Will blockchain and its associated technologies be used to replicate existing oligopolies online or will they truly open up and enable all market participants to engage in a more democratic and open marketplace?
The likelihood is that existing players (banks, brokers, exchanges, etc) will attempt to morph their intermediary-based business models into private permissioned blockchains which exclude all ‘non-approved’ participants.
New players such as T0.com have attempted to shake things up in the stock lending market using digital token technology based on blockchain, but initial resistance from vested interests such as pension/mutual funds and prime brokers has been hard to overcome.
Although theoretically blockchain should make it easier for market participants who do not have a prior commercial relationship to trade with each other, the legal ramifications of issues such as identification and counterparty credit risk are not easily resolved.
The ability to offer margin finance/leverage is also not directly impacted by distributed ledger technology such as blockchain, and therefore balance sheet and risk intermediation will remain valuable services provided by traditional banks.
Democratizing the benefits
The scope for a more ‘frictionless’ trade lifecycle is definitely out there. Very little innovation has taken place in the post trade clearing/settlement environment and even less when it comes to trading between counterparties. The FIX protocol helped usher in the world of high frequency/algorithmic trading but was to limited to only trade execution.
Blockchain is just one of a number of technological innovations such as machine learning/AI, multi-tenant cloud architectures, and Big Database platforms, that have the potential to liberate markets from incumbent players and start the process of real – not phantom – liquidity generation away from market makers and investment banks and toward the infrastructure of the market itself.
A major ancillary benefit is that a series of expensive, time-consuming activities could be dramatically reduced for hedge funds with the adoption of distributed ledger technology. A blockchain-based ledger would be continuously updated, secure and available to all permissioned participants. This would obviate the need to constantly communicate data back and forth between hedge funds and their trading counter parties and subsequently reduce the need to reconcile that data and store it ad infinitum.
Whether it is transforming traditional clearing/settlement cycles or supporting the price discovery/liquidity process across non-equity asset classes, investment banks (eg: Goldman Sachs), emerging technology players (eg: Digital Asset Holdings), exchanges (eg: Nasdaq Linq) and market data vendors (eg: MarkIT) recognize the opportunity and are positioning themselves accordingly.
Just a link in a wider chain
Blockchain-based technology represents just one aspect of a wider, more fundamental shift in the infrastructure of the global financial markets. As mentioned previously, the post-trade lifecycle has remained a largely innovation-free zone since the creation of Euroclear (arguably the last major post-trade innovation).
Now, a host of commercial imperatives are driving the adoption of new technologies such as blockchain, not least among them the impact of regulation on banks’ – particularly investment banks’ – returns on capital.
Instead of using their balance sheets and trading acumen as a competitive advantage, regulation is driving banks to look at technology as a means to achieve more stable, less volatile shareholder returns by morphing into utility-type players. It is no surprise Goldman wants to consider itself a “technology business”. The adjacent benefit of being a utility is that you see ‘flow’ and that itself may open up other monetizable opportunities.
Disruptive technology is where the future lies; and where everyone in the market appears to be long-term greedy.
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