Is Institutional-Grade Blockchain Ready for Its Great Leap Forward?

Early in the last decade, as bitcoin was pulling into its orbit an anti-establishment subculture that was suspicious of traditional finance, a few TradFi thought leaders began to contemplate the disruptive implications of the cryptocurrency’s underlying processing infrastructure.

By design, bitcoin and its self-governed distributed ledger technology (DLT) were poles apart from the highly controlled, tightly risk-managed networks on which banks, other financial institutions and governments relied for payments, securities transfers and other transactions and data transmissions.

Yet DLT – also known as blockchain – was seen as potentially adaptable to the critical payment, clearing and settlement functions assigned to established financial market infrastructures (FMIs), foremost among them Depository Trust & Clearing Corp. (DTCC). The U.S.-based post-trade utility was among the first entities of its kind to test and invest in blockchain projects and proofs of concept.

Major exchange and clearinghouse companies followed suit, as did top asset servicers and custodians such as Bank of New York Mellon, BNP Paribas, Northern Trust and State Street. These organizations, many of them designated by regulators as systemically important banks (SIBs) or financial market utilities (SIFMUs), now have digital-asset business units actively pursuing DLT-related opportunities.

BNY Mellon has “the scale to reimagine financial markets through blockchain technology and digital assets,” CEO Robin Vince said when the firm went live with digital-asset custody in October 2022. He has also characterized it as a measured, long-term strategic play.

Crowded and Fragmented

The field was already crowded with younger, “digital native” enterprises touting one or more ecosystem components, often forming partnerships and interconnections to facilitate or streamline interoperability. According to research published last year by the World Federation of Exchanges, there were more than 500 cryptocurrency trading platforms worldwide, split between centralized and decentralized finance (DeFi) approaches, their market valuations fluctuating along with the often volatile crypto assets.

The recent U.S. Securities and Exchange Commission approvals of spot bitcoin exchange-traded funds generated new trading interest and enthusiasm. Larry Fink, CEO of ETF market leader BlackRock, declared, “ETFs are step one in the technological revolution in the financial markets. Step two is going to be the tokenization of every financial asset.” An S&P Global Market Intelligence analysis concluded, “The ease of investing in bitcoin through an ETF structure will not only increase the popularity of this asset class, but is also likely to catapult it into the financial mainstream.”

Fueled by the introduction of new U.S. ETFs from BlackRock, VanEck and others, average daily digital-asset trading volume surged 224% in January, to $2.19 billion, according to CCData.

Defining infrastructure as “the framework that enables practical use of digital assets for users worldwide,” AlphaPoint, one of the longer-established ecosystem vendors, recently published an overview of essential capabilities – including DLT, digital exchanges, wallets, and payment, liquidity and compliance solutions – to explain why infrastructure is “pivotal to the growth of the blockchain industry.”

 State Street’s Nitin Gaur: “Areas essential to lowering barriers.”

In a LinkedIn post last August, Nitin Gaur, global head of digital asset and technology design at State Street, differentiated between crypto-asset technologies – e.g. “blockchain network infrastructure, key/wallet management and custody” – and the tokenization of existing, or real-world, assets, which comes with “hidden challenges” and “includes a greater degree of operational disruption.

“I have identified two broad areas that are essential to lowering barriers and reducing the impediments (and costs),” Gaur wrote: “a harmonized operational framework; and Interoperability on-chain and off-chain.”

Pleas for Standards

DTCC, meanwhile, has raised the interoperability ante through a meeting of minds with global peers and an acquisition of its own.

The still-maturing, fragmented nature of the DLT marketplace makes a “globally harmonized solution” – what DTCC sees as critical to its mission – “aspirational” and difficult to achieve, Jennifer O’Rourke, the industry-owned utility’s executive director, innovation strategy, said in November at an Atlantic Council conference on digital currency. The council’s GeoEconomics Center co-hosted the conference with the Digital Dollar Project, which on November 30 announced publication of a working paper, Interoperability Standards for Digital Assets.

Overcoming what is “problematic with the cards we are dealt” – avoiding creation of a “digital island” – requires collaboration and standards to ensure access and interoperability, O’Rourke said. “Systems are being created without these conversations.” Proactively embracing best practices is preferable to “having to reverse-engineer.”

