Blockchain, the technology driving cryptocurrency Bitcoin, is revolutionizing the entire finance and investment sector—the bond market is no different.
Let’s take a closer look at how Blockchain can, and already is, transforming the bond market.
In January 2018, Swiss asset manager, Lomard Odier Investment Managers (Lomard Odier IM), made what is believed to be the first ever private bond transaction using blockchain technology. They purchased catastrophe (CAT) bonds from Solidum Partners, an investment advisory company specializing in insurance-linked securities.
The main reason for utilizing the blockchain was because it allowed both parties to cut out the middleman and save on fees—in this case, a traditional bank’s structuring fee.
“Issuing on the blockchain allows us to lower fees and retain financial service providers only for the structural aspects that are required for the specific issue,” said Simon Vuille, Portfolio Manager, ILS team, Lombard Odier IM.
But What Exactly is Blockchain?
Blockchain is also known as distributed ledger technology, which is a non-centralized Peer-to-Peer digital network that sees all information stored on each individual node within the network, rather than in a centralized server.
This ‘chain’ of information is completely open for all peers to see, but also securely encrypted, meaning peers (and more importantly, regulators), can view the entire transaction history of the network without being able to influence it.
Bitcoin uses blockchain to log transactions of the currency. It’s now also being used in everything from P2P lending (allowing you to easily issue or obtain that $500 loan online), to health data exchange.
In the bond market, the cutting out of middlemen not only saves money but also …
Speeds Up the Issuance Process
Traditionally, this process has involved a convoluted number of different parties, from the issuing company to various forms of bank, legal counsel, and rating agencies.
There are emails, negotiations, documents that have to be drawn up and signed, and an assessment by the regulators, all of which can take weeks.
This can be solved by blockchain technology (which is already being used to issue and validate contracts), by accessing the single decentralized source of data stored on the ledger. Costs are reduced because there’s no need for the long-winded operations and reconciliation processes.
The system allows for near-instant access to the ledger when it would usually have to be done manually and could take days to complete.
So far, forty big banks have tested blockchain-based bond trading systems, including HSBC and Citi. However, despite these advances, the bond market is highly regulated, so it could still take a lot of time before such solutions are used on a daily basis in the United States.
The BlockEx Solution
One solution which claims to be close to completion is by BlockEx, which uses the blockchain to create “smart contracts” for bonds and specify coupons, payment dates, and maturities. Their aim is for the platform to settle trades within 30 seconds and for money to exchange hands within just one day.
“With the digital asset tool, costs can be substantially less than half, or even a quarter of current costs, and the big added benefit is that it leaves the securities with a secondary market,” said Aleks Nowak, CIO of BlockEx.
While most of the blockchain applications and cryptocurrencies out there are unregulated or stuck in a regulatory gray area, BlockEx is working in close partnership with the UK’s Financial Conduct Authority to make sure it meets regulations.
The SIX Solution
SIX Securities Services has taken things a step further, merging both the issuance and trading of bonds into one blockchain powered platform.
They claim their prototype has the ability to issue bonds through a similar smart contract process, with coupon payment dates specified, and buyers required to use a cryptocurrency to pay into the bond.
As these technologies progress and regulators catch up, it seems only logical that a faster, cheaper, and more secure bond market will emerge. Who the leading players will be is yet to be determined.
Are you involved in the bond market and/or blockchain technology? Let us know in the comments below about how you see the future of the bond market.