FIC Network is a decentralized fixed income securities network that enables the listing, exchange, and securitization of fixed income financial instruments. The platform is defined by an asset-agnostic, multi-currency distributed ledger and is designed to cultivate adoption by financial institutions. At a high level, FIC Network’s mission is to enable participants to source, buy and sell financial products in a simple, inexpensive, transparent and secure way. Should the platform develop as envisioned, it could ultimately broadly impact markets’ financial stability and resiliency.
FIC Network is building a blockchain-based ecosystem that will facilitate the trading of institutional-grade fixed income products. The technology will ultimately allow users to list, buy, and sell any type of fixed income security, including: loans, bonds, collateralized loan obligations (CLOs), syndicated loans, asset-backed securities (ABS), credit default swaps (CDS), and futures. The platform will also support the cryptoasset equivalents of these aforementioned products, should user demand be sufficient.
While the platform may be opened to individuals in future iterations, FIC Network is initially focused on a core set of institutional users, namely asset managers, banks, family offices, fixed income funds, hedge funds, insurance companies, and investment banks. In addition, the platform will support corporate users who are looking to raise debt capital without the help of traditional corporate and investment banking partners. Finally, the project will also provide read-only access to auditors, law firms, rating agencies, valuation firms, and regulators, as these entities may benefit from direct platform access.
FIC Network has taken a cue from early innovations in the U.S. bond market in its attempt to optimally structure the network’s underlying trading framework. Inspired by STRIPS, a fixed income security whose interest and principal portions have been separated, or “stripped” to allow for individual sale in secondary markets, FIC Network vies to redefine the mechanics typically utilized when diversifying exposure across a portfolio of borrowers. Traditionally, investors aggregate loan assets from many different borrowers (or obligors) into a single legal vehicle before parsing out ownership of the structure among investors. This pooling or securitization reduces investors’ exposure to any single borrower.
To clarify how such pooling reduces investors’ exposure, consider a pool of 20 loans of $5 each, a simple case where the asset pool is not divided into tranches tailored for varying levels of risk aversion, as is common with mortgage-backed securities. As a fixed income investor, one could purchase 10% of the portfolio, receiving 10% of the interest and principal paid by each of the underlying loan obligations. Conversely, were a borrower to default, the investor would lose 10% of the principal (and interest) expected from the defaulting $5 loan – a loss of at least 50 cents. This process, known as fractionalization, affords investors the benefit of diversification; without it, one unlucky investor would lose half of the principal she is owed, a loss that would drastically impact overall returns. While this system has significant benefits, as illustrated above, it has limitations: investors cannot customize their exposure. In order to facilitate granular customization across dimensions of time and obligor quality, FIC Network introduced a new concept, aptly named Expected Cash Flows (ECFs).
Despite some important differences that make ECFs particularly suitable for individual trading, ECFs are closely related to the incoming cash flows from a loan over time. Loan payments are typically defined by a date, an interest component, and a principal component, and all three may change after origination (in cases of restructuring, prepayment, late payment, etc.) A payment of this kind is therefore highly mutable and hard to predict. ECFs, on the other hand, are defined by a set location in the overall payment sequence and neither the amount nor the location ever change. While the questions of fulfillment and payment date remain, ECFs are simple, standardized and can be commingled irrespective of differences in the underlying financial instruments.
In addition, decoupling obligor payments from their standardized, tradable counterparts (a feature FIC Network calls “flexible granularity”) provides originators with flexibility and may also enhance privacy and liquidity. Since ECFs don’t need to correspond to actual payments, the originator can control the number, size and timing of ECFs. If ECFs matched the payment schedule precisely, the originator would inadvertently telegraph information about his or her business processes to competitors. With flexible granularity, however, this is countered, as detailed loan information is only available on a permissioned basis. This ability to decouple payments and ECFs also allows an originator to break down a large, potentially illiquid payment into several smaller ECFs that may be easier for the market to digest. For these reasons, ECFs appear to be well-suited as both the basic building blocks of portfolio construction and as units of trade in global markets.
