A Letter from Brian Cai（Founder and CEO of FORTUNA) #001Throwing a Stone into the 483 Trillion USD OTC Derivatives Pond
Hello everyone! My name is Liangbin (Brian) Cai, I’m founder and CEO of FORTUNA. I’ve started a series called ‘Founder Blogs’ to share some of the ideas me and my team have, that do not fit anywhere else. Welcome!
After graduating from Yale University, I won first prize at the International Mathematical Contest in Modeling. I worked in various segments of the financial industry all around the world (New York, London, Hong Kong, Shanghai and Hangzhou), in the fields of investment banking, supply chain finance, Anglo-American law trusts, civil law trusts, and private banking. At the age of 26, I was able to work my way up in a state-owned bank. Prior to leaving, I was the general manager of the private bank and was responsible for over 30 billion in assets. After these great experiences, I decided it was time for something new, something bigger. That is when I founded Fortuna.
Why did I create FORTUNA?Many people ask me: “with so many people focused on speculation, and little real knowledge about blockchain or financial derivatives, why would you want to create Fortuna?’’ In one sentence: To throw a stone into the OTC Derivatives pond and see what happens. If the stone ruffles the water, we should still feel comfortable. If waves start to rise, it will be great. And if earth-shattering disruption starts to take place, the view will be magnificent.
I have been telling others that we are a financial derivatives company that uses blockchain, rather than a blockchain company that has financial derivatives as a topic. Fortuna is not one of those companies holding the Blockchain hammer, looking to find nails to hit. Fortuna is also not a conceptual enterprise that simply replies to the blockchain hype.
Our team includes Bachelors, Masters, and PhD’s from Yale, Oxford, Columbia, Chicago and other top universities in the world. There are also elites from domestic and international large investment banks, top strategic consulting companies, private banks, hedge funds, and digital companies. We can gather together because everyone has a very strong sense of purpose and wants to create some real value in the financial industry. Because the financial industry is not transparent, direct, or fair “Make the World More Transparent” is our internal slogan. We chose to create Fortuna because we selected the entry for financial derivatives as the starting point for our campaign rather than blockchain. Several key points in the financial derivatives market are well-adapted to the blockchain’s technical system and economic thinking. Thus, FORTUNA was founded.
Why I chose OTC derivatives?Before answering the question, I would like to briefly explain the differences and merits and demerits between the “trading pit” and the “OTC trading” of derivatives.
Trading pitThe Trading Pit refers to the ground floor trading you see in old movies, where you can pick up options and futures at a bargain and it is basically all-out war. The advantages of this are that using an exchange that works this way helps control your counterparty risk through their guarantee mechanism and margin account systems. The so-called opponents’ risk is the risk of opponents’ cheating; the disadvantage is that the exchange, rather than the user, decides on the kind of transaction. The same thing goes for the contract terms. More importantly, futures and options on the exchange are standardized contracts, this means that you can’t change any terms or trading elements. These exchanges are simply ‘take it, or leave it’, there is no room for a custom, personal, preference.
This brings us back to the original question, the OTC derivatives market, and why we chose this market as our entry point. First, especially looking overseas, the OTC derivatives market is attracting and mysterious. In 2016, the total global nominal value of OTC derivatives was $483 trillion. Compared to a global GDP of $74 trillion and various other industries, this shows you the immense scale of the global OTC derivatives market. A very interesting market for Fortuna to enter, especially since our home market China is only just beginning to scale up their derivatives market.
At the age of 26, I began to serve a cadre of divisions of the state-owned bank. Prior to leaving, I was the general manager of the private bank belonging to a state-owned bank. In those two years, I learned about domestic private hedge funds and the derivatives industry. The more I learned, the more I realized that the domestic derivatives market wasn’t perfect. I was born in the year 1988, at that time the National People’s Congress pointed out that: “developing various types of wholesale market trades and exploring futures”, is a potentially huge market. Although so far, all the Chinese derivatives exchanges combined, support only 48 varieties of derivatives (including futures and Intra-market options).
A more crucial point is that although there are only 48 varieties in China, adding the fact that there is high demand, the transaction cost is still surprisingly high. According to the data from the 2016 Statistical Report of the American Futures Industry Association (FIA), showing the top 30 derivatives exchanges in the world, three of the four domestic derivative exchanges are listed:
- No. 6, Shanghai Futures Exchange;
- No. 8, Dalian Commodity Exchange
- No. 11, Zhengzhou Commodity Exchange;
In conclusion; this means that the demand is sufficient, even though there aren’t many exports, the transaction volume is still huge.
In fact, the relevant domestic departments are aware of the problem that there are only a few varieties of derivatives. They have also realized that derivatives have a lot of disadvantages compared to standardized products. Hence in 2013, the China Futures Association issued “Guidelines for Carrying out the Pilot Program for Futures Companies’ Establishment of Subsidiaries to Primarily Provide Risk Management Services”. This encouraged all types of financial institutions to provide ‘Over-The-Counter’ (OTC) derivatives such as OTC options to the market. In 2015 the OTC options business entered a period of vigorous development, this was caused by the margin trading of securities. As far as I know, an off-exchange business team consisting of 20–30 people, ran by a securities company, made a turnover of more than 150 billion Yuan (±24 billion USD) for customers in 2017. This shows how hot the market actually is. However, this market has only just begun! At present, only ultra-high-net-worth individuals can participate.
OTC derivatives are inherently peer-to-peer (P2P) markets that are aligned with blockchain technology.
The OTC derivatives market is an OTC market outside of an exchange. It’s a natural P2P trading market and will therefore face several problems:
- 1. How to establish trust between counterparties;
- 2. The cost and time of establishing trust;
- 3. Efficiency issues from combining transactions;
1. The distributed consensus algorithm and asymmetric encryption technology system can largely solve the problem of point-to-point transaction trust. At the same time, the structured smart contract of the map can be directly tied to FOTA to achieve the “decentralized margin system” of the margin account system. This is similar to a centralized exchange, it can keep control of the counterparty risk. Derivatives are automatically liquidated when the smart contract expires. Before expiration, the user can transfer the derivative smart contract for second-hand use.
2. Taking the domestic OTC option as an example; brokerage fees generally charged by brokers can be as high as 6%-7%, which is a very profitable business. The reason why they can receive such high agency fees is the lack of demand for means of connection. This can be solved by traditional Internet and blockchain. Because the two parties wishing to trade often vary there is a lack of trust. At the same time, the OTC market does not have a margin account system and supervision system that is owned by an exchange, so a brokerage firm must guarantee it and collects guarantees. These issues can be solved by using the blockchain technology that uses encrypted digital tokens and smart contract technology.
3. Take the domestic OTC option for example; the contract is artificially combined. The contract is created and signed manually. The maturity clearing is also controlled by people. This labor is very inefficient and does not have any hand-made feelings. Foreign financial IT service providers such as Bloomberg have already solved this part of the problem. Domestic Wind is also entering the market. However, through the traditional Internet and IT methods, only the connection efficiency of the matching and the management efficiency of the internal system can be solved, and the efficiency solution cannot be provided at the transaction level of the contract, including but not limited to contract creation, signing, and liquidation. This is exactly what the blockchain technology solves, as a representative of valuable networks.
Thanks for reading and see you next time!
Brian Cai.
