Have a stock portfolio? You can leverage blockchain technology to protect your investments
There’s a tremendous infographic on “The Blockchain meets the Stockmarket” by Visual Capitalist that explains better than anything I’ve yet seen abour how the blockchain can help you with your stocks in the near to unforeseeable future. I’ve expanded on the explanation of this infographic, with revisions along the way.
History of the Stock Market
The world’s first publicly traded company was the East India Company, launched because of extreme risk at the time. Voyagers lost their lives on the seas, fortunes were squandered – the endeavor was risky and expensive. So in 1600, investors formed “Governor and Company of Merchants of London trading with the East Indies”, also called the East India Company. In 1602, this conglomeration of businesses became the world’s first publicly traded company when it released shares of its corporation on the Amsterdam Stock Exchange. Stocks and bonds were issued to investors, and each investor was entitled to a fixed percentage of East India Company’s profits.
As investors began speculating on the prospects of businesses inclusive and exclusive to the East India Company, a secondary market quickly developed for these securities. People bought and sold stock in high volume, and a central registrar recorded their deals.
More than 400 years later, the dynamics of our modern stock market are very similar to those of the East India Company long ago.
Stock Transfer Agents
Today, more than 130 agents in Canada and the United States transfer the stock from buyer to seller. At the same time, they maintain the records of more than 100 million shareholders who bought stock from over 15,000 issuers. The agents issue and cancel certificates to reflect changes in ownership. Many act as the company’s intermediary for doling out dividends. Stock transfer agents also handle lost, destroyed, or stolen certificates and settle monetary transactions. In this last instance, they settle the shareholder’s cash and the company’s cash in separate accounts for protection in the event of bankruptcy and mismanagement of money.
Problems With this Model
While modern stock transfer agents in the United States have to be certified and are required to register with the U.S. Securities and Exchange Commission or a banking regulator, multiple problems persist:
- Transfer agents and their depositories are a single point of failure – Because there is no backup, the shareholder’s assets are wiped out if something happens to either the transfer agent or the depository.
- The system is exorbitant – It involves registration, transfer, distribution, scrutineering, and courier fees. And that’s just the beginning.
- Information asymmetry leads to market advantages – The agent holds all the information, so the shareholder could have a minimal, maybe skewed, understanding of the prospects of his investment.
- Counterparty risk – The likelihood that the company will not live up to its contractual obligations is systemic. In fact, defaults on loans was partly responsible for the global financial crisis of 2008, when, at least, 85 companies defaulted on debt, according to Reuters.
Other companies like Lehman Brothers collapsed that same year, triggering economic turmoil. Almost six million people lost jobs. There was a 5,000-point Dow plunge. The unemployment rate doubled to almost 10%.
Later, J. Christopher Giancarlo, chairman of the United States Commodity Futures Trading Commission (CFTC), had this to say:
Enter the Blockchain
Instead of having transfer agents and depositories serve as one single centralized source, the blockchain can be used to transfer share ownership between investors. This gives investors control over their investments and decreases the possibility of counterparty risk. Investments are secure since all bonds are replicated along the different “nodes” (i.e., participants on the platform), and it is investors, rather than the transfer agents who own their titles.
In 2017, Nasdaq reported how various companies, including its own, launched blockchain platforms for equity shares. Roughly, here’s how they work:
- Somebody decides to transfer a security.
- The transaction is broadcast to a P2P network consisting of nodes.
- These nodes validate the transaction and user’s identity (or KYC details) using complex algorithms. A valid transaction transfers the title of the security from issuer to shareholder.
- Once verified, the transaction is combined with other transactions that cross the blockchain and the data is permanently and unhackably encoded in the ledger.
AT&T has a fascinating research project in progress, called “An Internet Multicast System for the Stock Market”.
Its architecture uses three applications:
- A unified stock ticker of the transactions that are conducted on the various physical and electronic exchanges. The objective is to deliver the same combined ticker reliably and simultaneously to all receivers, anywhere in the world.
- A unified sequence of buy and sell offers delivered either to a single exchange or a collection of exchanges. The objective is to give all traders the same fair access to an exchange regardless of where in the world they live.
- A distributed, electronic trading floor to replace the current exchanges.
Blockchain technology makes the system cheaper, faster, more convenient, and hugely more secure.
Where do we go from here?
The path forward requires resolving issues such as blockchain scalability to handle added transactions, common standards for all blockchains in the world, regulation, and legislation. Nonetheless, at least ten companies have either adopted or are looking at ways to leverage the blockchain to fundamentally improve their traditional mechanisms.
Here’s a look at five of them:
- Nasdaq and Citi use a distributed ledger to streamline payment transactions between multiple parties.
- Korea Exchange launched Korea Startup Market (KSM) with Blocko’s blockchain technology to enable equity shares of startup companies to be traded in the open market.
- The London Stock Exchange, part of the PDTL Group, is involved in ways to improve the post-trade space using the blockchain technology.
- Santiago Exchange is considering blockchain technology for Chile’s financial sector.
- Toronto-headquartered TMX Group built a blockchain-based prototype to power a new service offering from Natural Gas Exchange (NGX).