Distributed ledger technology (DLT) turned thirteen years old in 2021, and like most rambunctious teenagers, it had its fair share of hijinks: from “meme coins” of little to no value (other than being promoted by social media influencers) to eye-popping thefts at insecure cryptocurrency exchanges that sometimes totaled in the hundreds of millions of dollars. So it’s easy to give an eye-roll and wonder if DLT is ever going to grow up.
At the same time, signs are emerging that this budding technology might ultimately emerge from its awkward teen years to become a vibrant and dynamic part of the financial services landscape. From market applications in private markets and repo to new developments and investments in infrastructure, the DLT journey that began with the publication of the bitcoin white paper in 2008 is showing signs of the mature, responsible adult that it might become.
Growing DLT Products and Marketplaces
New technologies often evolve in ways that might not be immediately apparent. In the case of the internet, few foresaw that early applications like email would lead to the disruption of the taxi industry (Uber), hotels (Airbnb), and entertainment (Spotify and Netflix), to name a few. In the case of DLT, initial instances like bitcoin and Ethereum are leading to robust offerings like Private Market Hub and repo from Broadridge.
Private markets are a prime candidate for DLT due to their bespoke structures, lack of transparency, and lower turnover that collectively lead to higher costs. Private Market Hub had its origins in a pilot project created by Northern Trust (NTRS), an event that we first covered in a blog post in 2018 and again in 2020 as NTRS spun off the project to Broadridge so that it could prosper in the private sector. Prosper it has, adding new participants this year and expanding capabilities, including the selection of a public cloud to help increase both functionality and scale.
On the opposite end of the spectrum, the repo market has many small transactions and a short time window for settlement, making it an ideal candidate for a standardized set of smart contracts to simultaneously lower costs and increase throughput. Broadridge launched the Distributed Ledger Repo (DLR) service in June and quickly averaged $35 billion in daily transactions while it added major banks like UBS in August, joining the likes of Societe Generale and Natixis on the platform.
Broadridge is not alone in driving DLT innovation, and others see great potential for the technology. In a recent research report, Royal Bank of Canada (RBC) found that blockchain technology has evolved enough to meet the demands of at “least certain segments in the banking and financial markets,” singling out asset-backed securities (ABS) markets, securities that pool together assets such as mortgage loans, auto loans, student loans, credit card receivables, and equipment leases as being prime candidates for DLT.
Laying The Foundations for Blockchain Success
More broadly, DLT is witnessing a proliferation of investment products and increased utilization as the technological backbone for traditional exchanges — and it is benefitting from an effort to set standards for cryptoassets.
CME Group was an early leader in launching crypto products, and their bitcoin futures contract (BTC) is now over four years old and has traded more than 10 million contracts to date, averaging over $4.5 billion notional in daily volume in 2021. BTC futures are not alone as there are a total of 20 derivatives products approved by regulators in the U.S. and Europe. Interest extends into investment markets as well, where the number of crypto-tracking investment vehicles more than doubled to 80 in 2021, with over $63 billion in AUM.
As a backbone technology, DLT continues to gain as well with DTCC moving their Project Ion initiative, an alternative settlement platform that leverages DLT and a subject that we first covered in 2020, from a pilot into a development phase beginning in January 2022. In addition, ASX, the Australian-based exchange, continues on a path to replace its core platform, CHESS, with a DLT-assisted version. ASX has also announced that 20 firms are exploring Synfini, which uses the same technology but is offered as a DLT-as-a-service, to deliver the same flexibility and functionality. In both of these cases, an expanding ecosystem will likely lead to increased penetration and growth as economies of scale are realized.
A final foundational piece is being delivered by ISDA, which is developing common standards that will define and govern cryptoassets. Unique features like airdrops, forks, and changes in regulation are covered as well as defining the boundaries and interactions with existing asset classes. Solid definitions encourage confidence and greater confidence leads to increased activity — something that is sure to follow in the years to come.
Cultivating Innovation Where Investment Dollars Flow
Investment and innovation go hand in hand, and 2021 witnessed both an increase in crypto investments and a dramatic increase in acquisitions among established financial infrastructure firms.
A report from Galaxy Digital found that venture capital (VC) firms invested $10.5 billion in Q4 2021 and the total for the year was $33 billion. All told, nearly 5% of all VC investment in 2021 were in the blockchain/crypto space. In many cases, these investments are targeted at the infrastructure building blocks like custody and integrated exchange services that will be the foundation of growth in the years to come.
Traditional exchanges have taken notice, and a number of combinations and acquisitions have been announced in the past several months:
- Cboe announced the acquisition of ErisX, a spot and derivatives exchange for digital assets.
- Deutsche Börse bought digital asset trading and brokerage firm Digital Finance.
- FTX gobbled up regulated futures exchange LedgerX.
- Crypto.com purchased Small Exchange and Nadex from IG Group. Small Exchange provides futures products aimed at retail investors while Nadex is a Chicago-based, online exchange and clearinghouse offering retail-focused derivatives products, including binary options.
- Coinbase has acquired FairX and, at the same time, has applied for membership to NFA, the quasi-private, U.S. based derivatives market regulatory body.
In all cases, growth and opportunities for expansion in a dynamic new area are driving investments. The resulting combinations and new ventures are expanding the base of products and services that will ultimately accelerate the growth and maturation in a virtuous cycle.
Maturing Through The Tumultuous Teens Years
For humans, the teen years are usually characterized by a certain amount of disruption and a whole lot of growth. In both regards, the world of DLT is poised to deliver the same for the financial services industry. At the same time, DLT will have to “mature” as it continues to grow. The long list of new or growing products, infrastructure developments, and investments point to a future that will ultimately leave the hijinks behind as the technology (and the industry) mature.
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