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Stock traders from Shanghai to New York look at distributed ledger technology (DLP) in the hope that it will make their computer systems more efficient, reliable and secure.
A pilot project in Canada suggests that these potential benefits will take time to be realized, and working around regulations will be a bigger obstacle to refining the technology itself.
All over the world, three quarters of the financial market infrastructure operators interviewed by Nasdaq and Celent are working on Ledger technology pilots distributed or already using DLT. The Australian Securities Exchange is the first major stock exchange to commit to replacing part of its settlement infrastructure with the DLT, although it has recently delayed the six-month shift to the spring of 2021.
An eight-week DLT pilot from the Canadian central bank suggests that practical applications for technology may take even longer to arrive.
"We see that there's a promise in the distributed ledger," said Scott Hendry, director of financial technology at the Bank of Canada in March, when he announced the completion of the pilot project, called Project Jasper Phase 3.
"But when you look at the central systems that are systematically important and have been optimized for over 20 years, the bar is very high for this alternative technology to offer a significant advantage," he added.
In the first two phases of the Jasper project, the bank collaborated with the national payments network operator, Payments Canada, to build a general accounting technology system for cash transfers between banks. The TMX Group – which manages the Toronto Stock Exchange – joined Phase 3, which envisaged the creation of a system to demonstrate the concept that could immediately execute the exchange of money and shares for the agreed negotiations.
Such a system could eventually be part of a more complete DLT negotiation infrastructure, which hopes that hope will be faster and reduce reconciliation costs. Project leaders say, however, that there are many other questions to answer before these benefits come.
"It's less and less the technology that actually matures and gets ready for production," says Andrew McCormack, vice president of payments and technology at Payments Canada. "These are regulatory, legal, monetary policy issues".
For example, says McCormack, brokers need digital money to pay for securities within the distributed accounting system in the pilot. The most technically simple option was to allow them access to funds issued by the central bank. A previous phase of the Jasper project had already made this digital money available to major banks. However, McCormack says that giving it to brokers would "break the chasm and literally break our own regulation and, in fact, the laws."
Brokers usually do not meet the budgetary requirements that banks must pass in order to gain access to central bank money, in what is called the high-value payment system, explains McCormack. He raised the question: "How can we get cash, in the front row, to those who are doing stock exchanges to facilitate the magic of what this platform can give us?"
In the end, the team found a technical solution by offering different levels of access to money and credit for the different participants. The ability to set rules like this is a key advantage that a private DLT platform has on bitcoin-style public blockchains, which give everyone equal access. A private platform of this type can be built to follow existing banking rules, maintaining the distinct roles of the central bank, commercial banks and brokers.
Despite this ability, McCormack continues to believe that regulatory changes will eventually be needed to facilitate any transition to DLT. These legal questions require more attention. "Otherwise you're just building TV on the Internet," he says. "We are trying to figure out a way to do it better."
The Bank of Canada is not yet engaging in this part of the problem. "The bank has not considered making regulatory changes to facilitate a change to the DLT," says Hendry.
"There's a huge amount of governance," says John Lee, managing director of business innovation and product development at the TMX Group. Cash-for-equity digital exchange may seem simple, but risk management and reliability assurance are not.
The Jasper project simply demonstrated that such a system could work. If it is able to operate on a large scale and meet the requirements of security, resilience and credit risk it remains an open question.
"If you really want to put it into production and scale it, you have to deal with the non-glorious elements," says Lee. "There must be a reason why DLT was the best technical solution for that case."
For McCormack, finding truly useful applications means deciding which parts of a nation's financial market infrastructure should be included in a DLT system. The Jasper pilot was limited to the regulation of the bonds. A future system could incorporate other phases into a securities trading; other assets, such as derivatives or bonds; or integrate with trading systems in other countries. The Canadian experiment showed at the same time the need to consider these more complex applications and the difficulty of making them usable.
"If you're too tight, it's hard to find the business case," says McCormack. "It is increasingly obvious to us now that we must be ambitious in scope."
In the end, McCormack believes that the merits of any transition to DLT should be assessed on the basis of cost-benefit ratios. "The cost and the interruption are worth it?" He asks. "This is exactly what we are thinking about."
