Blythe Masters Tells Banks the Blockchain Changes Everything
The banker who helped give the world credit-default swaps wants to upend finance again—this time with the code that powers bitcoin.
The penthouse meeting room in Le Parker Meridien hotel in midtown Manhattan is humming with chatter on this June afternoon. About a hundred money managers are networking at the end of the day at a Sandler O’Neill & Partners investor conference as the green rectangle of Central Park stretches into the distance 42 floors below. With neckties loosened and icy drinks in hand, the attendees largely ignore the founder of a fintech startup who’s presenting a PowerPoint about his investing smartphone app. But when the next guest takes the floor, the room falls silent.
These Wall Street veterans all know who Blythe Masters is. She’s the wunderkind who made managing director at JPMorgan Chase at age 28, the financial engineer who helped develop the credit-default swap and bring to life a market that peaked at $58 trillion, in notional terms, in 2007. She’s the banker later vilified by pundits, unfairly some say, after those instruments compounded the damage wrought by the subprime mortgage crash in 2008. Now, one year after quitting JPMorgan amid another controversy, Blythe Masters is back. She isn’t pitching a newly minted derivative or trading stratagem to this room. She’s promoting something wilder: It’s called the blockchain, and it’s the digital ledger software code that powers bitcoin.
Masters is the CEO of Digital Asset Holdings, a New York tech startup. She says her firm is designing software that will enable banks, investors, and other market players to use blockchain technology to change the way they trade loans, bonds, and other assets. If she’s right, she’ll be at the center of yet another whirlwind that will change the markets.
“You should be taking this technology as seriously as you should have been taking the development of the Internet in the early 1990s,” Masters, a lithe 46-year-old Englishwoman with auburn hair and the proper diction of the Home Counties, explains to the rapt audience. “It’s analogous to e-mail for money.”
That’s a bold statement, but Masters isn’t the only voice heralding the coming of the blockchain. The Bank of England, in a report earlier this year, calls it the “first attempt at an Internet of finance,” while the Federal Reserve Bank of St. Louis hails it as a “stroke of genius.” In a June white paper, the World Economic Forum says, “The blockchain protocol threatens to disintermediate almost every process in financial services.”
In a matter of months, this word, blockchain, has gone viral on trading floors and in the executive suites of banks and brokerages on both sides of the Atlantic. You can’t attend a finance conference these days without hearing it mentioned on a panel or at a reception or even in the loo. At a recent blockchain confab in London’s hip East End, the host asked if there were any bankers in the room. More than half the audience members, all dressed in suits, raised their hands.
Now, everyone’s trying to figure out whether the blockchain is just so much hype or if Masters’s firm and other startups are really going to change the systems that process trillions of dollars in securities trades. When investors buy and sell syndicated loans or derivatives or move money around the world, they must cope with opaque and clunky back-office processes that rely on negotiated contracts between buyers and sellers, lots of phone calls, lots of lawyers, and even the occasional fax. It still takes almost 20 days, on average, to settle syndicated loan trades.
Masters is betting that the blockchain, the breakthrough that permits people to buy and sell bitcoins without the need for an intermediary, can be used to streamline all manner of financial transactions. A June report backed by Santander InnoVentures, the Spanish bank’s fintech investment fund, estimated the blockchain could save lenders up to $20 billion annually in settlement, regulatory, and cross-border payment costs.
“You have front-end systems trading at warp speed, and nanoseconds of competitive advantage are being extracted, and yet the back end of Wall Street hasn’t been fundamentally overhauled in decades,” Masters says in an interview at her offices in Manhattan’s Flatiron District. “Firms are dealing with greater requirements for reporting, transparency, and dissemination of data. Costs have gone up and revenues have gone down. This technology really gets to the core of all those issues.”
That’s why there’s been a Cambrian explosion of blockchain startups, accelerators, and skunkworks in London, New York, and Silicon Valley. In April, UBS installed a half dozen developers in London’s Level39 accelerator to download blockchain source code from the Internet and delve into how it might revolutionize payments, cybersecurity, and other banking needs. Barclays, Goldman Sachs, the New York Stock Exchange, and Santander are backing cryptocurrency ventures. And no surprise, Marc Andreessen, Jim Breyer, Reid Hoffman, and other denizens of Sand Hill Road are all over this space. Venture capitalists plowed $400 million into dozens of digital currency startups in the first six months of this year, a fourfold jump from all of 2013, according to industry news site CoinDesk.
