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Gevork Vermishyan reveals where the company plans to make use of blockchain technology
MegaFon has become the first Russian issuer to place ruble bonds using blockchain. As part of a pilot placement, 500 million rubles of bonds were purchased by Raiffeisenbank. The company says the deal was primarily a “field test” of the new technology, rather than a commercial project. In an interview to Interfax, MegaFon CFO Gevork Vermishyan explains how the company tried to see blockchain as more than just a trendy word, the benefits of such deals and where else the company plans to use this technology.
— Today you announced the launch of a pilot project to place bonds using blockchain technology. When did you begin preparing the deal? Who did you work with on it?
— At the beginning of summer we started thinking how to make practical use of new blockchain technology. While we were thinking and working through options, we found like-minded thinkers in Raiffeisenbank and the National Settlement Depositary, part of the Moscow Exchange group, who were also looking for opportunities to use this innovative technology in their systems. We worked on the deal in the strictest secrecy, in a very confidential environment. We understood we would be pioneers and prepared meticulously so as not to make any mistakes. We decided not to publicly speculate about the deal and just rolled up our sleeves and got on with it. At the end of the day, I am very pleased that it all went well and that we set a precedent on the market, as the first in Russia and some of the first in the world to issue blockchain bonds.
— Nowadays it’s very cool to talk about blockchain and the technology’s potential. For you, is this more about following a new cool trend or is it a real project?
— There has long been a lot of hype around the word blockchain, which takes up the lion’s share of stories in the media. Everyone is discussing the technology, guessing where and how to use it, but it rarely goes beyond talk. There are only a handful of examples of real use. It’s easiest to understand what blockchain is through examples.
Let’s imagine you bought an apartment from me. Where will our deal and the rights of those involved be registered? Of course in the official registry, in the cadastral database. And now let’s imagine — although it’s certainly not something we want to happen, but let’s imagine — the registry building, with all its computers and back up copies, burns down and the databases are lost. Where is our deal registered now? Who owns the apartment? It’s unclear. For you, the buyer, it’s a sad situation. Now imagine that every building in the world is a registry and that they all store information about our deal. And not just our deal, but all deals. All the data is constantly updating and linking to earlier data, so, say if I also earlier bought the apartment from someone else, then that would also be shown in the system. That’s what blockchain is — a block of records linked in a chain. Even if a whole street of registries were to disappear, that wouldn’t be a problem because all the others are storing the information. Of course we could contemplate what would happen if all the buildings were to disappear, but you probably wouldn’t need an apartment then anyway.
Now let’s get back to our deal. Of course it wasn’t about financing. It was a small deal — 500 million rubles — and there were just three parties involved: the issuer, central depositary and investor. For us it was more of a field test of the new technology in a real deal with bonds. So while others were discussing blockchain, we were preparing the deal. We tried to see blockchain more than just a trendy word and to find a way to make effective use of it. The conclusions we reached, in my view, are valuable for the whole market. Our commercial blockchain bonds are not only the first in Russia but some of the first in the world.
— How does it work?
— Imagine a normal deal, which involves the issuer, who issues the bonds, the investor, who buys them, the central depositary and the depositary from the investor’s side. Interaction in the deal looks like this: each party interacts with each other, but they have their own databases and records, which don’t intersect, are separate and not managed centrally. The cost of maintaining that kind of interaction is obviously high, because each of the parties has its own costs for maintaining its records and doing a lot of paperwork for the deal. Let me give you an example of a transaction. Say you issued electronic bonds. I have to somehow send them to the investor from MegaFon’s account in the National Settlement Depositary (NSD) to the investor’s account in the depositary. MegaFon should have records that the bonds have been sold, settlement is complete, and the NSD should have records that I have given them to the investor. The investor and his depositary should also have records that the bonds have been purchased. That’s the traditional way things work, which today involves a lot of actions. You can visualize it as a rhombus, with the parties in the deal in each corner, with lines linking each of them in every direction.
What does blockchain do with these parties (referred to as nodes)? Each participant has its own databases and records but they are linked through the cloud and information is transformed into a system of distributed chain blocks. And most importantly, each party’s records are updated automatically. So if the update is done in one place, the system knows that the changes are authentic and updates the rest of the records itself. Remember our rhombus? Now inside the rhombus we have the cloud, and all the lines go through that. Maintaining such a system is significantly cheaper, primarily, on the side of the depositary.
— What are the benefits of using this technology?
— Having completed our deal, we see at least three important benefits. The first is speed. I’ve been working on the market for a long time; I issued my first ruble bonds in the 2000s. To prepare a ruble bond issue back then took 6 months. It took several days to settle after the order book was closed. And today we have proven that by using blockchain it’s possible to do that in just a few minutes.
The second advantage is security and reliability. Because the blockchain system is distributed and not hierarchal, you don’t need to worry about losing one of the parties or part of a transaction because there is a copy in all the parties’ records, a confirmed and protected copy. Security and trust is much higher than in the traditional scheme of doing things, because blockchain has the mandatory requirement that each participant of a deal must confirm that it’s their transaction or that, yes, it’s the transaction of one of the participants. In my view that’s a very important advantage. Let’s imagine that a minority shareholder keeps his equities in a bank in a depositary account, where it’s clearly confirmed that he owns them, has the right to vote and receive dividends. What happens if the depositary goes bankrupt or is hacked and the database and its “mirrors” disappear? The investor can only prove his rights through long court proceedings, while losing out from not being able to sell his shares. Blockchain makes it possible to very easily identify a shareholder’s rights because verified records are distributed in other linked databases. As such, the architecture for recording, tracking and settling with equities provides significant protection for the rights of shareholders and investors.
