The European Central Bank (ECB) has recently published a paper that analyses the key attributes of distributed ledger technologies (DLTs) that could influence their potential adoption by financial institutions and discusses how the use of these technologies could affect the European post-trade market for securities.

The paper, “Distributed ledger technologies in securities post-trading”, has been authored by ECB economists Andrea Pinna and Wiebe Ruttenberg. It discusses three potential models of how market players could adopt DLTs for performing core post-trade functions – in clusters, collectively or peer-to-peer.

“By adopting a DLT, competing financial institutions would be able to share a common digital representation of asset holdings and to keep track of the execution, clearing and settlement of securities transactions outside their legacy proprietary databases, and without there needing to be any involvement of a central database management system”, it said.

The paper added that theoretically, the adoption of DLTs has the potential to make post-trade processes more efficient, and could have a major impact on financial intermediaries that offer post-trading.

" It should, however, be kept in mind that, irrespective of the technology deployed, certain functions present in the post-trade market for securities will always need to be performed by institutions”, it added.

It further noted that while DLTs are to be adopted in financial markets, smart contracts may prove to be the element that causes real change. The paper explained that smart contracts could perform a number of the duties that are currently typically carried out by incumbent post-trade institutions.

“Consensus ledgers, restricted technologies and smart contracts all represent more viable and attractive options for financial institutions, as they draw on existing business models used in the post-trade industry for securities transactions and have the potential to create safer, more reliable and efficient post-trade processes”, the paper said.

The impact of DLTs on post-trade financial institutions depends on at least three factors:

• the level of the post-trade value chain being considered;
   
• the type of governance they would be subject to; and
   
• the way in which the core incumbent institutions are willing and allowed to implement the innovation

Barriers To Widespread Adoption

It further pointed out the potential barriers to widespread adoption of DLTs. Firstly, it said that the technology is not yet mature; second, the clarification of critical legal, operational and governance issues will take time; and third, even were DLTs to be adopted widely, certain post-trade functions will continue to be necessary.

In addition, it noted another major operational obstacle to the adoption and use of distributed ledgers that has also prevented greater interoperability between post-trading institutions: a lack of harmonisation and standardisation. In this context, it said that while common technical standards and business rules are prerequisite for unlocking the true potential of the DLTs, harmonisation is also needed to have market-wide gains in terms of safety and efficiency – every system in the market might need to be able to communicate with all the different DLTs adopted.

It said that it remains unclear whether DLTs will cause a major revolution in mainstream financial markets or whether their use will remain limited to particular niches.

The paper concluded saying, “It is possible that a DLT may find its way into the mainstream market, but should this happen, it is more likely to cause a gradual change in processes, rather than a revolution in the market”.