Block-chain in Financial Markets

A blockchain is essentially a digital ledger of transactions that is duplicated and distributed

across the entire network of computer systems on the blockchain. It allows for the creation of
immutable records of transactions accessible by all participants in a network. A blockchain
data base is made up of a number of blocks “chained” together through a reference in each
block to the previous block. Each block records one or more transactions, which are
essentially changes in the listed owner of assets. New blocks are added to the existing chain
through a consensus mechanism in which members of the blockchain network confirm
transactions as valid. By using decentralization and cryptographic hashing, Blockchain, also
referred to as Distributed Ledger Technology (DLT), renders the history of any digital asset
unalterable and transparent.
An individual named Satoshi Nakamoto (2008) created the blockchain to function as the
crypto- currency bitcoin's public transaction ledger. Without the need for a trustworthy
authority or central server, the invention of the blockchain for bitcoin rendered it the first
digital currency to address the double-spending problem. A type of 'Payment Rail' is called
the blockchain. The blockchain database is managed independently using a peer-to-peer
network and a decentralized timestamp server. The list of so-called blocks related to
encryption is growing. Each block contains the cryptographic hash, timestamp, and
transaction data of the previous block. By building it, the blockchain resists data changes.
Blockchain has been described as "an open and decentralized distributed ledger that allows
permanently verifying and recording the origin of transactions or digital assets between two
parties.
With the success of Bitcoin, Ethereum, Litecoin and other cryptocurrencies, the study of
public blockchains and their role in the domain of finance has become increasingly important.
FUNDAMENTALS OF BLOCKCHAIN AND DLT
Blockchain, a linearly connected chain of blocks, is a specific type of DLT, whereas DLT is a
decentralised ledger, which may not be a linear chain. All blockchains are DLT; however, all
DLT platforms are not blockchains.

Cryptographic hash functions

As the most important building block of blockchain, a cryptographic hash function
is a special type of function which takes input of any size and converts it to a small
and fixed size output, called hash. The same input will always give the same hash,
thus making it deterministic. It is practically irreversible in nature, implying that
one cannot estimate the input data from a given hash value and most importantly it
is collision free, i.e., no two inputs will give the same hash. Also, even a small
change in the input generates a very different output, which makes cracking the
output very difficult.

Public-Private key cryptography

In public key cryptography, every individual has own unique set of public-private key pair.
Public key cryptography is used to send the message to the right recipient in a secured
manner, whereas private key cryptography can securely determine the source of the message/
transaction.
Nodes
Nodes are the points in a network through which an individual or an entity interacts with the
network. In a DLT platform, nodes interact with each other to pass on information or conduct
transactions.
Tokens
Tokens are units of objects, physical or virtual, which can also express ownership of an
object. For example, Bitcoin blockchain has Bitcoin token as the native payment token.
Blocks in a blockchain
The main purpose of blocks is to record transactions. Use of cryptographic hash functions
ensures that the blocks are valid and tamper-proof.

PoS-based consensus algorithms where anyone holding tokens can participate in the process
of creation of new blocks. In PoS, blocks are not mined but forged. The influence of nodes on
the blockchain is proportional to their amount of stake in the system
Currently, there are at least four types of blockchain networks —

Public Blockchains-
There are simply no access limits on a public blockchain. As well as being a validator,
anyone with an Internet connection can submit transactions to it. Usually, such networks
provide economic incentives for those who secure them and use some sort of algorithm for
Proof of Stake or Proof of Work. The bitcoin blockchain and the Ethereum blockchain are
some of the biggest, most accepted public blockchains.

Private Blockchains-
A private blockchain is authorized. Access to participants and validators is restricted. The
Distributed Ledger (DLT) terminology is usually used for private blockchains to differentiate
between open blockchains and other peer-to-peer decentralized database applications that are
not open ad-hoc computing clusters.

Hybrid Blockchains-
A hybrid blockchain has a combination of characteristics that are centralized and
decentralized. Depending on which aspects of centralization decentralization are used, the
exact workings of the chain can vary.

Sidechains-
A sidechain is a blockchain ledger designation that runs parallel to a primary blockchain. It is
possible to link entries from the primary blockchain to and from the sidechain; this enables
the sidechain to otherwise work independently of the primary blockchain.
Smart Contracts
 These contracts are basically lines of code or logic on DLT that execute themselves after the
predetermined conditions are met. These can be interpreted as digital agreements where once
the terms of the agreement are met, then the smart contract verifies it and transfers the tokens
as per the terms.

