Exclusive: Overstock CEO Thinks He Can Prevent The Next Financial Crisis—And Revolutionize Short Selling—Using Blockchain

The financial crisis of 2008 that devastated millions of Americans and continues to haunt the country’s economy had several root causes. Fraud, bankers recklessly gambling on toxic assets and other Wall Street malfeasance reached a nadir that wiped out many people’s financial futures and changed the course of American politics.

Overstock.com, Inc. OSTK CEO Patrick Byrne sees one aspect of securities trading as key to the financial system’s collapse a decade ago—the stock location process that supports short selling.

“They say that short selling is when you borrow stock and sell it into the marketplace, but technically what you actually do is you have to locate stock [and] have a reasonably good faith belief that you have found stock that will support that short sale,” he told Benzinga.

According to Byrne, part of what exacerbated the crisis was over-locating.

“If [multiple] short sellers have the locate and all sell into the market and more shares start appearing then there are actual shares to support, that’s over locating,” he said. “[In 2008], there were far more of these locates being given out and much more stock being short sold than there was underlying stock to borrow, and the system wasn’t built to prevent that.”

See Also: Here's How A Stock Can Become Too Expensive To Short

A Blockchain Solution

But Byrne believes blockchain technology can prevent this from happening again. Overstock built a blockchain API that takes the stock location process out of the hands of the prime brokers and into the blockchain.

Called t0, the API has a built-in auction system. When a fund sends the stock to t0, it auctions the stock by generating a digital locate receipt on the blockchain. This prevents over-locating from occurring because the blockchain has all the receipts of the sale and records the underlying stock. The auction occurs on the Overstock API, which is licensed to prime brokers.

“This is disruptive to the activity at the very core of Wall Street,” Byrne said. “Eliminates over-locating and naked short selling, since naked shorting relies on over-locating. It’s a propeller to jet fuel conversion for the whole securities lending market.”

Overstock is licensing t0 to self-clearing firms and gives sponsored access to broker dealers.

Why Is This Necessary?

Byrne cites former Fed chair Alan Greenspan’s about-face on financial regulation of prime brokerages in the wake of the 2008 crisis as a key reason why he believes this blockchain tech is necessary.

“There are additional regulatory changes that this breakdown of the central pillar of competitive markets requires in order to return to stability, particularly in the areas of fraud, settlement, and securitization,” Greenspan said in testimony before Congress in October 2008.

“Settlement is an area that’s been looked over as a true prime cause of what happened in 2008,” Byrne said. “The capital markets settlement system got all screwed up, and that’s what Greenspan was referring to.”

Image by Davidstankiewicz (Own work) [CC BY-SA 4.0 (http://creativecommons.org/licenses/by-sa/4.0)], via Wikimedia Commons