Blockchain: How It’s Changing Capital Markets

The extraordinary rally by major crypto assets in 2017 drew global attention to the blockchain technology that supports these assets. While blockchain is most commonly associated with cryptocurrencies, its potential applications go far beyond.

CapBridge recently announced a strategic partnership with ConsenSys, founded by Joseph Lubin (more popularly known as the co-founder of cryptocurrency platform Ethereum). Together, we will explore ways to deploy blockchain technology for 1X, our private exchange. In light of this announcement, we would like to share more about the potential use of blockchain in the capital markets, as well as current industry use cases.

What is blockchain technology?
Invented in 2009 by Satoshi Nakomoto, whose identity is still unknown, blockchain was originally designed as a secure and efficient method of transferring bitcoins between two parties while eliminating the need for a third party.

Fundamentally, it is a distributed database that maintains a continuously growing list of ordered records, or “blocks”. Each new block undergoes validation prior to being added and bears a direct relationship to the previous block in the chain. This update is then shared with all participants of the network.

Blockchain is especially useful for financial processes as transaction logs cannot be tampered with, which means greater security and transparency of capital flows. It also has the potential to reduce the need for manual reconciliation, lower costs, and improve process efficiency.

Smart contracts
On more advanced blockchain systems such as Ethereum, users are able to deploy “Smart Contracts” – essentially little computer programs that follow pre-defined rules based on business logic. “Smart Contracts” enable conventional business processes to become automated, scalable and highly compliant.

For example, traditional issuance of share dividends is highly manual. Trusted professionals are required to verify, administer and validate share transfers over complex legal documentations. These can be programmed within Smart Contracts, allowing share dividends to be distributed over the blockchain network to authenticated parties.

Ethereum is by far the most established smart contract blockchain platform, with a market capitalization of over USD 40 Bn and hundreds of projects already on its network.

Blockchain in the capital markets
The Capital Markets is one industry where experts have predicted that blockchain technology will have a major impact. Several stock exchanges are exploring and implementing blockchain technology with Smart Contracts to streamline existing processes. Notable examples include:

• Australian Stock Exchange (ASX) – ASX represents the first major exchange to move on the blockchain, with plans to use blockchain to replace its registry, settlement and clearing system by 2020. ASX has partnered with U.S.-based Digital Asset Holdings, LLC as the implementation partner. We expect lower costs, reduced back-office processes, increased automation of corporate actions and shorter settlement times.
• NASDAQ – NASDAQ is one of earliest adopters of blockchain technology. Since 2015 NASDAQ has used blockchain for the secure issuance and transfer of shares of private-held companies on its secondary market platform, the NASDAQ Private Market. They also have a partnership with Citi for an integrated payment solution to trade securities internationally. Other highlights include their work on moving shareholder voting, new share issuances and board elections on the blockchain, as well as exploring the application of blockchain for mutual funds.

Other exchanges have experimented with blockchain within a smaller scope. Japan Exchange Group (JPX) has teamed up with IBM to test the potential of blockchain technology for use in trading in low transaction markets, whereas the Korea Exchange has used blockchain to enable the trading of equity shares of startup companies on its Korea Startup Market.

Why is blockchain technology useful for stock exchanges?
Current key processes such as pre-trade, trading, settlement, custody and security servicing are highly regulated and complex activities.

Multiple parties including brokers, custodians, exchange and depositories, are involved in each trade. Each party typically maintains their own records of asset transfers, ownership and cash balances. They are supported by armies of back-office staff, who confirm every trade for manual reconciliation and compliance purposes.

This results in duplication of effort, higher operational overheads, longer settlement times and counterparty risks –  ultimately creating friction in the transfer of assets. As such, exchanges typically develop into “walled gardens”, where investors trade within separate liquidity pools, due to the lack of a common regulatory and transaction standard.

Enter the blockchain. A highly secure and transparent database can be made accessible to all participants, allowing investors to take direct custody of their assets. This reduces the need to rely on intermediaries, reduces collateral and removes any risk of non-delivery.

Further, Smart Contracts can be tailored to ensure that all trades follow pre-defined rules, enforcing compliance and reducing settlement risks. Lastly, a common standard enables the creation of a global marketplace – – allowing investors anywhere in the world to easily conduct cross-border trades of any asset at scale.

Blockchain technology is changing the world of finance, addressing systemic inefficiencies and reducing costs and friction while opening up new opportunities. In our global financial system that moves trillions of dollars a day and serves billions of people,  blockchain is a real game changer. We at 1exchange are excited to be a part of this change.

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