3 Fascinating Benefits of Blockchain and How It Can Change Finance Forever

 

On Thursday, January 28th, 2021, Robinhood received a request for $3 billion in collateral from the Depository Trust & Clearing Corporation (DTCC). This prompted the broker to halt purchases of GameStop shares on its trading platform to reduce the size of the collateral desired by the DTCC. Robinhood has been rallying to move away from the current T+2 standard for settlement of trades to quick payment in the aftermath of this incident. This is because the DTCC collateral requirement results from the current T+2 standard. Essentially, the DTCC has to ask participating brokers, such as Robinhood, for collateral to insure against the event the broker goes bankrupt between the time the trade is entered into and the two days it takes to settle the trade.

While a move to instantaneous settlement might not be the panacea that Robinhood is hoping for, these recent events bring attention to the tremendous benefits of moving the financial infrastructure to the blockchain. This technology could ultimately enable the quick settlement of stocks.

A FEW YEARS AGO, while I was in San Francisco, I met with a private equity expert and technologist who would mentor and teach me blockchain technology. He essentially taught me that blockchain technology and smart contracts are a new paradigm in computing. This allows a software program to make steadfast commitments — something not possible before. This, in turn, enables instantaneous settlement of contracts with zero counterparty risk and an immutable, auditable trail of the transaction — all at essentially zero cost. The use cases are infinite, especially in the world of finance. Projects such as Maker, Compound, and Uniswap are now building a stable digital currency, money market, and exchange infrastructure. You will likely see an explosion of use cases across all finance segments such as payments, real estate, and insurance.

Let’s look at some of the critical advantages of blockchain technology and some of the potential impacts on the financial ecosystem.

1. Elimination of counterparty risk

In the 1960s, the US stock exchanges were on a T+5 settlement standard. The NYSE closed every Wednesday to ensure the settlement backlog could be cleared. Stock certificates were recorded in physical form and the settlement process required couriers, known as runners, to transport these certificates from one broker’s office to another.

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The creation of the DTCC in 1973, followed by the first immobilization and then dematerialization of stock certificates, enabled today’s T+2 standard and electronic trading systems.

However, distributed ledger technology can take us further into an era of instantaneous settlement. This would ensure that shares and money are exchanged wholly and simultaneously eliminate the risk that money is not delivered once the shares are traded and vice versa. This, in turn, can prevent the need for intermediaries in a transaction and open up participation in financial markets to people who otherwise were left out because they did not “know” the right intermediary or were not judged to be “reliable” counterparty by biased intermediaries.

Related: 15 Crazy and Surprising Ways People Are Using Blockchain

2. Increased transparency of ownership and reduced litigation

The DTCC only tracks ownership of stocks at the broker level in the current system. Each broker, in turn, keeps internal records of actual investors, called beneficial owners, who purchase supplies through them. There is, however, no master registry of actual stock ownership. As a result, there can arise situations where there are dual claims on request of the same stock.

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In contrast, a blockchain-based system would record the entire chain of stock lending, borrowing, and selling and maintain an accurate record of the actual owner of shares at any particular moment.

Under the current system, situations arise where it is impossible to correctly distribute proceeds to the right people because of these conflicting claims. This is easily observed in cases where trades remain unsettled before a take-private transaction or in situations where there is heavy shorting of the stock. A classic example of this is the Dole Foods case. A blockchain-based system would ensure that the rightful owners receive accurate proceeds in any situation and therefore make the financial system more equitable and reduce litigation.

Related: What is Blockchain? We Explain the Technology of Blockchains

3. Pay critical contributors for the value they create in a network

The low cost, instantaneously transmitted, and permanent record of ownership enabled by blockchain enables the transfer of “value” at scale. As a result, key contributors who help build a network and make it valuable can benefit economically from the network’s increase in value. Imagine if the vital early users and contributors on Facebook, Twitter, and LinkedIn could economically benefit from the value they provided to these networks.

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A great example of this concept is the compound token, which distributes the value of this lending platform to the key suppliers and borrowers who are helping build this platform.

Blockchain technology can deliver potent benefits, such as reduced counterparty risk, accurate ownership records, and fair value distribution to key network participants. All stakeholders must come together to move the backbone of our financial infrastructure to this technology.

 

(This article originally appeared on Entrepreneur.com by the same author)