According to the report prepared by Nasdaq and the consulting company Celent, which was published by the end of June 2018, only 5 per cent of the most important stock exchanges in the world have applied the blockchain technology in their operations, and as many as 20 per cent have no plans to do so. As many as 70 per cent of all the stock exchanges are working on the implementation of this technology, but it seems that they are approaching it with great caution. Despite the fact that 70 per cent of them are already using robotics, cloud-based data storage (40 per cent) and artificial intelligence solutions (35 per cent).
Blockchain is a technology based on a system of distributed registers, also known as the Distributed Ledger Technology (DLT). Simply put, it is a way of recording information that connects it into blocks making up a chain. In this solution, the data cannot be falsified (they are the more secure, the more users participate in the network), and are accessed instantly. The application of the blockchain technology can both streamline processes, accelerate them and lower costs, among other things, by eliminating intermediaries.
Companies and institutions from other sectors of the economy do not hesitate about using the blockchain technology. According to data from International Data Corp., this year businesses will invest USD2.1bn in the implementation of the DLT, compared to USD945m in 2017.
A more transparent market
There is no doubt, however, that the blockchain technology will — sooner or later — change the financial market beyond recognition. At least according to the analysts from the Bank for International Settlements. In their report they clearly emphasized: while cryptocurrencies are dangerous, the blockchain technology is extremely useful and will find a number of applications, also in the field of finance.
One of the biggest hopes associated with the blockchain technology is that the market will become more transparent after it is based on the DLT. In an article “New Kids on the Blockchain: How Bitcoin’s Technology Could Reinvent the Stock Market” published in the Hastings Business Law Journal, Larissa Lee, PhD, from Utah University argues that blockchain technology will not only enable us to smooth out price fluctuations due to the fact that the processing of orders will barely take longer than fractions of a second, but will also enable us to remove the shroud of secrecy surrounding the transactions, which will mainly apply to high-frequency trading and so-called dark pools in which large players can conclude transactions outside the trading sessions.
In its report for the year 2017, Nasdaq stated that it “continues to find a myriad of use-cases for blockchain technology across the capital markets ecosystem, specifically where an immutable record of transfers in ownership and inventory management are paramount”.
The WSE as a blockchain pioneer
Because of this conservative approach adopted by stock exchange operators, the Warsaw Stock Exchange still has the chance to find itself in the avant-garde of the blockchain revolution. WSE’s CEO Marek Dietl announced during the presentation of the key goals of the #GPW2022 strategy that the company was already preparing to launch a new trading market in Poland, based on the DLT. „The planned WSE Private Market will be based on the blockchain technology. The platform is supposed to connect companies seeking capital with investors on the private market thanks to the technology used as the foundation of Bitcoin and other cryptocurrencies,” said Michał Piątek, the WSE’s director responsible for the development of new businesses.
During the European Financial Congress 2018 in Sopot, the WSE’s managing director Izabela Olszewska assured that the company was carefully observing its competitors from all over the world and learning from their efforts in implementing blockchain solutions. „Blockchain technology can be used not only for the purpose of building a new market, but also in the area of post-transaction services. The Australian stock exchange is a shining example in this regard,” Ms. Olszewska pointed out.
The National Depository for Securities (KDPW) is also working on its own blockchain-based solution known as eVoting. It is a system enabling remote voting at the general meetings of shareholders. „eVoting will modernize the entire capital market and will bring it closer together. But this is not the only possible application that we see for the DLT. This technology could also be used to improve the relations and the cooperation between the asset manager, the broker, and the depository of securities,” said Sławomir Panasiuk, the Deputy President of KDPW.
We have to change laws and the mindset
Why are stock exchanges adopting such a conservative approach to the blockchain technology? The basic and most important reason is simple: lack of funds. According to the Nasdaq and Celent report, the exchange operators do not have sufficiently large budgets allocated to the IT in order to support both the maintenance of the existing systems and the works on the implementation of an innovative technology such as the DLT.
„When building tools based on the DLT, you have to create an entire system from scratch. Simply building on top of what already exists is not an option. You need to have the appropriate equipment, and the right software. You need to ensure the safety of the keys used to access the blockchain. This is obviously expensive, and consumes both time and money,” said Michael Coletta, the main blockchain specialist at the London Stock Exchange Group.
Arin Ray, an analyst at Celent, stated in an interview with the CIO Journal that the second and equally important reason is the necessity of maintaining a high level of security and stability of trading, while simultaneously meeting all the obligations towards the regulatory bodies and complying with the applicable legal regulations. Furthermore, market infrastructure providers must be sure that any new technology they want to use will not only support the development of the market and their business, but that it will also be safe for the market participants.
