Feature Story

How the blockchain will transform the stock market

by Amy Cortese

How the blockchain will transform the stock market

See why the blockchain has generated a near frenzy in the financial industry over the past couple of years.

For a glimpse of the future stock market, look to the state of Delaware.

In late July, the tiny state signed into law a bill recognizing blockchain technology as an acceptable form of stock issuance. The move was little noticed, but could pave the way for a radical streamlining of the way corporate records and transactions—from stock ownership and transfers to proxy voting and dividends—are handled.

It could pave the way for a radical streamlining of the way corporate records and transactions—from stock ownership and transfers to proxy voting and dividends—are handled.The law legitimizes blockchain technology generally, clearing up a gray area in the law. In addition, the Delaware Division of Corporations is working to implement a blockchain system from New York-based Symbiont. When it does, companies will be able to register, issue and trade shares on a blockchain in a seamless flow. The technology will also streamline other aspects of governance, such as proxy voting and stock splits.

The law was signed by Delaware Governor John Carney, but is part of a broader initiative started by his predecessor to leverage the distributed ledger technology known as the blockchain across Delaware's body of corporate law. As part of the initiative, Delaware has already applied blockchain technology to its public archives and other filings.

Though small, Delaware carries outsize weight in corporate finance. Two-thirds of the S&P 500 and 85 percent of IPOs are companies incorporated in the state. In fact, Delaware-registered firms outnumber its human population.

"We're a very small state and we have a very unique product —our corporate laws, court and judges," says Andrea Tinianow, a lawyer who heads up Delaware's blockchain initiative.

Delaware's actions are closely followed. Already, jurisdictions from Illinois and Nevada to Russia and Dubai have moved forward with similar laws recognizing the use of blockchain.

Reducing cost and complexity

The blockchain has generated a near frenzy in the financial industry over the past couple of years, with billions of dollars being invested in the technology by Wall Street firms and investment banks.

What excites (and scares) them is the blockchain's potential to upend the status quo. The blockhain is a distributed ledger system that underlies cryptocurrencies, such as Bitcoin, although the ledgers can be used independently.  

The distributed ledgers provide a single, shared, immutable record of transactions. When applied to currency, purchases and transactions are captured and recorded on the blockchain's distributed ledger, doing away with the need for a bank to store and track money. The same system can be applied to any kind of transaction, from property records to stock trades.

When paired with smart contracts—mini software programs that can execute instructions—the technology has the potential eliminate intermediaries that add layers of cost and complexity to even basic transactions.

That's especially true for stock issuance, settlement and trading—the functions of the stock market.

"Financial markets are inherently peer to peer markets" of buyers and sellers interacting with each other, says Caitlin Long, president & chairman of Symbiont, the distributed ledger and smart contracts provider that is working with the Delaware Division of Corporations. "Yet we have all of these intermediaries."

See also: Cisco's Hyperinnovation Living Labs hosts blockchain brainstorm

The intermediaries developed over the decades to handle important tasks that require a trusted third party, such as clearing trades, holding assets and keeping records. Many of these processes are outdated and can be handled more efficiently by a blockchain.

It takes three days to settle trades, for example. That lag can leave investor at risk.  "Anytime you have a delay in recognizing who really owns the security and who legally does, the systems get out of whack," says Long.

In one striking example, investors in a class action litigation suit involving Dole Food Company filed claims to 49.2 million Dole shares, even only 36.8 million shares were outstanding. The difference was mostly due to unsettled trades, which inflated the number of shareholders.

A long-term transition

Goldman Sachs has estimated that by automating post-trade settlement and clearing processes and other tasks, blockchain technology can save $2 billion in the U.S. alone, and as much as $6 billion globally.

See also: Blockchain and the next frontier of travel

The first companies to benefit from the Delaware law will be private companies. Every year, millions of new businesses are formed. These privately held companies must register with a jurisdiction (in Delaware, the Division of Corporations), and authorize the issuance of shares.

If a shareholder wants to transfer shares to another party, the company often has the right of first refusal, in which case is must sign off on the transfer. In some cases, shares are restricted for a year. So a seemingly simple transaction can take days and involve lawyers and documents being sent back and forth via email, explains Long. 

When Delaware integrates with the Symbiont blockhain, she says, "all of that will happen on the blockchain and be executed with smart contracts."  Symbiont's blockchain technology can also store the documents. 

It will take longer for public companies to see the gains—that will require action by the Securities & Exchange Commission as well as stock exchanges. Exchanges around the world have been investing in and experimenting with distributed ledgers, and Nasdaq has been has already issued shares using blockchain technology. New players, such as Estonia-based Funderbeam, are building new trading systems from scratch based on distributed ledgers.

"This is not a short term transition," says Long.  "It may take twenty years for publicly traded companies to fully transition over. But it's coming."

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