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Blockchain could disrupt traditional model of financial trading

Blockchain technology has the potential to disrupt the traditional model of financial trading, Daniel Marovitz, European president and global head of products at payments network company Earthport, has said.24 Nov 2015.

Marovitz told Out-Law.com that there is a "big technical revolution" taking place in the financial services sector around blockchain and predicted that "real use cases" will come to the fore next year.

Best known for being the technology that underpins trading involving the digital currency bitcoin, blockchain is best described as a public ledger solution with storage capacity that is secured by cryptography and a system of algorithmic problem-solving.

In the context of payments, blockchain enables peer-to-peer transactions to take place outside of existing bank clearing and settlement protocols, Marovitz said. This is because the distributed ledger system upon which it relies provides trust to the transacting parties by publically recording transactions made at "tens of thousands of points of truth" online, making it difficult for details of payments made to be "corrupted", he said.

"With blockchain you do not need to move the money, you just need to know who has it," Marovitz said. "You need to point to the asset and name the owner."

Marovitz said this principle could apply in the context of financial trading, and allow companies to use a distributed ledger instead to record and manage who owns shares in their business. He highlighted the move by the Nasdaq stock exchange in New York to operate blockchain technology to enable transfers in company shares.

At a global payments conference hosted by Pinsent Masons, the law firm behind Out-Law.com, last week, Marovitz identified "technical fear" as well as regulatory compliance issues as a "major blocker" to the adoption of blockchain in financial services.

As well as ensuring how to meet obligations such as those in relation to anti-money laundering rules, know your customer requirements and obeying trade sanctions, companies are also fearful of being left with "white elephant" technology as a result of the market "moving on" or at a different speed in the way it adopts blockchain, Marovitz said at the conference.

"Unless you have others that run the same software and systems to talk to yours it is useless," Marovitz said.

A number of major banks from around the globe are currently jointly exploring the potential of blockchain technology in an initiative developed by technology company R3. At the launch of the initiative, R3 said participating companies would be involved in collaborating on how to use "shared ledger solutions to meet banking requirements for security, reliability, performance, scalability, and audit".

However, a new report by the Committee on Payments and Market Infrastructures at the Bank for International Settlements (BIS) has warned that widespread adoption of blockchain technology could threaten the role banks play in the financial system (24-page / 527KB PDF).

The report said "disintermediation" caused by the use of blockchain could lead to a gap in the market for traditional banking services.

"Banks are financial intermediaries that fulfil a role as delegated monitor of borrowers on behalf of depositors," the BIS report said. "Banks also typically perform liquidity and maturity transformation in the channelling of money from depositors to borrowers. If digital currencies and distributed ledgers were to become widespread, any ensuing disintermediation might have an impact on the mechanisms for saving or accessing credit. It is unclear who would take up the roles of traditional financial intermediaries in an economy based on the use of these schemes or whether these services could be provided at all in such a context."

The use of blockchain also has the potential to diminish the role of central banks and disrupt the processes that surround the trading of financial products, it said.

The technology could "obviate the need for a central body entirely for certain functions", such as in relation to settlement of payments, it said.

"Settlement might no longer require a central ledger held by a central body if banks (or other entities) could agree on changes to a common ledger in a way that does not require a central record-keeper and allows each bank to hold a copy of the (distributed) common ledger," the BIS report said. "Similarly, in some extreme scenarios, the role of a central body that issues a sovereign currency could be diminished by protocols for issuing non-sovereign currencies that are not the liability of any central institution."

In respect of financial trading, BIS said of distributed ledger technology that it is "conceivable" that it could "impact on the pledging of collateral or on the registration of shares, bonds, derivatives trades and other assets".

"The use of distributed ledgers may also induce changes in trading, clearing and settlement as they could foster disintermediation of traditional service providers in various markets and infrastructures," BIS said. "These changes may result in a potential impact on [financial market infrastructures] beyond retail payment systems, such as large-value payment systems, central securities depositories, securities settlement systems or trade repositories."

"The development of 'smart' contracts based on distributed ledger technology capable of executing payments under certain conditions may create the possibility of making variation margin payments on an individual contract basis. This could significantly alter how bilateral margining and clearing works today, with net positions and collateral pools," it said.

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