AFX: Blockchain Structure Provides New Data on Capital Markets

Dr. Richard L. Sandor, Ph.D. the founder, chairman and CEO of the American Financial Exchange (AFX), recently held a news briefing to explain why the demise of Libor is an opportunity for financial innovation.  AFX’s unsecured interest rate benchmark, AMERIBOR® (American Interbank Offer Rate) is a Libor alternative.

Dr. Sandor was joined by Christopher Giancarlo, immediate past chairman of the U.S. Commodity Futures Trading Commission and an AFX board member, who explained that Libor was a historical anomaly and that multiple benchmarks are likely to arise after Libor is gone. This is a summary of the briefing.  

Among the topics covered was the AFX adoption of its blockchain initiative…

The origins of AMERIBOR

Dr. Sandor began developing the AMERIBOR exchange in 2011 prior to the Libor crisis.  Dr. Sandor saw the inherent weakness of Libor, which was pricing hundreds of trillions of dollars of debt on what was essentially a poll of lending banks. He recognized that:

-The price fixing scandal that emerged in 2014 highlighted structural problems with Libor, a benchmark set by participating banks. Even without the alleged price collusion, Libor was set based on very thin trading volume in unsecured bank-to-bank lending. Vast markets in mortgages, auto loans and student loans were pegged to an interest rate based on a dozen or fewer transactions a day.

-Interest rates were near zero, but that was unsustainable over the long-term.

-Further, there was no U.S.-based interest rate benchmark, even though America was the largest economy in the world representing 22% of world GDP.

Sandor began work on an American benchmark, in the midst of initial skepticism.  In 2015, AFX approached the Chicago Board Options Exchange (CBOE) about a transparent overnight unsecured interbank market, which would be called AMERIBOR. The benchmark would be based strictly on a weighted average of loans executed on AFX. It had a rule book of principles governing contract sizes, compliance, dispute resolution, business conduct committees, new products committees, which laid out the infrastructure for the exchange.  

Rapid growth to date

The AFX opened on December 11, 2015 with four participating banks. Over the next four years, AFX grew to 135 banks with an addition of more than 1,000 correspondent banks, representing approximately 22% of America's banks and over $2 trillion of bank assets.

AFX went from four credit lines to 1,350 and has now established about $45 billion in new credit lines. It is a fintech peer-to-peer lending platform building a trademark and a franchise on AMERIBOR. Lending volume now averages more than $2 billion a day.  

AMERIBOR is part of a diverse ecosystem of benchmark rates developing around the world as a response to transition away from Libor, including SOFR (U.S.), SONIA (U.K.), TONAR (Japan) and SARON (Switzerland). The proliferation of benchmarks gives banks and their clients more options for structuring loans and provides additional choices. AMERIBOR is an unsecured benchmark based on actual transaction activity, and it is already driving positive change in the U.S. capital markets.  

A national marketplace for unsecured loans

Historically, America has been divided into a series of regional economies. Economic activity varies across regions so you may have high growth regions where loan growth exceeds deposit growth and low growth regions with excess deposits.

AMERIBOR connects these regions through a peer-to-peer lending platform. Banks in high growth regions can borrow from banks in deposit-rich, lower growth regions. Over time, this will arbitrage out regional disparities in interest rates and create a national rate for unsecured borrowing.  

Blockchain structure provides new data on capital markets

AFX announced the launch of AMERIBOR on the blockchain on November 19, 2019. 

This is a first of its kind initiative to provide greater transparency to members of the AFX, regulators, academics and market participants. Unlike other markets that only provide time, quantity and price transaction information, AFX records a significant amount of additional data related to each transaction. This additional data includes the following:

• The entire order book at the time of each transaction (i.e., all the open bids and offers and the quantities at the time of each executed transaction).
• Geographical region of the counterparties to each transaction.
• Detailed counterparty information such as credit rating, type of institution (i.e., bank, broker-dealer, corporation, etc.) and detailed financial metrics for each counterparty.

AFX links borrowers and lenders across the country, creating, for the first time, a national market for American unsecured borrowing and lending. By using  the blockchain to record details on every transaction beyond last price, quantity and time, AFX has created a tape of bids and offers in real time, counterparties, geographical regions, and capital flows which provides a unique, one of its kind database of  information on liquidity flows between states and regions, non-performing loans and financial characteristics of borrowers and lenders.

Since AFX has members in all 50 states in the U.S., this data provides a wealth of information for analyzing and anticipating capital flows among different areas of the country. It can benefit members by helping them better understand trends and patterns in the marketplace. It can also be of value to researchers and regulators who can utilize the data for research and policy. AFX currently is maintaining the data on a private blockchain on a trial basis only for its AFX members. At some point, AFX will consider expanding the use on a subscription basis. 

The details of AMERIBOR on the blockchain are as follows: 

AFX now mints two ERC-721 non-fungible tokens for each AMERIBOR transaction on the AFX platform (for each counterparty to the transaction).  The pair of tokens is automatically minted when the transaction is repaid by the borrowing counterparty to the lending counterparty.  Each token contains the details of each transaction including the open bids and offers at the time of transaction and encrypted counterparty data.  The counterparty data is normalized prior to encryption to further preserve counterparty anonymity.  Tokens are transferred via secure queue to a private, proprietary, parity-based AFX Ethereum proof-of-authority blockchain. Tokens are then written to a cryptographic ledger to each counterparty’s account and are owned by the respective counterparties to the AFX transaction. 

This is AFX’s first major blockchain initiative. Sandor contends that this new and exciting technology has the potential to transform electronic trading and financial markets. According to Sandor, AFX is committed to remain in the forefront of this new technology.

The following is a visual description of how AFX uses blockchain technology to record AMERIBOR trades:

Launched on an innovative blockchain platform

Sandor has long been interested in the blockchain’s potential for reshaping trading activities and market operations. In his 2018 book, Electronic Trading and Blockchain: Yesterday, Today and Tomorrow, he  wrote: “As an economic innovator, I was enthralled not only by derivatives in cryptocurrencies, but also by the use of the underlying technology in other new financial products . . . Knowing that somewhere down the road transaction costs would be minimized or even obliterated meant that we could invent what we wanted.”

What’s Ahead:

AFX received approval from the Commodities Futures Trading Commission (CFTC) to list one-week and 90-day futures on AMERIBOR, and the AMERIBOR futures contracts were launched on August 16, 2019. AFX is in alignment with all nineteen Principles set forth by the International Organization of Securities Commission (IOSCO) for Financial Benchmarks. AMERIBOR recently was mentioned in the minutes of the Federal Reserve’s Federal Advisory Council on September 6, 2019 as a viable alternative to LIBOR.

Several AFX members not only use AMERIBOR as a primary source of funding reference but are now utilizing it as a benchmark for commercial loans. Floating loans, swaps and other financial instruments based on the AMERIBOR rate are currently in the works.

Dr. Richard Sandor is the Aaron Director Lecturer in Law and Economics at the University of Chicago Law School. He is also Chairman and CEO of the American Financial Exchange (AFX), theafex.com, an electronic exchange for direct interbank/financial institution lending and borrowing.