Blockchain in Settlement Process of Trade

Blockchain in Settlement Process of Trade

Author: Krishna Bhattacharya, KIIT school of law, Bhubaneshwar, India

1. INTRODUCTION

Whenever someone hears the word “ Blockchain” people instantly associate it with the “Bitcoin”. This notion is however very ostensible. The technology of Blockchain has much wider application and is used for different purposes as well and is applied in various sectors such as the banking sector, medical, in the capital market and other sectors as well.[1]

Blockchain is also called distributed ledger where complete content is copied across the entire network and stored in databases. The information in the database gets updated by itself with the help of consensus algorithms that are built for a particular blockchain. The advantage of this particular technology is that it makes nearly impossible for anyone to hack the system and change the data which is already stored.[2]

To understand how blockchain is going to help in the settlement process of trade, the article will put emphasis on the technology behind blockchain and how does it work, effect of blockchain on the stock market, application of blockchain in settlement process of trade, how blockchain is used in the global market and finally the paper will critically analyze whether it is beneficial to adopt the technology of blockchain in the settlement process of trade.

• The technology behind Blockchain

In the year 1991, for the first time, Stuart Haber and W. Scott Stronetta wanted to create a system that could timestamp documents cryptographically so that the documents could not be tampered with.[3] This system led to the development of bitcoin using the technology of blockchain by Satoshi Nakamoto in the year 2008.[4]

In simple terms technology of blockchain essentially means that blocks containing information are joined chronologically and are connected via the chain.

The following are the steps of the working of blockchain:[5]

1. A block starts with a person putting information in the form of a symbol, number, figures, alphabets, etc and is digitally encrypted ( similar to digital signature in the present day to verify the credentials of the user) via public key or private key.[6] This transaction is done through a node ( node means a software, computer, laptop or any other device which can run the algorithm of blockchain).
2. A particular transaction has to be validated by the peers via different nodes on a preset criterion across various networks.
3. After validation, the information of the transaction is put in a block and the status shown to the peers is that of confirmed.
4. This newly created block gets links to another block cryptographically. The link through which it gets connected is called a hash pointer. Again when the block is added to other blocks validation is required by other peers through nodes to confirm that the information put inside the block is a valid one.
5. Every time a block is created confirmation is required. Once it gets confirmed it becomes the blockchain. This essentially prevents hackers from hacking. If someone tries to change information, immediately the information goes to people in the network in the blockchain for confirmation.

Some of the features which make the blockchain a unique one are as follows:

1. Decentralization: Blockchain is decentralized which means no person or group of people control the entire process or have access to the information in the blockchain. All the people involved in the blockchain has a copy of all the ledger, the newly created ones and as well as the old ones. This feature also prohibits to modify, add or delete information on his or her own. Decentralization provides transparency and as well as security.

1. Peer to Peer Network: This feature allows network participants to give approvals for transactions through machine consensus ( or via nodes). A person doing a transaction from one part of the world can get his or her transaction approved within minutes without any transaction cost involved.

1. Immutable: once data are written in a block it cannot be changed or altered. It is similar to sending a message. Once a person had sent a message to a bunch of people it cannot be deleted. The only option then left is that the person has to ask individually to delete the message which will be a tedious job to do. In the blockchain, it is nearly impossible to do because the identity of the participants in the blockchain is kept anonymous.

If by chance one block is changed, the hash of each block will change and ultimately the entire blockchain will be changed. This feature of blockchain makes it tamper-proof.[7]

• EFFECT OF BLOCKCHAIN IN STOCK MARKET

Blockchain can become a solution to a lot of problems in the stock market in which investors, intermediaries and all other people and institutions involved face on a daily basis. This comes handy especially when the country is struggling with cybersecurity and follows the norms of KYC. Some of the uses are as follows :

