In 2017 it looked as if bitcoin, the original manifestation of distributed ledger technology (DLT), was on course to become a dominant and ubiquitous force in financial markets. Unfortunately, bubbles are bound to burst and bitcoin was no exception. However, out of the rubble of the cryptocurrency crash an interesting trend emerged: the corporate financial services world began to pay attention and explore DLT as an option for the development of new systems and processes. Now, new efforts are taking shape that seem destined to develop DLT infrastructure in ways that will radically change the very face of financial markets.
The path to transformation is often built upon a foundation of successful proof-of-concept (POC) exercises. Four recent examples in financial markets illustrate the different ways that POCs can be structured and offer suggestions on how DLT will shape the future of financial services. Specifically, cases from Northern Trust, DTCC and OCC show how POCs can lead the way.
Northern Trust: Start small with a sharp focus and evolve logically
Northern Trust was one of the earliest corporate adopters of DLT, kicking off a highly focused POC and working model beginning in 20161. The effort was aimed at the private equity market and the initial project was purposely limited, using DLT for one fund in one location with one administrator and one regulator. This laser-focused approach allowed Northern Trust to prove the concept and then grow the result with further additions such as the inclusion of audit as the concept was proven. From there, the bank took an interesting approach by transferring the technology to Broadridge Financial Solutions in June 2019. Northern proved the case for DLT but recognized that widespread adoption would only come if the technology was controlled by a neutral third party. Similar actions will be required for DLT to grow and flourish.
DTCC: A continued commitment to DLT
As a private company, Northern Trust faced stiff headwinds in setting standards for DLT but no such constraint applies to the Depository Trust & Clearing Corporation (DTCC). DTCC functions as an industry utility and this neutral position allows them greater latitude in exploring, and ultimately providing, innovative solutions that benefit the broader financial ecosystem. DTCC was also an early advocate for DLT and two recent POC projects are prime examples of how DLT is likely to evolve and grow.
- Project Ion is the more sweeping of the two efforts. It envisions the possibility of dramatically increasing the speed of trade settlement in the U.S. through a Digital Accelerated Settlement Service (DASS).
DTCC asks the question: “Can the digitization of assets on DLT reduce cost and risk for the industry while paving a path to modernizing capital markets infrastructure and facilitating accelerated settlement?” To find out, DTCC has developed a POC and is now engaging the industry to “demo the proposed concepts and gather feedback.” At the same time, DTCC is conducting a technical assessment to determine the best technical stack for implementation.
Ambitious in scope, Project Ion will have a long row to hoe before production and is, therefore, less likely to ever see the light of day. However, DTCC has imagined Project Ion as an optional service, which will allow the service to begin operation without having to secure unanimous consent from all industry participants. Also, the gains to be won in terms of regulatory risk capital are large and this alone might drive adoption. All in all, Project Ion has the potential to be a real game-changer.
- Project Whitney takes a smaller bite of the apple and is therefore that much more likely to see quicker adoption. Interestingly, it focuses on the same private market as the Northern Trust example above. Ion looks to digitalization as a way to simultaneously increase the flexibility and lower the cost of private assets through their entire lifecycle, from issuance to distribution and secondary transfer. Private markets, which include private placements, private equity, and private debt, are a relatively small part of capital markets, but they are experiencing high rates of growth compared to public markets and they suffer from significant inefficiencies, making them an ideal candidate to consider for the application of DLT.
DTCC developed Project Whitney in just 12 weeks and has recently moved on to participant testing as phase two. Lessons learned there will lead to phase three, which will incorporate feedback from phase two and expand integration to DLT markets beyond Ethereum, beginning with Hyperledger Fabric and extending to R3 Corda. It should be apparent by EOY or early 2021 if DTCC is on to something with Project Whitney.
OCC: Putting it all together
While Northern Trust followed a logical path in developing and then spinning off a DLT solution and DTCC continues to display a vigorous and innovative examination of DLT, the new project from the OCC has all the ingredients that may lead to a viable and game-changing implementation of DLT.
OCC is developing a DLT-based system for its securities lending (stock loan) business. This use case has the dual benefit of being challenged by significant bottlenecks that are ideally suited to DLT and also being a business where OCC can make a significant contribution. In the first case, manual processes and the lack of reliable “golden source” data lead to slow processing and high costs associated with clearing and reconciliation. In the second, OCC is the only CCP (central counterparty) in the U.S. that offers a stock loan service. Gains in efficiencies here will be compounded as customers also gain from cross-margining and other benefits afforded by a CCP.
The securities lending ecosystem is well suited to a permissioned DLT solution because it is a closed, professional-only business community where participants have similar needs but sometimes adversarial business objectives. In such a scenario, a permissioned solution helps to lower costs by increasing speed and efficiency while preserving anonymity and maintaining proper hierarchy among distinct participants.
OCC is working with industry-leading firms to develop this DLT-based solution for stock loan. Taken together with the OCC’s Renaissance Initiative to fundamentally transform their technology infrastructure, the securities lending project has the potential to be a big win for both the OCC and the industry at large.
Frameworks for future DLT success
Just as the dotcom era was characterized by boom, bust, and phoenix phases, digital ledger technology has been emerging from the ashes of the bitcoin meltdown in 2017/2018. While companies like Northern Trust led the way by definitively establishing the viability of DLT, efforts from major industry utilities like DTCC and OCC are likely establishing the frameworks upon which future success with DLT will be based. While we’re still in the early stages, the precedent is clear: DLT is likely going to change the structure and functioning of capital markets forever.
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1 Maven Wave published a blog about the DLT project at Northern Trust in August 2018.
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