As someone with background in traditional buyside finance, initially I have been skeptical of the most well-known application of blockchain technology - cryptocurrencies. However, I started learning more about the topic thanks to my wife @Lena . She is a big believer in decentralized future and is involved with a bunch of blockchain projects, so no surprise that new consensus mechanisms / scalability solutions / other geeky topics come up quite often at family dinners. I came across interesting use-cases and analogies that made me think of technology’s applicability in general (Use case #1) and Proof of Authority in specific (Use cases #2 and #3).
Use case #1 - Acquisition/Leveraged Buyout Deal Mechanics:
I did not want to talk about p2p lending and micropayments as blockchain use-cases in finance, instead I wanted to take a look at how decisions are made and consensus is reached between financial institutions working together on a deal.
Let’s take a look at a specific example.I work at a private equity firm that invests in mature companies across various industries. Whenever the deal is executed, there are multiple parties that participate in the process, who are either directly involved or play a supporting role.
Typically those parties are:
- Seller - owners of the target company, who are looking to fundraise through selling part of the business or exit through selling the entire company
- Buyer - typically a private equity firm and/or a strategic buyer (i.e. another company that is looking to have partial or full ownership of the selling company)
- Lawyers - facilitators of the deal, negotiating the documents and playing the role of middlemen that ensure all parties act in good faith
- Financing providers - investment banks, credit investors, other financial institutions, that lend money to the buyer to finance the transaction
Once all the parties agree that closing conditions have been met (i.e. parties reached the consensus on terms and conditions of the deal and all the preparatory work is over), lawyers, who typically store digital signatures of the parties in escrow, start releasing them. After the signatures are released, parties start transferring funds. Funds flow is not visible in the system, so each party has to provide a federal reference number which details who is sending money where. This is typically done over the email (it could have been worse, think of fax times ). One by one parties share the numbers with each other to prove that they acted in accordance with the agreement. Once all the reference numbers are provided, the deal is deemed to be completed.
One can easily spot the intermediary function of lawyers that I have described in the above scenario. At this particular moment they play the role of the “gatekeepers”, watching over the interests of whoever they represent. Each party is represented by a law firm, which makes sure that “if… , then….” function comes into play (e.g.“If parties agree, then release the signatures. If signatures are released, then ensure the transfer of funds”, etc.) It’s a straightforward function, which, if automated, could reduce costs, accelerate the process and most importantly eliminate human risk factor.
I will not invent the wheel here, but let’s entertain the idea of replacing this part of lawyers’ work with smart contract platform: once the deal terms are agreed upon by the parties and the triggering event occurs (e.g. approval by the investment committee), parties automatically release the signatures, which in turn triggers release of the funds from the smart contract’s escrow, that can be tracked in real time. This creates an environment, where parties do not necessarily need to follow the pre-established order of events. No more calls, no more email confirmations.
To make it clear, lawyers play a very important role of negotiating the deal terms, but their function would be limited to advisory only, leaving patrolling functions to trustless technology. It’s just a much wiser use of human potential and corporate budgets!
Use case #2 - Investment Committee Decision Making
I got very interested in the POA’s consensus that is reached by a pre-selected group of trusted individuals. This reminded me of the way investment decisions are made by most investment firms.
All the investment committee members get together and start voting. Similar to blockchain, consensus is reached when majority of participants agree on the same outcome (some committees require 100% agreeement, but most are majority-driven). If we compare all the existing blockchain consensus mechanisms, Proof of Authority has the closest resemblance. And here is why:
- All investment committee members have the same stake - their reputation and their authority in the industry
- All votes have equal weight, regardless of how much of the carry (i.e. “fund shares”) is owned by a given committee member (that’s why PoS or DPoS would not make a good analogy here). These people come to a decision that would affect a wide community who entrusted them with their finances (e.g. pension funds, sovereign wealth funds, etc.), so the only thing that they stake is their authority, reputation, and trust from the community, whose interests they serve
- New committee members are nominated by existing committee members. The number of seats on the investment committee is limited
- Committee members are incentivized to act in the best interest of the community through the firm’s management fee (analogy: transaction fees that come from the existing tokens in circulation) and carry (analogy: block fees that come from annual emission)
- Most importantly, they are incentivised to make educated decisions and contribute to the decision making process (i.e. community) because their reputation is at stake
Use case #3 - Non-for-profit Organization Accountability and Decision Making
An even more illustrative use case would be a non for profit (“NFP”) organization that I am involved with.
The NFP is run by a leadership board that gets together on a frequent basis to decide how to allocate funds that donors entrusted them with.
The decision making protocol at the leadership board works similar to investment committees described above, with few minor differences
- There is a limited number of seats, which are taken by people who have demonstrated their commitment to the cause of the organization.
- The board votes on the ideas that come either from the organization members or directly from the leadership team, and consensus is reached when majority of the voters come to an agreement
- Unlike the investment funds, NFP the board representatives come from different walks of life and thus contribute different expertise and views on things. They are unaffiliated (unless they start forming relationships after having been selected for the position)
- Every quarter NFP publishes a summary for the donors’ review to show how the funds were allocated
- Let’s imagine that the NFP I have just described launches a clone of POA, where validator positions will be taken by the current leadership board members.
- This way all the transactions that occur within the organization could be tracked in real-time on the blockchain.
- This would give a piece of mind to the donors, who will now have a 24/7 access to the information on how their donations are being spent.
- For me, having more transparency that comes with unlimited permissionless access to the information and immutability of events record is enough of advantage to keep learning more about the technology
Those are the initial thoughts that came to my mind after getting to know POA. While I have been discussing the concept with my colleagues and fellow NFP members, I would love to discuss those topics further with the POA community. I welcome your feedback and ideas.
P.S. In order not to come across as someone too theoretic, I launched a bootnode this weekend. Although I studied computer science in college and frequently look at tech companies as investment opportunities, I do not work in tech. I definitely had some fun during the process: the feeling of misery quickly gets replaced by “Now I am a real hacker” mood and then goes back to misery. But after some time and some googling, I successfully launched it. It was a great learning experience and I am happy to share some tips that I came up with. I am feeling inspired and determined to dig deeper.