Project Medici intends to create a blockchain based securities exchange. The first hint at this project was in May when, during the Q & A of his keynote address at the Bitcoin2014 conference in Amsterdam, Patrick Byrne, CEO of Overstock (OSTK), let slip that he was interested in listing Overstock securities on a blockchain based exchange. It recently congealed with Overstock's hiring two of the the three founders of CounterParty, a decentralized exchange built on top of Bitcoin. The project, named Medici, was announced on October 6th at the Inside Bitcoins Las Vegas conference.

Overstock initially reached out to the Bitcoin community for information on asset trading platforms. Ethereum, NXT, and CounterParty were all considered. Overstock landed on the partnership with CounterParty, touting its use of Bitcoin--which has the most secure blockchain--and the CounterParty founders' grounding in math and computer science as well as their philosophical outlook.

Patrick Byrne and Overstock

Patrick Byrne, born in 1962, studied philosophy, completing his bachelors, masters, and then Ph.D., which he received from Stanford in 1995. Not long after completing his Ph.D. and entering the business world, Byrne was tapped by mentor Warren Buffett in 1997 to become the President and CEO of Berkshire Hathaway company Fechheimer Brothers, Inc. In 1999, Byrne invested money in D2-Discounts Direct, taking a 60 percent equity stake, and then took over as CEO, renaming the company to Overstock.com. Utah based Overstock initially focused on liquidating excess inventory online but has broadened into general e-commerce and competes with Amazon.com. Byrne has grown Overstock to 1500 employees and a market cap of over $500 million.

Overstock became the first large retailer to accept Bitcoin, going live in January of 2014. While some speculated that the move was merely a publicity stunt, Byrne's keynote address at the Bitcoin2014 conference in Amsterdam revealed that Bitcoin resonated deeply with his philosophical outlook, and the announcing of the Medici project backs that up.

CounterParty

CounterParty is a peer-to-peer exchange built on top of Bitcoin. By being built on top of Bitcoin, it gains the security of the robust Bitcoin network. CounterParty allows users to write smart contracts using a Turing Complete programming language. The contracts get written into the Bitcoin blockchain. They are executable on the CounterParty Network and allow digital assets to be traded on conditions recognizable by the contract.

CounterParty was founded by Adam Krellenstein, Robby Dermody, and Evan Wagner, and launched in January of 2014. Counterparty's non-minable native currency, XCP, is traded on several exchanges, but not on the larger crypto-currency exchanges. The market capitalization for XCP at the time of publication is $14.4 million. All XCP, just over 2.6 million, was issued in January of 2014 using a process called 'proof-of-burn', where people were issued XCP after sending Bitcoin to an unspendable address, thus rendering the Bitcoin unrecoverable. Burning 1 Bitcoin yielded between 1000 and 1500 XCP, with more being yielded earlier in the burn period. The proof-of-burn process was used as a means to fairly distribute the currency.

Aims of Medici

The WSJ reports that while SEC regulations will require Medici to operate a clearinghouse, Medici hopes eventually to be able to run a legal peer-to-peer exchange. "In the long run, Mr. Demody said, peer-to-peer share trading over Medici would incur just 20% of the costs carried by the current, centralized system run by the Depository Trust & Clearing Corporation, the entity owned by Wall Street banks and brokerages that manages clearing for most securities in U.S. capital markets."

Medici would also offer complete traceability of trades, as opposed to the Depository Trust & Clearing Corporation's (DTCC's) Continuous Net Settlement (CNS) system. Patrick Byrne illustrates by hypothetical example the potential problem with CNS: "Goldman submits to the DTCC’s Continuous Net Settlement system that it sold 2,000 shares that it does not deliver. Imagine Morgan Stanley was on the other side of that particular trade. But maybe Morgan has a client who sold 1,000 to a Goldman client, and which that Morgan client failed-to-deliver. The DTCC nets the two trades, and therefore sees just 1,000 shares of failure (Goldman to Morgan)."

The traceability of Medici would make any naked short selling very evident on the Medici exchange. Naked short selling is a practice heavily criticized by Byrne and his media project Deep Capture, especially in the middle part of the last decade. While short selling is normally enabled by the short-seller borrowing shares of the stock they wish to short, naked short selling is the practice of short-selling without having first arranged to borrow the stock, and is technically legal as long as the investor intends to borrow the shares and has reasonable grounds to believe they can be borrowed. It has been argued that naked short selling is used as a tool by unscrupulous hedge funds to attack vulnerable small and mid-cap companies and profit from a decline in the target company's share price or even its bankruptcy. Strong suggestions this practice has taken place can be seen in stock Failures To Deliver (FTDs). According to a report by Gary Matsumoto, in 2006, about $6 billion worth of trades every day would result in a fail to deliver. Regulation Short Sales (Reg SHO), enacted in early 2005, set out standards intended to limit abusive short sale practices. Reg SHO requires that organizations such as the NYSE and the NASDAQ publish lists of securities where the organization is the primary listing venue and the security meets Reg SHO threshold requirements indicating a certain level of failures to deliver in that security. Before 2008, when regulation was made stricter, the number of companies on these lists was regularly several hundred or more. Thousands of companies over the years have appeared on Reg SHO's threshold lists, some appearing on the list for up to 400 days in a row. The Medici exchange would stymie the practice of naked short selling with its quick settlement times and traceability.

The DTCC

Created in 1973, the Depository Trust and Clearing Corporation now clears more than 1.7 quadrillion dollars in transactions every year, pulling in over a billion dollars of revenue. Every two days it processes the equivalent of the US annual gross domestic product. It touts that it is advancing automation, centralization, and standardization. It is user-owned and serves as the centralized clearinghouse for more than 50 exchanges and equity trading platforms in the US.

The Bottom Line

Overstock is aiming to compete with the DTCC by leveraging the Bitcoin blockchain and the CounterParty peer-to-peer exchange platform. Byrne says "The technology is a hurdle we can quite comfortably clear. We don't know yet how high the regulatory hurdle is, but we've jumped regulatory hurdles before and we don't have reason to think this is insurmountable." To aid on the regulatory aspect of the venture, Overstock has hired law firm Perkins Cole which represents dozens of Bitcoin startups.

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