How distributed ledger technology can impact the role of centralized clearing parties

Periodically, transformative technology emerges that instigates profound changes across multiple industries, redefining the way we live our lives and conduct business. Distributed ledger technology (DLT) is one contemporary example.

DLT operates on the principle of decentralization, structured upon layered protocols and frameworks. At its core, it distributes transaction data across numerous points, all connected to a shared ledger acting as the golden source – removing many reconciliation efforts. This shared ledger, updated collectively by “nodes” utilizing diverse consensus mechanisms, forms the backbone of DLT’s architecture, with blockchain technology driving its mechanics.

Tokenization and physical assets

One of DLT’s most striking applications is the tokenization of physical assets, creating what are known as digital assets. From tokenized securities to cryptocurrencies and central bank digital currencies (CBDCs), these digital representations revolutionize the trading landscape. Tokenization empowers investors to transact assets with unprecedented speed and fractional ownership, fostering liquidity and lowering bureaucratic hurdles.

Impact on centralized clearing parties (CCPs)

Through DLT, counterparties engage in direct trading, bypassing traditional intermediaries. This raises pertinent questions about the future role of CCPs in this DLT-driven paradigm shift. But before we look into the future, let’s examine some current developments in this arena.

What’s the latest in the industry?

BlackRock, a globally leading asset manager, has revealed plans for a digital fund leveraging Ethereum’s blockchain, while simultaneously acquiring a stake in Securitize, a platform facilitating asset tokenization. This strategic move underscores their commitment to tokenization infrastructure and a shift in the approach.

Meanwhile, Cleartoken are a new industry disrupter in this space, who recently raised $10 million in seed investment. Their declared mission is to be one of the first entrants in the CCP space for digital assets. The plan is to establish a central clearinghouse that will mitigate risk and encourage wider institutional adoption of crypto currencies by creating a more secure trading environment.

As the industry forges ahead, regulators and governments starting to recognize the potential of digital assets. Treasury Secretary Janet Yellen advocates for US leadership in the crypto space, while regulators from the UK, Singapore, Switzerland, and Japan collaborate to explore digital asset use cases. Additionally, the US Securities and Exchange Commission’s approval of Bitcoin ETF earlier this year highlights the evolving regulatory landscape.

Opportunities for traditional CCPs

Despite the potential threat emerging to the role of traditional CCPs – they also have opportunities to take advantage of. Many parties will require guidance and assistance to navigate the digital assets infrastructure space. CCPs are uniquely placed with their existing relationships to both help inform regulators, and guide parties through the new regulatory landscape. CCPs could also take a lead in setting up technical infrastructure within organizations to make digital asset trading possible. Clearing parties’ familiarity with the market, individual participants and the regulators mean they are uniquely placed to be at the forefront of change if they have the right strategy. This would allow them to continue their role as facilitators, with less control of the processing, but more influence within the individual parties. There will also be a demand for hard copies of ledgers, at fixed points in time. As leaders on the blockchain with high stakes in various chains, existing CCPs could be able to produce this.

Whether participants strongly believe in the power of DLT or have lingering doubts, one thing is clear: DLT is here to stay and it’s changing the world of post-trade financial services forever.