Mr. Fonss is Co-founder and former Chief Executive Officer of AccuShares, where he now serves as Chief Architect of the company’s intellectual property portfolio, covering a range of product and market structure innovations. Mr. Fonss is an inventor and holder of patents and technologies directed at electronic ledgers and tradable securities. Technologies include new markets, the control of asymmetric risks, and real-world blockchain systems. Mr. Fonss has held management, trading, structuring and coverage roles at UBS Securities, Deutsche Bank, and Credit Suisse Financial Products. He began his career in finance at McKinsey & Company, and received an MA in Public and Private Management from the Yale School of Management.
What’s your background, and how did you become involved in the blockchain space?
I had already been in finance, in the securities and derivatives industry before I got to SOM. I continued to study finance, and I went to SOM for the terrific faculty. I was initially motivated by Burton G. Malkiel, one of the first Deans of the School of Management. He peaked my interest in the school. Unfortunately, he left before I got there, but the faculty has always been tremendous.
I have done a lot of securitization and derivatives work in finance since SOM. Most of the work I did on Wall Street, mainly with Deutsche Bank, Credit Suisse, and UBS, focused on financial derivatives in nearly all markets: equities, fixed income, foreign exchanges, and so on. More recently, my work has been in exchange traded funds (ETFs). I’ve launched an ETF company and, more recently, consulted for some of the larger ETF sponsors. That’s the way I’ve come at it.
My view of the crypto/blockchain space is probably a little bit unique, in that I think the classic ways people look at the technology’s usefulness and adaptions are unnecessarily limited by conventions and orthodoxy.
What do you see as blockchain’s most promising applications or direction?
The first, obvious application is a virtual currency. I would consider the other applications, publicized through commercial companies like IBM, pretty rote, mundane database applications. Then, from the Wall Street perspective, there’s an expectation that somehow blockchain is going to create really incredible efficiencies in back-office, middle-office, and operations, because securities processes are often relics from the 1960s and many inefficiencies can go away with a really well-designed distributed-ledger structure.
What are the problems?
One is cost, obviously. The number of people involved in the securities and financial business is decreasing, even as transaction volumes increase. There’s still a tremendous amount of duplicative work. Bond markets have probably attracted some of the most interest in blockchain technologies, and they’re probably the worst in terms of being duplicative. Transactions in the bond market are often recorded no less than three to four times.
There will be a real boon in that industry once people bite the bullet and give up some of the orthodoxy. When it comes to people doing blockchain work, there’s a purist orthodoxy that everything must be virtual. Once people give up a little bit of that and become more practical, once they realize there are going to be some mainstream applications that are “centralized”, then I think the technology will gain a lot of traction.
You’ll be able to trade things and settle things quicker with a lot less cost. Right now, it can take days for these trades to settle. Theoretically, you could settle trades instantaneously.
What else do you expect the industry to focus on?
The real magic, which I don’t think anyone’s tackled, will be adopting this tech into the whole industry and not just the pipes. It’ll open up avenues to create entirely new instruments. I think people have focused on efficiencies, cost saving, and operational accuracy, but now you can create new instruments.
Blockchain-like ledgers will blow open the set of available market information and dynamic instruments. That’s because you know where everything is in real time and where everything’s previously been, you can trace everything, you know every claim of a thing, you know every unit of a larger instrument. You can create very, very new and innovative instruments.
Think of what happens to bonds and stocks. You’re limited to corporate action: who’s entitled to it, and who owns it on each date. Bonds have this whole thing of day counts and who held what when, and it’s ridiculously redundant. The practical limitations of current corporate actions limits tradable instruments to a simple static and backward-looking world – all these limits fall away with well-designed ledgers because you can do many new things in real time. I think people are missing that, and I predict the creation of these entirely new classes of instruments.
What about the practical limitations in ledgers like blockchain? How do you handle latency and the ability to handle higher transaction frequencies?
I think there are some limitations in a strictly hyper-orthodox, fully distributed world. I think there are advantages too, but I think the tech’s disadvantage is the one you’re referring to, which is the amount of data you need to push, the calculations, and the size of transmissions you need to accomplish. I think these problems will be mitigated when one is willing to accept a reasonable degree of centralization and central parties.
Facebook’s Libra project is a good example of what I would describe as “constructive centralization.” They had 20 partners which were going to be the nodes of their project. When I look at Libra, I actually see an exchange-traded fund (ETF) in that it really works almost exactly as the ETFs on Wall Street do: It has a prescribed basket of currencies which it holds in some account somewhere, and it has in-kind redemptions. If you want Libra, you get the currencies and deliver them to the partners. If you want the currencies, you can back out again. So, I see that as a constructive way to get to adoption.
As the industry and the people working in the industry diversify, the orthodoxy falls away. I think more centralized nodes will get us there: A system where you have prescribed people who handle the transactions, or the other tricks, and where you have pathways for quick settlement and throw the actual result on the blockchain after-the-fact. You’ll have the necessary speed and overhead reduction
But what are the advantages you see? Do we get beyond just another form of payment?
Two things. The one that’s frequently pointed to is that you have fully disintermediated exchanging, so you and I can transact directly with one another without Jamie Dimon at JP Morgan being our intermediary. You and I can exchange without having accounts at a particular bank. That’s the thing that everyone points to, and it’s a real benefit to be able to send money to someone that has access to one of these nodes.
The other point is the one I alluded to earlier, which is that once you get into the world of ETFs, you can create new ETF funds. This not a point for Libra, per se, but since you know who held what and when, you can create precise, prescribed return entitlements for people as if they each had their own account. That’s great if you want to create a hedge fund experience for investors, i.e., if you want to sell shares, distribute shares, or be able to transact or transfer shares via this kind of technology.