The Deputy Chairman of the Polish Financial Supervision Authority (KNF) Marcin Pachucki declared that Polish supervisory authorities were open to the use of the DLT in finance. „Products and services using the DLT cannot be placed in a legal vacuum. It’s another thing altogether that Polish legislation is not keeping up with technological developments. We will be working on this and trying to change this situation,” he added.
There is also the issue of the mindset of the capital market participants. Some simply aren’t ready to adopt this technology yet. „For some shareholders of the companies operating the stock markets, the use of the DLT is not acceptable. Time has to pass, and their attitudes will likely change,” said Joséphine de Chazournes, an analyst at Celent.
„The Polish market isn’t entirely ready for blockchain. This technology is not yet fully understood. Something positive is starting to happen, as both the KDPW and the WSE have announced that they will implement blockchain projects. A department for cooperation and development of the fintech market was established at the KNF. But all these developments are happening at a pretty slow pace. If we want to build an advantage over others, we should be working faster,” said Jarosław Dominiak, the President of the Association of Individual Investors, at the European Financial Congress.
The adoption of the blockchain technology is not that simple also due to certain dangers hidden in the readily available solutions such as the blockchain on which the Bitcoin crypto currency is based. This issue was pointed out, among others, by Professor Angela Walch from Harvard University in an article “The Bitcoin Blockchain as Financial Market Infrastructure: A Consideration of Operational Risk”.
Joseph Lee, PhD, from the University of Exeter in his article “Distributed Ledger Technologies (Blockchain) in Capital Markets: Risk and Governance”emphasizes that blockchain would not solve all the problems of the capital market like a magic wand, because it also has some drawbacks and limitations.
Stock exchange platforms based on the blockchain technology are already operating
There are the first examples of the application of the blockchain technology on the capital market. They are listed below in the alphabetical order based on the name of the stock exchange operator.
Australian Stock Exchange (ASX) — the Australian exchange has a bold plan: it wants to base all trading on its main market on the blockchain technology, in order to increase transparency, but also to significantly shorten the transaction execution time. The ASX has been working on this solution since 2015. This will probably be the first application of the blockchain technology on the capital market on such a large scale. The revolution is supposed to be completed at some point between September 2020 and March 2021.
Deutsche Boerse — the German stock exchange is conducting several research projects concerning the application of the DLT. One of them concerns the facilitation of international trade on the stock market. Another pilot project is called CollCo — it permits the transfer of money from commercial banks to capital market institutions with zero risk. In a recently published “road map” until 2020, the Deutsche Boerse has announced expenditures reaching EUR270m on the development of new technologies, including blockchain.
India’s National Stock Exchange (NSE) — the Indian stock exchange cooperates with several banks (including IDFC, Kotak Mahindra, ICICI, IndusInd Bank) on a DLT-based project which is supposed to help it to better understand the needs of customers and investors (so-called Know-Your-Client rule — KYC).
Japan Exchange Group (JPX) -– the Japanese stock market has contracted IBM to analyze whether it would be possible to improve trading on the market of small companies (which are generally characterized by low liquidity) through the use of the DLT. The JPX conducts extensive research on the DLT.
Korea Exchange — the blockchain technology has been used on the Korea Startup Market (KSM) since the end of 2016. The KSM market is devoted to trade in the securities of start-up companies.
London Stock Exchange (LSE) — the London stock exchange is working on several projects related to the blockchain technology. The most important of them provides for the launch of a platform for trade in the shares of small and medium-sized companies.
Luxembourg Stock Exchange — a DLT-based system for storing and publishing information from issuers has been functioning on the Luxembourg Stock Exchange since the end of 2016. The FundsDLT platform for trade in investment fund participation units has been operating since July 2017.
Moscow Exchange (MOEX) — the Moscow stock exchange has successfully implemented a system of e-voting at the general meetings of shareholders. The exchange also launched a bond trading platform based on the blockchain technology and boasted of these achievements in the presentation of its results for 2017.
Nasdaq — the American technology stock exchange launched the Nasdaq Linq platform for trading in the shares of private companies already in 2015. In May 2017, Nasdaq started working with the Citi group on the development of an integrated payment system based on the blockchain technology. The American operator also works with the Swedish Bank SEB on a platform for trading in mutual fund units.
Santiago de Chile Exchange (Bolsa Comercio Santiago) — the Chilean stock market has also recently entered the blockchain era. It launched a DLT-based tool which facilitates the lending of securities. This is the result of cooperation with IBM which has been initiated in May 2017. More new solutions are supposed to follow.
SIX — the Swiss stock exchange is planning to launch SIX Digital Exchange, a DLT-based trading platform for digital assets, in mid-2019. If this plan is carried out, this will be the first cryptocurrency exchange in the world launched by an operator subordinated to a national regulatory body.
TMX Group — the operator of the Toronto stock exchange launched a pilot program for a blockchain-based solution over a year ago. It enables a significant increase in the efficiency of gas trading on the Natural Gas Exchange (NGX).