Distributed Ledger Technology: The case for our capital markets

•Pic caption: The Project Castor breakout session is happening today 2.00pm at the Securities Commission.

The Securities Commission’s (SC’s) annual fintech conference, SCxSC, kicked off this year with exciting news about their use of blockchain technology.

Since the introduction of their Digital Markets Strategy in 2016, two years later today they announced the completion of Project Castor, a technical and implementation feasibility study of Distributed Ledger Technology (DLT) as the underlying market infrastructure for unlisted and OTC markets.

This pilot project used the Equity Crowdfunding (ECF) ecosystem as an example of how DLT could be applied, and findings of the whole study can be found at the microsite, www.castor.my

The website provides a downloadable blueprint which lays down “what the SC considers the foundational elements when building a decentralised market structure.”

Sure enough, the title of the blueprint is “Capital Market Architecture Blueprint in a Decentralised World.”

This blueprint is written by SC’s Executive Director of Innovation, Digital & Strategy, Chin Wei Min, as well as the division’s Assistant General Manager, Chan Zhong Yang.

In its introduction, the authors introduced the concept of capital markets which are more decentralised and the underlying infrastructure that enables this.

But, a walk down memory lane revealed that this wasn’t always the case. In the blueprint’s introduction, it is revealed, “However if we cast our memories slightly further back in history, what we know today as a single centralised exchange (or the national stock exchange), are often the result of consolidation between multiple smaller markets. Investors were already trading securities with each other, where buyers found sellers via intermediaries such as brokers, or within small private pools before central exchanges came into place. “

The capital market rapidly embraced centralisation as a means of greater efficiency – exchanges, clearing houses, custodian banks and trade repositories are prime examples of this phenomenon.

According to the authors, centralisation has brought about greater price discovery and liquidity, certainty of clearing and settlement, more orderly market operations as well as greater pre- and post-trade transparency. Adopting centralised models have delivered significant benefits.

So, why would the capital market want a more decentralised infrastructure?

The evolution of the market in terms of product innovation and increasingly varied investor demands, is bringing about multi-tier markets; new types of different markets which cater to specific needs and niches.

This is demonstrate by how the unlisted and OTC markets have evolved.

The blueprint points out that these OTC markets value bespoke and tailored products, and they operate in a more bilateral manner which may require greater privacy at times.

“So how can we build decentralised and highly flexible market infrastructures to support the unlisted and OTC markets, while still adopting some of the best practices from centralised markets, for example transparency?” the authors pose this challenge/question in the blueprint.

In summary, DLT is hoped to overcome these challenges:

  1. A decentralised, yet private network means buyers and sellers can connect directly with each other without the need for intermediaries.
  2. All transactions performed on a DLT-based network will be automatically recorded on theLedger with is highly auditable and immutable, while there are methods to still maintain individual transactional privacy.
  3. With the right permissions, a participant on the network can view the entire transaction historyof a particular  instrument.
  4. “Smart Contracts” on the DLT can be implemented to codify any tailored or bespoke form of products, and are self-executing based on pre-defined criteria.
  5. The nature of the DLT being a decentralised trusted network means complex bilateral settlement processes can be simplified – a participant does not need to know or trust the other participants, but only need to trust the integrity of the ledger itself to ensure that transactions are executed properly.

The authors also cautioned that DLT is still in nascent stage of development, and that several concerns with the technology itself limits its use in selected cases.  One significant weakness is its limitations at scaling to higher transaction per second capacity.

This makes it unsuitable for the trading space where speed and throughput are paramount, currently.

The DLT architecture blueprint for capital markets, can be found at www.castor.my