In any competitive marketplace, organizations seek out transformative technology that will help set them apart. For capital markets firms, that's where blockchain enters the picture.
Developed as the transactions database for digital currency Bitcoin, blockchain today serves as a public ledger of every confirmed bitcoin exchange. Through a transparent system of chronological ordering, blockchain provides a freely accessible and comprehensive history of the cryptocurrency's transactions -- one that can only be appended, not reordered or deleted. Though it's the tool that powers Bitcoin, blockchain technology can be applied to other sectors, including the capital markets.
There's huge potential there, but we won't see it realized this year. Here's why.
Blockchain's Capital Markets Potential
Blockchain is already making waves throughout the fintech world. Back in September, for instance, a group of industry players including Citi, Visa and Nasdaq invested $30 million in San Francisco-based blockchain start-up Chain.com. At the beginning of January, Chain.com made headlines for its involvement in Nasdaq's first private security transaction using its dedicated blockchain ledger, Nasdaq Linq.
There's little question that blockchain will eventually have a significant impact on the capital markets, and financial institutions are already looking into how it can help evolve longstanding industry processes. One thing it promises to overhaul is the traditional trade lifecycle; transactions that take place on a transparent and collectively agreed-upon platform can be settled immediately, eliminating the need for a three-day settlement period.
Beyond making transactions more efficient -- not to mention driving down the back-office costs associated with the traditional settlement process -- distributed ledger technology has the potential to reduce transactional risks. Because blockchain offers an unforgeable, irreversible and collectively authenticated database (one that was designed to facilitate trust between anonymous parties) it could mitigate pervasive industry security issues like fraud. With blockchain, there's always a digital trail.
Barriers to Mainstream Blockchain Adoption in 2016
While blockchain has the potential to transform key processes within the capital markets, that won't happen this year. Some marketplace projections have suggested as much, painting 2016 as the year that blockchain will reshape finance systems. But there are challenges to mainstream blockchain deployment that must be addressed before the technology can be widely adopted across the industry, including:
- The need for industry standards: Blockchain was designed to provide a shared, public platform on which cryptocurrency trades could take place. But within the capital markets, there's already a push toward proprietary deployments like Nasdaq Linq. Such implementations make sense as firms familiarize themselves with the technology, but the widespread emergence of these and similar private solutions could impede the development of a uniform set of blockchain standards in the capital markets. An industry-wide regulatory framework will be crucial before blockchain can become the accepted transactional platform for banks and brokerages.
- Questions of scalability: Blockchain's transaction speed and storage capacity will have to improve before it can see mainstream capital markets use. Currently, when you carry out a blockchain transaction, users have to wait for miner verification before it gets added to a new block -- a process that can take an average of 10 minutes. Adding to blockchain's speed issues is the fact that it can currently only process seven global transactions per second. To put that figure in perspective, VISA's system was stress tested at a peak of 56,582 transactions per second in July 2014. Additionally, blockchain storage issues present a hindrance to broad-based capital markets deployment: The technology has not been designed to scale over time. Instead, the chain just expands with each added block; over the past year alone, the bitcoin blockchain has roughly doubled in size. This growth could morph into unmanageable "block bloat" down the line -- particularly if capital markets users are added into the mix.
- Security and compliance concerns: Blockchain offers a public window into transactional information. While this transparency might help reduce fraudulent trades, it could also open the door to privacy issues. Cybercriminals, for instance, could devise methods for compromising or even exploiting traders' identities and private information. Compliance is also a concern for blockchain, since the technology's decentralized nature presents challenges when it comes to arbitrating questionable transactions. Without a central authority, what happens when an erroneous or misrepresented trade occurs? Given the capital markets' growing emphasis on security and compliance issues, business leaders will have to ensure that the industry's push toward blockchain is matched by a commensurate focus on designing future-centric monitoring resources.
Baby Steps Toward Blockchain Adoption
While 2016 won't be the year that blockchain moves into the capital markets mainstream, it will mark an important step toward broader blockchain adoption. As Nasdaq Linq's private security transaction illustrated, industry efforts to use digital ledgers are already underway. Financial institutions from CME Group and Barclays to Union Bank of Switzerland have all jump-started their own blockchain efforts, and more organizations will undoubtedly follow suit.
For capital markets firms -- and broker-dealers in particular -- blockchain will be a transformative force, reshaping the way trades are carried out and secured. But that will take time; the "move fast and break things" mentality of the tech world doesn't translate easily to the highly regulated financial services world.
Within the capital markets, the push toward widespread blockchain adoption will happen incrementally, as industry standards are developed, and scalability and security issues are tackled. In the meantime, firms should prepare by learning as much about the technology as they can.