A new report from financial giant Japan Exchange Group (JPX) contends that distributed ledgers will work “better” when applied to capital markets if third parties are involved.
The finding comes from a 27-page working paper, released yesterday, in which JPX offered insights into its proof-of-concept efforts, as well as the key takeaways from its experiments. For JPX, the report is the latest product of its deepening interest in blockchain, following a partnership with IBM announced in February.
Given that the bitcoin blockchain was designed to remove third parties from online transactions, the proposition that derivative technologies will be more effective without this feature is likely to emerge as a controversial one.
Still, JPX’s report argues that it’s necessary for financial institutions to pursue this architecture as a means of guarding against the risk that blockchain data is accessible to other financial institutions who might be using a shared ledger.
The report reads:
“Considering these concerns or business requirements, it is preferable that all stored data is only accessible by related parties. Since this will lose the feature of ownership certification by public trust, nobody can validate his/her claim of securities ownership. Therefore, full data access privilege needs to be given to a trusted third party who is responsible for the ownership certification.”
JPX revealed that during its proofs-of-concept, central securities depositories played the role of a certification authority, a system that it believes will be as secure as the decentralized version employed by the bitcoin blockchain at scale.
Other entities that could come to facilitate blockchain transactions include regulators and IT vendors, it said.
The authors go on to assert that having a third party will also mitigate the risk of settlement failures, arguing it could mediate situations between buyers and sellers in which gridlock emerges due to the lack of a promised delivery.
The statements are the latest that find major financial institutions grappling with the question of how to gain the speed and efficiencies of shared ledgers without offering full transaction history to all participants.
As noted by leading analysts, this issue, whether real or perceived, has emerged as a pressing question that may be holding back larger adoption of distributed ledger tech.
Replicating bitcoin
Yet even as the paper finds JPX offering a more narrow definition of a distributed ledger for enterprise firms, it was effusive in its praise for how the bitcoin blockchain has applied advances in cryptography to finance.
For example, the authors said that while the bitcoin blockchain featured what they referred to as “well-defined parameters”, they noted that DLT is not yet a comparable technology in terms of its development stage.
Still, the report went so far as to label distributed ledger technology as “extremely attractive” for infrastructure uses, citing its immutability and resistance to system failure, as well as its ability to enable a shared ownership registry.
“On top of these technological features, redesigning the business process by exploring DLT would bring industry-wide efficiencies including financial service innovation or broader cost reduction,” the report reads.
The report evaluates six aspects of DLT including its applicability to capital markets, throughput, consensus process, data privacy, availability and cost.
JPX sees clearing and settlement as the layer it considered “the most important use case”, as it could make existing workflows “more efficient”, while the firm said it believes other use cases, such as trading or reconciliation, would be more problematic.
Call to action
Elsewhere, JPX sought to indicate that it remains committed to investigating and expanding its support for distributed ledger applications despite challenges ahead.
One of the primary reasons, according to the report, will be the cost savings it believes financial institutions can achieve by changing the existing business processes with DLT. The report asserts that DLT could come to reduce hardware, software and maintenance costs.
The paper uses this observation as a call to action, with JPX voicing its commitment to participate in more technology trials as an infrastructure operator.
The authors concluded:
“Unlike bitcoin, which has been operating since 2009, DLT application in capital market infrastructures has rarely been investigated and needs further experiment and enhancement until it matures to be a fundamental technology of capital markets.”
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