Bonds' industrial revolution is still in its nascent phase

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Bonds' industrial revolution is still in its nascent phase

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Legacy institutions are keen to get into the new digital marketplace, but it is not clear that will bring efficiency

A wide range of institutions have been innovating and experimenting with new distributed ledger technology that enthusiasts believe could transform the infrastructure of capital markets.

Supranational organisations such as the European Investment Bank and World Bank are among the issuers that have experimented with blockchain technology and sold bonds in new digital formats.

Central banks — realising they too will be affected by digital transformation — have conducted their own trials, including testing the uses of central bank digital currencies.

It comes as no surprise that banks, exchanges and clearing houses have also begun investing in digital technology, such as applying distributed ledgers in bond market processes.

Having ploughed money and deployed resources into digital innovation, it is only reasonable that institutions seek a return on their investments.

Yet as financial institutions vie with each other for a piece of the new digital business, it raises questions about efficiency. Legacy institutions are keen to secure their stakes in the nascent marketplace, but it is not clear that that makes economic sense.

Of course, adopting new technology and trying to make it work within legacy frameworks is nothing new.

Go back a couple of thousand years and the Romans came up with their own innovative and brilliant solution — using arches to build bridges.

Then, years later, a new material to build bridges emerged — steel. For a while, engineers continued to construct steel bridges using the same Roman geometry, even though steel was strong enough that arches had become redundant.

Eventually they learned how to build flat steel bridges and suspension bridges.

Fast forward, and the equivalent of arches are being proposed in digital capital markets.

Market participants want to build systems to connect different, independent blockchains.

But that looks unlikely to deliver the claimed efficiencies, compared with today's centralised systems.

Many think one shared ledger, on which all participants could enact transactions, would be more efficient.

But getting to that point looks difficult. There is no agreement on how best to evaluate the competing merits of different technical solutions. And who, if anyone, should decide.

For the moment, DLT in capital markets is stuck in the steel arch phase.

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