DTCC, the Depository Trust and Clearing Corporation, is the most significant institution in the processing of securities worldwide: in 2019 its various arms processed $2.15 quadrillion’s worth of securities transactions.
It’s at the heart of the infrastructure that blockchain could, in theory, make redundant. DTCC has pursued its own initiatives in using distributed-ledger technology. Then last year it took the next step and began to get its head around the emerging prospect of asset tokenization: creating securities in purely digital form.
If securities tokens are to go mainstream and scale, it will likely require the participation of DTCC and firms like it.
So what is the latest in DTCC’s thinking?
Jennifer Peve, managing director for business innovation at DTCC in Jersey City, N.J., says the firm has looked at two use cases: private markets and STOs (security token offerings).
DTCC doesn’t play in private markets until a company stops being private and goes for a listing and makes its shares public. Private equity markets have grown in the U.S. as more companies, particularly those in tech, prefer to stay private for as long as possible.
This may suit those founders, but it deprives securities investors of access to growth opportunities. Private markets are also hard to digitize; vendors only service late stage, pre-IPO companies in anticipation of their going public.
Tokenization, however, allows the private shares to be represented on a blockchain, where they can be exchanged. This makes these instruments easy to process – thus providing DTCC with an opportunity to play in this space. The same thinking extends to the emergence last year of the first STOs.
STOs launching on Ethereum is where the innovation is happeningJennifer Peve, DTCC
“Private markets have seen some vendor solutions that are built on public blockchain,” Peve said. Wall Street firms have typically not embraced public blockchain, at least not directly. “DTCC saw an opportunity to extend our strengthsof providing post-trade infrastructure to the private market space.”
DTCC has built Project Whitney, a prototype digital infrastructure on Ethereum, a public blockchain, for issuer services across primary and secondary private markets.
Public Ethereum or private DLT?
Whitney includes activities including registrar, recordkeeping, and compliance. The project’s specs included smart contracts, off-chain infrastructure, and API integrations. The prototype followed a test company to mint tokens and have them trade on Whitney.
DTCC now seeks outside firms to test the prototype, but Peve says DTCC is exploring enterprise, permissioned blockchains for future developments.
“We saw most STOs were launching on Ethereum; that’s where we see the innovation happening,” she said. “Using Ethereum enables you to reach a global marketplace quickly. DTCC believes our findings and industry sentiment will inform on whether long-term solutions should be built using private ledgers.”
DTCC has tested Ethereum to understand the pros and cons of using a public blockchain. The pros included access to a wide range of wallets, trading venues, and custodial offerings in the market, while remaining compliant; its off-chain stock record provided tokenholders a real-time view of their accounts.
The cons, however, may outweigh the benefits.
These projects are designed to fit within Wall Street’s existing ecosystemJennifer Peve, DTCC
“Public blockchain led to uncertainty of transaction cost,” Peve said. Although Whitney was able to optimize Ethereum’s proof-of-work consensus protocol, it still found variation in how much “gas” (electricity and time) was required to validate blocks and confirm trades. “This variability creates costs and uncertainty,” she said – although Whitney will continue to test on Ethereum.
DTCC hopes to expand testing with more participants while extending its integration to Hyperledger Fabric and R3 Corda.
Processing for securities tokens
Meanwhile DTCC is also working on DLT solutions for its existing securities processing business. DLT has the potential to enable the U.S. market to settle on T+1 (one day after the trade is executed) or even T+0. This capability already exists in DTCC’s traditional infrastructure but Wall Street players tend not to have internal systems capable of meeting those speeds; final settlement is usually T+2.
Project Ion is a DTCC project to “lift and shift” Wall Street’s plumbing onto DLT to enable it to operate faster and modernize capital-markets infrastructure. This implies intra-day settlement, a reduction of risk, lower capital reserves for clearing among financial institutions including DTCC itself (through its securities processing arm, National Securities Clearing Corp.).
This represents a much broader, more aggressive approach to DLT than DTCC’s previous experiments, which looked at very niche parts of its processing businesses – in some cases, DTCC found its traditional infrastructure remained the better option.
If Project Ion is to be deployed, it would most likely be put to work first for securities tokens. Thus it represents the destination for private digital assets that graduate from Whitney into the public domain. But the longer term implication is that DTCC will be ready for other firms to tokenizing outstanding securities – and perhaps provide them with a nudge.
Project Ion could also be used for the cash legs of transactions (as in, say, repo agreements). This puts it in the realm of digital payments. By representing cash on blockchain, Ion also puts DTCC in a position to handle central-bank digital currencies, should those arise, or stablecoins representing dollars (say).
“If these projects move forward, they are designed to fit within Wall Street’s existing ecosystem,” Peve said, giving the DTCC a role in fund administration, transfer agency, issuer services such as proxy voting, and other capital-markets processing. But that ecosystem itself is going through big changes.