The buzz around the potential benefits of distributed ledger technology, commonly known as blockchain, has seemed to reach a fever pitch. Proponents tout blockchain’s potential to revolutionise securities and derivatives trading. Global financial institutions and start-up companies have invested millions of dollars in research and development efforts dedicated to implementing the technology. But like any new technology, market participants should balance blockchain’s potential benefits together with its real-world limitations.

Blockchain technology can remove the need for a trusted settlement intermediary in certain transactions between buyers and sellers. With blockchain, all prior transactions are recorded in blocks on ledgers distributed across a network of servers, known as nodes. When a buyer and seller seek to enter into a new transaction, the transaction is validated using cryptographically secure algorithms that confirm the accuracy of the blocks stored on each of the nodes. If the transaction is validated against the existing blocks, the trade is executed, and a new block of executed transactions is added to the chain. Once a new block is added to the chain, it cannot be reversed. This immutability, plus the distribution of records across a number of nodes, makes it possible to transact without an intermediary. Moreover, some blockchains can support self-executing agreements, known as smart contracts, capable of automating payments and deliveries based on pre-programmed instructions. Blockchains can be public (like the one that underlies Bitcoin trading), partially decentralised (open to the public, but only to permissioned users that satisfy prescribed standards) or private (where a single intermediary or group of pre-permissioned users may operate the network).

Apr-Jun 2017 Issue

McGuireWoods LLP