Blockchain Disruption in Finance: Securities Trading, Clearing, and Settlement
Over the course of the past two years, the blockchain has moved from being a fintech buzzword to establishing itself as one of the most promising technological innovations of our time that is poised to disrupt a wide range of industries and sectors.
In this article series, titled ‘Blockchain Disruption in Finance’, you will discover how blockchain technology is reshaping the financial services industry. In this first installment of the series, you will be introduced to how the blockchain disruption is challenging the status quo of securities trading, clearing and settlement.
What is the Blockchain?
The blockchain is a decentralized digital ledger that allows users to securely record, store and transfer data in a trustless and immutable manner without the need of an intermediary. Due to its open-source nature, the blockchain can be developed for a range of different purposes such as financial transactions, the creation and storage of digital identities, the recording of land titles, among many more.
Blockchain technology first appeared as the underlying network for the world’s first decentralized digital currency bitcoin, where it enables individuals around the world to store, send and receive digital money without the need of a financial intermediary as the distributed network participants verify and process transactions to keep it up and running.
Securities Trading on the Blockchain
Securities trading is a multi-billion dollar market segment within the financial industry. On the New York Stock Exchange (NYSE) alone, $50 billion dollars worth of stocks is traded on a daily basis.
While this sub-sector of the financial markets has already undergone several waves of technological innovations, such as the move towards electronic trading in the 1990s and Direct Market Access (DMA) and algorithm high-frequency trading in the 2000s, the securities market is not immune from disruption from distributed ledger technology (DLT) in the coming years.
Through the use of blockchain technology, securities transactions can be conducted and recorded in a manner of seconds in a trustless and immutable manner with a clearly visible audit trail for all involved parties, and at a much lower cost than existing systems.
An area where blockchain-based securities trading is taking its first roots is in the private securities market. Leading U.S. technology exchange, Nasdaq, for example, launched the first blockchain-based trading platform for unlisted securities in 2015 called Linq.
In its press release, the company stated: “Nasdaq Linq is a digital ledger technology that leverages a blockchain to facilitate the issuance, cataloging and recording of transfers of shares of privately-held companies on the NASDAQ Private Market. […] Nasdaq Linq clients will be provided with a comprehensive, historical record of issuance and transfer of their securities, offering increased auditability, issuance governance and transfer of ownership capabilities.”
Two months after the launch of Linq, the first-ever securities issuance powered by blockchain technology was conducted on Nasdaq’s new platform when Chain.com documented its issuance of shares to a private investor. “For this transaction, Nasdaq enabled the issuer to digitally represent a record of ownership using Nasdaq Linq, while significantly reducing settlement time and eliminating the need for paper stock certificates”, according to Nasdaq’s press release.
Having said that, blockchain implementation in the securities space goes beyond issuance and trading. The adoption of the blockchain for the clearing and settlement process of financial securities transactions will likely be even more impactful for the industry.
Clearing and Settlement on the Blockchain
Once an investor has bought an exchange-traded security before money actually exchanges hands for the security, the transaction first needs to clear and settle. In the financial markets, clearing refers to the updating of accounts of the involved trading parties and the arranging of the transfer of the securities versus money. Settlement is the final stage of the securities transaction at which point money is exchanged for security ownership. This is a long process that involves several parties and intermediaries. That is why the securities clearing and settlement process is poised to be replaced by blockchain-based solutions.
Using blockchain technology, the updating of accounts of the two trading parties as well as the transfer of funds in exchange for the security could be conducted in a trustless and immutable manner effectively immediately. This would largely alleviate the need for clearing houses, reduce transactional overheads, and increase transaction speeds of securities trades.
The Australian Stock Exchange (ASX) is Spearheading Blockchain-Based Settlements
One of the first stock exchanges to jump on the opportunity to adopt blockchain technology for its post-trade services is the Australian Stock Exchange (ASX). In January 2016, the exchange purchased a stake in the blockchain startup Digital Asset Holdings LLC, which it chose as its partner to develop distributed ledger technology (DLT) solutions for clearing and settling of securities transactions.
In December 2017, the exchange confirmed that it will replace its existing post-trade infrastructure with a blockchain-based system developed by Digital Asset Holdings. The new blockchain-powered platform will be operated by the stock exchange on a secure private network where “permissioned” participants will have access and must comply with ongoing and enforceable obligations. The exchange’s customers will be able to connect with the new post-trade service in a similar way as they do with the addition of ISO 20022 messaging or interact directly with the blockchain. Further testing will still be conducted before the new settlements system will go live.
Dominic Stevens, ASX CEO and Managing Director, said: “We believe that using DLT to replace [the existing system] will enable our customers to develop new services and reduce their costs, and it will put Australia at the forefront of innovation in financial markets.”
Blythe Masters, Digital Asset Founder and CEO, said: “After so much hype surrounding distributed ledger technology, today’s announcement delivers the first meaningful proof that the technology can live up to its potential.”
The financial industry will benefit greatly from the adoption of blockchain technology over the course of the next ten years. Nasdaq’s blockchain-powered exchange for the private market and ASX’s implementation of the blockchain in its post-trade service are small first steps in the direction of a much more technologically-driven financial services industry of the future.
As more and more financial institutions collaborate with blockchain startups to develop new business solutions for the industry, it will likely not be long until we will witness large parts of the financial industry “running on the blockchain”.
Get ready for the next installment in this 5-article series: Blockchain Disruption in Finance: Asset Management.
