Blockchain in capital markets: Here’s what we’ve learned after 5 years of experimentation

In the five years since the World Economic Forum published “The future of financial infrastructure”, the world of blockchain has changed dramatically. Bitcoin — the oldest and most widely known cryptocurrency, and the first major blockchain application — saw its value peak in late 2017, before falling and then rising to new records over the past several months. Most of the world’s major central banks have announced research programmes on Central Bank Digital Currencies (CBDC), and a few smaller countries have launched live CBDCs. In many ways, it appears that distributed ledger technology (DLT), of which blockchain is the most common architecture, has moved from the margins to mainstream adoption.

In the capital markets — stock, bond, derivatives and related markets — DLT has been regarded as, depending on whom you ask, one of:

While some companies have taken a wait-and-see approach to understanding how this technology could be used in the industry, many financial institutions and technology firms have invested heavily in exploring the technology and its capabilities. After more than five years of experimentation, what has been learned?

Impacts on the industry

Over the past year, the World Economic Forum has convened a series of global workshops bringing together financial institutions, technology providers and the public sector to explore these learnings and the path forward for DLT in capital markets. Unsurprisingly, many in the industry are excited by this technology’s ability to create trust in shared data sources, enable greater automation of processes and facilitate more efficient asset transfer. As we explore in a newly launched report, written in collaboration with BCG, the capital markets are still far from either total disruption or DLT-enabled transformation, but it is clear that this technology is having an impact on the industry.

At a high level, there is growing agreement that there are significant inefficiencies, challenges and potential risks associated with the current technologies, systems and processes that underlie global capital markets. While these markets and their infrastructures have generally proven functional and resilient, incidents like the January 2021 GameStop trading debacle reveal the degree to which the “plumbing” of capital markets is often viewed as slow, costly and complex. Outside of the stock market, these challenges may be even more pronounced.

While these inefficiencies are real, the key question is whether DLT is the appropriate technology to address them. Answering this question requires analysing potential DLT use cases and understanding: 1) whether DLT provides unique advantages that align with the needs of this use case and that other technology options cannot provide; and 2) what it would take to transform a complex, highly regulated ecosystem without introducing new risks.

Many firms have set out to answer these questions by building proofs of concept or value to test the technology. Over the years, many of these projects have stalled, either because the value may be unclear or — more likely — because the roadmap to implementation is far more complex and costly than any individual institution (or even a consortium) is willing to take on. However, more recently, we’ve started to see significant DLT use cases go live, with more expected over the next year.

As real value starts to move using DLT-enabled solutions, what does this mean for the future of capital markets?

Despite these exciting recent developments, the jury is still out. Given the complexity of transforming even a small subset of the capital markets ecosystem, a significant amount of cross-institution collaboration will be necessary to realize any of the potential benefits of DLT. While this is happening in profound ways as institutions collaboratively explore different use cases, players in the industry are still far from uniting behind common visions of the future. In some instances, this is because there are substantially competing incentives between different types of institutions. In others, it may be more down to the fact that achieving DLT’s benefits requires different ways of working across institutions.

A to-do list for capital market leaders

So what should capital markets executives do now?

1. Executives must deepen their understanding of DLT and its potential roles in the industry, sharpening their view on where it does and does not make sense, and what their institution’s role should be in any future ecosystem. We hope this report is a useful resource in that education.

2. Relatedly, firms must work to break down the silos that traditionally define how capital markets operate. DLT-enabled solutions potentially have implications across institutions, affecting front office, back office, treasuries and other departments. Moreover, given the opportunity to redefine how markets operate, traditional lines between asset classes may start to blur. Given organizational structures and incentives, this will be challenging, but it may be necessary for realizing any benefits.

3. The industry must continue to unite behind common standards for contracts, data models and processes. These standards are generally viewed as a prerequisite for DLT-enabled transformation, but they can create inefficiencies and reduce risks regardless of what technologies are ultimately used. ISDA’s Common Domain Model for derivatives is a great example of how this can be done, but also of the effort required to implement common standards in practice.

4. The industry must continue to actively engage regulators on DLT and their visions for transforming markets. Uncertainty about regulation has long been a challenge highlighted by market participants in this space, but regulators cannot make decisions in a vacuum. Capital markets firms must continue to be proactive with involving regulators early on in building new solutions.

In the capital markets, DLT may be at an inflection point, where market participants advance from experimentation, proof of concept, and early product launches to reimaging the value chain across entire asset classes. If market participants are collectively able to align behind common strategic visions, then DLT could unlock significant value and transform the roles and value propositions of institutions across the industry.