In capital markets, the nirvana of a golden record, representing the single source of truth for trade data, ensuring that all parties in a transaction have access to the same consistent information, has been as elusive as the quest for the “Holy Grail”.
The use of a golden record is fundamental for accurately tracking and referencing trades across various systems and stakeholders, facilitating error-free processing, regulatory compliance, and efficient risk management, providing a complete and immutable record of a financial transaction.
What is the use of a Golden Record essential for?
1. Transparency and Traceability:
- Unified Data Source: A golden record ensures all parties use the same data, eliminating discrepancies and reducing errors.
- Standardisation: it standardises trade references, improving data quality and consistency across the trade lifecycle and markets in general.
2. Operational Efficiency:
- Simplified Reconciliation: One source of truth makes reconciliation easier and less resource-hungry. Reconciliation is 30-40% of back office costs – most of which can’t be passed on to the customer – so improving these processes can save 50%.Streamlined Back Office: Automation reduces manual intervention and minimises errors, which leads to big cost savings. Lower trade breaks would also save market participants millions per year.
3. Risk Management:
- Real-time Monitoring: Accurate and up-to-date trade data enables better risk assessment and management.
- Dispute Resolution: A clear, authoritative record of trades simplifies, reduces and speeds up dispute resolution.
4. Market Integrity:
- Transparency: Enhances transparency by ensuring all market participants have access to the same trade data, providing a consolidated tape where necessary/requested.
- Trust: Builds trust among market participants by maintaining the integrity and reliability of trade data.
5. Regulatory Compliance:
- Traceability: The golden record provides a clear audit trail, simplifying regulatory compliance and audits.
- Reporting Efficiency: Accurate regulatory reporting supports Digital Regulatory Reporting (DRR) and avoids fines of tens of thousands to tens of millions.
Understanding the UTXO Model
Definition of the UTXO Model
A UTXO (Unspent Transaction Output) is a fundamental concept in blockchain technology that represents a discrete unit of cryptocurrency that has not been spent. Think of it as a digital coin that is available for use in future transactions. In the UTXO model, each transaction output is treated as an individual entity that can be used as an input for a new transaction. This model is employed by various cryptocurrencies, including Bitcoin and Cardano, to ensure that every transaction output is accounted for and can be independently verified.
How UTXOs Work
UTXOs work by meticulously tracking the ownership of digital coins on the blockchain. When a transaction is initiated, the sender’s UTXOs are used to fund the transaction, and new UTXOs are created for the recipient.
For example, if Alice sends 1 Bitcoin to Bob, Alice’s UTXO is marked as spent, and a new UTXO is created for Bob. This new UTXO is then stored in Bob’s wallet, ready to be used in future transactions.
The UTXO model ensures that each UTXO can only be spent once, effectively preventing double-spending and maintaining the integrity of the blockchain.
The UTXO set is a critical component of the UTXO model, responsible for keeping track of all unspent UTXOs on the blockchain.
Every time a transaction occurs, the UTXO set is updated: spent UTXOs are removed, and new UTXOs are added.
This dynamic ledger ensures that every unit is accounted for, preventing double-spending and maintaining transaction integrity.
By tracking unspent outputs, the UTXO model provides a clear and transparent record of all available digital coins, facilitating efficient processing and verification of transactions.
Synergies of integrating a UTXO-based Blockchain with Finos CDM, and FpML
Tokenovate discovered the “holy grail” through a combination of the “trinity” of UTXO (Unspent Transaction Output), FinosCDM (Common Domain Model), and FpML (Financial products Markup Language), creating a powerful ecosystem for capital markets:
- Trade Initiation: A trade is executed, and an FpML message is generated.
- Golden Record Creation: A comprehensive golden record is created, incorporating trade details in accordance with the CDM and including relevant elements of the FpML.
- Blockchain Recording: The golden record is recorded on a UTXO-based blockchain, which allows for parallel transaction processing. This means multiple transactions can be processed simultaneously, enhancing efficiency and scalability.
- Data Enrichment and Validation: Additional data points are added to the golden record, and data quality checks are performed using CDM rules. New UTXOs are created during transactions, breaking down existing UTXOs into new ones for the sender and recipient.
- Real-time Access: All stakeholders can access and verify the golden record through the blockchain, including, where necessary, permissioned access via a private ledger.
- Smart Contract Integration: Smart contracts can be embedded within the golden record to automate certain aspects of the trade lifecycle, as required. The UTXO model’s ability to process transactions simultaneously significantly enhances transaction throughput compared to account-based models.
The Importance of UTXO-Based Infrastructure and Unspent Transaction Outputs
A UTXO-based infrastructure, compared with account-based systems (e.g., Ethereum, Solana), offers several advantages for implementing the golden record:
Security: UTXO-based systems maintain distinct and traceable notional units of account (satoshis) for each transaction, enhancing privacy by making it difficult to link transactions to specific users.
This structure also provides better security against certain types of attacks, as each UTXO is a unique entity that can be tracked independently.