There are two primary ways to trade ECFs: 1) using the built-in exchange; and 2) using a bundled, inventory trading approach. The platform’s built-in exchange system is straightforward and is best suited for secondary market trading, offering enhanced liquidity and price discovery at the cost of relatively large required deposits and a risk of not selling all ECFs simultaneously. The bundled approach is most appropriate for trades in the primary market or large trades in the secondary market and involves creating an inventory account to house the group of ECFs that will be traded as a unit. Using this approach, the seller fields incoming bids from potential buyers, using a timed locking feature to efficiently and securely close the transaction with the selected bidder. Using this method, traders can efficiently sell large batches of ECFs at constant technical costs and in an all-or-nothing manner. Yet the method may be less attractive from the perspectives of liquidity and price discovery as many buyers may prefer to layer on exposures incrementally, implying a potential for reduced demand for large batch orders.
For sophisticated investment managers looking to immunize their portfolios against sensitivity to movement in underlying interest rates, the ability to purchase or sell cash flows with such specificity, e.g., a single cash flow or a set of cash flows that occur once a year in a particular month, represents a novel approach to fixed income portfolio construction. This low-cost, low-friction method of trading and portfolio construction could eventually become industry standard should enough participants join the platform, fostering a marketplace with critical mass and diversity.
In addition to plans to periodically audit the network and KYC performed at the time of onboarding by Factury Inc., the company behind the platform itself, FIC Network has also introduced a somewhat novel approach to quantify and track credit risk and originator quality. While the project founders would no doubt stress the importance that investors perform their own credit analyses, the platform tracks a ratio called the Borrower’s Expected Repayment Rate (BERR) to allow for the comparison of obligors across different types of assets and time horizons. The ratio is calculated as the sum of expected principal, interest, and fee income, divided by initial principal. When quoted on a percentage basis, the calculation could be anywhere from 0% to 200% or greater, with higher values corresponding to more favorable anticipated returns. After the loan matures or the obligor defaults, the ratio is recalculated using the actual principal, interest, and fees collected. These two figures are then compared and aggregated across all transactions for a given originator, thus establishing a quantitative measure of an originator’s ability to predict obligor repayments. This measure of an originator’s prediction accuracy will be tracked via FIC Network’s immutable ledger and should encourage originators to be as accurate as possible when publishing BERR figures.
What is the Significance of Blockchain Tech?
FIC Network technically uses its own distributed ledger (or blockchain), although the ledger is substantially based on the Stellar Consensus Protocol (SCP). FIC Network’s selection of SCP as its protocol muse comes as no surprise as Stellar represents a genuine innovation in the consensus mechanism space (and is modeled as a Federated Byzantine Agreement). Standard Byzantine Agreement solutions are centralized; however, SCP utilizes the mechanism in a distributed manner. While the use of distributed consensus is not an innovation per se, most cryptocurrency protocols in production rely on all nodes trusting other nodes that solve hash puzzles (Proof of Work) or that hold currency (Proof of Stake). In SCP, each node is free to select a set of nodes that it trusts and define conditions under which it agrees with statements the nodes make. In other words, a given node does not need to listen to the entire network; rather, it defines a “quorum slice” – a subset of nodes within the network that it trusts. When enough nodes in this quorum slice agree on a statement, the node itself will agree. In aggregate, this system creates an interlocking set of agreement dependencies that allow the network to reach consensus very quickly.
FIC Network has not modified the fundamental Stellar protocol, and has instead defined certain special features that allow the objects to effectively represent financial instruments and network participants (i.e., loans, bonds, users, etc.). FIC Network’s implementation of the SCP also adds a semantic layer on top by defining the term “verified entity,” which could be a Gateway, a Regulator, or Factury Inc. Factury participates on the network as a participant holding consensus slices with all verified entities. The rest of the distributed network participants are required to have a pre-defined, minimal set of other nodes and verified entities in their quorum slices. In theory, this generates a fully interconnected network with flexible trust, low latency and largely decentralized control.
