By Raghavendra. K.A., Global Head of Engineering, IOT, and Blockchain Practice, Infosys
Packing numerous attributes, such as transparency, traceability, security, immutability, and efficiency, Blockchain or Distributed Ledger Technology (DLT) is transforming capital market operations globally. NASDAQ, London Stock Exchange, Deutsche Borse are among some of the global exchanges experimenting with and implementing DLT for issuance, trading, settlement, and other functions. SIX Digital Exchange is a key Switzerland based financial market infrastructure (FMI) currently operating the entire securities value chain.
DLT benefits not only stock exchanges, but also issuers, fund managers, traders, brokers, regulators, and investors. Key advantages for the securities lifecycle include asset tokenization, accelerated T+0 settlement, cost optimization, and transparency. Asset tokenization increases liquidity and accessibility by fractionalizing asset value, allowing broader investment opportunities beyond private markets and High Net Worth Individuals (HNIs).
For issuers, programmable digital assets built on a DLT foundation enable faster, easier access to capital at lower cost. They can issue new securities, with all the terms, conditions, rights, and obligations programmed within, in minutes. Because digital assets can be fractionalised into smaller units, there is a positive impact on liquidity and investor diversity. Further efficiencies accrue through asset lifecycle automation.
DLT lowers issuance barriers and customizes financial products for investors. By tailoring financial instruments to fulfil individual expectations around risk, return, and investment horizon, issuers can forge deeper relationships with investors. Investors benefit from the liquidity driven by the lower cost of trading programmable digital assets and are assured that their holdings are securely stored on DLT, safe from theft or tampering. Also, with full visibility into the DLT ledger, investors can make informed decisions.
In case of a larger financial ecosystem, since multiple financial institutions use the same DLT network, it becomes easier for regulators to oversee their operations. With regulators having direct access to all transactions in an ecosystem, a digital asset platform can be qualified as perpetually audit ready.
Specifically for Stock Exchanges, DLT can deliver benefits across securities trading and management, corporate services, and index licensing operations. Accelerated clearing and settlement, at T+0 on the same or next day, as opposed to the traditional T+2, two days later in a traditional exchange, saves time, and overhead costs. Reducing settlement times to T+0, could lead to significant optimization in value of margin and collateral required to manage the risk of default by counterparty. Finally, the advent of digital payments on DLT, backed by tokenized cash, stablecoins and eventually CBDC and others, can enable Delivery versus Payment (DvP). DvP ensures simultaneous exchange of an asset with the corresponding payment – with rules defined in smart contracts ensuring an atomic transaction.
Similarly, post-trade settlement activities – reconciliation, trade expense management, corporate actions, regulatory reporting, and others – can be automated on DLT to improve efficiency and security. Also, collateral management, custody, and similar services can be very seamlessly managed on a DLT-based securities value chain.
Decentralized Finance (DeFI)
Distributed Ledger Technologies can deliver transformational benefits for traditional exchanges. DLT can also usher in a new paradigm for financial markets, Decentralized Finance, offering typical services like lending, investing, or exchanging assets, while eliminating the need for intermediaries like a traditional Stock Exchange or banks.
A DeFI platform implements financial services like lending, trading, and settlement in a non-custodial ecosystem via smart contracts on DLT. Users interact with these smart contracts instead of intermediaries. DeFI differs from Crypto exchanges like QuadrigaCX, FTX, or Wazirx, which are centralized and require customers to relinquish custody of their crypto assets to largely unregulated private parties.
Key characteristics of a Decentralized Finance platform include automation of financial activity such as market making. Early regulatory intervention could expedite DeFI implementations. However, delegation of complex financial services to computerized programs implies creation of a very complex set of algorithms, which is subject to financial market risks.
While it’s unclear if and when DeFi will achieve mass adoption, it is a key transformative development that might shape the future of our financial ecosystem.
Conclusion
DLT can transform stock market operations by reducing the cost and time taken for clearing and settlement, creating an efficient, reliable trading environment. By improving transparency and security in stock market transactions, DLT builds market integrity and inspires trust among issuers, traders, investors and regulators. It holds tremendous potential to offer innovative solutions to transform financial markets.