Will blockchain transform the stock market?

Blockchain can make it easier to transfer property rights and other assets by reducing transactional costs and boosting trust between investors. But can it be used by the world’s largest stock exchanges?

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Norbert Biedrzycki blog blockchain stock market

The rules that govern trades in financial assets have changed little over the past two or three centuries. Some say those rules have worked relatively well (apart from a few world-shattering crashes now and then). Does it need to change? Should it change? Can it change? 

I believe it needs to, should, and can. What can we do to convince boards, investors, sellers, buyers, intermediaries and supervisory bodies to adopt new solutions? Assuming change is feasible, will blockchain be a major step toward doing away with traditional stock exchanges?

That not-so-good old-timey exchange

Today’s investor relies on a traditional system of buying, selling and accounting for transactions that’s old enough to be called ossified. The system generates considerable costs and adds to the time needed to close transactions. This is because trading in financial assets requires multiple entities arranged in a complex web of intermediaries, settlement systems and business partners. Whether they are investors, brokers, depositaries, stock exchange management or central supervisory bodies, all actors taking part in asset trading – buying, selling, or transferring – are obliged to generate messages, receive authorizations, and continuously update transaction status records. 

Blockchain can change all this. Key transaction-related processes such as issuing securities, trading, clearing and settlements could be handled swiftly and without much friction with the use of blockchain’s distributed ledger.

And then came the crash

There is another factor to consider: trust, the willingness of investors to believe and have faith in the general rules underpinning the stock exchange system.

The fiscal crisis of 2008, triggered (in part) by the proliferation of opaque financial instruments, called into question the transparency of the existing global model. The crash we experienced a decade ago laid bare the need to search for alternative solutions that would help build a more transparent, tamper-proof system. What emerged in the wake of the crash were new government regulations that today, in the U.S., are being rolled back.

Blockchain cannot be rolled back.

Given its properties, I think that blockchain would give us hope for a stock exchange of the future. In a blockchain-based exchange, murky transactions would become a thing of the past. Smart contracts could dispel doubts as to whether settlements have been made correctly. Supervisory mechanisms – today indispensable, albeit inefficient – would no longer be needed.

Trust would be a given.

Will blockchain trigger a shakedown of the global financial system Norbert Biedrzycki

Blockchain hits the largest trading floors

The investment market is on the cutting edge of early blockchain deployments.

For instance, Nasdaq management has been looking at blockchain for three years. As early as May 2015, the private share-trading platform, Linq, was launched to enable unlisted companies to represent their shares digitally. Last year, Nasdaq Stockholm and the Swedish bank SEB started testing the use of blockchain to register all transactions in real time. Blockchain-based solutions have undergone rigorous testing on the Nasdaq Tallinn exchange. The premise of the project is that corporate shareholders would be able to vote during investor meetings or digitally transfer their voting rights to a proxy. 

The London Stock Exchange Group, in cooperation with IBM, has begun testing a blockchain-based platform to fully digitalize trades in the shares of small and medium-sized enterprises. The tests are being carried out by the Italian operator of LSEG, Borsa Italiana. And the Australian Securities Exchange plans to finish its two-year-long process this year to develop a system that will increase operations transparency and enhance investor security.

One remarkable example of how blockchain can become a fact of life is the “Delaware Initiative.” In 2017, Delaware, known for its high concentration of listed companies (and business-friendly regulations and taxes), legally recognized blockchain as an official settlement system. State authorities are now setting up a system that will allow businesses to generate and store any company-related data. People who lobbied for blockchain in Delaware noted the complex nature of the securities market. They were particularly concerned about the challenge of tracking share ownership. The project’s promoters said that blockchain is a good solution that will make it possible to more easily verify share ownership and considerably reduce transaction times.

This is neither fantasy nor hype. This is happening now.

How the blockchain future will flower

Financial institutions must, above all, be certain that their customers’ money is secure. It is therefore unsurprising that even given the examples related, capital markets are still slow to embrace blockchain. To see genuine progress, certain conditions must be met, primary among them the establishment of the most stringent security standards for the block system. Blockchain implementations require proper laws. Unfortunately, right now, the legislative environment everywhere is somewhat polarized and inconsistent. 

We must also bear in mind that the technology continues to be limited. Work is underway to boost its capacity and reduce transaction costs. On the New York Stock Exchange, there are around three billion trades on a normal day. The development of new platforms to handle such volume is likely to prove complicated and time consuming. And that translates into costs. 

