Over the course of history, technological advancements have reshaped the nature of money and finance. The decades-long journey from analog to digital finance has resulted in cash all but disappearing from our lives and made transactions quicker, easier and cheaper. The same transition is now transforming capital markets, with financial instruments changing hands instantaneously in a global trading environment that is both sophisticated and complex.
Today, the next phase of transformation will be powered by blockchain technology, which has the potential to reimagine existing financial market infrastructure by enabling the digitalization of all asset types and automation of trading of such assets. It is early days and we have seen a few hiccups, but with bold thinking, commitment to innovation, and constructive partnerships, a vast array of opportunities to reshape financial markets await.
Blockchain’s potential in finance
While current market mechanisms allow for immediate trading, existing over-the-counter (OTC) processes for trading securities or asset swaps involve multiple intermediaries that slow down both the initiation and settlement of a trade, adding friction that costs time and money.
Imagine how we could unlock greater efficiency in capital markets through blockchain technology. Tokenization allows financial and other assets to be fractionalized and securely and reliably represented on a distributed ledger. Combined with smart contracts, which allow the automatic execution of transactions when pre-determined conditions are fulfilled, these assets can in turn be traded, borrowed, or loaned across peer-to-peer networks through decentralized finance (DeFi) without the need for intermediaries. This in turn improves the speed, efficiency and transparency of these processes.
In recent industry pilots, the trading process is automated to enable pricing, trade conditions and other pre-determined criteria to be stored in a smart contract that triggers an instant exchange of value and assets when those criteria are met, with all parties involved able to view the transaction at the same time. By bypassing intermediaries, this lays the foundations for building global institutional liquidity pools that enable increased trading velocity, greater transparency, higher efficiencies, lower settlement risks, and economies of scale from a more liquid secondary trading market.
Challenges to overcome
While there is significant potential for blockchain to reshape the current financial market infrastructure, there remain technical challenges in scaling the technology. First, new blockchain applications need to interoperate with current financial infrastructure as well as among different types of blockchains, to allow blockchain technology to scale and create meaningful impact. Second, security risks along the value chain, including smart contract risks, need to be addressed and suitable safeguards put in place.
To harness the full potential of blockchain, however, technological advancement alone is not sufficient as participants need to trust the ecosystem in which they operate. This entails implementing risk management and regulatory compliance protocols to govern transactions between parties that do not know each other.
In addition, regulatory clarity on the legal rights associated with digital assets is critical to fostering widespread adoption of blockchain technology and digital assets. This involves modifying existing laws and regulations or putting in place new guidelines to ensure that regulations are fit for purpose in a digitalized future. Key legal and regulatory issues that need to be addressed include defining property rights for tokenized assets, which has so far been achieved only in the U.S. state of Wyoming, as well as defining how a token in its fractionalized form can truly represent the relevant asset and its associated rights.
Singapore as regulator and innovator
While blockchain technology allows us to enhance existing financial market infrastructure, fully harnessing the power of blockchain will require a whole-of-industry approach, with industry players and regulators coming together to collectively experiment with creating opportunities to reimagine financial markets and mitigate associated challenges.
In Singapore, specifically, the country’s financial regulator — the Monetary Authority of Singapore (MAS) — has played a leading role in enabling innovation at scale within a safe and controlled environment. In May 2022, MAS launched Project Guardian, a collaborative initiative with the financial industry that seeks to explore the economic potential and value-adding use cases of asset tokenization, while managing risks to financial stability and integrity. In less than six months, the project completed its first industry pilot. The pilot, which was led by DBS Bank, J.P. Morgan and Marketnode, tested the trading of foreign exchange and government securities using permissioned DeFi liquidity pools on a public blockchain. With Project Guardian, all anonymous wallets were also verified by trust anchors such as “know-your-customer” processes before trading is allowed to take place within the pool. This provides confidence to all participants involved in the transaction process.
The success of the test trade was ground-breaking in two ways. Beyond clearly demonstrating the benefits of using blockchain technology, it also marked the first instance in which a permissioned DeFi protocol could be used in such a way. With benefits spanning instant and simultaneous (atomic) trading, settlement, clearing and custody, Project Guardian clearly points to blockchain technology’s role in driving greater efficiency by reducing friction and minimizing risks. More importantly, the successful completion of the industry pilot paves the way for further tests to be conducted to not only assess the feasibility of applications in asset tokenization and DeFi, but to also build a robust digital assets ecosystem in partnership with key industry stakeholders.
Pilots such as these propel a forward-looking regulator and the like-minded in the industry to the forefront of technology. These pilots are crucial to facilitating the development of blockchain markets as processes can be tested and mapped in a safe and secure environment.
Singapore, which offers a conducive regulatory environment that supports and rewards the courage to innovate, and is one of the most advanced digital markets globally, is well-placed to lead the reimagination of financial markets. It houses a sophisticated ecosystem of financial players, technology providers and innovators who both support and lead change, buoyed by a deep pool of talent and expertise. This has created a virtuous circle that will allow Singapore to forge ahead as an innovative financial hub.
While we are in the early stages of an exciting transformation journey, with courage, imagination, and collaboration, we look forward to building a flourishing ecosystem in which industry players and regulators alike explore the multitude of possibilities to reimagine the future of financial markets.