PHOENIX – An emerging network technology that has already begun to trickle into the securities industry has the potential to make the municipal market more efficient and transparent, broker-dealers say.
Blockchain uses distributed ledger technology to record digital transactions in a way that is accessible throughout a given network of computers, meaning that there is no need for a third-party or centralized data storage center. The technology has already been applied in servicing the digital currency Bitcoin, and is now under examination by broker-dealers big and small, as well as the trade groups that represent them.
“Blockchain bundles transactions into ‘blocks,’" the Chamber of Digital Commerce said in a report earlier this year. “Each block contains the previous block’s ‘hash’ or digital signature, so each block is linked to the prior one, and together they interlock to form a chain. It is therefore extremely difficult—and for practical purposes impossible—to change one block without changing all the others that followed it. Each block and the data it contains are essentially immutable.”
Blockchain also time stamps all new entries and changes, providing a secure record of what has been done and when. The nature of the chain, built into a number of computers rather than a central server, also increases security.
San Francisco-based broker-dealer Neighborly is among the leaders in trying to bring distributed ledger technology to the muni market, market sources said. Jase Wilson, chief executive officer at Neighborly, said his firm views blockchain as a jumping off point for a change in the way technology and the muni market intersect.
“It is the base layer in what we view as the next paradigm in technology,” said Wilson, who added that his team is currently exploring how to integrate distributed ledger technology into its operations. “We’re very excited about bringing it to public finance.”
Wilson said that he envisions a muni market that becomes increasingly low-cost for smaller players and individuals to do business in, facilitated by technological advances such as blockchain.
“We see the opportunity to eventually collapse the cost structure,” Wilson said. “It’s a work in progress because it’s so new. In a few years, it will be everywhere.”
Market sources said they see a variety of possible applications for blockchain in the muni market, particularly in speeding the business up and lowering costs.
“I definitely see it being utilized in the clearance and settlement of trades,” said Bond Dealers of America federal policy advisor Justin Underwood.
Blockchain technology could be paired with smart contracts to automate much of the trading process, the Chamber of Digital Commerce said. Securities can be coded as smart contracts, which execute when given certain parameters. Underwood and Wilson both said they could see near instantaneous, or “T+0” settlements in the future.
A dealer source who preferred not to be named said that he could see using the technology to comply with rules such as “know your customer” regulations. Firms could use their distributed ledgers to keep a virtually tamper-proof record of their information about and interactions with their customers, allowing regulators to see on what basis a firm thought a trade was suitable for that customer.
The Chamber’s report also laid out a regulatory use for blockchain.
“With its immutable audit trail recorded simultaneously on multiple nodes, blockchain can store financial information accurately, safely, and cheaply,” the report said. “It can also share it in real time with regulators.”
Underwood cautioned that it may take some time before the muni market fully embraces a sweeping technological overhaul like distributed ledger technology, even though that technology would continue the trend of transforming the muni market to more closely resemble the equities market. BDA is interested in the technology, Underwood said, but smaller and middle-market dealers may face a cost barrier to entry.
“Public finance markets need to have an open mind towards it,” Underwood said. “We need to speak with and partner with our regulators to ensure that there are no issues going forward.”
