June 28, 2013

Unbundling held so much promise for Commission Sharing Arrangements (CSAs). Unbundling was supposed to let asset managers apply commission credits earned through execution services from one broker to another broker's service, such as for research. It all seemed like a great idea and asset managers traded frequently with Lehman Brothers and Bear Stearns. But, when those firms collapsed, the commission credits disappeared, as they were not viewed as real currency.

The Hedge Funds or large institutions that I work with all want the same thing -- one aggregated balance to which they can apply their earned commission credits across different services, regardless of where they executed their securities transactions.

For a long time I thought the best way to achieve this was through a single CSA system with a trusted clearing company that could be used as an aggregator. As long as the asset manager felt confident that the clearing broker was solid and could not collapse, it would be easy to build a single account where research and services could be paid. But for now, asset managers spread their commission credits around, constantly assessing where they think there is less risk and trading off between the cost of execution services and where they can get the the most benefits.

Enter Bitcoin
But there is another way. What if the asset manager gets immediate access to their commission credit through Bitcoin: the peer-to-peer (P2P) digital currency?

Here's how it could work. The asset manager trades just as usual, instructing the broker to unbundle execution services from research and related services. Once the trade is done, a commission credit is generated and sent back to the asset manager as a Bitcoin. The broker can provide a wrapper around the BitCoin to track the use of the currency for only approved services.

[For more on Bitcoin and its future, read: Bitcoin Joins the Academy of Other Financial Market Bubbles].

The asset managers are happy because they can freely aggregate all of their Bitcoins from the many brokers they use and apply them to research and services that they are allowed to buy. They don't have to worry that the broker goes out of business.

The brokers are happy because they can track how the Bitcoins are being used and the administrative processing shifts to the buy side. The broker is still regulated, but the burden of processing checks and invoices disappears. Now we can let the best research win.

FIX And Bitcoin?
Taking it one more step further, the actual Bitcoin can come directly through a trade confirmation message itself using the FIX protocol. This is the "killer app." Now, rather than relying on rate calculations and detailed accounting, the commission credits are an intrinsic part of the trade itself. In the same way that gold holds intrinsic value, so too can the actual trade confirmations. As we all know, every asset manager can already process FIX, so integrating this new information would be simple work.

As long as there is faith that Bitcoin (or an analogous "Commission Credit Coin") is a solid currency, as there appears to be at least among the hedge fund community, then this could lead to tremendous progress in using CSAs for everyone.

What do you think? Will Bitcoin work as a possible alternative to funding and keeping track of CSAs?

George Kledaras is the founder and Chairman of FIX Flyer, a financial technology company in New York City. He is also the author of numerous articles about the FIX protocol ...