By Natalie Lord
The potency and potential of blockchain technology is immense. Last week we looked at the ways in which it could impact the banking industry, focusing on the payments and clearance and settlements systems in particular. Here we take a look at how it could generate further change and result in significant cost savings in the fundraising arena and in the securities market.
Traditionally, fundraising has been done through raising venture capital, which is a drawn-out procedure. You compile a deck, attend numerous meetings with various parties and engage in extended negotiations over equity and valuation, with the hope of getting a commitment for funds.
With initial coin offerings (ICOs), money is raised by selling coins or tokens, therein cutting out the traditional investor or venture capital company, along with all the due-diligence that comes with that way of investing.
In an ICO, projects sell coins of tokens in exchange for funding. The value of the token is linked, in theory, to the success of the blockchain company. This means that investing in tokens enables the investor to hopefully benefit from value and usage.
In 2018, after a year-long ICO, blockchain company EOS raised more than US$4bn.
In the securities arena, blockchain removes the go-between in asset rights transfers. This lowers asset exchange fees and gives access to wider global markets, therein reducing the instability of the traditional securities market.
Currently, in order to buy or sell assets like debt, commodities or stock you need to be able to track who owns what. This is done through a complex chain of exchanges, brokers, clearing houses, central security depositories and custodian banks. It’s all about paper ownership, which is slow and vulnerable to inaccuracy or deceit.
If you buy a share in a company now you might place an order through a stock exchange which matches you with a seller. You’d then pay for a certificate of ownership for the share. When you’re trying to execute this transaction electronically, it gets even more complicated. Instead of dealing with the daily management of assets, we outsource the shares to custodian banks for safeguarding. But buyers and sellers don’t often use the same custodian banks which means the banks need to rely on a trusted third party to hold onto all the paper certificates. Simply put, to settle and clear an order on an exchange involves multiple intermediaries and potential for error.
The system is inefficient and imprecise. Timewise, securities transactions take from one to three days to settle because all the books need to be reconciled at the end of each day. Then transactions often need to be manually validated and this comes at a cost.
Because of blockchain’s distributed ledger, the rights to an asset can be transferred through cryptographic tokens. Bitcoin and Ethereum have achieved this through digital assets, but new blockchain companies are looking into ways of tokenizing all manner of real-world assets from real estate to gold. Further, tokenized securities can work as programmable equity because of smart contracts. This means that thanks to a few lines of code, paying out dividends or performing stock buybacks can be easily managed.
It’s estimated that moving securities on blockchain could save between US$17bn to US$24bn annually in global trade processing costs.
In our final piece on the benefits of blockchain in the banking industry next week, we’ll look at how the technology can reinvigorate the loans and credit and trade finance sectors.