Distributed Ledger Technology and its Implications for the Securities Industry

By Geoff Hafer, Spring 2017 Student Intern

What is DLT?

According to FINRA, distributed ledger technology, also known as blockchain, has received significant interest in the financial industry recently.  So what exactly is Blockchain?  Blockchain is the technology that forms the underlying infrastructure of the cryptocurrency called Bitcoin.  Distributed ledgers, like bitcoin, are databases that keep track of who owns a specific asset.  This asset can be physical or electronic.  Every participant can keep a copy of the ledger which is automatically updated when new transactions occur.  For example in Bitcoin, all Bitcoin transactions are processed and recorded on the Block Chain.  Literally every Bitcoin transaction ever made is recorded and can be traced to the corresponding account.  Once a transaction is verified, the information is “cryptographically hashed” or given a non-predictable value.  This cryptographic hashing process presumably secures the integrity of the data such that once it is recorded on the network it cannot be modified.

How would DLT translate to the Securities Industry?

Market participants in the securities industry are considering various applications of DLT in sectors with perceived inefficiencies in operational processes or administrative functions.  For instance, some market participants are considering DLT-based applications to implement a system to track trading and ownership of both private and public company shares.  Additionally, in the debt market DLT technology is being considered to facilitate faster clearing and settlement of syndicated loans and repurchase agreements along with the issuance and trading of corporate bonds.  These are but a few examples of some of the various applications of DLT currently being explored in the securities industry.

So What Does this Mean for the Securities Industry?

Potential Pros

  • Market Efficiency – DLT has the potential to reduce settlement times for securities transactions by facilitating the exchange of digitally represented assets contemporaneously with the execution of a trade.
  • Transparency – DLT technology entails maintaining a database that contains the complete history of all securities transactions that occurred on the DLT network.

Potential Cons          

  • Security Risks – Because DLT involves sharing of information with various entities over a network, there is potential for security risks.
  • Governance – Bitcoin established what is known as a “trustless” environment open to the public. This means no single party is responsible for, or empowered with, governing and operating the network.  Although this can offer certain advantages, it may also pose some vulnerability if it leads to ineffective management of the system.

For more of an in-depth discussion see Distributed Ledger Technology:  Implications of Blockchains for the Securities Industry.