Nevertheless, I believe that financial markets will see the most important implementations of blockchain. They will become the training ground for other sectors. 

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Works cited

New York Time, Alan Rappeport and Emily Flitter, Congress Approves First Big Dodd-Frank Rollbacklink, 2018. 

NASDAQ.com News, Nasdaq and Citi Announce Pioneering Blockchain and Global Banking Integration, link, 2017. 

The Wall Street Journal, Markets Diary: Closing Snapshot, link, 2018. 

Forbes, My Say, Why The Delaware Blockchain Initiative Matters To All Dealmakers, link, 2018. 

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8 comments

  1. JohnE3

    Interesting and thought provoking article – thanks Norbert

  2. Ms404

    Great article! I’m working on a paper about systemic risks of CCP and I am curious about your opinion if there is a solution for such a problem triggered by Einar Aas(Norwegian trader)?Maybe new technologies implemented by CCP could prevent waterfall? Can distributed ledger technology minimize the risk caused by lack of information? Is it all about lack of transparency or just bad luck? I need help to investigate the core problem of CCP and how to prevent it. I would appreciate any information, I am still learning and I see you understand AI and DLT and I was wondering if they might help improve efficiency of CCPs.

  3. johnbuzz3

    don’t get me wrong. This is very compelling article

  4. johnbuzz3

    Bitcoin had a fair launch. Anyone who knew about Bitcoin and had access to a PC could mine from day 1. Over time, mining became more difficult but people could easily buy BTC on various exchanges or from other people who had Bitcoin. You didn’t have to be a member of a privileged class to get into Bitcoin at the ground floor.
    Ethereum had a fair launch. Unlike Bitcoin, the project was far too ambitious for the people who conceived of it to pay for its development out of pocket. So they held an open crowd funding to pay for development. Anyone who heard about Ethereum could participate in the crowdsale, priced at about 30 cents/ETH. After the chain launched, anyone with a modern graphics card could also mine Ether and put some away.
    Some founders on the team didn’t care for that funding model for Ethereum. They wanted Ethereum to be funded by insiders and VCs and held private for a long time. Some even left the project, or were encouraged to leave, over the difference in vision between an open community non-profit project, and a VC-held and VC-controlled for-profit organization.
    And of course both Bitcoin and Ethereum are open-source projects with licenses that encourage the ability to copy, rework, and reuse the project code.
    These days there are lots of Ethereum “killers”, ETH 2.0 “killers” and ETH competitors launching and planned for launch. For the most part, they do not adhere to the Bitcoin or the Ethereum open participation models. Some are closed-source, copyrighted projects. Almost all were and are funded by VCs and the wealthy via SAFTs, often through secret deals where price and amount of tokens are not disclosed. The public is generally not allowed to participate until the tokens get marked up 5x, 10x or 100x before an exchange listing. So you will end up with the vast majority of tokens owned by a very few, already very wealthy people.
    But a radically unjust token distribution isn’t all that these new “Ethereum Killers” have. No, they also are, almost to the last, designed around plutocratic governance. That is, if you are one of VCs, the insiders and wealthy allowed to buy in early before the marking up to retail, you will have orders of magnitude more tokens and therefore you will have orders of magnitude more control over future changes to blockchain rules than the hoi polloi. Some even see this kind of governance as a feature and a good thing. I disagree emphatically!
    Ethereum was an open, community-supported launch organized by a non-profit entity. It is today an open and community-participatory project. There are no fees to attach your application to Ethereum, other than gas costs. The blockchain is permissionless, no plutocracy can “vote you off the island”. Ethereum is not run by rich VCs and “accredited investors” who got in on the ground floor when you couldn’t.
    I do hope that Ethereum wins out. I think there is an enormous difference between an open community project and almost all of the competitors who launched after. I do not want the future of humanity’s financial internet to be based on plutocratic control by the fabulously wealthy. How would that be one bit better than the existing financial system?
    If making these observations, if hoping that Ethereum becomes the global financial commons, instead of a pluto-chain taking over, makes me a narrow-minded Ethereum maximalist, so be it.

    • Karel Doomm2

      Quntum Intenet in the long term is a fantastic development that reshapes security and encryption. But during early adaption, it may create some imbalance as systems transition from legacy models to QC.

      Your thoughts on mitigating this, please.