From the perspective of four types of market participants, interpret the use cases of blockchain in the capital market

Author: Maoqiu Technology

Original Title: "What Use Cases Does Blockchain Have in Capital Markets? Starting from Four Types of Market Participants"

Broadly speaking, there are four types of market participants in capital markets, and blockchain-based solutions provide significant benefits for them: issuers, fund managers, investors, and regulators.

Below, Maoqiu Technology will analyze the benefits of blockchain in capital markets for these four participants.

Issuers

Blockchain enables issuers to raise capital more easily, cheaply, and quickly through programmable digital assets and securities, bringing substantial benefits to issuers. New securities can be issued in minutes, with corresponding rights and obligations encoded and automated, which can enhance the speed of financing for issuers.

The ability to program or encode terms and conditions into assets (for example, in the case of securities issuance) provides greater flexibility and customization than ever before. Blockchain technology can streamline KYC/AML processes and provide investors with real-time updates and analytics through a single interface, thereby enhancing transparency and efficiency.

One of the main advantages of digital assets is the ability to fractionalize each asset. Digital assets can be broken down into more affordable and transferable units, creating opportunities for greater liquidity and investor diversity in certain markets.

Moreover, the barriers to issuing assets or securities are significantly lowered, providing greater opportunities for smaller issuers while existing issuers benefit from new markets or forms of securities. Finally, the entire lifecycle of the asset has the potential to be automated, simplifying the speed of event handling from investor services to dividend situations.

Fund Managers

Fundamentally, blockchain supports peer-to-peer transactions of any asset on a verifiable ledger. Funds benefit from faster and more transparent settlement and clearing, which reduces the risk of defaults or systemic risks in less transparent markets.

Faster processing means that funds and managers occupy less capital and can utilize and allocate their existing capital more efficiently. Funds will lower costs by improving operational efficiency, such as streamlining fund services, accounting, distribution, and management. Automated fund services can reduce or eliminate fees for services like fund accounting and management, transfer agency, and even custody that are paid to third parties.

There is no doubt that many new financial products and tools created using blockchain technology will emerge, creating new asset classes for capital allocation. While there will be explosive growth in financial products, most of these assets will share specific programmatic standards, simplifying the structuring of new financial products or tools.

The ability to issue digital assets and fractionalize existing assets will create a broader investor base, especially as new investors become more willing to embrace the idea of holding a digital asset portfolio.

Investors

Blockchain technology significantly lowers the barriers to issuing new assets or financial products. As the costs of issuing new securities decrease and the speed of issuance increases, issuers will be able to customize new tools based on the needs of each investor.

The enhanced ability to customize digital tools to more accurately match investors' return, time horizon, and risk preferences may profoundly impact the relationship between investors and issuers, establishing direct connections between capital seekers and investors.

Investor demand reduces risk while increasing potential returns. One of the main drivers of risk is lack of liquidity. This is addressed through the programmable nature of digital assets and financial instruments, which allows for reduced transaction costs, increased potential liquidity of assets, and more comprehensive risk management.

Combined with the connectivity and improved efficiency of capital markets, investors will see greater liquidity and lower capital costs. Additionally, the transparent and distributed blockchain ledger will facilitate a deeper understanding of asset quality and has the potential to strengthen the due diligence process.

Regulators

Regulatory agencies are often criticized for either over-involvement in capital markets or not being fast enough, as seen during the 2008 financial crisis.

Government agencies and regulators can benefit from the distributed ledger of blockchain, which is transparent and verifiable at any time of the day. The immutability of blockchain—meaning transaction data cannot be altered—enables regulators to automate functions such as auditing and compliance.

As multiple agencies use the same blockchain network to track their holdings and asset lifecycle events, regulators will be able to spend more time on analysis and risk forecasting rather than learning the characteristics and customized transaction representations of each company's system environment.

The ability to reduce friction between various labor- and time-intensive processes will simplify legal and regulatory processes. The improved data quality and disclosure quality achieved by blockchain ledgers will lower indirect costs and potentially prevent certain types of systemic risks.

What Use Cases Does Blockchain Have in Capital Markets?

• Issuance

Issuance refers to the process of issuing securities or other investment assets to investors to raise funds. Blockchain can create digital representations of existing traditional securities and entirely new digital assets to be launched in the market in token form.

By using blockchain issuance platforms, the securitization of financial instruments and securities will become more customized and streamlined. Improvements can be made throughout the asset's lifecycle, including at the time of company registration or for the digitization of equity for managed assets.

With enhanced programmable features, traditional securities-backed assets can be digitized to create tokens representing individual securities.

Blockchain supports new business models, such as decentralized crowdfunding, which can raise funds more effectively and create better equity and governance rights distribution. Another benefit of blockchain throughout the securitization lifecycle is improved transparency and manageable cap tables, which can conveniently record on a single distributed ledger.

• Sales and Trading

Sales and trading are one of the primary functions of investment banks. It refers to the buying and selling of securities and other financial instruments. Blockchain enables digital securities to be seamlessly listed through various mechanisms, including bilateral negotiations, centralized trading, decentralized trading, matching algorithms, and auctions.

