Hi everyone, thank you for joining us and for your interest in the next generation of collateral management. Very excited to be back here with you at DTCC again this year. I think what we've seen a lot of recently is tokenization starting to take off, and tokenization of cash, equities, funds, and various other assets being something that the capital markets are very interested in because of its benefits. But I feel that the last key thing that tokenization requires is for those tokenized assets to have greater utility, and ideally greater utility than even their tradfi alternatives. And so the real goal from my point of view is to create not only the tokenization of the assets but connectivity and venues and systems that bring real utility and value to those tokenized assets after they've been tokenized, right? So that's what I feel that together with DTCC we've been able to achieve.
I'm very impressed by the immense innovation and willingness that the DTCC has as such a large and storied organization to move so quickly to actually create this utility for tokenized assets. So I've worked with a lot of large organizations and I found that to be, you know, very impressive. The problem that I feel we are solving here is basically fragmentation. Fragmentation of data, fragmentation of how everybody connects to move collateral and settle transactions. Fragmentation of all the different systems that need to talk to each other and aren't able to talk to each other quickly enough to allow intraday collateral movement, to allow the proper moving on collateral 24/7, 365, and the ability to share information seamlessly all the time. All of this siloing of systems across asset managers, prime brokers, CCPs, agent lenders, and other key market participants basically creates a world where you have a lot of limitations. For example, you can't even do intraday collateral movement, much less 24/7, 365, which creates all kinds of risks, reduction in yield, and various other problems. So the question then becomes, how do we solve this problem? I think it's through blockchain technology that creates a properly regulated settlement environment that's efficiently connected to all the systems and data and connected to the relevant liquidity. Right? That's what needs to happen.
So we're very lucky that the DTCC is willing and able to introduce something like the DTCC collateral app chain, where we can now have a reliable, secure, regulated settlement layer that creates legally guaranteed relationships, similar to how the DTCC creates all of those super valuable relationships for all of us today, and creates the same level of reliability and risk management by doing that. Right? So that's I think one of the first steps that's been missing. After that, you need all the relevant data and connectivity to power the collateral agreements to make everything work properly. And also you need to connect that unique settlement environment that the DTCC is now making available, or going to be making available soon, or doing availability whenever they want, which is all their choice and not mine in any way. You know, there will then be a need for liquidity, right? And because there have been so many chains and because there have been so many sources of on-chain cash and now there's more tokenization in various places, liquidity is in different places, right? So you need the settlement environment that's reliable and regulated and legally binding in a way that's attractive to capital markets, you need that settlement environment to be connected to all the places and data that it needs to function the way it should function, and you need to connect it to all of the relevant sources of liquidity so that that liquidity can experience the benefits of that settlement environment. Right? So that's what I feel we've done here. That's what I feel we're moving towards in a state of production. That's what I feel is going to really solve this problem. And, you know, the components of this are basically the DTCC's collateral app chain, the Chainlink runtime environment as a source of orchestration between those different systems and data sources, the cross-chain interoperability protocol as a way to move assets and value and liquidity to and from the app chain, and all of the relevant synchronization that needs to happen. But that synchronization doesn't happen over days or on Monday because it was the weekend. It happens 24/7, 365, right? And that's I think a very big shift and very positive for the capital markets.
The very concrete benefits here for the capital markets are the ability to have intraday management of collateral at a minimum, and ideally 24/7, 365 management of collateral. You also have the ability to manage your balance sheet with much less risk. Now, even at the end of the day, you can shift around risk, you can shift your assets from your balance sheet to wherever you want to hold it. You can optimize for yield. You can optimize for risk. You can do that 24/7, 365. All of this risk reduction then also results in a funding reduction, right? Less risk means less cost for you. That less cost for you is worth in the billions for larger institutions, in the hundreds of millions for small to medium institutions. So that's a very, very real and very, very serious, very practical benefit. And as I said at the beginning, that's what we're seeking to achieve here. How do we take tokenization from just a thing is on a chain to something is providing real value because it's tokenized, right? That's the project we're involved in here. That's what I feel is very exciting about this.