Some of these ventures are building on the actual bitcoin blockchain. In June, Nasdaq teamed up with Chain, a San Francisco firm, and launched a project to use the blockchain to issue and transfer the equity shares of closely held companies on the exchange’s private marketplace. “The blockchain is going to bring levels of efficiency to the financial markets that we’ve never seen before,” says Nasdaq CEO Bob Greifeld. “In time, it could be as impactful on the back office as electronic trading was on open outcry.”
By contrast, Ripple Labs, another San Francisco company, runs a self-contained network for financial institutions that doesn’t rely on bitcoin at all. Masters plans to offer banks and other financial players both options: Digital Asset is creating an off-the-shelf private blockchain product and developing ways to connect its customers to the existing bitcoin system.
Whatever form it takes, the blockchain has the potential to change the very structure of the financial services industry, says Oliver Bussmann, the chief information officer at UBS. “If you brought up bitcoin with bankers 12 months ago, you’d lose their attention immediately,” Bussmann says. “Now, everyone sees this as a critical topic. I know of more than 100 firms that are trying to make the blockchain more scalable, more secure, to make the one that everybody will use. There’s a race on out there.”
Maybe so, but rewiring the market’s infrastructure is an awfully big task. So is persuading financial players to place their trust in a system embraced by cryptocurrency anarchists and other fringy characters. Even if market pros do grasp the blockchain’s potential, will they buy in?
“Look, the technology is potentially great, but you’re going to have to bring along all the regulators and the banks to change the ecosystem,” says Hank Uberoi, the former co-head of Goldman Sachs’s global technology operations and now the CEO of Earthport, a London-based payments venture. “Change comes very slowly in that world. That’s going to be the hardest part.”
When it comes to adopting innovation, the financial services industry doesn’t exactly have a stellar record. For example, the global interbank payments system, which Uberoi’s Earthport is trying to shake up, is managed by a consortium of more than 10,000 institutions. It’s so antiquated that it still takes days to send transactions from one part of the world to another. Jon Matonis, a founding director of the Bitcoin Foundation, a Washington group that promotes the cryptocurrency, says a private blockchain run by banks could end up as just “another cartel” and function as poorly as the payments consortium.
Blythe Masters swings open the door of her ninth-floor offices, parks her suitcase, and exhales. Fresh off a flight from London, she’s relieved to be back on solid ground. Masters says her airliner was landing when it suddenly roared back into the sky to avoid a collision on the runway. “That’s the most dangerous moment I’ve ever had on a plane!” says Masters, who’s dressed in a black knit tunic, black tights, and Burberry-plaid flats.
Her new digs at Digital Asset Holdings, with a worn wooden floor and views of air shafts, are a far cry from the Park Avenue executive suite at JPMorgan. The glass walls are covered in scribbled pieces of code and diagrams with a lot of boxes and arrows. A gray terrier named Luna, the office pooch, scampers under the conference room table. A guest notes that Nasdaq has just hired a “blockchain technology evangelist.” “We have a blockchain artist,” Masters replies, pointing out the one decorative object in the place, a painting depicting a network of black and blue lines. “That is our COO’s homegrown work,” she says with delight. “I rather like it.”
Born in Oxford and educated in economics at Cambridge, Masters came of age at JPMorgan. At 18, she joined its London office as an intern during a year off before university. By her mid-20s, Masters was working on the bank’s derivatives team in New York. She helped design a way to remove lending risk from JPMorgan’s balance sheet by getting another party to protect the bank against a default in return for a premium. The contract, which made it possible to bet a bond would fall in value, was dubbed a credit-default swap, and investors fell in love with it. In 1999, Masters, then 30, was named head of the bank’s global credit derivatives unit.
“Blythe has about as much wrapped up in one brain as I’ve ever encountered in finance,” says John “Mac” McQuown, co-founder of KMV, a maker of widely used credit analysis tools. McQuown, 81, has known Masters since the early 1990s. “She is inventive, a risk taker, and beyond a doubt a force to be reckoned with.”
