Blockchain is transforming capital markets in Singapore and beyond

Throughout history, technological advances have reshaped the nature of money and finance. The decade-long journey from analogue to digital finance has resulted in cash almost disappearing from our lives and made transactions faster, easier and cheaper. The same transition is now transforming capital markets, with financial instruments changing hands instantaneously in a global trading environment that is both sophisticated and complex.

Today, the next phase of transformation will be driven by blockchain technology, which has the potential to reimagine existing financial market infrastructure by enabling the digitization of all asset types and the automation of trading in such assets. It’s early days and we’ve seen a few hiccups, but with bold thinking, a commitment to innovation and constructive partnerships, a wide range of opportunities await to reshape financial markets.

Blockchain’s potential in finance

While current market mechanisms allow instant trading, existing over-the-counter (OTC) processes for trading securities or asset swaps involve multiple intermediaries that slow down both the initiation and settlement of a trade, adding friction that costs time and money.

Imagine how we could unlock greater efficiency in the capital markets through blockchain technology. Tokenization allows financial and other assets to be fractionated and represented securely and reliably on a distributed ledger. Combined with smart contracts, which allow the automatic execution of transactions when predetermined conditions are met, these assets can in turn be traded, borrowed or borrowed across peer-to-peer networks through decentralized finance (DeFi) without the need for intermediaries. This in turn improves the speed, efficiency and transparency of these processes.

In recent industry pilots, the trading process is automated to allow prices, terms of trade and other predetermined criteria to be stored in a smart contract that triggers an immediate exchange of value and assets when those criteria are met, with all parties involved able to see the transaction simultaneously . By bypassing intermediaries, this lays the foundation for building global institutional liquidity pools that enable increased trading speed, greater transparency, higher efficiency, lower settlement risk and economies of scale from a more liquid secondary trading market.

Challenges to overcome

While there is significant potential for blockchain to reshape today’s financial market infrastructure, there are still technical challenges in scaling the technology. First, new blockchain applications must interoperate with existing financial infrastructure as well as between different types of blockchains, to allow blockchain technology to scale and create meaningful impact. Second, security risks along the value chain, including risks to smart contracts, need to be addressed and appropriate security measures put in place.

To exploit the full potential of blockchain, however, technological progress alone is not sufficient, as participants must trust the ecosystem they operate in. This involves implementing risk management and compliance protocols to govern transactions between parties who do not know each other.

In addition, regulatory clarity on the legal rights associated with digital assets is essential to promote widespread adoption of blockchain technology and digital assets. This involves changing existing laws and regulations or putting new guidelines in place to ensure that the regulations are fit for purpose in a digitized future. Key legal and regulatory issues to be resolved include defining property rights for tokenized assets, which so far has only been achieved in the US state of Wyoming, as well as defining how a token in its fractional form can truly represent the relevant asset and associated rights.

Singapore as regulator and innovator

While blockchain technology allows us to improve existing financial market infrastructure, fully harnessing the power of blockchain will require a holistic approach, with industry players and regulators coming together to jointly experiment with creating opportunities to reshape financial markets and mitigate associated challenges.

In Singapore, specifically, the country’s financial regulator – the Monetary Authority of Singapore (MAS) – has played a leading role in enabling large-scale innovation within a safe and controlled environment. In May 2022, MAS launched Project Guardian, a collaborative initiative with the financial industry that seeks to explore the economic potential and value-added use cases of asset tokenization, while addressing risks to financial stability and integrity. In less than six months, the project completed its first industrial pilot. The pilot, who was led by DBS Bank, JP Morgan and Marketnode tested currency and government securities trading using permissioned DeFi liquidity pools on a public blockchain. With Project Guardian, all anonymous wallets were also verified by trust anchors such as “know-your-customer” processes before trading is allowed to take place in the pool. This gives confidence to all participants involved in the transaction process.

The success of the test trade was groundbreaking in two ways. In addition to clearly demonstrating the benefits of using blockchain technology, it also marked the first instance where a permission of the DeFi protocol could be used in such a way. With benefits spanning instantaneous and simultaneous (atomic) trading, settlement, clearing and custody, Project Guardian clearly points to blockchain technology’s role in driving greater efficiency by reducing friction and minimizing risk. More importantly, the successful completion of the industry pilot paves the way for further tests that can be conducted to not only assess the feasibility of asset tokenization and DeFi applications, but also to build a robust digital asset ecosystem in collaboration with key industry stakeholders.

Pilots like these drive a forward-looking regulator and like-minded people in the industry to the cutting edge of technology. These pilots are essential to facilitate the development of blockchain markets as processes can be tested and mapped in a safe and secure environment.

Singapore, which offers a favorable regulatory environment that supports and rewards the courage to innovate, and is one of the most advanced digital markets globally, is well positioned to lead the reimagining of financial markets. It houses a sophisticated ecosystem of financial players, technology providers and innovators that both support and lead change, driven by a deep pool of talent and expertise. This has created a virtuous circle that will allow Singapore to move forward as an innovative financial hub.

While we are in the early stages of an exciting transformational journey, with courage, imagination and collaboration, we look forward to building a thriving ecosystem where both industry players and regulators explore the diversity of opportunities to reimagine the future of financial markets.