Blockchain brings various new possibilities, including the creation of new and customized digital tools to meet investor demands. These new assets are made possible by the instantaneous and customizable nature of digital securities issuance, which can be programmed to seamlessly execute different types of business functions. For example, digital and automated invoices or other short-term obligations can be enabled using blockchain networks and digital tokens or assets.

• Collateral Management

Current collateral management processes are slow and inefficient due to manual reconciliation and physical delivery of securities, which limits responsiveness to market conditions. Information is also highly siloed, making it difficult to obtain a unified picture of collateral holdings across warehouses and entities. This siloed structure further limits the ability of entities to optimize collateral deposits or net balances across entities and geographies.

Blockchain achieves more effective collateral management by digitizing collateral into a single, optimized registry. Additionally, smart contracts can achieve precision in collateral management by automatically issuing margin calls and invoking predetermined rules for each bilateral or intermediary relationship.

The creation and digitization of collateral tokens or assets facilitate new markets and possibilities. For example, collateral represented digitally on the blockchain can be used for real-time redeployment and settlement, eliminating delays between valuation and calls.

• Exchanges

Exchanges are typically responsible for countless tasks, including market services (trading and managing stocks, fixed income, derivatives, etc.), corporate services (IPOs, OTC upgrades, investor relations), and licensing (data or index licensing).

Blockchain has the potential to improve the business operations of exchanges across many of their functions. Lower trading costs combined with faster settlement and clearing could reduce indirect costs and improve existing processes. A shared distributed ledger supported by a blockchain network can enhance KYC and AML compliance and provide trade matching or confirmation.

The transparent ledger of blockchain can assist trading through data verification and access permissions, providing a more robust alert system for trading activities in the best cases.

The digitization of assets allows new financial products and derivatives to have enhanced asset servicing capabilities (geofencing, whitelisting, time-locking, etc.). Furthermore, the combination of blockchain with new digital assets and securities opens up the potential for new primary or secondary markets to enhance the liquidity of certain assets.

• Clearing and Settlement

Clearing is the process of updating accounts and organizing the transfer of funds and securities. Settlement is the actual exchange of assets and financial instruments. Smart contracts can be programmed to match payments with transfers through off-chain cash payments, cryptocurrencies, or stablecoins.

For settlement, they can match various models, taking into account the market's risk tolerance and liquidity needs, including atomic settlement, deferred settlement, and delayed net settlement.

• Post-Trade Services and Infrastructure

Once a trade is completed, post-trade services come into play. However, due to the instantaneous nature of trades and volatile prices and markets, today's post-trade settlement processes face risks.

The global cost of post-trade processing ranges from $17B to $24B annually, including reference data, reconciliation, trade cost management, client lifecycle management, corporate actions, tax, and regulatory reporting. Blockchain automates and simplifies these processes, enhancing security and efficiency while reducing costs and settlement times.

• Asset Servicing

Asset servicing refers to the need for a unique set of services, while asset management is the management of money and securities by investment banks and other financial institutions.

Blockchain supports the automation of digital security lifecycle events, including coupons, dividends, rights exercises, maturity dates, and pricing, simplifying servicing and management processes.

• Mutual Fund Management

Mutual fund management encompasses various processes, including fund management, entity registration, trade management, and reporting.

Fund management currently relies on manual processing of fund data and other error-prone management tasks. Blockchain enhances fund management processes by automating and securing fund reference data among key stakeholders in near real-time. This significantly improves the transparency and security of fund data and any other information.

Entity registration is costly and requires intensive KYC/AML compliance procedures. Essentially, blockchain provides entities with a unified public ledger that can automatically store, verify, maintain, and distribute records. Additionally, more processes can be streamlined for fund operations, such as fund unit ownership registration, investor and fund cash balances, cash distributions, and more.

The new markets supported by digital assets and securities provide funds with opportunities to differentiate their products by creating new products and digital financial tools.

Fund compliance information can be shared with regulators or other network participants as needed. Regulators and auditors will be able to verify all existing information and trust the validity of existing fund data and information.

• Custody

Custody refers to the safeguarding or holding of securities to minimize the risk of theft or loss. The advanced security attributes of blockchain technology, including its decentralized architecture and cryptographic security code, ensure that assets are extremely secure.

• Transfer Agents

Transfer agents are responsible for maintaining ownership records of registered shareholders for issuers, including contact information. Transfer agents manage the transfer, issuance, and cancellation of issuer shares and regularly assist registered shareholders.

With the support of smart contracts and digitization, blockchain networks can act as digital transfer agents by maintaining the chain of asset provenance and encoding payment instructions for asset lifecycle. This will allow investors to receive payments, request investor signatures, and review materials without additional agency tasks.

Greater logic can be implemented in digital transfer agents, such as recording net subscriptions initiated by investors and clearing/redemption.

Additionally, digital agents utilize smart contracts to identify stock classes and automatically allocate earnings, such as dividends. A multitude of other tasks can be encoded into digital transfer agents supported by blockchain technology to enhance asset servicing for funds, investors, and other key stakeholders.