How blockchain will change the way you trade in stock markets
With stock markets across the globe increasingly embracing blockchain’s native capabilities as the basis for market transactions, the Securities and Exchange Board of India () is exploring how technology can be used in the Indian stock market.
Recently, Sebi appointed an advisory committee, called Committee on Financial and Regulatory Technologies (CFRT), for conducting research on the blockchain platform and other technologies that have been making waves in the sphere of fundraising, asset management and post-trade settlement.
Blockchain offers huge potential for tracing securities lending, repo and margin financing and monitoring systemic risk.
Sebi is taking early steps to understand how the technology is being used in markets globally and can possibly derive the benefits gradually. Many market regulators and global exchanges across geographies, including the and Deutsche Borse, have already showed their intent to evaluate the feasibility and advantages of blockchain.
Japan’s Financial Services Agency has allowed the Japan Exchange Group, which operates the Tokyo Stock Exchange, to use blockchain as its core trading infrastructure. In 2015, Nasdaq unveiled the use of its Nasdaq Linq blockchain ledger technology to successfully complete and record private securities transactions.
What does blockchain bring to stock market?
Blockchain can be the answer to interoperability, trust and transparency issues in fragmented market systems.
Stock market participants such as traders, brokers, regulators and stock exchange are required to go through a cumbersome process (which takes 3+ days to complete transactions, mainly due to the role of intermediaries, operational trade clearance and regulatory processes).
Blockchain can make stock exchanges much more optimal through automation and decentralisation. It can help reduce huge costs levied on customers in terms of commission while speeding up the process for fast transaction settlements.
The technology can have viable use in clearing and settlement, while securely automating the post-trade process, easing paperwork of trade and legal ownership transfer of the security.
Blockchain can eliminate the need of third party regulator to a large extent, since the rules and regulations would be in-built within smart contracts and enforced with each trade in order to register transactions with the blockchain network acting as a regulator for all transactions.
Automation of post-trade events
Applying blockchain and smart contracts to post-trade activities can eliminate the need for intermediaries, reduce counter-parties and operational risk, while providing the infrastructure for faster trade settlement.
Financial institutions can settle securities in minutes instead of days, with the major benefits being
streamlined real-time settlement, improved , supply chain optimisation and increased transparency.
Blockchain can offer a solution to the post-trade events processing to maintain a single source of truth jointly owned by all participants in the system.
Mechanism for fairness and transparency
If implemented, blockchain can act as an online automated surveillance system for each transaction. A blockchain-based exchange can have inbuilt characteristics to track, block and report illegitimate attempt made by anyone on the network, and can provide a robust platform to implement the security policy and standards.
Since the blockchain ledger is designed in such a way that all participants have full record of
transactions and, therefore, holdings of investors, it can bring in complete transparency and trust in the market.
Lower transaction costs
Blockchain transactions are faster, as trade confirmations are done through smart contracts by peers instead of any intermediary. As the intermediaries in the system get minimised, costs associated with them, like trades record keeping, audits and trade verifications also get eliminated or reduced.
Mechanism for risk containment
Through blockchain technology, margining system and payment of margin can be done instantly and the frequency of valuation of securities deposited as capital can be done daily compared with the weekly process prevalent now, minimising the risk.
Blockchain can reduce the inefficiencies through automation, which also leads to reduction in cost and thus lowering entry barriers resulting into increased market base. For people, who could not access the markets due to cost barriers will be able to participate, ultimately increasing liquidity and investment.
There are challenges, too
It is potentially attractive to regulators due to increased transaction security and reduced risk of manipulation, but this new technology can also give rise to difficult legal and regulatory challenges that regulators are grappling to understand.
The financial market ecosystem is currently uncertain about the extent to which blockchain, particularly as applied to capital markets, will live up to its promise.
The implementation of blockchain also brings along the risks of maintaining security standards across a decentralised database, legal and regulations and concerns around . Blockchain looks to combine elements of trading, clearing and settlement but current legal and regulations ascribe them separately.
The road ahead
While the market monitors potential regulatory developments, effective governance is the key to the successful implementation of blockchain to protect participants, investors and stakeholders while ensuring that the system is resilient in the face of systemic risk, privacy concerns and cybersecurity threats.
Blockchain has the potential to disrupt the financial services, particularly in automating market surveillance events processing and in automating post-trade events processing.
The technology promises to address problems such as loss of data, data fragmentation, insider trading, review of margin system, reconciliation and ticket matching.
However, the full potential value from restricted mutual distributed ledgers and smart contracts will require widespread changes in business processes and investments from firms, virtually from buy-side and sell-side of the industry.
Regulators will also have to play an active role by adopting shared data arrangement for regulatory reporting.
( The author is Director, Technology at Sapient Consulting. Views are his own and do not represent those of ETMarkets.com)
This content was originally published here.