Tokenising the world
Tron (1982), The Lawnmower Man (1992), The Matrix (1999) and now the Metaverse: the fascination for the digitisation of bodies and minds is not new.
With the arrival of the Internet, information was digitised and transmitted without limit and almost instantaneously. Markets have seized this opportunity to grow exponentially, resulting in the landscape we know today. In Europe, France was one of the pioneers of this adventure with SICOVAM, which digitised securities and transactions as early as the 1980s. It should be noted that the digitisation of transactions was much faster on “front” market activities (transmission of simple information: ISIN1 , quantity, price) than on securities settlement activities (exchanging securities for “physical” cash via multiple intermediaries and disparate systems), with some markets still using paper in 2020 (pure registered shares in France; certain notes in Germany; multi-iCSD2 issues).
This tremendous progress took existing schemes (securities banks, paper transactions, financial intermediaries) as a model to digitise and scale them quantitatively but without profoundly changing the structure and operational models. This innovation was incremental and accompanied the globalisation of exchanges, while maintaining strong local ties (CSD, custodian, stock exchanges), adapted to regulations. The arrival of blockchain technology, and particularly cryptocurrencies (Bitcoin in 2009 and Ethereum in 2014), has brought to light another way of conceiving value exchange. This technology, originally designed to eliminate the trusted third party that is the basis of financial transactions, is so disruptive that it is still impossible to grasp its full potential and risks.
This new way of doing finance is changing 3 fundamental aspects of the very structure of capital markets:
1 - The trusted third party that stores the securities (formerly paper and now electronic) is disappearing, being replaced by a decentralised and automated network similar to the Internet that obeys computer code rules valid all over the world and does not require a legal contract between the trusted third party and the user of the service. The computer code embedded in the digital security, or “smart contract”, is replacing registration in the securities account and the associated legal contract that are the basis of all securities law.
2 - The emergence of decentralisation in the validation of operations: computer nodes of “mining” validate transactions in return for payment. These nodes are in competition with each other but, once the transaction is validated, they store it and immediately distribute the information in the network, ensuring the immediate transfer of the securities to the buyer, and this all over the world in the same way, unlike the private and therefore geographically constrained networks of traditional market intermediaries. It should be noted that this unique and natively global mechanism (like the internet) can be used to transfer units of account, securities, digital art representations, etc. in the same way, and can therefore be used to transfer currency instantly from one end of the planet to the other, unlike traditional banking mechanisms also limited to a geographical area, hence the debate on “digital currencies” issued only by a sovereign state.
3 - Centralising assets as a token makes them exchangeable in a seamless and automated way. Clearing, arbitrage or liquidity management mechanisms can thus be automated in the form of “smart contracts” of “decentralised finance” and thus improve the behaviour of markets that are inherently imperfect. The removal of certain intermediaries would limit fees for customers while maintaining an equivalent quality of service. The management of liquidity pools and over-collateralisation rates would be outweighed by more frequent and automatic margin calls, reducing capital requirements and improving LCR3 ratios.
This new way of handling securities would effectively align the level of digitisation of “physical” securities settlement activities (post-trade) with that of market activities handling information very quickly and easily. This would have several visible commercial impacts:
• The centralisation of cash and securities on the same technology substrate (which is not the case today) would reduce reconciliations between counterparties and internal and external actors in complex transaction processing chains. This would thus have an impact on financial institutions’ fixed costs and therefore lead to a restitution of this margin to customers and participants in these activities (employees, shareholders, etc.)
• Distribution channels would be truly global, allowing sales teams to distribute products industrially and identically everywhere. Reaching a new customer would be technologically easy, even in countries with the least well-equipped market infrastructures, and only limited by regulatory aspects. This would boost financial inclusion and make it possible to have smaller nominal values while preserving margins if the structural cost reductions are indeed achieved.
• The use of public blockchain combined with the registered share regime would speed up client onboarding procedures (opening the equivalent of a securities account takes a few minutes and is done online for free, without any specific tool) and to guarantee a detailed knowledge of the Final Beneficial Owners, which is critical for anti-money laundering operations as well as for the marketing use of investors’ identities.
• The use of blockchain securities would be a step towards platformisation similar to that seen in e-commerce, with multi-product platforms allowing cross-asset investment solutions, the easy sale of products bundles (a bond and a hedging derivative, for example) and value-added services (market data, marketing data, alerts, etc.)
To conclude, the appeal of these solutions is that they are compatible with a gradual implementation, without the big bang that every finance professional fears because of the operational risk involved. France and Europe have been pioneers in this dynamic by establishing a flexible and non-trivial regulatory framework, with the PACTE4 law and then the MiCA5 and Pilot Regime regulations. Countries such as Luxembourg and Germany have quickly followed. This in-depth understanding, particularly within the regulatory teams (AMF6 , ACPR7, Banque de France), is an intangible asset that each player can benefit from and allows our financial centre to have a significant lead on the world stage: now it is up to our companies to make the most of it.
1International Securities Identification Numbers.
2International Central Securities Depository.
3Liquidity Coverage Ratio.
4Action Plan for Business Growth and Transformation.
5Market in Crypto Assets.
6The French Financial Markets Authority.
7Prudential Supervisory and Resolution Authority.
David Durouchoux, Deputy CEO, Societe Generale Forge