Financial market infrastructures (FMI) is the technology that enable trillions of dollars of capital to move globally on a nightly basis. Some of the infrastructure still runs on systems designed in the 1970s, including mainframe and COBOL. Blockchain is now starting to be deployed as a solution to modernize these systems, after years of trials and proof-of-concepts. A key reason for blockchain adoption is that it provides a single, decentralized source of truth, data verifiability and programmable assets to an ecosystem of market participants that currently maintain siloed ledgers. In this session, we will share how financial services have deployed blockchain in order to enable new services, achieve greater efficiency, and improve client service delivery.
Financial services has become one key application category for blockchain. Specifically, the benefits are seen in the backend machinery that powers financial services. The backend machinery for financial services is also called financial market infrastructure. Depending on the sub-category, the backend machinery can be paper based (no digitization), or multiple digitized systems running in separate siloes, with its own database.
Blockchain technology offers several compelling advantages that make it a potentially transformative force for financial market infrastructure (FMI):
1. Enhanced Efficiency and Speed:
- Streamlined Processes: Blockchain can automate many manual, paper-based processes involved in traditional FMI, such as clearing, settlement, and reconciliation. Smart contracts can automatically execute transactions when pre-defined conditions are met, reducing delays and the need for intermediaries.
- Faster Settlement: Traditional settlement processes can take days. Blockchain enables near real-time or T+1 settlement, freeing up capital faster and reducing counterparty risk.
- Reduced Reconciliation: The distributed and shared nature of the blockchain ledger means all participants have a synchronized view of transactions, significantly reducing the need for costly and time-consuming reconciliation processes between multiple parties.
2. Cost Reduction:
- Lower Operational Costs: Automation, reduced manual work, and decreased reconciliation efforts translate to lower operational costs for FMI participants.
- Reduced Transaction Costs: Faster and more efficient processes can lead to lower transaction fees for end-users.
- Disintermediation: By enabling direct peer-to-peer transactions and automating processes, blockchain can reduce the reliance on numerous intermediaries like clearinghouses, custodians, and correspondent banks, each of which charges fees.
3. Increased Trust Security and Transparency:
- Immutable Records: Once a transaction is recorded on the blockchain, it is extremely difficult to alter or delete, creating an auditable and tamper-proof record of all activities. This enhances trust and reduces the potential for fraud.
- Greater Transparency: All authorized network participants can view the same transaction data, increasing transparency and reducing information asymmetry. This can improve market oversight and reduce the potential for manipulation.
- Improved Traceability: Blockchain creates a clear audit trail, documenting the provenance of assets and transactions at every step. This is particularly valuable for regulatory compliance and identifying the source of issues.
4. Reduced Counterparty Risk:
- Atomic Settlements: Smart contracts can facilitate "atomic" settlements, where the transfer of one asset automatically triggers the transfer of a related asset, eliminating the risk that one party fulfills their obligation while the other does not.
- Real-time Visibility: The shared ledger provides a real-time view of positions and transactions, allowing participants to better manage their exposure to counterparties.
5. Innovation and New Services:
- Tokenization of Assets: Blockchain enables the representation of traditional financial assets (like stocks, bonds, and real estate) as digital tokens. This can fractionalize ownership, increase liquidity, and make assets more accessible to a wider range of investors.
- Programmable Assets: Smart contracts can embed rules and conditions directly into digital assets, automating corporate actions like dividend payments or interest distribution.19
- New Marketplaces: Tokenization of new digital assets via Non Fungible Token (NFT) marketplaces such as OpenSea.
- Improved Digital Identity Management: Blockchain can provide a more secure and efficient way to manage digital identities for KYC/AML (Know Your Customer/Anti-Money Laundering) processes, reducing duplication and improving compliance.20
However, it's important to note that the widespread adoption of blockchain in FMI also faces challenges:
- Scalability: Some blockchain networks, such as Bitcoin and Ethereum, may face limitations in the number of transactions they can process per second due to Proof of Work (PoW) consensus. Other forms of consensus (Proof of Stake) are being explored and adopted to lower energy consumption and increase transaction throughput.
- Interoperability: Different blockchain platforms may not be easily compatible, potentially creating silos.
- Regulatory Uncertainty: The legal and regulatory frameworks for blockchain in finance are still evolving, such as the SEC and how politics can sway it.
- Legacy Infrastructure Integration: Integrating blockchain with existing, complex legacy systems can be challenging.
- Data Privacy Concerns: While blockchain offers transparency, ensuring the privacy of sensitive data requires careful design and implementation.
- Governance: Establishing clear governance structures for blockchain networks involving multiple participants is crucial.
Despite these challenges, the potential benefits of blockchain for enhancing the efficiency, security, transparency, and resilience of financial market infrastructure are significant and continue to drive innovation and exploration in the financial industry.24
Conclusion : Blockchain is transforming the infrastructure for financial market because it provides several key ingredients : a single TRUSTED source of truth, the intelligence of smart contract, and auditability. That’s the power of blockchain - providing multiple transformative value in one technology adoption. The repurchase (repo) market is only the start. Any intra and inter enterprise transactions systems that passes through multiple siloes before completing a transaction process is now ripe to be done in a fraction of the time – thanks to blockchain.