The third advantage is cost. Of course we can’t yet say that we see any direct effects in money terms in our deal. Costs for circulation of the bonds are not lower. However, we are now closer to the assertion that as penetration rises in future, the cost of deals using blockchain for the market will be reduced significantly. Imagine if we are talking about transactions in the billions, with several hundred participants. Servicing such transactions requires powerful servers. But with blockchain, there is no need for separate registers, which cuts costs for maintaining a large volume of data — buying the servers, electricity, etc.
— Is this somehow related to crypto-currency?
— No, it’s not. In our case we are talking about traditional commercial bonds, sold for normal rubles. Blockchain in our deal is the technological platform for recording the rights to securities, a platform that a lot can be done on: bonds, shares, property, etc. So our deal is 100% legal and complies with Russian legislation and doesn’t use crypto-currency. So we are talking exclusively about using blockchain technology to record rights; it’s important to underline that.
— And who will support the technology?
— It’s possible to use what you’ve developed yourself or open-sourced solutions, of which there are many on the market. In this case (placing blockchain bonds), the choice and maintenance of the technical solution was down to the National Settlement Depositary.
— Did you set up a working group with the NSD for this?
— The deal involved Raiffeisenbank, us and the NSD. We all made our contribution to developing how the deal would work and to its practical implementation. A big team of specialists from each of the parties worked on the project.
— Who has already tested such placement technology before you?
— At the end of June, carmaker Daimler AG issued 100 million euros of bonds using blockchain. They were one of the pioneers and possibly the first with bonds; we followed right behind them. Daimler is a company that often turns to the market, with some 50 — 70 deals a year, so it makes sense that they decided to test recording, registering and settling an issue of German bonds using blockchain. Their deal was a success, they got the money and everyone was happy. I am sure they are already thinking how to expand the use of this technology in their corporate business.
— Does it cost a lot to maintain this technology?
-Supporting the blockchain system requires a lot of processing power. But not a huge amount. I don’t think it’s a serious barrier. Demand breeds supply. Chipsets are becoming smaller but ever more powerful. Quantum computers are not far off and their performance will be thousands of times better, with so much processing power that they will easily be able to cope with blockchain databases. I think for us that would be like comparing the speed of a donkey with a supersonic jet. Of course energy demands will rise too but new chips will be more energy efficient.
— Where else can this technology be used in business and in what timeframe?
— I think our example will help push other market players to try using this technology as well. I think we are not far off the point when simple operations like registration, settlement, movement, debiting and crediting will be done through blockchain for any asset, be it equities, contracts, property or intellectual rights. I think this process will begin as early as next year.
Aside from the financial market, blockchain can be used anywhere that operations need to be tracked.
For example, the technology has enormous prospects on the property market, in logistics. There was an experiment in America that, through the use of IoT and blockchain, helped track supplies of salmon from the Atlantic to a diner’s plate in a small fish restaurant. The experiment showed it is possible to create a clear and protected information chain, making it possible to track the whole chain of counteragents, from the fishermen, auction broker and transport company through to the wholesale market and also to guarantee the quality of the product by measuring storage parameters at each stage.
Another hypothetical area where this technology can be used is user identification. For example for mobile subscribers. But to do all of this, a normal, clear regulatory and legal framework needs to be created so that different aspects of transactions can be handled using normal schemes and using blockchain. Right now it all sounds rather vague, but why not? It would be useful for subscribers and for the company and overall would fit in with the interests of the state.
— What type of regulation are you talking about?
— Primarily I mean standard legislation regulating interaction between economic entities and record keepers, different registries and agencies, or between themselves to authenticate contracts and confirm original documents for services and settlement for them. That’s a huge sector. There needs to be a fairly systematic concept on the level of federal and regional legislation to push this technology into practical use. Specialists in this field can give a more accurate answer to this question, I think it would be better to ask them.
Another interesting example is operations on the financial markets: the buying and selling of derivatives. All regulators and self-regulating organizations that carry out control and oversight of stock market operations always strive to ensure that investors’ rights are considered as much as possible in settlement and that settlement is done as quickly as possible. So blockchain technology could potentially be used with derivatives as well.
— What comes after the pilot?
— We intend to use blockchain for larger deals as well. Next up is working horizontally, to broaden usage. We don’t want to stop on just one, albeit very historic, bond issue. We see prospects for the future and are ready to move forward.
If it were legally possible, we could maintain a record of shareholders using technology allowing the use of blockchain. That would help boost the quality of corporate governance, including in terms of protecting minority shareholders’ rights and the speed of deal processing. And this isn’t some kind of “mythology”. In the state of Delaware in America, the law sets out the possibility of issuing and keeping record of shares using blockchain technology for private companies. There are also talks about using the technology for public companies; as you’re aware, Delaware is where the most famous tech companies are registered.
Secondly, we of course want to look to increasing the percentage of electronic documentation we use blockchain and also at signing smart contracts.
MegaFon is associated with innovation and the latest technologies — it’s a form of promise to all our subscribers and partners. And I am very pleased that we were the first to take the practical steps to test blockchain, not because it’s trendy but because we had the hypothesis that changing the whole architecture of processes would make it faster, ensure a very high level of reliability and security and also make it cheaper. Our deal confirmed this. Using blockchain really is significantly faster, clearer and, in future and market-wide, handling deals will be significantly cheaper.