Masters advanced quickly up JPMorgan’s ranks. Following a stint as CFO of its global investment bank from 2004 to 2007, she was appointed chief of a newly formed unit that helped clients manage risk in commodities markets. During the next five years, she built it into a profitable business that oversaw billions of dollars of physical assets. At the same time, Masters served as a board member and then chair of the Securities Industry and Financial Markets Association, known as SIFMA. Along the way, she earned a reputation as that rare figure on the Street, a corporate player with the innovative chops of an entrepreneur.
“You were one of the most powerful women on Wall Street,” CNBC host Bob Pisani noted during an onstage interview with Masters at a fintech conference in June.
“What do you mean I was?” Masters deadpanned.
After the fall of Lehman Brothers in September 2008, some media outlets highlighted her work with credit derivatives and cast her as one of the instigators of the crash. She became such a target of critics that a French graffiti artist spray-painted her likeness onto the wall of a museum called the Abode of Chaos near Lyon.
In a speech that year at SIFMA’s annual conference in New York, she noted that she’d been dubbed “The Woman Who Built Financial Weapons of Mass Destruction.” She responded to the swipes by saying the problem wasn’t the instrument but the way people used it. “Unfortunately, tools that transfer risk can also increase systemic risk if major counterparties fail to manage their risk exposures properly,” she said.
JPMorgan CEO Jamie Dimon backed her all the way through this period, but her fortunes turned in 2013, when the Federal Energy Regulatory Commission investigated whether traders in her commodities division manipulated California’s electricity market. JPMorgan paid a $410 million settlement to end the case without denying or admitting wrongdoing; Masters wasn’t implicated in the matter. Dimon agreed to sell the business to a Swiss trading firm called Mercuria Energy Group in March 2014, and Masters resigned.
For the first time in her career, she had nowhere to be and nothing to do except hang out with her husband and daughter in her Tribeca townhouse, catch up with friends, and pursue her passion for show jumping. Masters has won first-place ribbons riding her two beloved European warmblood horses, Aslan and Vamos.
Then one day that summer, she grabbed breakfast with Sunil Hirani, an entrepreneur who co-founded Creditex Group, one of the first CDS brokerages. Hirani, 48, an effusive man who’s made a fortune at the intersection of technology and derivatives, couldn’t stop talking about bitcoin. He was toying with the idea of creating futures contracts around the ersatz currency. He was also forming a startup, Digital Asset, to explore how to apply the blockchain to the markets. He’d teamed up with Don Wilson, the founder and CEO of DRW Trading Group, a Chicago-based market maker and trading firm.
Masters was surprised. Hirani was a shrewd Street vet. He’d sold Creditex for $513 million to Intercontinental Exchange in 2008. Why was he messing around with a technology associated with cypherpunks and anti-Fed libertarians? Wasn’t the currency’s price cratering amid scandals involving bitcoin-lubricated online drug bazaars and bankrupt bitcoin exchanges? “Can’t we talk about something more serious?” Masters pleaded with her old friend.
Hirani knew that Masters’s knowledge of the inner workings of the markets would make her the ideal person to build the firm he envisaged and to sell this new technology to Wall Street. So he persuaded Masters to do some homework. Over the next few weeks, she delved into bitcoin’s origins and discussed its potential with Hirani and his colleagues as well as her network of regulators and market players.
So what, exactly, is this thing that sounds like something you’d build with Lego pieces? Like many innovations in finance these days, the blockchain is code.
In 2009, a mysterious coder named Satoshi Nakamoto released bitcoin and the math that makes it work on the Internet. He (or she or they—Nakamoto has yet to be identified) created a peer-to-peer network to enable people to buy and sell bitcoins and to automatically secure and perpetuate the system. Every 10 minutes, coders around the world known as miners race to be the first to solve mathematical equations and record transactions made with bitcoins as entries, or blocks, on a digital ledger. In return for their work, which requires brute force computing power to complete, the program rewards miners with bitcoins, which motivates them to process transactions faster.
Here’s the key part: Every new block is connected to every prior one in a digital chain. So the record of every bitcoin transaction lives on the computers of the miners and is updated with each new entry. That’s why the blockchain is also called a distributed or a decentralized ledger. This replication makes the blockchain secure. The only way to tamper with it would be to seize control of most of the computers holding the blockchain in their memories, which miners call the “51 percent attack.” Such an assault has a better chance of materializing in the next Bond flick than in reality, says Matonis, who’s also an editorial board member at CoinDesk.
