You’ve probably heard a lot about blockchain, the technology underpinning bitcoin, but did you know that it could have an important role to play in capital markets even when bitcoin is out of the picture? With potential implications for negotiation, regulation and improving the efficiency of numerous processes, it has been warmly welcomed by many of the big players and is gradually being adopted in many different parts of the market.
What is blockchain?
When one sets aside all the complicated terminology, at its core, blockchain is just a database. Because it’s decentralized, existing across a network, lots of people can see what’s happening on it, and all the computers in the chain must approve an exchange before it’s finalized. Because it records every transaction, it makes fraud much more difficult, and cryptography keeps those transactions secure. It can be used for virtually any system built on individual exchanges, so it’s ideal for market transactions.
Whereas a regular contract sets out terms and conditions that may include ‘if/then’ statements predicated on particular actions or external factors, smart contracts can actually enforce them insofar as they can alter the mechanics of the central exchange. For instance, an agreement could be made to exchange one currency for another at a certain time unless the value of either had fallen below a set level, and neither party would then have to worry about the transaction going ahead anyway and having to be pursued after the fact. In the capital markets, exchanges might be agreed within limits based on interest rates, the trading value of related stocks or bonds, or the overall performance of a sector – as long as you can assign a number to it, any variable can work.
Using a blockchain system can be a fast way of verifying trades without compromising on security. It’s the perfect way to confirm that details match, obviating the need for manual checking and therefore saving on time and labor as well as reducing the potential for error. That, in turn, makes it less likely that reconcilement issues will have to be dealt with, which also reduces costs and makes things simpler for everyone.
Improving regulatory compliance
Reducing reliance on the human element immediately reduces the potential for corruption and also helps to promote regulatory compliance in a number of other ways. There’s no need to worry about traders going over their limits when further transactions can be stopped automatically. Using smart contracts makes it easy to do this because the transaction will not be finalized if the financial positions of the parties involved are not as specified. What’s more, the code enabling this can be automatically added to every contract that a trader issues.
Additionally, blockchain has the potential to enable production of accurate reports much more quickly – in effect, snapshots of activity can be taken at any time, making it easy to investigate any concerns.
If you’re trading independently, not going through an institution, what does all this mean for you? Most significantly, it means that the markets are going to start moving more rapidly, with stock prices potentially fluctuating faster in response to events. You’ll need a good data feed to keep up. Hammerstone is a useful source for rapidly updated market information and can help you handle the pace. The real plus point for independent traders is that there’s less risk of falling prey to corruption when engaging with large capital markets providers – and in the long term, the security blockchain provides could reduce insurance costs for financial institutions, potentially making your banking cheaper.
Introducing blockchain is a bit like redecorating your office: you know that it’s a good move, but you don’t like the idea of the disruption you’ll face while it’s being done, and you really don’t want it to put off your customers. The solution? Close off one room at a time and redecorate there while everything else continues as normal. That’s basically how capital markets are making room for blockchain to be adopted. It’s a slower process but it allows everything to keep running smoothly.
Blockchain will make the most difference to financial institutions and capital markets providers by significantly reducing the risks they face while increasing efficiency. By providing a holistic perspective on the trading process it will also make it possible for them to identify strong and weak points in their systems and adjust accordingly. As it’s gradually introduced and comes to influence more and more of the market, we should see trading aberrations and fraud decrease – and that’s good for everyone.