1. Blockchain can be used to directly transfer share ownership instead of going through a centralized hub. This would reduce the time and cost involved in the transaction.
2. The trading and settlement process which takes a span of few days could be reduced to minutes.
3. The introduction of blockchain will eliminate the third party and the ease of doing the transaction in the stock market would increase by multifold.
4. Many companies are using this technology for an effective transaction such as the Royal Mint Gold by which it uses to transact and trade physical gold in a secure and effective way.[8]

• APPLICATION OF BLOCKCHAIN IN CLEARING AND SETTLEMENT PROCESS

In the Indian stock market settlement of shares means the actual transfer of money and clearing means to update the accounts after the final payment and transfer of shares. This process takes almost two to three days after the trading day. This is done through the National Securities Clearing Corporation ( NSCCL), a wholly-owned subsidiary of the National Stock Exchange (NSE).

The present process of the Trading and Settlement process is as follows [9]:

1. The order is placed in the stock market via a broker.
2. NSCCL notifies the trade details to the custodian. In case there is custodian participant it affirms the transaction to the custodian and further, the custodian affirms the transaction back to NSCCL.
3. A pay-in obligation arises based on which clearing banks are given instruction to pay in time the amount.
4. Further instructions are given to the depositories for the transfer of shares via depository participants.
5. After this, there is pay in of securities where they debit the pool account of the depositories and credit the account of the depository.
6. Similarly, there is pay in of funds where the clearing bank debits the account of the buyer.
7. Further, there is a payout of securities and funds where the seller’s account is credited for funds and debited for securities via the depository and the custodians.
8. Finally, the Depository informs the custodians through depository participants to update the account when the transaction is successful. Similarly, clearing banks also gives an update of the transaction status to the custodian.

The entire process though takes only two days but it is very complicated when it is put into practice. This process is further complicated when foreign investors buy stocks in the Indian market. The time gap between the two countries makes the process more complex. This entire process can be further shortened up and simplified with the advent of the blockchain technology in trading and settlement process. The following are the steps as to how blockchain can be beneficial[10]:

1. A ledger shall be distributed to all the nodes, i.e the depository, clearing bank, custodian, etc.
2. After trading, the information shall be distributed to all the nodes for validation and confirmation.
3. Through the public and private key, the transaction will be verified.
4. Once it is verified and the transaction is completed the information shall be stored in the block and the block automatically shall get connected to the chain of blocks.

Therefore, the above process of trading and settlement can be completed in these few steps with the help of the blockchain.

• BLOCKCHAIN IN GLOBAL MARKET

Nasdaq is effectively using the blockchain technology in banking, clearing and settlement process and is further expanding the technology.[11] Not only abroad but also in India, the largest bank, State Bank of India (SBI) has partnered with Bankchain and intel to develop blockchain solutions.[12] Hong Kong stock exchange, Jakarta stock exchange, Australian Securities Exchange and many others are using the technology of blockchain.[13] The usage of this technology has clearly shown an increase in the activity in these stock exchanges as more people are participating because of the ease it provides and transparency.

• CONCLUSION

Chandrajit Banerjee, director-general, a confederation of Indian Industry notes, “Given its size and innovation development, India has the potential to make a true difference to the global innovation landscape in the years to come.”Additionally, Research And Markets connote “56% of Indian businesses are moving towards Blockchain technology, making the technology a part of their core business. As a result, there is increasing demand in relevant blockchain-related skillsets which have led to the launch of numerous educational initiatives”.[14]

Blockchain is an innovative technology that can change the ways of the working of the Indian capital market and bring in a revolutionary change. However, the cost of putting blockchain technology into the Indian stock market is high but in the long run, it would be beneficial as it would reduce the operation cost. It is also very necessary before implementing this revolutionary technology India should have a proper cyber law in force and a proper data protection law. The legal question which is involved with the implementation of Artificial Intelligence is similar to that of Blockchain such as if something goes wrong who is to be held responsible? Or under articles 16 and 17 of Europeans Unions Data Protection Regulation certain data can be modified to suit the legal requirement but how will modification of data take place in blockchain? And many other conflicts.

