The technology underlying crypto-currencies such as Bitcoin is likely to be a disruptive force in the derivatives market in the coming years, with settlement, trading and securities issuance most likely to be impacted, according to bankers and technologists.
The so-called blockchain technology at the centre of crypto-currencies is beginning to be applied to exchanges, securities and protocols that support trading in derivative markets.
“Blockchain technologies can make banks more efficient – for example through instantaneous settlement rather than the days it takes at present, lower costs and lower operational risk,” said Alex Batlin, chief technology officer for innovation at UBS, at the IDX Derivatives Expo in London. “The simple lesson for banks is that if we don’t do it someone else will.”
Blockchain technologies are based on the concept of shared ledgers, with contract flows stored on the internet and maintained by stakeholders who agree on changes to the ledger.
The consensus process is based on concepts derived from game theory, and theoretically neither a single validator nor multiple cooperating validators can effectively control the ledger. How validators find a consensus varies between systems.
In a recent trial UBS produced a smart-bond, in which risk free interest rates and payment streams were fully automated, creating a self-paying instrument.
“The key attraction is that there is no middle or back office, and no registry, so clearly a major impact on costs,” said Batlin.
Exchange operator Nasdaq in May announced plans to launch blockchain-enabled digital ledger technology for equity record keeping.
“Utilising the blockchain is a natural digital evolution for managing physical securities,” said Nasdaq CEO Bob Greifeld. “Once you cut the apron strings of need for the physical, the opportunities we can envision blockchain providing stand to benefit not only our clients, but the broader global capital markets.”
Still, hurdles remains. For example the proof of work needed to verify crypto-contracts takes time and large amounts of electricity (to drive computing power). That means the technology as it currently stands would not work for high-frequency or algorithmic trading.
“All kinds of revenue opportunities can emerge, but it’s still more expensive, so there is a way to go,” said Batlin.