Traceability: The distinct nature of UTXOs allows for more granular tracking of each unit’s provenance, facilitating the application of traditional legal doctrines like tracing.
This is crucial for reclaiming misappropriated assets and establishing ownership, offering greater legal robustness compared to account-based systems where asset identity is often lost due to the mixing of funds. UTXOs help track ownership and movement of digital coins, ensuring clear exchange histories.
Scalability: UTXO systems handle high exchange volumes more efficiently by processing multiple transactions in parallel, unlike account-based systems that update balances sequentially. This scalability is essential for large-scale financial operations, ensuring low latency and high throughput for tokenisation and other financial transactions.
The UTXO model incentivises the use of new addresses for each transaction, enhancing user privacy.
Tokenovate creates UTXO-20 tokens by acquiring “clean” satoshis from the coinbase output, which are derived from the mining reward.
Therefore, they have not previously been spent or circulated and have no previous transaction history. A token is attached to one satoshi and has the notional value inscribed on it as metadata.
When a transaction occurs, old UTXOs are marked as spent and new UTXOs generated. This model does not maintain a single global state but tracks transactions through unspent outputs.
This contrasts with account-based tokens, which are necessarily mixed when transferred to a single public address (where that address already holds a quantity of the same tokens).
This approach further mitigates uncertainty as to deficiencies in the prior chain of title, which facilitates the golden record.
Tokenovate then embeds metadata within the token to identify any relevant off-chain information.
The account model’s method of recording transactions is similar to traditional bank accounts, where transactions involve transferring value between accounts.
The Significance of FINOS Common Domain Model (CDM)
The FINOS CDM is a standardised, machine-readable, and machine-executable data and process model for how financial products are traded and managed across the transaction lifecycle.
The CDM is based on cross-industry collaboration between ICMA, ISDA, and ISLA and facilitates trade processing of repo, securities lending, bond, and derivatives transactions.
The CDM provides a standardised framework for capturing trade data. Its integration into the golden record offers:
- Data Standardisation: Ensures consistency in data representation across different systems.
- Data Enrichment: Enables the inclusion of additional relevant data points.
- Data Validation: Facilitates data quality checks and error prevention.
The Power of FpML® (Financial products Markup Language)
FpML® is the open source XML standard for electronic dealing and processing of OTC derivatives. It provides a standardised format for electronic communication, ensuring consistent and accurate trade data exchange between parties.
Incorporating FpML into the golden record provides:
- Precise Contractual Terms: Ensures accurate representation of complex financial instruments.
- Interoperability: Facilitates seamless data exchange between different systems and institutions.
- Automation: Supports automated processing of trade data for various purposes.
Implementation Steps
Data Capture and Standardisation:
- Trade Data Collection: Capture trade data in the Finos CDM format, ensuring standardisation and consistency.
- FpML Output/Templates: Convert the standardised trade data into FpML templates for electronic communication and sharing.
Blockchain Integration:
- UTXO Model Implementation: Use a public blockchain that supports the model to record trade data, now in FpML format, on the blockchain as UTXOs. For instance, each transaction in the UTXO model is broken down into inputs and outputs, where the outputs of one transaction become the inputs of another, ensuring traceability and transparency.
- Golden Record Creation: Each UTXO represents a unique trade record, forming the golden record on the blockchain.
- Token generation is optimised by certain “proof of work” chains, rather than “proof of stake/account based” chains, as parallelised processing enables the scalability and reduction of cost required for a Capital Markets network.
- Contrary to misconception this can be achieved without excessive energy consumption and maintains confidentiality through the use of a private ledger capability, with permissioned access, on a public blockchain.
Smart Contracts and Automation:
- Smart Contract Development: Implement smart contracts to automate trade validation, execution, and settlement processes.
- Compliance Automation: Incorporate regulatory requirements into smart contracts to ensure compliance.
System Integration:
- APIs and Interfaces: Develop APIs to integrate blockchain-based golden record data with existing trading, clearing, and settlement systems.
- Data Synchronisation: Ensure that blockchain data is synchronised with internal systems, maintaining consistency and reliability.
Security and Regulatory Considerations:
- Security Protocols: Implement robust security measures to protect trade data and prevent unauthorised access. Examples include multisignature spending policies, which require multiple approvals for a transaction, and atomic swaps, which enable secure, peer-to-peer exchanges of assets without intermediaries.
- Regulatory Approval: Work with regulators to ensure that the blockchain-based system meets legal and regulatory standards.
Conclusion
The integration of golden records through the “trinity” of UTXO model, FINOS CDM, and FpML presents a transformative vision for the capital markets.
This framework has the potential to revolutionise the industry by significantly enhancing the efficiency, accuracy, and transparency of trade processing in the capital markets.
While challenges exist, the potential benefits are substantial and warrant further exploration and development. This integrated approach ensures a reliable golden record with unique trade identifiers, streamlines regulatory compliance, and fosters greater trust and productivity in the market.
Tokenovate have unearthed the Holy Grail!
