Case 66: Blockchain Can Improve Capital Markets

When trading on the capital market, there exist a set of procedural steps that enable the trading of assets in a legally conforming fashion, as well as a number of custodian services revolving around facilitating the trade. A broad definition of these steps can be termed as such:
1. Create a representation of an asset, such as a
currency, bonds, stocks, gold, etc.
2. Enable a trade to take place between two or more
3. Balances must be recorded and kept.
4. The eventual liquidation of an investor’s position.

This process is made considerably more complex due to coordination between multiple necessary stakeholders. Typical examples of such stakeholders would be:

  • Securities custodian: Licensed to create a certain asset
  • Currencies custodian: Guarantees that the asset is backed by a currency, so that the asset can be eventually liquidated.
  • Investor: The buyer of the asset
  • Originators: The seller of the asset, though can often be a bank acting as an intermediaryDue to the increasing amount of stakeholders and intermediaries over time, the trade process has become overly complex, prone to error, and expensive. This is
    underpinned by a wide variety of inefficient legacy IT infrastructure which are not interoperable.

By adopting a shared distributed ledger platform, stakeholders could be eliminating the need for replication and duplication of the same data. As a consequence there will reduced error rates, increased speed, and cut cost associated with reconciliation and management of data. If you can speed up the process of which assets change hands, capital requirements drop because there is a resulting lower rate of operational risk and counterparty risk. As an added bonus, these environments are cryptographically secured, and since they are distributed they are less vulnerable to single-point-of-error due or operational failure due to cyber attacks.

Moving away from the more general benefits, we can also observe the advantages achieved in each of the trade process steps:

  • Asset creation – Any type of asset can be created on the network if the trading partners are in agreement.
  • Trading – Assets can be traded on the network with a minimal transaction fee in atomic transactions (either fully executed, or not at all)
  • Balance – Balances are recorded on an shared replicated ledger where each position are constantly netted.
  • Settlement – The network can also host the currency assets that back the tradable assets. Securities trading is a massive market worldwide, with plenty of stakeholders set to either gain a lot from blockchain technology, or be disintermediated by it. Both in pre and post trade processes there are several companies vying to develop and deliver the blockchain software that will run the future financial market. This paper will look at two of them, one created by NASDAQ partnered with blockchain startup Chain, and the other delivered by Digital Asset Holdings.


Case Study: NASDAQ & Chain

NASDAQ will leverage the Open Assets Protocol, a coloured coin innovation built by blockchain startup Chain. In its first application expected late 2015, they will launch a blockchain-enabled distributed ledger that will be used to expand and enhance the equity
management capabilities offered by its Private Market platform. NASDAQ’s claims that their blockchain solution will offer efficient, fully-electronic services that facilitate the issuance, transfer, and management of private company securities.

For their first use-case, they decided to use the Bitcoin Block chain to issue shares in the form of coloured coins. These coins are essentially a micro transaction (a hundred-millionth of a bitcoin), on which would be coded metadata stating how many shares of the company are being transferred along with it. If some of the shareholders later wanted to sell all or part of those shares to an investor, a currency custodian could be tasked to hold the shares of all wanting to sell. The shareholders would then transfer their shares to that
currency custodian’s wallet, and investors could buy those shares. Each transaction would only move a tiny fraction of bitcoin encoded with the number of shares, not an amount in bitcoin equal to the value of the shares themselves.

This is currently a pilot project, but if it goes well, the system could be rolled out to more private companies in Nasdaq Private Market and even the public exchange in the near future. Although the current pilot is run on a public ledger solution, i.e. the Bitcoin Block Chain, they are also developing a private ledger solution named Linq.

Case Study: Digital Asset Holdings

The Depository Trust & Clearing Corporation (DTCC) is one of the biggest post-trade financial service firm, with an annual handling of more than $1.6 quadrillion in transactions. This is an example of an incumbent being in danger of disruption, due to its position as third party and facilitator in a securities transaction. Former JPMorgan top exec Blythe Masters, now the CEO of Digital Asset Holdings, said in a recent panel debating the current pain points of post-trade processes: “We’re spending a lot on keeping everything in synch, instead of having one truth and agreeing on it. We incessantly send it off to each other and attempt to reconcile, and go through expensive post-trade processes to remedy errors, fails, and inconsistencies. Distributed ledger technology could solve these points of pain”.

She followed up with an interview with Bloomberg where she claimed that the blockchain threatens to disintermediate almost every process in financial services, and that her company, Digital Asset Holdings are out to fundamentally overhaul how the back end processes involved in the post-trade effort are carried out.

Digital Asset Holdings recently acquired three different startups called HyperLedger, Bits of Proof, and Between them, the capabilities offered by Digital Asset’s acquisitions have the potential to address perceived performance, scalability and integrity challenges that exist in Bitcoin’s Block Chain, and also make integration of existing financial markets back-office systems into the digital ledger world a more straightforward exercise.

Little is yet known about their blockchain platform, but indications are that they are building a significantly different solution to some of the current approaches. Unlike similar distributed ledgers, their Hyperledger has no native cryptocurrency and a quite strict permissioned protocol.

Incumbents participating in solutions