2. Why DLT?
Moving beyond ‘digital assets’
As DLT experimentation and production continues to scale, nuances around the benefits of DLT in specific usage cases are becoming increasingly central. We’re moving from generic “digital assets” to specific, usage-case-driven applications and benefits.
Atomic settlement & smart contracts are well understood… but we can't overlook the data
DLT’s value in facilitating atomic settlements is well understood today. By enabling ‘atomic settlements’ (notably the instantaneous exchange of cash for security within nanoseconds of trade execution), DLT is opening the door to a radical re-shaping of counterparty risks and associated balance-sheet commitments.
Equally, as the basis for smart contracts, DLT is also creating the possibility for us to use sophisticated rules engines to automate highly complex tasks on a market level and to remove vast quantities of human-based procedures across the industry.
But less discussed at a market level is the simple benefit of DLT as a real time, synchronous data platform – which is seen as equally important as atomic settlement and process automation (in a three-way tie for top priority).
In a world of continuing legal constraints around legal recognition of digital assets, the value of DLT in enabling a consistent, market-wide view of securities and positions in real time is highly compelling and strikingly achievable today.
There are few obstacles in the world today to tokenising existing collateral, swaps or private equity holdings and to reflecting those holdings on a blockchain – thereby radically reducing trade fails and reconciliation breaks. Indeed, the two most compelling usage cases of DLT today (OTC derivatives and Private Equity) are both centred around this benefit ahead of all others.
Data is a here-and-now benefit for DLT.
Importantly, the benefits of DLT in facilitating digital identity appear to be valued by very few – except for those who have most experience in running DLT projects.
Despite the vast potential implications of a digitised KYC/CDD landscape, the values of automated identity management seem only to present themselves once people are already working on DLT roll outs, where they quickly become compelling (in the case of swaps and mutual funds).
Should we be paying more attention to this core attribute today?
Not all digital assets deliver the same value
The benefits of DLT depend on the problems that it is solving – and so it is no surprise that the technology is delivering different economies depending on the specific usage-case application.
At the sweet-spot of DLT today is the highly networked, highly ‘paper-based’ security – almost always a basket product that offers exposure to a series of underlying securities (through a consolidated structure).
From mutual funds to structured products or securitised assets, these over-the-counter securities never saw the benefits of dematerialisation and continue to be managed across the industry via excel and emails. With few large-scale ecosystems available to facilitate industry-wide process automation, these asset classes have remained stubbornly costly (and risky) despite years of investment in technology.
By automating and eliminating thousands of manual procedures for these asset classes, DLT is today providing significant and immediate efficiencies in workflow automation, settlement risk, reconciliations and book-keeping (to name only a few) – putting these paper-based assets at the front of the DLT queue.
Equally, by housing a highly complex and dynamic data model on blockchains, market participants are also beginning to realise benefits that were previously imaginable around exposure-look-through and management for a wide range of securities.
At one end of the spectrum, DLT is transforming traditional OTC markets by enabling bespoke, rules-based management of individual holdings (taking into account credit and risk criteria instantaneously).
At the other end of the scale, this same capability is also enabling the creation of a new generation of data-intensive assets, whose credibility (and hence value) can be evidenced and supported uniquely on a blockchain. Carbon credits are driving value in the carbon markets through their ability to instantly evidence provenance and authenticity; and green bonds are explicitly linking the value of debt investments to issuers' green performance in a way that has never been achieved before.
As these asset classes begin to transform capital formation, the value of DLT as a bedrock can only grow.
In comparison to these extensive benefits of DLT across the lifecycle of paper-based and ‘new’ asset classes, the near-term value of DLT in today’s dematerialised markets appears to be less – but probably only in the short term.
Our ability to already trade a future or an equity in nanoseconds today with little friction may seem to negate the potential value of DLT. Compared to a corporate bond, the incremental value of tokenising the entire lifecycle of an equity is far less compelling.
But that only means that we need to look more specifically at individual parts of the security lifecycle - most notably in the post-trade space. Today, we continue to spend vast technical, human and financial resources managing trade-matching, fails and corporate action error-queues every day – underlining the compelling value for DLT as a means of resolving vast waste and duplication in the back office.
Based on our research, around 50% of the DLT work going on today with dematerialised securities is in the post-trade space (the highest of any asset class).
Whilst DLT’s transformative potential in the listed markets is much more significant in the medium- to long-term (where the introduction of atomic settlements and single, market-wide ledgers could trigger a transformation of our entire industry), the journey to new efficiencies begins at the end of the trade.
Different DLT journeys depend on who you are
DLT’s value is not just shaped by asset class. It is also shaped by where you sit in the investment cycle and by who your core stakeholders are.
Financial Market Infrastructures and Custodians have so far led the DLT push – driven strongly by the commercial incentive of offering new products to their existing ecosystems. FMIs are keen to offer their members access to bond and private equity trading; and custodians are racing to offer their clients crypto custody in an effort to monetise their existing customer bases ever more.
By contrast, brokers, investment banks and institutional investors appear strongly focused on driving internal efficiencies within their own trading infrastructures – in equities and securities finance; and green bonds respectively. Without the compelling, commercial prerogative, DLT engagement is noticeably lower in these segments.
Should these different and disparate development paths be a cause for concern - in that vendors appear to be focused on different priorities from those of their clients?
"We're seeing our clients generate immediate savings of around 10% on their clearing fees. Beyond that there are much deeper efficiencies across reconciliations, settlements and operations that are only now becoming clear"
(Horacio Barakat, Broadridge)
