Blockchain Short Story 001: Flattening the Hierarchy

The payment and securities settlement infrastructure in the finance industry is a hierarchical, fragmented, and relay-based network. For transferring digital values, customers depend on banks and custodians as intermediaries. However, just as their customers, these institutions have the analogous dependencies on other intermediaries like for instance central securities depositories (CSDs), global custodians, central counterparties (CCPs), exchanges, clearing houses, triparty agents, etc.

The rise of blockchain and distributed ledger technology (DLT) has triggered a disintermediation process. This technology allows the participants to transact directly without having to rely on a trusted third party anymore. The role of the trusted third party is being shifted from a legal entity to a decentralized peer-to-peer network. However, in the same way, also the responsibility is shifted from the trusted third party to the participant itself. That means that the absolute decentralization also inevitably implies the absolute responsibility. So being a direct participant in a decentralized network has two sides. The one side is the independence, and the other side is the responsibility for operating the nodes and managing the accounts (wallets).

For most individual participants and smaller institutions it will be too costly and/or risky to manage these responsibilities on their own, so they still will want to use central services offered on a decentralized network. However, for larger participants, like for instance custodian and commercial banks, blockchain/DLT is a historical opportunity to reduce the dependency on their intermediaries, which directly translates to complexity and costs reduction. However, to fully leverage this opportunity, the participants, which might be competitors at the same time, have to closely collaborate to setup a network, define standards and a scalable governance model.