The blockchain concept, most known for being the technology underpinning Bitcoin, has generated a huge amount of interest within capital markets. Blockchain (or distributed ledgers) offers a new approach to data management and sharing that is being proposed as a solution to many of the inefficiencies afflicting the industry. The prize on offer is a new architecture, where all capital market participants work from common datasets, in near real-time, and where supporting operations are either streamlined or made redundant.
What is blockchain/distributed ledger technology?
Put simply, blockchain technology is a method of recording and confirming transactions where instead of a centralised platform, participants each hold a complete record of transactions through peer to peer verification of transactions.
This means there is no central recording system, rather each participant keeps a record of all transactions ever made.
This is the same system which allows bitcoin to operate with no central body.
Integrating blockchain technology in share market trading.
Instead of the clearing house settling trades, trades will be settled by participants confirming transactions through the peer to peer network. The network (likely made up of brokers) records the buyer and selling participants, the number of shares traded, price of shares, time of exchange and the exchange of funds.
- Blockchain has great potential to cut inefficiencies in the share settlement function. As trades are settled by peer confirmation, there is no need for a clearing house, auditors to verify trades or custodians to ensure a fund has the shares they say they hold. Essentially, this is cutting out the middleman in the back office which means less cost in record keeping and in turn less costs to trading on the stock markets.
- The peer confirmation of trades also means settlement can be almost instantaneous. Compare this to the current settlement period of three working days (‘T+3’) normally on stock exchanges as the market needs to make sure the participants have the money and shares on hand to exchange. This would make shares a far more liquid investment – almost as good as having cash on hand.
- Higher liquidity means more investment into shares – As all participants have the full record of transactions and therefore holdings of investors there is complete transparency in the equity market. This makes it almost impossible to falsify transactions or to alter prior transactions. If a false trade occurs, participants will find inconsistencies in their full ledger and reject the trade. For example, an investor would be unable to sell stock that they did not own as all participants would know exactly how much stock the investor owns now.
- Transparent real-time data would create major operational benefits for users. It could remove the need for data enrichment (such as aligning trade data with settlement data), reconciliations and disputes amongst counterparties. Participants could selectively reveal trusted data to another counterparty ahead of trade time to provide greater certainty of their own worthiness, thereby reducing risk and/or credit exposures.
- More efficient settlement of transactions and processing would occur as everyone sees the same data, and updates are quickly circulated across the market. Cash transactions could settle in (near) real-time since the trade is complete when the next update to the blockchain is agreed, embedding the transfer of ownership of an asset or other agreement. This would remove the need for post-trade affirmation or confirmation and central clearing during the settlement cycle
- Distributed records are stored locally by participants as their golden source of information. Many of their existing systems that are currently used to track and maintain their records of holdings and transactions could be retired. The need to interrogate centralised databases or send messages to other participants to ensure data alignment is removed.
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