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The optimal model for the application of distributed ledger technology (DLT)

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2019/04/29

CLS’s Alan Marquard explores how the financial industry and regulatory community can realize the benefits that new technologies such as DLT can deliver.

Successful application of DLT occurs, if and only if, there is a clear understanding of a business problem. While there has been no shortage of PoCs, not all have been successful in improving existing ways of working – often because the application of DLT was a solution looking for a problem. When it comes to DLT applications in the financial market infrastructure space, safety and resiliency should be the priority rather than speed to market. If a PoC does not move to production, this is not a failure of DLT but an acknowledgement that DLT’s application does not benefit a particular process.

...in the financial market infrastructure space, safety and resiliency should be the priority...

Further, in certain cases, DLT may be used to improve an existing process that is run on a mature technology stack. A significant amount of integration may need to take place between the new technology and the legacy infrastructure, equating to a significant investment in infrastructure build and resources. Firms will need to proceed with caution as they consider the best way to enable interoperability. Without interoperability there will be duplication of effort and unnecessary cost, as well as a delay in time to market.

Defining rules and technical standards is another must. Clear technical standards are required if interoperability is to deliver maximum benefit to the industry. A digital ledger network of thousands of firms requires well-understood rules and technical standards for the ledger’s operations and integration with any legacy technology or systems. Without clear rules and technical standards, there is a risk that participants establish multiple parallel business networks that do not communicate with each other; preventing scalability and wide-spread adoption, while creating silos and duplication.

Technology maturation also takes time and typically undergoes at least two stages before it reaches maturity: 1) the research and development (R&D) phase, where investment is made and the prospects of failure are typically high; and 2) the ascent phase, where costs have been recovered and the technology begins to gather strength. The maturity phase marks the point at which the technology is delivering a high and stable income. DLT is only now moving to the ascent phase, and it has a long way to go before it can be considered mature. Further, when it comes to systemically important financial market infrastructures like CLS that have adopted DLT for activities such as netting, the journey from R&D to ascent has probably taken even longer due to a strict testing program designed to ensure its resiliency, reliability and safety to the market.

The reach and power of a network makes the DLT proposition attractive to users. Once that network is formed, immediate questions arise: who is going to run, operate, and integrate the network? In financial markets, these questions can only be answered via the formation of a partnership between a market infrastructure and a technology company. The market infrastructure understands the business problem to be addressed and has experience in managing operations at scale, while the technology provider has the experience of running technology and operations.

The absence of any one of these components will prevent the financial industry and regulatory community from realizing the benefits that new technologies such as DLT can deliver.

First published in “Views – The EuroFi magazine”, April 2019