Blockchain in Capital Markets: More Evolution than Revolution

Executive Summary

While numerous blockchain-related initiatives have been announced during the past two years in the capital markets, the industry is still very much in a learning phase. Use cases are being tested, while the technology is being refined, adapted, and transformed. However, there is currently very little hard data to evaluate the benefits of blockchain-supported systems over existing infrastructures.  The industry is just starting the journey with this technology, and its ultimate value to market participants has yet to be revealed.

Nevertheless, numerous impediments to its implementation in capital markets have been overcome. Blockchain platform providers now have solutions that have significant processing capabilities and scalability. The issues around anonymity and threat of potential information leakage have also been addressed. There are now offerings that have been designed to cater to the specific needs of capital markets.

However, in doing so, most providers have created solutions that are very different from the original design of the Bitcoin blockchain or even Ethereum.   The terminology used reflects that evolution, as we have moved from blockchain to distributed ledger and, in some cases, shared ledger technology.

Acknowledging the entrenched nature of capital market providers, it is not surprising that a majority of initiatives in the industry has been launched by incumbent players.  It demonstrates the willingness of market participants to improve the current infrastructure, and also how seriously they take the potential threat created by the technology. While new entrants have developed offerings around certain asset classes (equities, FX, bonds, derivatives), products (mutual funds) and processes (KYC), they have left the complex instruments (structured product) and administrative tasks (collateral management, proxy voting) untouched.

Numerous blockchain-like solutions are essentially providing a peer-to-peer communication and record network. In markets that are already very fragmented with limited central gateways and where market participants must maintain an extensive web of bi-lateral connectivity, the implementation of this new solution is likely to be more easily adopted, while resulting in less disruption.  The foreign exchange (FX), Know Your Customer (KYC) and mutual fund markets are therefore appealing use cases. 

With the potential development of numerous chains, interoperability between blockchain offerings will be a challenge. If the multiplication of chains replicates the siloed structure of existing databases, the industry would be back to square one. The issue has already been identified, and there is a certain level of collaboration between participants to reach a technological solution. However, technology is not the only dimension to this problem. Market players need to consider the operational risks involved. Interoperability between two databases that operate under different technological stacks and operating models will inevitably generate significant operational risk and potentially counterparty risk.   The situation could be even more acute in the case of two competing chains operating in the same market.

 

The initiatives to watch and learn from in 2018 are:

  • Australian Securities Exchange (ASX): If the ASX infrastructure decides in December to replace its legacy CHESS clearing platform with its blockchain solution, it will be the first major infrastructure switch. Depending on the results, it could pave the way for more blockchain rollouts across Asian markets. 
  • Cobalt DL. As we’ve mentioned, the technology is well suited for the FX market, the project is quite mature already and the firm has gathered numerous players across the FX ecosystem around its solution.
  •  AST: The proxy voting service provider will conduct the next proxy voting round of March 2018 through its blockchain platform.
  • SETL’s IZNES: Pan-European fund record-keeping, distribution and life cycle management platform is expected to go live in Q1 2018.
  • DTCC: The replacement of DTCC CDS trading information warehouse with a blockchain-based solution will be rolled out next year. 

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