As Masters dug deeper into bitcoin, she learned that it was just one of many applications that could run on the blockchain. Startups in London, Silicon Valley, and even Mexico City were already developing ways to use it to transfer and record land titles, airline miles, gold, and diamonds. Masters realized that bitcoin wasn’t really about bitcoin—it was all about the blockchain. “I had an aha moment,” Masters says.
She then plumbed why the ledger could transmit assets without an intermediary, which would change everything she knew about the way the markets completed trades. Buyers and sellers, of course, can’t automatically trust one another. In the fixed-income market, for example, we need middlemen to draw up contracts between buyers and sellers that cover interest payments, terms, and collateral, plus clearinghouses to guarantee the exchange of cash for securities.
Through her research, Masters understood how you could input all that information into a digital “smart contract” on a distributed ledger. Conceptually, it’s similar to the way you can embed video in an e-mail. But the difference is that when you send that smart contract along, it doesn’t just contain data, it transfers ownership of the security. The value belongs to whoever possesses it. So a trade could be settled in minutes instead of days or weeks, Hirani says.
Anyone with access to the ledger can read the contract with a click of a mouse. That means regulators, who depend primarily on self-regulatory organizations to police the markets, could easily verify that a securities transaction didn’t violate anti-money-laundering rules or other laws. The blockchain, in essence, automates trust, Hirani says.
The clincher for Masters was how the technology can affect risk. Every hour that a trade hangs suspended between sale and purchase, the chances mount that it won’t be fulfilled, she says. Institutions have to set aside capital to protect themselves from such failures. Since the 2008 crash, regulators in the U.S. and the European Union have directed banks to allocate ever-larger sums to cover their exposures. If the blockchain could shorten the settlement time for, say, syndicated loans, from 20 days to 10 minutes, this risk would be reduced and capital would be freed up.
“I spent my whole career thinking about risk, markets, infrastructure, and regulation,” Masters says. “I had seen the financial crisis unfold, and I had seen the credit derivatives market get operationally ahead of itself, which resulted in systemic risk counterparty exposures. I began to believe that distributed ledgers had the capability to tackle that problem.”
In March, Masters joined Digital Asset as CEO. She, Hirani, and Wilson set to work developing blockchain-based software for three inefficient markets they deemed ripe for an overhaul: syndicated loans, U.S. Treasury repos, and equity shares in private companies. At the same time, Masters recognized that the open structure of the bitcoin process—no one controls who does the mining—would be anathema to an industry in which client confidentiality is sacrosanct. So in July, the company acquired Hyperledger, a San Francisco software firm that’s developing the technological equivalent of gated communities. Its system is designed so that users will be able to process transactions themselves rather than depend on the open bitcoin blockchain.
“With private chains, you can have a completely known universe of transaction processors,” Masters says. “That appeals to financial institutions that are wary of the bitcoin blockchain.”
While this vision of a superefficient financial world is enticing, let’s not forget that Masters and her rivals will have to persuade institutions and regulators to uproot decades of legacy IT systems and practices. And the introduction of the blockchain will make the markets’ infrastructure even more complex than it already is, at least in the short term.
Skeptics question whether one piece of code could in a single stroke make finance faster, more transparent, and more efficient. “People are talking about how the blockchain is going to be some kind of Messianic savior for the database industry,” says Bradley Howard, the head of digital media at Endava, a London-based IT services provider. “It may be fantastic in some cases, but it could also just be the latest fad.”
Yet Masters, who in July joined the board of Santander’s U.S. auto financing unit as nonexecutive chairman, is betting that the mindset at the highest levels of finance is changing. The advent of peer-to-peer lending, mobile banking, and other innovations is forcing Wall Street’s chieftains to rethink their businesses. She says the blockchain may be the biggest fintech play of them all.
“Blythe sees that a new industry is being created,” says Hirani, who’s known Masters for 17 years. “There’s no infrastructure. There’s no companies that have any kind of scale. She’s done the bank thing. She did commodities. She did derivatives. She did loan portfolio management. This allows her to bring all of that experience to bear in creating an ecosystem—and a company around it.”
Twenty-three years ago, Masters opened up fresh territory with credit derivatives. Now, she’s determined to do it again, although this time it’s with a technology that was initially designed to bypass the financial system. Masters, with a very British dose of understatement, puts it this way: “I’ve always been motivated to innovate where the implications are significant.”
This story appears in the October issue of Bloomberg Markets magazine.