In its paper, the Digital Dollar project, which had earlier with DTCC explored post-trade, DLT-based security settlement with a U.S. central bank digital currency (CBDC), pointed to “a patchwork of first steps undertaken by both public and private-sector entities, aimed at achieving disparate objectives . . . focused on frameworks, guiding principles, and, in some cases, the broad development of standards for digital assets.

“Some are CBDC-specific, while others have general applicability in the payments sector. As governments and stakeholders collaborate to establish consistent benchmarks for CBDC development, it's crucial to identify, organize and align standard-setting endeavors.”

Trust, Resilience and Connectivity

In September, DTCC issued a paper together with FMIs Clearstream and Euroclear contending that DLT was being held back by sub-scale, isolated and proprietary pools of liquidity. It made the case for collaboration, standardization and interoperability to overcome those and other limiting factors and underscored the technology’s potential to “reshape securities issuance, accelerate settlements and empower data transparency.”

“We are at an inflection point as an industry when it comes to DLT and digital assets,” DTCC managing director and global head of strategy and innovation Jennifer Peve said in a statement. “With digital assets forecasted to grow in value to around $16 trillion over the next 15 years, now is the time to assess what is needed to propel advancement.

 DTCC’s Jennifer Peve: “Need for well-regulated, neutral players.”

“While we have all accelerated our learnings and identified the benefits of, and constraints related to, DLT on a smaller scale in recent years, there is broad recognition of the growing need for well-regulated, neutral players to provide trust, resilience and standardized connectivity in their respective ecosystems – the role FMIs like DTCC have played for decades – to drive digital asset adoption.”

Jens Hachmeister, managing director, head of issuer services and new digital markets at Clearstream, part of Deutsche Börse Group, said, “As a neutral financial market infrastructure, we are uniquely placed to help the industry’s transition efforts by modernizing infrastructure and driving the adoption of standards across DLT protocols and smart-contract language that will lead to better and faster interoperability between ecosystems.”

Euroclear introduced its Digital Financial Market Infrastructure (D-FMI) platform in October, with the World Bank as the first customer of its DLT Digital Securities Issuance service.

Acquisition of Securrency

In December, DTCC completed its $50 million acquisition of institutional-grade blockchain infrastructure developer Securrency. The brand name was retired, and Nadine Chakar, the former head of State Street Digital who was Securrency’s CEO, became global head of the new DTCC Digital Assets business. She reports to managing director and chief information officer Lynn Bishop.

Securrency, which brought some 100 employees, “is an important strategic acquisition that will give us the technology to drive market-wide transformation by enabling end-to-end digital lifecycle processing for tokenized assets, digital currencies and other financial instruments,” DTCC president and CEO Frank La Salla said when the deal was announced in October.

“By bringing together DTCC’s commitment to providing market stability and our unparalleled network of financial market participants with the sophistication of the Securrency technology,” La Salla went on, “we will be in a leading position to unlock the value of digital assets and help guide the industry through its digital transformation journey. We believe this next generation of financial market infrastructure will further reduce settlement times, facilitate market transparency and risk management, enhance regulatory oversight and controls, and unlock efficiency and innovation to create an improved investor experience.”

“We look forward to providing global leadership to establish a robust digital infrastructure that protects the safety and soundness of financial markets and delivers on the enormous promise and potential of institutional DeFi in the coming years,” La Salla said when the transaction closed.

DTCC Digital Assets “will play a pivotal role in digital assets management and transaction automation,” Chakar, also a managing director, stated in a “2024 outlook” comment. “We’ll bridge the gap between traditional financial systems and DeFi, creating new levels of transparency and new data sources that will aid in compliance and transaction reporting. 

“Looking ahead, we expect firms to prioritize asset tokenization, process automation and seamless post-trade settlement . . . Cross-chain interoperability and the establishment of industry standards will remain critical enablers for sustaining the emerging digital asset ecosystem.”

A digital-asset vision for financial market infrastructures, from the DTCC-Clearstream-Euroclear paper.

International Progress

The U.S. has lagged other countries in collaboratively applying DLT to securities clearing and settlement, according to Coalition Greenwich senior analyst and head of fintech research David Easthope. He cited as an example Project Guardian, a Monetary Authority of Singapore-led asset-tokenization and interoperability initiative with multinational, multi-institution participation.

“They’re moving out of pilots and proofs of concept, into production,” Easthope observed. “They’re actually taking a meaningful role in the tokenization story.”

