Blockchain is likely to have the most impact across the entire spectrum of front-to-back processes and operating metrics of an investment bank.
The problem
Finalizing a transaction is a complex, sequential process. It encompasses transaction execution, clearing, and settlement.
Reliance on third-parties
The process requires intermediaries for two crucial functions:
- Creating trust: Intermediaries act as trusted third-parties, ensuring that the buyer has sufficient funds and that payments are subtracted and added correctly.
Additionally, they offer buyer protection for counterparty risk, if the buyer is not receiving the goods they were promised. - Establishing security: intermediaries validate identities
Central authorities such as stock exchanges, payment providers or brokers, match buyers and sellers for transaction execution.
Lastly, settlement, the actual exchange, is often done using a central securities depository (CSD). A trusted custodian transfers ownership via a book-entry system.
Clearing usually involves a central counterparty (CCP), which acts as a buyer for all sellers, and the other way around. The goal is to minimize the risk of failed trades.
- Single point of failure
- Inefficient processes
Systemic delays
This multi-step procedure causes payment delays up to multiple days. As a result, the current situation is often referred to as T+3.
Specifically, international settlements are a challenge because they involve multiple custodians, different settlement cycles, currencies, and legal systems.
- Long delays
- Slow cross-border operations
High fees and custodial risks
Intermediaries take a fee for their services, raising transaction costs.
Furthermore, by relying on trusted third parties, market participants are exposed to custodial risks. Again, international trade is impacted severely due to long and often intransparent lists of custodians.
- Raised transaction costs
- Custodial risks
“Investors bear the risk associated with all intermediaries that
operate between them and the issuer.”
E. Micheler, L. von der Heyde
The solution
Almost instant and low cost
The blockchain, a shared and decentralized database, allows for instant, near real-time and extremely low costs settlement.
Authorization, clearing, and settlement are done in one single step, making T+0 a reality.
- Settlement in seconds
- Near 0 fees
- High-throughput
No middleman
By cutting out intermediaries, clearing and settlement become faster, cheaper, and safer. Moreover, blockchains provide a similar level of transactional safety while eliminating custodial risks.
- Increased transparency
- No single point of failure
- No custodial risks