal natme of the contractual 

agreements themselves, which are agreements that provide legal recourse against a defaulting counterpart's balance sheet. This is arguably a statutory innovation by the Commodities Futures l\Iodernization 

Act of 2000 (CFl'vlA), which does run contrary to a long-standing Anglo Saxon common law principle 

that Contracts-for-Difference are not enforceable in a court of law. 

Therefore, another question that we believe is worth exploring is whether there should be an alternative 

legal wrapper arou11d a DCN's computational co11tracts, 011e that is not based on ISDA documentatio11 

at all. Instead, it could be based on documentatiou that binds the counterparts of the trade to the 

output of the program implementing the derivatives deal on the DCN's PDL, with recourse against a 

defaulting counterpart. limited t.o collateral posted. In the "long-I.ail" scenario where loss absorbing capital 

is exhausted, it amounts to variation margin haircutting. Such a scheme in many ways resembles the 

membership model of a 19th Century exchange. 

\Ve at Clearmatics are committed to developing POL solutions that decentralize financial intermediation 

and would welcome the opportunity to open a dialogue with regulators to explore how this might be 

accomplished. In particular, we would very much like to explore how Title VII of Dodd-Frank might 

accommodate DCN model of clearing. 

Thank you again for providing Clearmatics with the opportuuity to make this statement. We arc always 

available to discuss any of the points above with you or any member of your staff: I would be delighted 

3 
to handle any queries personally and can be reached at rs©clearmatics. com. 

Kind regards, 

Robert Sams 

Founder and CEO 

4