The Stellar network relies on entities called Anchors to facilitate asset exchange operations. Anchors can issue assets on the network – an Anchor might accept BTC credits and provide BTC in exchange, and vice-versa. Individual network users can elect to trust specific Anchors by creating a Trustline that links their own account to an Anchor. The FIC Network utilizes a very similar approach, instead referring to Anchors as Gateways. Similar to the Stellar network’s procedure, Gateways are the only type of user that can issue currency tokens on the FIC Network and register them in the shared ledger. A user may only transact with a Gateway after the user indicates trust by establishing a Trustline to the Gateway.
In conjunction with the distributed ledger, this network of Trustlines facilitates rapid settlement between buyers and sellers, even in instances involving multiple intermediate Gateways (when several layers of currency conversion may be required). Once a trade has been initiated and accepted by parties involved via the SCP verification process, the trade automatically clears and is written to the ledger. This allows applications on the FIC Network to focus on transmitting relevant information on a permissioned, P2P basis, while relying on the FIC ledger for verifying and settling trades. While this process does not necessarily require mining or staking, FIC Network has included a staking requirement overlay in its reimagined, SCP-based ecosystem.
Token Economy and Investment Thesis
Use of the FIC Network is subject to a reasonably elaborate system of FIC-denominated deposits and fees based on specific user actions. For example, originators will need to stake 123 tokens for as long as their account is in use – at the ICO price of 10 cents per token, that translates into $12.30. Similarly, originators must deposit 10 FIC tokens for each ECF created on the platform; deposit (or stake) amounts are returned when the action is completed, i.e., when the ECF is sold. While fees are also assessed for all major actions executed on the platform, the amounts appear to be low in most cases (absent an astronomical price increase in FIC): 0.00001 tokens per ECF sold, 0.00004 to bid on a loan, etc.
An evaluation of likely token price drivers helps assuage concerns that simultaneously pricing services in tokens while restricting platform access to those staking tokens will produce increased volatility: as there will be approximately one signer, one metadata file, and many ECFs for any given financial instrument – and many more financial instruments than user accounts – the aggregate deposit amount will be closely tied to the number of ECFs currently owned on the platform. As more FIC Network tokens become locked as deposits in a scenario where network usage increases significantly, FIC prices could rise, increasing the fiat price of individual fees. These increased FIC prices may in turn encourage users to create loans with fewer, and thus larger, ECFs in an effort to minimize fees. The effect would be to slow aggregate growth in ECFs on the network. On balance however, any resulting decline in the rate of newly-created ECFs would likely be dampened by the increase in both platform users and ECFs that would have been necessary to increase the token price in the first place. While it is challenging to predict the precise interplay between these opposing forces relative to token prices, it is reasonable to assume that the network benefits from a mechanism that should reduce the occurrence of wild swings in token price, particularly once the platform has obtained a broad constituency of originators and investors.
Not unlike Winding Tree, an open-source, decentralized, wholesale-level inventory distribution platform for the travel industry, FIC Network is implementing a monetization strategy obviating the business’ reliance on platform access fees. Our discussion with FIC Network’s CEO revealed that fees will not go to the company behind the platform, and will instead be immediately burned. To counteract the reduced token supply, the network will mint new tokens annually in an amount that will precisely offset fees generated, distributing the newly minted FIC to existing holders (both individual users and node operators) on a pro rata basis, as approved by the user network. While this would prohibit FIC Network from profiting from the payment of fees directly, the company’s long-term view calls for generating revenue via monetizing specialized applications that help institutional users build portfolios, evaluate obligors, and otherwise benefit from the platform. Furthermore, the proposed compensation format seemingly aligns user, company, and token holder incentives reasonably well, since team allocations from the token sale of 20% vest over a 3-year period and any additional company compensation is only possible in the case of a thriving FIC Network ecosystem where the sale of specialized applications proves profitable.
