How Blockchain is disrupting financial markets

Insights from GemCap UK Director and CEO Stuart Alexander on blockchain’s potential to transform financial markets.

Blockchain technology and the digital assets it can create were once shunned and treated with suspicion – but, then again, people are often reluctant to accept change. However, now we see highly respected multinational corporations and even governments beginning to understand and roll out blockchains (and digital assets) as they realise the transformational opportunities this technology offers.

Greg Medcraft, who was the chairman of the Australian Securities and Investments Commission and has been in Paris at the Organisation for Economic Co-operation and Development (OECD) for three years, is very candid about the outlook for banks and what regulators need to do about blockchain technology:

  • Regulators need to prepare for disruption by blockchain
  • Blockchain business models can reduce costs and make markets more transparent, but, as OECD’s extensive policy work on blockchain shows, many new challenges will arise
  • ‘Decentralised Finance’ (DeFi) will emerge over the next decade, creating a parallel financial system operating on the internet. DeFi is revolutionary: the next frontier, without question
  • The arrival of mainstream central financial institution digital currencies (CBDCs), which will enable DeFi, are maybe 5 years away
  • With DeFi, there’s no friction
  • You’re looking at replicating numerous current elements of banking: it is inevitable that governments will have digital variations of paper cash, which can sit alongside non-public “stablecoins” (digital foreign money whose worth is pinned to an underlying fiat foreign currency), to allow funds to settle reliably in actual time on blockchains

This is not the first time that Medcraft has been outspoken and supportive of blockchain technology. When he joined the OECD in 2018, he stated in the podcast The blockchain revolution and power of positive distruption:

“I see blockchain’s potential coming from its three key use cases:

1. Secure transfer of value;

2. Secure transfer of data;

3. Cyber-security and privacy, provided by its distributed nature of nodes.

Blockchain’s benefits for businesses include:

  • Reducing the number of intermediaries needed for any type of transaction
  • Improving the transparency and traceability of goods in the supply chain
  • Speeding up payments and reducing costs
  • Increasing security and privacy of data and assets
  • Improving access to markets and financing, particularly for SMEs

To this end, policymakers’ efforts should be guided by three objectives:

i) To be pro-active and forward looking. This will help us avoid regulatory knee-jerk reactions and resist the temptation to jump in before we properly understand developments.

ii) To ensure regulators and policymakers keep up to date with the rapid changes brought about by new distributed ledger applications, and the need to build up their capacity to understand and deal with these innovations.

iii) To ensure a coordinated approach on two fronts: first, working collaboratively with key stakeholders, including industry, academic and consumer groups. Second, internationally. The global nature and inter-connectedness of markets call for international co-operation to avoid regulatory fragmentation, curb incentives for regulatory arbitrage, and spread best practice.”

The importance and transformational impact that blockchain technology is likely to have, and the importance that the OECD attaches to it, can been seen with three out of the four topics for the OECD 2021 Symposium on Digitalisation and Finance in Asia this autumn which are focused on the use of the technology:

24th September 2021

SESSION 1: Central Bank Digital Currencies (CBDC): latest developments and design considerations. SESSION 2: Artificial Intelligence (AI) in Finance.

1st October 2021

SESSION 3: Decentralised Finance. SESSION 4: Asset tokenisation: latest trends in policymaking.

Meanwhile in Australia, the government is clearly taking note of the potential disruption that blockchain technology offers. The Digital Finance Co-operative Research Centre (which is comprised of over 20 members from the finance industry in Australia) has been selected to receive AU$60million from the Australian government in order to examine the digitisation of real-world assets such as equities, bonds, commodities and real estate.

However, there are undoubtedly challenges that need to be addressed in order for DeFi to realise its real potential. For example, a means by which to identify who is trading – that is, digital identity is required to efficiently function in a truly digital environment. Having digitised assets and created digital transparent platforms, and having removed many of the current intermediaries, investors will be able to trade 24/7. Blockchain-powered platforms will also enable compliance officers and regulators to view transactions and the ownership of assets, such as equities and bonds, in real time. Payments, too, will need to be digitised, hence the necessity for digital currencies, which possibly explains why we are seeing payment platforms such as Visa, Paypal and Mastercard embracing these new digital currencies.

Unfortunately, many of the banks continue to turn their backs on the digital currencies as they cling onto their largely analogue, manual-based systems and procedures. It is therefore likely that the impetus for change and increased adoption of digital currencies, DeFi, tokenisation of real assets, etc, will now come, not from the cyberpunks who first advocated the use of Bitcoin et al nor the techies swooning over their latest ‘new new thing’, but from compliance departments and regulators. Indeed in Germany, DZ Bank and Bayern LB have started to trade an over-the-counter (OTC) interest rate derivative using blockchain technology and smart contracts. This increased automation ought to lead to a reduction in counterparty risk. Furthermore, the DTCC (which processes $10 trillion in derivatives in the US) is aiming to launch its blockchain-powered settlements platform in 2022.

Real time transparency, reduced number of parties required in transactions (thus lower costs) coupled with the ability to use smart contracts and other technology to monitor and then report on an exceptions basis, as opposed to manually checking all transactions, is highly appealing. More importantly, regulators and compliance officers will be afforded more time on risk management, as opposed to ‘box ticking’, with the promise of lower costs but improved controls and stronger procedures.

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