How does the Digitization of Financial Instruments Impact Finance?

The digitization of financial instruments – comprising digital assets, smart contracts and
programmable money – takes the benefits of blockchain further by forging unprecedented
levels of connectivity and programmability between products, services, assets and holdings.
These digitized instruments will redefine the processes of commercial and financial markets,
creating a new paradigm where value is brought at every touch point.
Digital financial instruments offer the following business benefits:

 Authenticity and scarcity: Digitization ensures data integrity, and enables asset
provenance and full transaction history in a single shared source of truth
 Programmable capabilities: Code that addresses governance, compliance, data
privacy, identity (KYC/AML attributes), system incentives and features that manage
stakeholder participation (for voting and other rights)— can be built into the assets
themselves
 Streamlined processes: Heightened automation increases overall operational
efficiency. It enables real-time settlement, audit and reporting; and it reduces
processing times, the potential for error and delay, and the number of steps and
intermediaries required to achieve the same levels of confidence in traditional
processes
 Economic benefits: Automated, more efficient processes trigger reduced
infrastructure costs, operation costs, and transaction costs
 Market reactivity: Digital securities allow greater customization than standardized
securities, and can be issued within shorter timeframes. Issuers can create bespoke
digital financial instruments directly matched to investor demand.
 New products and markets: Secure, scalable and rapid asset transfers, fractionalized
ownership of real-world assets, tokenized micro-economies, and more

Together, these benefits result in more accountable transparent governance systems, more
efficient business models, improved incentive alignment between stakeholders, greater
liquidity, lower costs of capital, reduced counterparty risk, access to a broader investor and
capital base, and access to all other digital financial instruments.

What are the Blockchain Use Cases in Financial Services?

 Capital Markets
o Issuance
o Sales and trading
o Clearing and settlement
o Post-trade services and infrastructure
o Asset servicing
o Custody
 Asset Management
 o Fund launch
o Cap table management
o Transfer agency in asset management
o Fund administration
 Payments and remittances
o Domestic retail payments
o Domestic wholesale and securities settlement
o Cross border payments
o Tokenized fiat, stablecoins and cryptocurrency
 Banking and Lending
o Credit prediction and credit scoring
o Loan syndication, underwriting and disbursement
o Asset collateralization
 Trade Finance
o Letters of credit and bill of lading
o Financing structures
 Insurance
o Claims processing and disbursement
o Parametrized contracts
o Reinsurance markets

How does blockchain impact capital markets?

Capital markets refers to the pairing of issuers with demand for capital, to investors with
corresponding risk and return profiles. Whether issuers be entrepreneurs, startups or large
organizations, the process of raising capital can be challenging. Firms face increasingly
stringent regulations, longer times to get to market, volatility from interest rates and liquidity
risk. Particularly in emerging markets, they must navigate the lack of rigorous monitoring,
thorough regulation and sufficient market infrastructure for issuing, settlement, clearing, and
trading. Blockchain offers multiple benefits for several capital market use cases:

 Elimination of a single point of failure through decentralized utilities

 Facilitation of capital market activities streamlining processes, reducing costs and
decreasing settlement times
 Digitization of processes and workflows, reducing operational risks of fraud, human
error, and overall counterparty risk
 Digitization or tokenization of assets and financial instruments, making them
programmable and much easier to manage and trade. In token form, they gain wider
market access through increased connectivity and the possibility of fractionalized
ownership. This results in increased liquidity and decreased cost of capital.

How does blockchain impact asset management?

Venture capital firms, private equity firms, real estate funds, and specialty markets are facing
demands to improve liability risk management, adapt more dynamic decision-making
structures, and address the increasing complexity of ever-changing regulations. Blockchain
can effectively streamline asset and stakeholder management. It allows:

 Automated fund launch

  Seamless stakeholder engagement with digitized assets and services
 Digitization of portfolio and existing holdings for wider market access, liquidity and
fractionalization
 Customizable built-in privacy settings for transaction confidentiality
 Voting and other shareholder rights and obligations programmed into digital assets,
resulting in seamless user experience and reduced risks of human error
 Creation and enforcement of incentive mechanisms to promote participation and
punish nefarious activity
 Improved governance and transparency for investors and stakeholders
 Efficient cap table management
 Automated fund administration
 Automated transfer agency in asset management

How does blockchain impact global payments and remittances?

