Blockchain Clearing and Settlement: Crossing the Chasm

The interest in Blockchain from the financial community has been tremendous. The thought of decentralized trust, greater transactional transparency, an immutable transaction record, compacting settlement periods, and the freeing up of capital as we reduce settlement counterparty risk has many both outside and inside the industry salivating.

Finally, with one technology we can totally rethink the anachronistic settlement and clearing process that has plagued both banking and financial markets.

Is this the Holy Grail, or what?

Investors, private equity, and entrepreneurs are lining up. The R3 initiative has 42 major financial institutions involved in creating standards and developing solutions; Digital Asset Holdings, Blythe Master’s platform, has raised more than $60 million of investment capital from 14 global banks and IBM, as well as just winning a deal with the Australian Stock Exchange (ASX). Symbiont and t0 (Overstock.com’s blockchain platform) have executed financial transactions using the blockchain, and those initiatives don’t even include the gaggle of Silicon Valley-based projects relying on blockchain to shift the balance of financial power from overcast (opaque) New York to sunny (transparent) California. (For a more complete list of the major blockchain initiatives targeted at financial markets, please read TABB Group’s research note: Blockchain Technology: Pushing the Envelope in FinTech.)

While not all blockchain initiatives are targeted at the back office for highly liquid securities, the idea of revolutionizing the clearing and settlement of products such as equities, sovereign debt, or even corporate debt is the wide-eyed dream of many entrepreneurs and industry professionals. Just the thought of using blockchain as a lever to pry open settlement and clearing facilities unlocks the potential for streamlined settlement, reduced errors, lowered default risks, decreased costs and increased transparency in a very opaque world.

This is the securities industry professionals’ idea of motherhood and apple pie. A universal truth.

While this would truly be wonderful, getting there will not be easy. Blockchain has substantial capabilities to help facilitate, trade, track, and automate the processing of many types of securities, however in order for the public blockchain to replace the core of our traditional central clearing solution for equities, sovereign debt, or any liquid product, many massive and, in some cases what seem to be insurmountable, challenges need to be overcome across banks, investors, custodians, and industry infrastructure.

This note looks at these challenges and puts them in context. We look at 8 major issues including ownership, securities lending, foreign exchange, allocations/confirmations, physical securities, fractional ownership, netting, and technology challenges across the sub industries of investing, custody, the institutional sell-side, and retail brokerage. We also score these challenges by strategy, operations, technology, risk, and potential opportunity.

While the block chain has very significant opportunities, for it to scale and become a major force in the processing of liquid securities, we as the financial community needs to understand how we can get blockchain across this chasm.