Blockchain – a buzzword in the tech industry - has been accepted as a disruptive technology that is past the initial hype and is now being considered a reality. According to experts, enterprises are now moving blockchain projects into production at a faster pace. Although several organizations have started adopting blockchain in real-time and as part of Proof of Concept, many firms still prefer a reality check on its implementation and benefits.
However, despite the potential offered by the technology it has yet to take off in a big way. While blockchain can be adopted in various industries it’s capabilities as a disruptive technology are also being deliberated for capital markets firms and their business operations. Here, we attempt to lay out some perspectives around the use of blockchain in capital markets and offer a view on where we are headed with the adoption of the technology.
Blockchain Adoption: Slow but Steady
Financial services are set to reap the greatest benefits of blockchain in areas such as digital currencies (Bitcoin), digital assets, capital markets, KYC/AML. Additionally, blockchain adoption has increased due to growing preference for digital technologies.
The technology is also being recognized by various regulators in the capital markets industry. As recently as September 2020, the European commission adopted a digital finance package, including legislative proposals on crypto assets. Similarly, the SEC has recognized the importance of Digital Assets and has published guidelines and frameworks for the same. However, it still begs the question why hasn’t blockchain taken off in a big way? We feel, the lack of industry-wide adoption and subsequent demonstration of tangible benefits of the technology, has meant the larger impact of blockchain on entities has not been understood so far. In addition, there is need to understand the impact of blockchain pertaining to processes and operating models of key entities. While the understanding is evolving rapidly the adoption so far has been gradual.
Although several leading capital market firms have initiated pilot projects for blockchain, and a few have even adopted the technology on a limited scale, large scale implementation is still awaited.
Blockchain in Capital Markets: Who Can Say Where the Road Goes …
We have now reached a phase where we can widely start exploring the impact and benefits of the technology. This is reflected in a few examples of blockchain adoption including Nasdaq’s Marketplace Services Platform that facilitates the exchange of digital assets, and fintech company Paxos Settlement Service, that facilitates settlement with delivery-versus-payment settlement finality using a private, permission-based blockchain network.
Going forward, we see blockchain adoption in the following key entities in capital markets:
Custodians: The concept of distributed ledger can be leveraged by custodians to automate many post-trade processes such as reconciliation, asset servicing, settlement, account maintenance, and reference data. Blockchain will result in disintermediated peer-to-peer processing resulting in operating efficiency.
Market Infrastructure Firms:
Stock Exchanges: Blockchain can improve the operational efficiency of various processes like trade matching, accelerated settlement, quicker KYC. Blockchain can also create new primary and secondary markets for digital assets.
Depositories: The technology considerably reduces counterparty risks and increases settlement efficiency through delivery versus payment (DVP) settlement and central bank digital currency. Many asset servicing processes like corporate actions can be faster due to smart contracts and reduced reconciliation.
Transfer Agent: Blockchain has the potential to replace a conventional transfer agent with a digital transfer agent. The process of transferring ownership of a security in issuer records could be confirmed and transacted digitally, while still maintaining end-to-end compliance and guaranteeing user security.
Broker Dealers: Will be able to leverage blockchain to bring more efficiency into the existing processes such as client onboarding, AML compliance, reconciliation, settlement. Additionally, blockchain has created opportunities for new instruments like digital assets. It can bring down the cost of operations through reduced reconciliation.
Mutual Funds: Blockchain will have a great impact on client onboarding, reports for customers and regulatory reporting. Mutual fund industry depends on many intermediaries such as transfer agents, registrars and fund administrators and the technology has the potential to disintermediate through a new model for fund subscription/redemption without the need for any intermediary.
Wealth Management: Blockchain brings relevance to wealth management across processes such as KYC, settlement, digital assets. Blockchain brings benefits through faster and cheaper KYC with reduced settlement cycles. Wealth management will gain from advantages of digital assets like faster liquidity, accessibly of assets to larger customer, improved operational efficiency.
While blockchain adoption depends on the viability of business use cases, the technology is evolving with respect to scalability and security and blockchain awareness among regulators is also on the rise. There is need for partnership and thought leadership collaboration among different entities to gain industry-wide benefits. However, for wide-spread adoption, this technology must also clear regulatory benchmarks.