Blockchain startup Nivaura has today initiated its first bond denominated exclusively in ether.
Built under the regulatory oversight of Britain’s Financial Conduct Authority (FCA), the first-of-its-kind instrument was issued by London-based luxury retail startup LuxDeco and created with the help of industry leaders to give the company a new way to raise capital for short-term seasonal demand.
But what’s truly disruptive about the issuance isn’t the use of cryptocurrency, rather it’s that the bond will be cleared, settled and registered on the public ethereum blockchain. With a relatively short lifecycle of only one week, the bond is also part of a larger experiment to see if removing financial middlemen can make such investment vehicles more accessible to small businesses on a massive scale.
“As an entrepreneurial business we are always looking at ways to gain advantage and scale,” said the founder and CEO of LuxDeco, Jonathan Holmes, in an interview with . “So, if cryptocurrency becomes a valid funding and trading option we would definitely look at issuing further bonds in the future.”
And while private blockchains have largely been the purvey of CSDs and other legacy infrastructure providers, the founder and CEO of venture-backed Nivaura, Avtar Sehra, argued that the new bond shows the potential of public blockchains when applied to enterprise business models.
“What we’re showing is you can use open public infrastructure for regulated financial instruments, and this is a very critical step, because from the earliest stages we’ve always believed that public blockchains are the way forward.”
Big name input
To ensure the ethereum bond aligned with existing workflows, a number of counterparties were involved in its creation.
As part of JPMorgan’s in-residence program Nivaura received input for the development of an automated bookbuilding process that could be deployed for a number of different financial instruments. With the help of law firm Allen & Overy Nivaura then used that structure to construct legally compliant documentation that automated the work using ethereum smart contracts.
In turn, credit rating firm Moody’s priced the instrument by providing data to generate yield curves, factoring the volatility of ethereum into the structure of the bond itself.
Specifically, while a control experiment (discussed in greater detail below) paid 2.5 percent annual interest, the ethereum bond is expected to offer annual interest of about 10 percent to help offset the perceived risk of using a cryptocurrency prone to rapid price fluctuations.
Ether used to purchase the bond was be deposited to a public address called the Nivaura Client ETH Account. To help conclude the process, investors, in turn, must confirm the account in which they’d like to receive principal and interest when the bond reaches maturity on Nov. 29.
While the entire process was designed to be as self-service as possible, a trustee service is also being provided by Australia-based Link Asset Services (previously known as Capita) in case the issuer defaults on the loan.
“A blockchain can’t do that,” said Sehra, elaborating:
“A blockchain can’t go and enforce a contract and reclaim the assets for the investors. This is essentially where an accountable third party is always required.”
Yet, the ethereum bond issued today is just the latest of a two-part experiment designed to show how public blockchains could turn bond issuance into an increasingly self-service industry.
Considered a control group for comparison with the ethereum bond, the earlier work was conducted using the bitcoin blockchain, resulting in a more manual process in part due to expected difficulty writing smart contracts.
This bond was created last month as part of another regulatory sandbox similarly set up by the FCA to give the partners assurance they won’t accidentally violate industry controls.
In spite of the difficulty automating some of this earlier work, end users were still afforded a degree of self-service, by using private keys assigned to them via a KYC/AML onboarding process built into the Nivaura platform.
The biggest difference between the tests was that instead of depositing the cryptocurrency directly to an account on the blockchain, as with the ethereum bond, British pounds were deposited into Nivaura’s Client Money Account.
A document given by Nivaura to the counterparties explained the limitations of this arrangement:
“This meant that the ownership of money on the blockchain could not be considered as the independent source of truth due to the dependency on, and management of, the funds held in a Client Money Account.”
With the lessons learned from both of these live experiments, Nivaura and LuxDeco have plans for a number of further implementations.
LuxDeco’s Holmes said he first discovered Nivaura in response to global customers who wanted to pay for their goods in ethereum and bitcoin – and if the bond matures without any problems, that’s exactly what the firm would like to do next.
“If we eventually start accepting payments in cryptocurrency, which we think will come, there is potentially a natural case for funding our working capital cycles through this means too,” he said.
As for Nivaura, Sehra is mindful of other bond issuers such as Daimler, Fisco and Overstock who have used cryptocurrency for part of their process. As those companies, and others working in derivatives, make their own progress, he expects to see a convergence.
“We’re already seeing derivatives in cryptocurrency. Bonds and derivatives are going to be the next step. They’re going to be the next pioneers.”