Global payments and remittances today are executed by a number of intermediaries that exact
tolls for their service. It takes 2 to 7 days and costs a global average of 6.94% to send
$200 between countries. This means that remittances are directly reduced by $48B through
fees, intermediaries, and financial institutions. Blockchain can streamline payment and
remittance processes, reducing settlement times and significantly reducing costs. It allows:

 Rapid and secure domestic retail payments

 Rapid and secure domestic wholesale and securities settlement
 Rapid and secure cross border payments
 Real-time gross settlement between central banks, commercial banks, and
independent banks
 Digitized KYC/AML data and transaction history, reducing risks of fraud and
enabling real-time authentication
 Automated regulatory oversight and auditing
 Multiple forms of payment enabled on blockchain: Tokenized fiat, stablecoin,
and cryptocurrency

How
does

blockchain impact Syndicated Loans?

Syndicated loans provide clients with the ability to secure large‐scale diversified financing at
the current market rate. These loans are funded by a group of investors (e.g. syndicate),
where one investor serves as the lead arranger. The lead arranger serves as the underwriter for
the loan and performs all administrative tasks throughout the loan life cycle, charging a fee
based on the complexity and risk factors associated with the loan. Blockchain can streamline
Syndicated Loan services, reducing counterparty risk, and decreasing issuance and settlement
times. It allows:
 Automated syndicate formation: through programmable selection criteria within a
smart contract, syndicate formation is automated, reducing the time for a
corporation’s loan to be funded.
 Embedded regulator: throughout the syndicated loan life cycle, regulators are
provided with a real‐time view of financial details to facilitate AML/KYC activities
 Automated diligence and underwriting: corporation financial information analysis and
risk underwriting are automated, reducing the execution time and the amount of
resources required to perform these activities.
 Technology integration: diligence systems communicate pertinent financial
information to underwriting systems, streamlining process execution and reducing
underwriting time
 Reduced closing time: loan funding is facilitated in real time, eliminating traditional
t+3 settlement and centralized lead arranger operations.
 Servicing disintermediation: activities are executed via smart contracts, eliminating
the need for third‐party intermediaries
 Reduced counterparty risk: the disbursement of principal and interest payments
throughout the loan life cycle is automated, reducing operational risk.
 How does blockchain impact trade finance?
Trade finance refers to the infrastructure, processes and funding that support international
trade supply chains. The industry continues to rely on paper-based processes that are
susceptible to security vulnerabilities. Individual transactions can take as long as 90-120 days
in order to process letters of credit, verify documents, and establish trust among stakeholders.
Blockchain can digitize the entire trade finance lifecycle with increased security and
efficiency. It can enable more transparent governance, decreased processing times, lower
capital requirements and reduced risks of fraud, human error, and overall counterparty risk. It
allows:

 Real‐time review: financial documents linked and accessible through DLT are
reviewed and approved in real time and KYC/AML data, reducing the time it takes to
initiate shipment.
 Transparent factoring: invoices accessed on DLT provide a real‐ time and transparent
view into subsequent short‐term financing.
 Disintermediation: banks facilitating trade finance through DLT do not require a
trusted intermediary to assume risk, eliminating the need for correspondent banks.
 Reduced counterparty risk: bills of lading are tracked through DLT, eliminating the
potential for double spending.
 Decentralized contract execution: as contract terms are met, status is updated on DLT
in real time, reducing the time and headcount required to monitor the delivery of
goods.
 Proof of ownership: the title available within DLT provides transparency into the
location and ownership of the goods.

 How does blockchain impact insurance?
Insurance is a financial risk management product in which an individual or entity receives
protection against losses (e.g. property, asset, casualty and health) from the insurer.
Commercial property and casualty (P&C) insurance (e.g. commercial motor, commercial
property and commercial liability) protects businesses against risks that may result in loss of
life or property. Blockchain can securely streamline data verification, claims processing, and
disbursement, reducing processing time significantly. It allows:

Simplified and/or automated claim submission: through a smart contract, the claim submission
process will be simplified and/or fully automated (in cases of smart assets.

 Authenticated documentation and KYC/AML data, reducing the risk of fraud and
facilitating claim assessments
 Automated claims processing with the use of smart contracts
 Automated parameterized contracts to pay out upon occurrence of certain risk
 Automated disbursement of insurance payments
 Tokenized reinsurance markets to facilitate policy reinsurance in open marketplaces,
stepping away from traditional broker and relationship-based systems