Timeline and Project Status
FIC Network launched its Testnet and Alpha version of the platform in Q3 2017. Anticipated by Q4 2018, the first iteration in production on Mainnet is expected to support mortgage trading. The first iteration allows originators and investors to trade whole mortgages, without the ability to purchase individual ECFs. While the team doesn’t have a detailed, publicly available roadmap for future platform deliverables for regulatory reasons, Smith + Crown understands that FIC Network plans to launch the network and app by Q4 2018, with hopes to launch individual ECF and corporate bond trading at some point during 2019.
Having initially conceived the concept for a blockchain-based secondary loan market in February 2016, Factury Inc. received investment from Startupbootcamp in March 2016 and was asked to join the firm’s New York City-based fintech accelerator. Later that year, Factury received investment from Boost VC’s Silicon Valley accelerator, subsequently securing seed funding from Bialla Venture Partners in February 2017.
Backed by multiple prominent fintech VCs, FIC Network clearly has caught the venture community’s eye. Investment from Boost VC in particular, a highly-regarded accelerator in the blockchain space that has invested in landmark projects such as IPFS, Etherscan, Tezos, and Coinbase as early as 2012, suggest that Boost envisions significant institutional demand for the platform.
FIC Network is also partnering with Ismail Malik, an ICO strategist and the chairman of Blockchain Lab in London. Acting as a specialized crypto development project partner for existing digital ledger technology projects, the Lab has focused on researching secure, embedded smart contract-trusted execution environments on the Ethereum, Bitcoin and Corda blockchains. Although perhaps slightly less impactful, FIC Network is also partnering with Civic to streamline its identification and KYC process, further demonstrating the project’s comfort collaborating with external parties.
Peers and Competitors
Of the long list of projects seeking to create some form of financial exchange, a majority have clearly focused on the relatively lucrative ERC-20 token trading space (see below chart illustrating the magnitude of exchange ICOs over time). While some projects (Jibrel Network, Wanchain, Polymath and BlockEx, to name a few) have sought to tackle the challenge of bringing traditional assets on chain, it appears that the industry is still in the first inning of development, with substantial work remaining in guaranteeing regulatory compliance and finalizing technical buildout. Other projects, such as ETH Lend and Lendingblock, have also taken a foray into the world of fixed income, but they appear to be focused exclusively on instruments with cryptoasset underlyings, and are therefore targeting crypto investors only rather than traditional Wall Street fixed income traders.
When asked, FIC Network indicated that it considers Polymath and BlockEx as primary competitors. For purposes of comparison, BlockEx’s wide-ranging ambitions include acquiring regulatory approval, the ability to vet all projects prior to hosting ICOs on the platform, and ultimately to develop a highly liquid platform supporting the trading of fixed income instruments such as bonds and mortgages. Polymath, however, appears focused on the trading of securities tokens backed by equity, venture capital, and real estate. The co-existence of these three players is not in jeopardy for the time being, as one can reasonably conclude given FIC Network’s clear near-term focus on initiating an institutional-grade fixed income marketplace.
FIC Network’s team appears to be adequately robust to execute the project’s fundamental objectives. The project is led by CEO Arturs Ivanovs, a marketing executive and project manager turned blockchain enthusiast with a background in law, economics and fintech regulation. Joining him at the helm is Co-founder and COO Alvar Soosaar, a seasoned venture capital and fixed income investor. Alvar has nearly a decade of experience on the fixed income side, having previously managed a $7.8 billion portfolio of fixed income securities where he handled origination, structuring, monitoring and workout efforts.
The project has hired several veteran developers with experience ranging from blockchain tech, to enterprise network architecture, to theoretical quantum nanoelectronics. Two developers have even received accolades from the International Mathematical Olympiads, and all team members have experience either founding or working for startup companies.
|Incorporation status||Factury Inc. (Delaware)|
|Team openness||Full transparency|
|Blockchain Developer||Peteris Ratnieks|
|Technical White Paper||No|
|Available Project Code||No|
Token and Sale Details
FIC Network will release a preliminary ERC-20 token on the Ethereum blockchain, called eFIC. At such time that the production-level FIC blockchain is launched (likely later in 2018), token holders will be able to convert eFIC tokens to FICN tokens (and all eFIC tokens will be destroyed). FIC Network plans to issue 200 billion FICN tokens; eFIC token holders will receive FICN tokens in proportion to their respective eFIC holdings.
