Blockchain Semantics Insights
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Applications of Blockchain in trade settlementJan. 23, 2018, 5:50 a.m. GMT
Most of the previous decade in the capital markets space has been spent on optimizing the efficiency and speed of the pre-trade processing. Pretty much all of today’s stock exchanges are extremely efficient centralized electronic marketplaces running fully computerized order-matching engines, with the ability to receive and process tens of thousands of buy/sell orders per second. As a result, they generate hundreds of millions of trades per day. The underlying order processing latencies are already measured in nanoseconds. Highly computerized algorithmic trading was the main driver for this type of technological innovation.
Despite the fact that buy and sell orders can be rapidly processed, booked and matched on a stock exchange, the actual clearing and settlement—including delivery of the underlying security asset (to the buyer) and actual payment (to the seller)—are still measured in days. The current post-trade processes are perceived as highly complex, slow, expensive and inefficient—and as such, in dire need of optimization and streamlining that is ripe for technology disruption.
There are many ways in which Distributed Ledger Technology could be harnessed to deliver measurable improvements to securities settlement processes. In fact, Using a Blockchain for clearing and settlement of securities – potentially cutting waiting times from days to minutes – is one of the hottest use-cases for the technology.
In the Blockchain model, the record of each security would be held on a Blockchain asset ledger, which records the ownership details and transaction history of each security. Separately, a Blockchain cash ledger records the cash (or cash equivalent) balance available for settlement purposes to each investor. When Investor A and Investor B enter into a trade, they should (in a utopian world) both prove to each other, via the relevant ledgers, that each has the means to complete the transaction.
The two parties will then execute the transaction which could if signed with their respective private keys, also provide all the information needed for settlement. The signed transaction is broadcast to all nodes of the two distributed ledgers to be verified, and a new block recording the transfer of ownership will then be added to all copies of the asset ledger and the cash ledger in line with the consensus mechanism. This would complete the transaction. Participants in the settlement system can compile individual securities account balances by aggregating the transactions recorded in the Blockchain associated with their identity on the network. Individual securities accounts could be updated whenever there is a validation of the network.
Smart contracts could also be used to provide automatic updates to securities accounts, for example by automatically crediting dividends or adjusting margins, on the occurrence of pre-programmed events. In this model, the need remains for coordinated oversight of asset issuances and ensuring an orderly functioning of the market. The ledger may become the primary destination of asset issuances, although we might expect traditional Central Securities Depositories to play the role of operational governance, responsible for coordinating the evolution of the ledger protocols, managing the introduction or cancellation of tokens on the ledger, regulator interface, and so on.