What are Incumbent Market Infrastructures Learning from Cryptocurrencies?
What are the main takeaways?
• Cryptocurrencies are new and scary but they are an unprecedented innovation in the history of market infrastructure.
• Most cryptocurrency assets themselves thus far have underdelivered on the potential of blockchain technology, but many existing financial market infrastructures are beginning to use the breakthroughs of blockchain technology for more useful means.
• The right blockchain technologies for digital assets are the platforms that capture the unique innovations of cryptocurrencies, but still address the functional and non-functional requirements of the existing financial world.
• The DTCC, SIX, and the Deutsche Börse/HQLA-x initiatives are all trailblazing efforts.
Cryptocurrencies vs Existing Market Infrastructures
Cryptocurrencies have often been met with skepticism. Some skepticism is certainly deserved. However, one thing is undeniable; the technology is unprecedented and a breakthrough in the history of market infrastructure. This technology introduces several inherent advantages over assets that are issued, traded, and custodied through incumbent market infrastructures:
1. Global Access
2. Shortened Settlement Lifecycle
3. Operational Resilience
Cryptocurrencies are Underdelivering: Will Existing Market Players Step up?
Despite their novel technological features, thus far, cryptocurrency assets themselves have underdelivered on their potential. Out of the over 2,200 cryptocurrencies, many today are just a speculative digital asset, with little real-world application or use.
Fortunately, existing market infrastructures are beginning to apply the breakthroughs of blockchain technology for more useful means. These existing market players are better positioned to leverage blockchain technologies with digital assets because they have existing customer bases within the broader financial market community, understand consumer protection, and are familiar with regulatory compliance.
Further, the market is beginning to consolidate around the right blockchain technologies for digital asset issuance. The right technologies are the platforms that capture the unique innovations of cryptocurrencies, but still address the requirements of the existing financial world, such as performance, availability, recovery, security, and privacy. These financial market requirements have evolved over hundreds of years of market activity.
For example, scalability is an important requirement with market infrastructures today. Technologies such as Corda, when tested by the DTCC, performed “at levels necessary to process an entire trading day’s volume at peak rates, which equates to 115,000,000 daily trades, or 6,300 trades per second for five continuous hours.” Meanwhile, a cryptocurrency like Ethereum, by comparison, is currently limited to around 15 transactions per second, which is orders of magnitude below what is required within wholesale capital markets.
Exchanges are now running Corda nodes to hold tokens recorded on Corda in the same way as in the past they have run Bitcoin nodes to hold BTC and or Ethereum nodes to hold ETH/ERC20s. Much like ERC20, the Corda Token SDK provides a standard that makes assets easy to create, list, trade and settle but where nodes only store and hear about transactions that they are involved in. With Corda, there are no risks of 51% attacks and other novel risks introduced due to a lack of settlement finality. Additionally, you avoid other architectural complexities that come from modifying cryptocurrency-based architectures to meet the requirements for regulated financial markets. Corda avoids these issues because it was built from the ground-up alongside the technical teams from 40+ of the largest financial institutions in the world.
Both Incumbents and New Entrants Are Building
As the blockchain-based financial markets have matured, we are in new wave of issuance, trading, and custody led by several incumbents and upstarts alike. The wide range of applications and companies building CorDapps contribute to the breadth of the digital asset ecosystem.
For example, SIX, Switzerland’s national stock exchange, is launching the Swiss Digital Exchange (SDX), a next-generation marketplace for digital assets. Perhaps what is most notable about this initiative is its global ambition — it aims to provide globally accessible assets, unlike traditional national or regional stock exchanges. Further, initiatives like BlockState even allow existing cryptocurrency-based assets to be more accessible to institutional investors by “passporting” those assets into SDX.
The Deutsche Börse & HQLA-x collaboration also demonstrates how market infrastructures and start-ups are collaborating. HQLA-x addresses current intraday risks that banks, regulators, and major market participants face when using existing settlement infrastructures in the high-quality liquid assets (HQLA) market. The solution helps market participants better manage excess and trapped liquidity by enabling baskets of securities to be instantaneously exchanged through atomic delivery-versus-delivery transactions.
Additionally, there are also many new start-ups such as Wethaq (see recent paper here) aiming to improve the end-to-end asset management lifecycle in place today, through faster deal execution, settlement, lifecycle events (such as interest payments) automated regulatory compliance and fewer disputes and intermediaries.
Fearing the Millennial’s Changing Preferences
Now that millennials have experimented with cryptocurrencies, for many, there’s no going back. The demands and preferences of investors are changing, particularly among younger investors. Investors want to access global assets, settle quickly, would like increased liquidity and trading hours, experience streamlined end-to-end asset lifecycles, and have the latest technologymbehind their assets. Additionally, many still also prefer the old world’s consumer protections, regulatory credibility and financial market know-how.
Each new enterprise blockchain initiative using an appropriate technology is another step towards meeting customer evolving demands. In particular, existing market infrastructures are beginning to create new revenue streams for themselves by entering new markets. The real opportunities now lie in the way tokenised assets can further widen pools of investors, expand the range of assets available to investors, and create new liquidity in regulated securities and other types of real-world assets. It is time for modern digital asset infrastructures, and cryptocurrencies have shown the way.
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