Who Needs a CSD? Nivaura to Issue First Regulated Bond in Ethereum

Blockchain startup Nivaura will today initiate its first bond denominated exclusively in ether.

But what’s truly disruptive about the issuance isn’t the cryptocurrency denomination itself. Rather, its that the bond will be cleared, settled and registered on the public ethereum blockchain, potentially rendering irrelevant traditional central securities depositories.

Built under the regulatory oversight of Britain’s Financial Conduct Authority (FCA), the first-of-its-kind bond is being issued by London-based luxury retail startup LuxDeco, and was created with the help of JP Morgan, Moody’s and others, in part to help LuxDeco raise capital for short-term seasonal demand.

With a relatively short lifecycle of only one week, the bond is also part of a larger experiment to see if removing unnecessary financial middlemen from the equation can eventually 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 CoinDesk. “So if cryptocurrency becomes a valid funding and trading option we would definitely look at issuing further bonds in the future.”

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 to finally breakthrough into enterprise adoption.

Sehra said:

“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.

Law firm Allen & Overy helped Nivaura construct legally compliant documentation that was then automated using ethereum smart contracts. JPMorgan then helped build the bond in alignment with its own requirements to show how a bank might eventually participate.

In turn, credit rating firm Moody’s helped price the instrument by providing data to generate yield curves and price the volatility of ethereum into the structure of the bond itself.

Specifically, while a control experiment (discussed in greater detail below) payed 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 will be deposited to a public address called the Nivaura Client ETH Account, with the investors in-turn confirming the account in which they’d like to receive their principal and interest when the bond reaches maturity on Nov. 29.

While the largely self-executing 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. “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.”

Bitcoin control

The ethereum bond to be issued today is just the first of a two-part experiment designed to show how public blockchains could turn bond issuance into an increasingly self-service industry.

The first bond – also issued by LuxDeco – was issued on Oct. 10 as part of a regulatory sandbox set up by the FCA to give the partners assurance they won’t accidentally violate industry controls.

Built using the bitcoin blockchain, this first bond’s end users were able to manage their own issuance using private keys assigned through a KYC/AML process built into the Nivaura platform.

But in this test, considered a control group for comparison with the ethereum bond, smart contract functionality was more difficult to achieve, resulting in a much more manual process. In addition, instead of LuxDeco depositing the cryptocurrency directly, as with the ethereum bond, the startup deposited British pounds 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.”

Going forward

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.com 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.

Sehra concluded:

“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.”

Disclosure: CoinDesk is a subsidiary of Digital Currency Group, which has an ownership stake in Nivaura.

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