You would be able to create somewhat of a magic system, as if everyone had their own prime brokerage account at Goldman, where everyone is doing their own trades, and no one is beholden to pooled trading and pooled rebalancing. You could get the benefit of pooled investment, but give everyone their own personalized day-to-day experience.
Think of when you’re working in the securities industry, it’s almost impossible to know who holds what and when. You have DTC holding the immobilized stock of Microsoft, and you have a hundred brokers who are members of DTC, Morgan Stanley, Goldman Sachs, not to mention clients of those people. So, you can never pierce that veil. But, all of a sudden, you know everything real time about everything because of this technology. For instance, proxy votes are a big pain the immobilized, physical securities world, and that becomes a complete non-issue.
Do you think the SEC will love the tech?
I think that’s a very likely outcome. It’s funny. I think when the regulators look at it right now, they may view it as somehow riskier. But, I think if you adopt a constructive form of centralization, where somebody has recourse to somebody if something goes wrong, the regulators like the CFTC or the SEC will benefit from increased tracing capabilities.
Right now, many things you’d like to know are almost impossible to know. You won’t really need to net anymore because the ledger doesn’t force you to net settle – when you net report, lots of vital information can get lost. I think the key in my view has always been that the big companies in this industry, the ones doing the most work in this space, are a little too beholden to convention. I think the seminal blockchain work was done almost as an anti-establishment movement. Too many practitioners continue to hold on to this slightly anti-establishment perspective, and I think that limits the technology’s potential. Ideally, if this is going to become more mainstream, we need more centralization.
Does centralization help users and the applications, or just the companies trying to centralize?
Think of the auditing capabilities if you get this right. I read the Facebook Libra whitepapers and all the commentary around it. I think that was a pretty good and constructive start. I appreciate why it offended the sensibilities of the orthodoxy, but it’s a good start toward that end. Auditing is easier because, theoretically, everyone can see everything.
Some of the scary crap that goes on right now would be easy to handle. Your question is a good one when you think of people interested in Tether, right? I look at it, and I can’t wrap my head around it. I know a lot of people who trade Tether for the reasons you would think, but if you look at it from the standpoint of its credit-worthiness and functionality, it isn’t up to par. The New York Attorney General went after it because it couldn’t reconcile the books. Tether tried to dodge whether the dollars actually exist. There’s now some notion that 60 to 70 percent of the transactions might be backed by dollars in a Panamanian bank. I don’t think that helps. For me, the irony is that a lot of very smart people in finance dig deep into Tether and are somehow okay with it. I think the Facebook-Libra structure may help go a long way to clean that up.
But is somebody like Facebook the right firm or group to create these solutions?
I think they may be better-suited, right? I think there are probably very few companies that are more clever than Facebook. But, I think you’re right. The Libra project came into the world with a lot of the hair on it. It was mostly Facebook itself, but the whitepaper also presented a little bit of an over-the-top narrative. I think you’re right. There are other, potentially better-suited people, already in this space at a moving in.
So, you’re suggesting that the firms which are currently active aren’t headed in the right direction? Would Amazon be better than Facebook?
There are a couple of things that aren’t helpful. In some sense, there are specific players in the industry reluctant to do the normative things that people expect, e.g., the normative audit procedures. Tether’s a pretty good example. Until you do that, there are going to be some problems. The other is that things go wrong in transactions. Not every trade settles like it’s supposed to because something happens in the pipe along the way.
The one good thing that happens in the world of securities is that for very large trades, things ping back and forth until there’s resolution. The duplication is good because it double and triple checks errors. So, I think whatever happens in mainstream adoption, there must be some resemblance to the traditional finance world: Did we double check the transaction? If something goes wrong, who would help us fix the transaction? Who do I call if I think I’ve gotten hacked? I don’t understand what happened because I can’t find something– who do I go to?
I think the Facebook-Libra project was heading toward some links to that, and perhaps Amazon may be an even better example of some more trustworthy enterprise that gives us comfort. It’s kind of like the exchange traded market, the derivates market, or anything else. The industry is shooting for Mars, and so it’s kind of poopooing some of the more mainstream applications. I think if some of those take hold, the more adventurous applications will follow.
But is there an advantage to being a first mover? It looks like Facebook is going to have a tough time being early.
Yeah, although the key is that you get to control the narrative, you get to control the architecture, and you may be able to control the way it works and ensure the protocols suit you. I think there’s an advantage, right? I think that was probably some of the thinking of JP Morgan. Once we get to that point of more seamless transacting, or once you and I get to transact directly and we don’t have to bounce through JP Morgan’s bank account, I think you can have hyper-customized instruments that provide the actual experience of owning a separately managed account in the investment world. That’s because you know when I enter, you know when I exit, and you know exactly what my piece of the pie looks like. All of that, and you still achieve the benefit and economies of the collective management. You get one big box with individualized experiences, and I think that’s the big benefit that everyone’s missing.
But, the big breakthrough is going to be achieved by relinquishing some of the orthodoxy. So many people spend so much time cleaning data, and they’re really reluctant to reference an already pre-existing, well-established data set. You can’t really hack the S&P 500 closing market price or the gold price reported by the Gold Council in London. Those are perfectly reasonable metrics to put in a tokenized format, and they’ll have big benefits and accrue other benefits as well. I think there’s still a little bit of reluctance in the industry to tie things to the digital world.
What are you currently doing in the space?
I focus on the intellectual property aspect, because I’ve held the view that the potential for the industry and technology is hampered by its orthodoxy. As this orthodoxy falls away, we will see the creation of new instruments. That will happen through combining old tools, that are used in the securities and asset management industries, with new distributed-ledger technology. I think the marriage of those two things is going to be enormously powerful, so that’s an active interest and venture.