Then you have a number of technical benefits once systems begin working this way. You have the ability for liquidity to move efficiently between chains. Chains are very good environments for liquidity. And with CCIP and reliable bridging cross-chain connectivity, you can now bridge between chains and move liquidity. You have the ability to automate risk through smart contracts. You can set all kinds of various conditions around how to automate real-time risk controls. You can avoid liquidations. You can manage risks in ways that you can't even manage them today, because by the way, in a 24/7, 365 world, you're going to have to manage risk 24/7, 365. So the corresponding risk management systems will need to upgrade to do that as well. But frankly, those risk management systems will be better. And then finally, the thing that, you know, we feel we play a strong role in is providing an efficient way to interface with this system, an efficient way to use the system, an efficient way to connect it to other chains, to connect it to data, and also to connect it to your systems through both CRE for developers and Fulcrum as a business owner interface. And the ability to lower the cost of integrating this and lower the cost of participating in this better method of collateral management, I think is going to remove a very big hurdle to adoption, right? Because the cost of participating and beginning the process of today's collateral management flows is high, and maintaining that cost is high. The cost of using this collateral management flow and maintaining it and doing it is going to be low. And so that's another really important thing that I think will accelerate adoption much, much faster than people expect. Now I'm going to hand it over to Dan, the CTO of digital assets at DTCC, and Ryan, our director of capital markets at Chainlink Labs. They have worked through the details of how this works in a way that I only hope to one day understand, but they've done a great job and I'm going to let them walk through the details.
Thanks, Sergey. And before Dan gets into the live demo — in case you didn't know, you're getting a live on-chain demo, you are — we'll walk you through some high-level diagrams to explain what you're about to see. So, what we've built together is a cross-chain application. We have two parties. We have a lender and a borrower who agree to terms on a single interface, and Chainlink on the back end orchestrates what's happening across multiple blockchains. So we're not limiting just the liquidity on what happens in one single siloed chain. This is a cross-chain application. So what happens first is the lender comes in, they define their terms. In our case, it's going to be a pension fund. We originate the loan agreements on two blockchains. So the legally enforceable contract, which Dan is going to go in later and show you on app chain, is where the collateral is going to be posted and managed. The assets are going to live on public chains. So when we originate the loan and orchestrate that, that's the first step. So borrower and lender agree to terms, two different blockchains. What we're then going to show you is actually delivery versus delivery. So the collateral actually has to be sent to Dan's collateral agreement on app chain, but this has to happen atomically. Currently there's a lot of problems with collateral management where someone's receiving cash which is completely disjointed from the collateral. What we're doing here is, with a single workflow, orchestrating with Chainlink services two different blockchains, where the collateral is being sent to one blockchain and the cash is being released on another. We're also using Chainlink price feeds to continuously update the price of the collateral to manage the risk of the collateral through the continuation of that loan. So enough of the diagrams, let's actually dive in.
Okay, great. So as Sergey alluded to, this is our cross-chain application that we're calling Fulcrum. I'm logged in as a pension fund. I have idle cash. I want to make that idle cash go to use. So the first step is going in and defining my financing terms. So this is granular per trade as a pension fund. I can determine my risk but also the yield I want to earn per transaction. A lot of you may be familiar with how this works today. It's paper-based, it's static, it's off-chain. These are the on-chain enforceable terms in a smart contract about how we're going to manage this loan. So, as a pension fund, let's say I want to earn 4% yield in this case. I can adjust my yield. By the way, maybe I want to take more risk and have a counterparty compensate me for that risk. Maybe I don't like their risk profile, I'll just change the risk parameters of the loan to accompany that. But for the sake of this loan, let's use 4%. Okay, so a pension fund's going to be more conservative than your average firm. Let's say I don't want to allow rehypothecation of this collateral. It's going to stay locked on app chain for the duration of the loan. Margin calls. I can determine dynamically at the start of this loan what I want to be the target ratio for the collateral that's coming in for this loan. So once again, let's be conservative, 100%, but we have toggles that we can adjust based on the risk appetite per transaction.
So if the collateral falls below the value of 100%, margin calls are automatically going to be triggered in the system to keep the loan and the pension fund always in their risk parameters. Another benefit of this is instant liquidation as well as a default ratio where we can trigger that liquidation. So target ratio at 100%, right below that we can trigger margin calls. Below 90% we can automatically replace that bad debt with good debt, automatically. All of this adjustable. So now for the really cool part, and Dan will get into this as well. Your eligible collateral is just not limited to equities, fixed income. It's also with digital assets across any different blockchain. So a pension fund should say, okay, I can accept equities. I can change the haircut to whatever I want. If market conditions are smooth, maybe a 2% haircut. If things get choppy, maybe a 15% haircut. Maybe I want to accept native digital assets on different public blockchains because of the liquidity profiles on the weekend. Doesn't matter. I can adjust these haircuts and ensure that the counterparty is always going to be configured to this at all times. So for the purpose of this demo, the pension fund is going to select all of these terms: seeking 4%, 100% target ratio, 90% liquidation ratio, and Microsoft as collateral. So what's happening behind the scenes here? CRE is orchestrating all of those terms into enforceable smart contracts on public Ethereum. So it's taking all of that data that we just entered into the user interface and it's publishing it on any blockchain you want. In this case, public Ethereum. So it leaves a perfect audit trail, line item by line item, with timestamps. And once it's written to chain, we're not just going to leave it on chain. It's actually listening for confirmation. So we're writing to chain, but we're also listening to chain. So the confirmation and storage of what just happened is now in the user interface. So great.
