A Look at the Blockchain-Induced Capital Market Sector

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Written by
Shivani Tripathi
Published on
February 21, 2023

What is a capital market in a financial market?

A capital market is a trading marketplace where enterprises bring more funds to their businesses. For businesses and corporations looking to broaden their horizons, blockchain is one of the most important industries today.

As capital and cash are used effectively, economic activity gradually increases. Keeping issuers, fund managers, investors, and regulators who play a key role in the capital market ecosystem updated is an essential part of capital management.

But in the modern era, as businesses and industries are undergoing several innovative challenges, digitalization has led businesses to have a capital market infrastructure that is sometimes difficult to manage in a centralized system.

With the advantage of blockchain technology, capital markets are benefitting as they bring several transforming shifts to the current infrastructure. This has seemingly increased in recent years, and the blockchain capital market is expected to grow.

Along those lines, it is also seen that around 45% of companies that have more than $50 billion in assets are planning to implement Blockchain-based services in their enterprise, while around 5% of the business have already implemented advanced blockchain-enabled protocols.

Evolution of Blockchain in the Capital Market

Currently, blockchain has become a widely adopted technology across all industries. The financial industry has long been in the game - the World Economic Forum stated that blockchain would reshape the financial infrastructure in their 2016 report - The future of financial infrastructure.

Post-2016, the usage of blockchain was widely adopted, and the trust in this innovation kept growing. Financial institutions like JP Morgan & Chase, Banks of America, and many others started to invest in this growing technology. Gradually, the awareness of decentralized finances and smart contracts grew.

Thus, capital markets and financial institutions are aiming to solve the inefficiencies noticed in the past seven years through blockchain. Some of the inefficiencies are expensive and time-consuming transfers of capital market securities and less visibility of their management.

But what are capital market securities?

Companies raise funds and capital via market securities, which are traded in the primary or secondary market. Some of the common capital market securities are stocks, bonds, securities, derivatives, and real estate trusts (REITs).

Many existing financial intuitions have introduced distributed ledgers for managing capital market securities. As per the World Economic Forum Report 2021, repos, corporate bonds, private funds and administrations, and private equity funds can also now be decentralized through blockchain.

Based on the 2021 report, it is clear the potential of blockchain technology in the capital market and financial industry is expanding.

Benefits of Blockchain Technology in Capital Markets

The capital market infrastructure has been fast changing ever since the implementation of DLTs as it eliminated the market intermediaries and directly connected the markets with investors.

This brings several benefits and opportunities for the institutions. Some of the key benefits that the industry and investors can benefit from are as follows.

1. Shared Data

Blockchain infrastructure enables the data to be stored and verified across all the nodes in the network. Thus, this removes the need for an external party to complete the verification process.

Additionally, this restricts the data from being modified once entered, which enables more security for the data. Though they are stored in the shared ledger, the capital, funding, or investment details are still secure as the access will be only under authorized personas.

It increases the data accuracy and maintains transparency of financial and capital records across the ecosystem.

2. Tokenization

Tokenization of assets, securities, and data is one of the key benefits of utilizing blockchain technology in capital markets.

It is tokenized by integrating a blockchain token into the asset, and when an investor gets a hold of this tokenized security, the ownership is transferred as soon as the deployment of the smart contracts.

These securities are backed by cryptographic keys. This also enables the investors to fractionize the securities as small units.

3. Smart Contracts

The primary benefits of integrating distributed ledgers are the smart contract uses, which might highly benefit the capital market.

As the smart contract encompasses all the pre-set rules, and funding allocations, the execution of the contract is automated when all the requirements are met.

Some use cases of smart contracts in capital markets are as follows.

  • As soon as the majority of the board approves fund allocation, the capital is automatically released to the required departments.
  • These allocated capital and funds can be utilized only for approved purposes, as smart contracts do not approve other utilizations.

Thus, by bringing in distributed ledgers, the capital can be rightly used, which might ensure there is no outflow of funds. This also reduces transaction risks during transfer or settlement while also complying with legal regulations.

Use Cases of Blockchain Technology in Capital Markets

Market participants like shareholders, fund managers, lawmakers, and investors are greatly benefitted from blockchain and the capital market.

This infrastructure can be deployed on any private or permissioned Blockchain, depending on the institutional requirements. Some of the critical use cases of blockchain in the Capital market are as follows.

1. Issuance

Capital issuance is usually done in the primary or secondary markets with the issue of stocks, bonds, or securities to raise capital in return for a dividend.

These processes are automated via smart contracts such that as soon as the security order is placed, verification is done, and ownership is transferred instantly.

2. Fund Administration

The process of fund administration is started as soon as the investments are initiated.

The current fund administration process is prone to errors or misallocations, but when funds are managed through distributed ledgers, it will enable the stakeholders to oversee the investment allocation, which increases transparency.

3. Transfer of Assets

Asset transfer is one of the common terms and processes in the investment and capital market sector.

In the current ecosystem, the transfer of assets is normally managed by an external party - transfer agents who cancel the asset as per the investor's instruction.

This external party is replaced via the smart contract, which enables both the investor and institution to maintain privacy.

3. Clearing and Settlements

The clearing and settlement process is done as the investor files for a security withdrawal.

As the blockchain acts as a single source of data, these payments and settlements are processed quickly and allow real-time transactions, as there is no need for the involvement of third-party to verify the instructions.

4. Streamline Post-Trade Services

Financial institutions and capital markets need to oversee their previous investors in assisting them with post-trade services in order to not cause any friction with settlement, reconciliation, and tax filing processes.

It is stated that over 2 million post-trading contracts are happening per day with over 100 trading entities. Normally it takes T+1 or 2 days to complete the post-trade processes, but blockchain streamlines them and brings them together under one ledger, enabling the processes to be done quickly to save time, cost, and efficiency of the trading partners.

Wrapping Up

Blockchain and capital markets, when integrated together, ensure the ecosystem remains transparent. Along with the capital market institutions, the market participants, and trading partners are also benefited. Thus, we can see how blockchain technology is redefining the financial industry by bringing subtle yet efficient changes.

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