One of the solutions to this problem is to use private and permissioned blockchain instead of a private permissionless blockchain. The above problems could only be solved by doing more research just like other countries are doing and implementing it. Many new technologies are coming up every day such as cloud storage, Robotic Process Automation and many more. All these technologies unless given a trial cannot be tested. The same is the case with blockchain technology. Also, given the advantages of using blockchain, it should be adopted for the trading and settlement process in India.

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[1]Arvind Narayanan, Joseph Bonneau, Edward Felten, Andrew Miller, Steven Goldfeder,Bitcoin, and Cryptocurrency Technologies ( vol.1 Feb 9, 2016) pp.4.

[2]“Zibin Zheng, Shaoan Xie, Hongning Dai, Xiangping Chen, and Huaimin Wang, An Overview of Blockchain Technology: Architecture, Consensus, and Future Trends, 2017 IEEE 6th International Congress on Big Data, pp.2.

[3]Dr. Asif Ali, Mr. Jacob Antony, A Survey on Applications of Blockchain beyond Bitcoin, IJSRD – International Journal for Scientific Research & Development| Vol. 7, Issue 04, 2019 | ISSN (online): 2321-0613.

[4]“Joseph Chukwube, The Technology Behind Blockchain-based Supply Chain: What Does it Actually Do?”(October 21^st 2019) available at <https://hackernoon.com/the-technology-behind-blockchain-based-supply-chain-what-does-it-actually-do-3804f23c7387> ( accessed on 22.12.2019).

[5]Ibad Siddiqui, What the hell is blockchain and how does it work?, (26^th Oct,2019) available at<https://medium.com/coinmonks/what-the-hell-is-blockchain-and-how-does-it-works-simplified-b9372ecc26ef> ( accessed on 20.12.2019).

[6]Sainul Abideen, BLOCKCHAIN, Cybrosys Limited Edition E-BOOK, pp.16 available at <https://www.blockchainexpert.uk/book/blockchain-book.pdf> ( accessed on 20.12.2019).

[7]Doug Galen, BLOCKCHAIN FOR SOCIAL IMPACT MOVING BEYOND THE HYPE, Stanford Business, study for social innovation, pp.6, available at <https://www.gsb.stanford.edu/sites/gsb/files/publication-pdf/study-blockchain-impact-moving-beyond-hype_0.pdf> ( accessed on 20.12.2019).

[8]Lee Bohl,What is blockchain and how will it affect the future of trading? available at <https://www.schwab.com/active-trader/insights/content/what-is-blockchain-and-how-will-it-affect-future-trading> ( accessed on 23.12.2019).

[9]National Stock Exchange of India ( NSE), Capital Market- Clearing and Settlement, ISMR, P.118, available at <https://www.nseindia.com/content/us/ismr2009ch5.pdf> ( accessed on 23.12.2019).

[10]Surya Ann Thomas(2018), Application of Blockchain in Clearing and Settlement: A Case Study of NSE, ISSN 2321–2705.

[11]Nasdaq Blockchain, Johan Toll, Product Manager Blockchain, December 2017.

[12]Harsh Agrawal, 11 Blockchain Startups From India – CoinSutra Picks ( 11^th August 2019), available at <https://coinsutra.com/indian-blockchain-startups/> ( accessed on 20.12.2019).

[13]Why are Nasdaq, JFX, and othertraditional exchanges switching tothe blockchain? (December 2nd 2018 ) available at <https://hackernoon.com/why-are-nasdaq-jfx-and-other-traditional-exchanges-switching-to-the-blockchain-3ef5ecd76eb6 > ( accessed on 20.12.2019).

[14]Why India is Poised to be a Leader in Blockchain Technology Adoption – Hyperledger, (August 22, 2018) available at <https://www.hyperledger.org/blog/2018/08/22/why-india-is-poised-to-be-a-leader-in-blockchain-technology-adoption> ( accessed on 19.12.2019).