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Digital diversity is key to the blockchain bond boom
Bonds using distributed ledger technology have been in development for a decade. During this time, the market has accumulated a growing number of public and private initiatives exploring how DLT, otherwise known as blockchain, could be used in market infrastructures to improve bond issuance, trading and settlement.
Such fragmentation may seem to contradict the goal of expanding the digital bond market. Indeed, it is a vital foundation for what is to come.
There is a sense that the development of DLT systems is motivated not only by the desire to innovate, but also by not wanting to miss something. According to McKinsey, the volume of tokenized assets is expected to reach $5 trillion by 2030. On Tuesday, Switzerland’s SIX Digital Exchange reached the rather low milestone of over 1 billion francs of digital assets on its platform.
The European Union has noticed this and perhaps got ahead of its rivals in Asia and the United States by embarking on the ambitious processes of the European Central Bank last week. More than a dozen banks, central banks and market participants will test central bank digital currencies for bond settlement.
As the market develops, it will have to choose whether to support a single, cohesive digital system or persist with fragmented systems that seek to be interoperable.
The irony of fragmentation
The current phase of innovation naturally generates a wide range of solutions, each with its own strengths and weaknesses.
This is the experimental phase, during which the market needs to test different solutions to find the best one. But the price of innovation is fragmentation.
Fragmentation is, of course, an ironic externality in the case of blockchain technology. After all, the very purpose of blockchain technology is to create a single, shared, incorruptible and indisputable ledger for all.
At the moment, it is unclear for many market participants how they can achieve anything in the bond market more efficiently using DLT than traditional methods – and even if they believe in a digital future, the development costs to get there are enormous.
So the mission is to figure out how to move from a series of fragmented systems and protocols to something that can be used by the entire market.
The idea of a single blockchain to rule them all is fanciful. After all, financial systems run on trust, and it’s hard to imagine banks entrusting their own and their customers’ security and compliance to a single decentralized system; or to a blockchain built by a rival.
Therefore, the watchwords are harmonization and interoperability: building a lean digital market where different technologies connect to each other seamlessly, in a standardized way and without redundancy. This is certainly the version of the future that the ECB Governing Council is supporting.
The ECB processes will test three solutions for the next big problem to solve in building a digital bond market: how to settle cash on the blockchain. But this isn’t necessarily a tournament. It is thought that all three methods – one French, one German and one Italian – could coexist.
The functioning of the digital bond market on different and fragmented platforms has been described as an obstacle to its growth. It’s a fair comment, even if the market is still in its infancy.
To grow, it must develop interoperable solutions that connect the supply of digital bonds with demand at every stage of their life, from issuance, through the secondary market, to redemption (or restructuring and default, of course). Until everyone can trade with each other as they do in the analogue market, digitalisation will be limited.
For now, though, fragmentation is not a bug but a feature: it stimulates competition.
The result will be systems built to do what its users need: a marketplace with a single point of access to many blockchain infrastructures.
The market is likely to maintain a range of DLT bond solutions, which will be enhanced to work together, rather than realizing a large-scale unified ledger. To achieve a level of seamless interoperability, innovation, fragmentation, cooperation and healthy competition are needed.