So we've gone in, we've defined our risk parameters, we've set up the container of this specific transaction. Now we need to fund it. So right now we have idle liquidity in this financing contract. And let's say I have $10 million of idle liquidity. What we're going to do is deposit tokenized cash of $10 million, sign our wallet, and send that directly to that financing contract as a container. So why are we doing this? Anyone that comes along, and we'll show this shortly, that likes these financing terms immediately has access to this liquidity on chain. It's pre-funded. We don't have to wait for two to three days for a wire to hit. It's available instantly. So it just updated. The pension fund's wallet just moved 10 million of tokenized US dollars into this financing contract and it's funded. Now, what I want to do is change personas. So if we go back to the diagram, we've just set up the terms and we've deposited liquidity into this financing smart contract.
Ryan, while you're switching personas, I want to emphasize a point here. We're showing this particular case, two entities, a pension fund and a hedge fund. But folks will recognize that the transaction that we're doing here is the central transaction in institutional finance. Basically, parties are trading liquidity for yield in this mechanism. The same mechanism we're showing here works for repo, works for securities lending, and well beyond. Effectively, this is a model that ultimately takes what amounts to transactions in excess of 20 trillion a day and completely automates the process. Folks who are in institutional finance are familiar with this step where the borrower has to seek the potential lender and that process is a painstaking model here. You see all your options right before you in real time.
That's right. So the hedge fund logs in, the hedge fund has a need as well. Maybe the hedge fund doesn't have cash. I don't know of many hedge funds that sit on a lot of idle cash. And if they do, they probably don't need this service. So if you remember, the pension fund says, 'Pay me 4%. I'll send you liquidity instantly. It's available instantly. All you have to do is meet the configurations that I set forth earlier.' Okay. So Microsoft at a 15% haircut. So the hedge fund logs in, looks across all these various options. Okay, there's different APRs in here. There's different configurations. This is exactly the one the hedge fund needs. So, $5 million. I'm going to submit my loan request and I'm going to confirm that transaction.
Okay. So, what's happening behind the scenes is CRE is orchestrating a very complex workflow. Things are happening across two different blockchains all at once as on top of compliance. So first we check that the wallets in the transaction are fully compliant. KYC, AML, are they not on the sanctions list? Yes. Are the terms of the transaction — is that $5 million that the hedge fund wants fully available in that financing contract? Yes, we have 10 million of idle liquidity. Then what happens is CRE simultaneously is orchestrating two different blockchains with two different loan agreements. And Dan's going to show you what's happening on the app chain later. First on the public blockchain, we're creating a loan obligation. The loan obligation is just tracking the accounting of the current loan. The collateral agreement is being created on app chain, which is the legally enforceable agreement, probably most similar to like a CSA agreement or an official agreement of price sourcing and things like that. After both things have been orchestrated with a single click on both chains, CRE listens to both of those events, indexes those events and closes them. So, just to recap what we've done so far before I hand it off to Dan: the pension fund came in, deposited liquidity, the hedge fund came over, agreed to terms, we've created a collateral agreement on DTCC app chain in a state of awaiting collateral. So, what do we have to do next?
Pay the collateral. Now, if you remember, the collateral is on public Ethereum. It's not on app chain yet. How are we going to get it to app chain? CCIP. So the hedge fund currently, if you see here, they don't have any cash yet. They have zero dollars. How are we going to release the cash? Bridge the collateral to the app chain. So if you remember, the pension fund's at 100% target ratio. We have to meet that target ratio for $5 million, but there's a 15% haircut on Microsoft. So, we're going to over-collateralize this loan and we're going to key in 11,900 Microsoft shares. The Chainlink price updates, $516.17. We're over-collateralized, so we're effectively sending $5.2 million over to app chain. So, let's bridge the asset. All right, cool. This is Chainlink's cross-chain tracker. So on the left you have Ethereum, this is the source blockchain where the Microsoft shares have lived. What we're doing now is bridging those shares over to app chain, to the collateral agreement, which Dan is about to walk us through. Over to you, Dan, to walk us through app chain.