 Coalition Greenwich analyst David Easthope

At this stage of market development, “DTCC wants to be there to be able to support, create standards, be a player,” Easthope said. The Securrency move “is a recognition that things are moving ahead.”

“It’s a matter of, in the next five to 10 years, what the market will look like and how intermediaries can be disintermediated to make a more efficient market,” the Coalition Greenwich expert continued. He noted – as have DTCC officials – that DLT could come into play as the securities industry shortens its settlement cycle to trade date plus one, or T+1, from T+2, now scheduled to occur in the U.S. this May.

In a “2024 predictions” article published by CoinDesk, Moody’s Investors Service analyst Cristiano Ventricelli saw momentum building in digital-asset tokenization by issuers including the European Investment Bank and Société Générale. “Many of these entities gravitate towards [the Ethereum blockchain] given its extensive ecosystem of applications and networks” and provisions for interoperability and security.

“Over time,” Ventricelli wrote, “in Moody’s view, public blockchain networks like Ethereum and traditional infrastructure will be more interlinked, which will enhance blockchains’ use cases, promoting industry growth.”

Crypto infrastructure pioneer Paxos, which is known for its stablecoin platform – it launched the PayPal PYUSD last year – and security and commodity settlement services, stated in a January 11 blog that both “Ethereum and Solana have gained popularity because they offer solutions to common pain points related to scalability, speed and cost. These platforms have also sparked an entire ecosystem of subsequent innovation,” pointing toward “a transformation of the way global commerce operates.”

“With their ability to power instant, 24/7 financial transactions across borders,” the Paxos post said, “blockchains may be particularly attractive to enterprises operating in multiple countries or those engaging in high-volume trade, not to mention the implications for sectors like e-commerce and digital supply chain management.”

Risk Reduction

Those who are already trading securities using digital technology may welcome DTCC. For INX Digital’s licensed cryptocurrency trading platform, DTCC’s dominant position in clearing and settlement is a plus, both in terms of its market presence and as a vehicle for reducing counterparty risk, said Alan Silbert, INX Digital North America CEO.

Securrency gives DTCC a protocol for tokenization – in effect, a recordkeeping system, Silbert added. “Securrency developed a compliance-friendly, regulatory-friendly tokenization platform. DTCC thought it was easier [to acquire] than starting from scratch.”

With standards set and DTCC in a clearing role, INX could handle secondary-market token trading on its platform. “There’s definitely enormous interest from institutions, in addition to the general public, to have a piece of their assets in digital [form] and digital currencies,” Silbert said. “DTCC could do it on their token standard, clear it and do the recordkeeping . . . Brokers make the trades and then everything clears through DTCC at the end of the day.”

Adaptive Intermediaries

Datos Insights strategic advisor for capital markets Vinod Jain believes leading custodians such as BNY Mellon and State Street also have important roles. Custody and sub-custody intermediaries are “very much a critical part of the overall adoption of distributed ledger technologies.”

Custody banks are in the advantageous position of serving institutional clients who will prefer working with a proven, established partner firm. There is added flexibility, in the sense that “the custody bank can combine traditional assets with the digital assets,” Jain said. “If 80% of your assets are with Bank of New York Mellon, why would you go to a different solution provider?”

“Everything that we do, we want to do for digital assets,” Roman Regelman, BNY Mellon senior executive vice president and global head of securities services and digital, said last May, as quoted in Blockworks.

Jain maintained that the custodians, DTCC, central banks and Swift – the global financial messaging utility, which has conducted blockchain interoperability demonstrations – all have roles in the ecosystem. They must “come together to build up the infrastructure required for the market participants to adopt distributed ledger technologies.”

“The push for modernizing U.S. capital markets’ infrastructure aligns with the demands of digital-native generations for efficiency and transparency,” legal advisor and cryptocurrency expert Beth Haddock, with Clay Haddock, wrote in a December article, Crypto Had Reputational Issues This Year. 2024 Will Change That. The crypto community, they said, “has an opportunity to champion a narrative emphasizing zero tolerance for fraud and highlighting clear use cases.”

An article published February 1 on the Bank Policy Institute website described banks as ready and able to strike the necessary balance between risk management and DLT innovation, but because of regulatory “uncertainty and the long engagement process the regulators require, banks have not yet launched this technology at scale, limiting the benefits it can provide.”