Of the 316.5 million tokens created, 50% will be distributed to the public, 20% will be retained by the team, and 30% will be placed in reserve. The reserve will be deployed primarily to encourage platform adoption, likely in the form of discounts given to key institutional target market prospects such as large banks and asset managers. (Tokens allocated to team members are subject to a 3-year vesting period).
|Role of token||Payment/Access|
|Token supply||316.5 million FIC|
|Distributed in ICO||160 million FIC|
|Hard Cap||16MM USD|
|Consensus method||Stellar Consensus Protocol|
Prospects and Challenges
While some may be daunted by the challenge of penetrating the well-established institutional fixed income market, others may see a need to reduce reliance on centralized intermediaries and create infrastructure for the next generation of cryptoasset-based fixed income instruments. As an effective first-mover in the space – given the project’s laser-like focus on fiat-denominated fixed income specifically – FIC Network is uniquely positioned to capitalize on the next generation of fixed income trading.
It is fairly straightforward to appreciate many of the benefits of a secure, fully-digitized system with granular, cash flow-level data from the perspective of a loan originator or portfolio manager: one can easily understand both aggregate and net exposures across a multitude of dimensions and fine-tune portfolios accordingly. Furthermore, the decentralized nature of the network can help eliminate some of the inherent drawbacks present in current systems in terms of friction, lack of interoperability, asymmetry of information and operational risks. The platform also simplifies trading across multiple sets of currency pairs, utilizing Stellar’s Trustline concept to facilitate global and cryptoasset-denominated trading. What’s more, the FIC Network will support rapid settlement, on the order of a few seconds, in comparison to the three days that are required using traditional methods.
In fact, the exceptional transparency of FIC Network may have more altruistic applications even still. In a scenario where the platform observes widespread adoption, the resulting database of detailed cash flow, obligor and investor financial exposures could be utilized by regulators to obtain an accurate picture of underlying financial interconnectedness. In an age where global financial institutions operate without borders and outstanding derivatives exposures exceed $1 quadrillion, FIC Network’s platform may offer a way to simplify the complexities of a financial system that seemingly has a mind of its own.
In The Road to Ruin, James Rickards explains that the prevailing risk models typically used by Wall Street produce consistently weak forecasts because they assume financial markets are an equilibrium system, as opposed to the complex adaptive or critical state systems that they truly represent. As such, these approaches are insufficient and will likely fail to protect us from the next great market decline.
In an effort to predict such an event without relying on these fundamentally flawed theories, Rickards applies Bayesian statistical techniques and complexity theory to the study of the global financial system. While many economists reject Bayesian probability because of the need to “guess” initial outcomes, the fact remains that it is the most effective way to solve a problem in the absence of having enough initial data to meet the demands of classical statistics. In fact, Rickards points out that Bayesian approaches are used extensively by agencies such as the CIA and the Los Alamos National Laboratory. When your job is to predict the next terrorist attack, you can’t wait for twenty more attacks to build up your dataset! He concludes that the best way to truly understand the level of our financial precariousness (and to be well-positioned to effectively combat any impending crisis) is to digitize and document derivative exposures held at major banking institutions, creating a single, global, machine-readable database of fixed income and derivative securities. While FIC Network is surely far off from such a feat, it is comforting to know that there are some projects underway that may end up pointing us in the right direction.
Clearly, FIC Network has identified several meaningful ways to improve upon existing methods of fixed income trading, irrespective of its ability to significantly influence the development of one of the world’s largest markets. While speed, transparency, cost, and security benefits can be immediately realized as the project’s loan operations come online, facilitating the creation of large, institutional-grade asset-backed structures will take some time. However, to the extent FIC Network’s loan offering proves successful, it is logical that the creation of these more complex and expensive structures would be within reach. Only then would users begin to truly benefit from all that the project has to offer, as the cost of securitization operations are reduced substantially through the removal of expensive trustee, auditor, clearinghouse, and SPV intermediaries.