Blockchain and financial markets: myth or reality?

Blockchain technology was developed in 2009 to manage transactions based on the Bitcoin cryptocurrency. Since then, numerous sectors of activity, including finance, have shown interest in its applications. However, there has been no significant use of the technology in finance, despite numerous pilots. Why is this? Is Blockchain a myth or a reality for financial markets?

Blockchain technology faces a number of obstacles to widespread use. First of all, financial markets are subject to regulation that reinforces investor protection but in turn creates major operational constraints. For example, to limit risk and improve transparency in OTC derivative transactions, a “compensatory” trusted third party (TTP) is mandatory. In many fields, it is not possible for the TTP to be replaced by a Blockchain, unless it develops its own Blockchain applications. (See the examples below.)

There is also the issue of performance: Blockchain transactions are slow compared to traditional transactional technologies and their infrastructures, such as Swift. In the short term, it seems clear this technology cannot replace the highly automated processes that handle vast quantities of data. Finally, the Blockchain learning curve remains long (around 18 months), exacerbated by the lack of stability in the underlying technologies.

Yet if any technology has the potential to significantly disrupt financial markets, especially post-market financial institutions, it is Blockchain.

Blockchain dispenses with the need for a TTP provided by a specific financial institution, playing this role itself as a peer-to-peer network that links up the different parties involved in a process and verifies every step of the process. Furthermore, Blockchain-based “smart contracts” are computer codes that automatically execute the conditions of a contract and therefore reduce the number of parties involved in numerous activities.

But Blockchain does not merely just a disruptive model but also a solution to market inefficiencies and weaknesses.

In Blockchain, every transaction is recorded and traceable at every step. This can reduce the need for transaction reconciliations, a resource-intensive activity for financial institutions.

Every node in the Blockchain network has access to the entire transaction history, offering improved transparency and authentic traceability.

Every transaction is encrypted and protected, lowering the risk of hacking to alter data.

To sum up, Blockchain technology offers four benefits: 1) improved transparency and traceability for operations, 2) significantly shorter lead times in the case of disintermediation or manual processes, 3) greater security, and 4) lower costs due to direct contact between the parties and verification at every step of the transactional process.

Currently, the most promising applications are in the test phase: transactions in derivatives and complex financial products (e.g. DTCC repo clearing services), transactions in commodities (e.g. Euroclear’s settlement service for the London gold market), unlisted securities issues and registrations (e.g. TIW for DTCC CDS contracts or managing fund prospectuses), and transactions in subscriptions or redemptions and KYC compliance on funds (numerous projects, including LaBChain in France, with Utocat, a fintech company).

In conclusion, the difficulties are real but do not support the status quo since, sooner or later, this technology will mature and become truly disruptive. In this period of uncertainty for Blockchain, one thing is sure: financial institutions that do not get on board will be left behind.

First published in FinTech Mag