The dawn of Decentralized Finance: A digital EU Securities Market
By Robin Massini

Nov 25, 2020

Part III in a series dedicated to the DeFi boom & Dusk Network’s role in its future

In Part I, we describe how blockchain has spurred an experimental form of finance that does not rely on intermediaries such as banks or exchanges to settle transactions between participants, instead by using blockchain technology transactions can be mediated by smart contract programs. In Part II we wrote about why, regardless of smart contract functionality, most cryptocurrency transactions still occur on centralized exchanges. Key takeaway being that the importance of convenience and a familiar user experience are important for blockchain adoption, and must not be underestimated.

In part III, we dive into the opportunities, and future role of blockchain technology in regulated markets. We look at opportunities from a policy-making and business perspective, describe recent events in DeFi and the shortcomings of currently available blockchain technology to satisfy the needs of these markets.

Settlement & Interoperability

One of the most promising aspects of applying blockchain technology in regulated markets is to change the way regulated entities collaborate, and interoperate. Nowadays, most of the clearing and settlement of securities is done through Central Securities Depositories (CSDs). Here, a transaction is settled once the CSD credits the buyers account with the purchase. This is a book entry in a central ledger, the benefit of this system is that physical certificates do not need to actually change hands. And, while this works well for local markets, there is very little transaction volume between CSDs.

According to the T2S Annual report 2019, cross-CSD volume accounts for less than 1% of all settlement volumes. There are 21 CSDs from 20 European markets, and every additional CSD database needs to be manually added to the ecosystem. The T2S report states: “while the consolidation of the domestic markets is still ongoing, the CSDs and their communities have started focusing on other priorities”. Indicating real progress is lacking. Blockchain infrastructure could very well be the much-needed solution to bring down the barriers and to open up cross-border trade and settlement.

The EU Securities Market Potential

To show just how big the opportunity is for blockchain. In 2019, T2S settled a staggering total value of €282 trillion, which amounts to an average daily value of €1106 billion traded. To provide some context to these numbers, in April 2020, the New York Stock Exchange listed companies with a total equity market capitalization of more than $25 trillion USD.** Thus, a single stock exchange eclipses the size of the entire market capitalization of cryptocurrencies by a factor of 43. This is an enormous new market for blockchain to capture, support and facilitate transactions for. **Statista, November 23, 2020

EU Regulatory Momentum

Blockchain and security tokens also seem to be relevant to the priorities laid out by the European Commission on September 24, 2020. In the new Digital Finance Package (DFP), the main priorities are about removing fragmentation in the Digital Single Market and to allow consumers EU-wide access. The DFP sets out general lines on how Europe can support the digital transformation of finance in the coming years, while regulating its risks.

It seems that the European Commission is looking favourable upon blockchain to innovate the financial sector, as long as it is done in a way that preserves financial stability and protects investors. In their legislative proposal on crypto-assets, Markets in Crypto Assets (MiCA), she even proposes a pilot regime and a framework to categorize crypto-assets. This EU Regulatory momentum will have a positive impact on (financial) institutions to trial blockchain innovations and bring forth the next wave of decentralized finance.

Decentralized Finance 1.0

However, for blockchain infrastructure to become the back-bone of a new regulated securities market, additional safeguards need to be present. Just looking at recent highlights in DeFi news, there’s reports of smart contract design issues that allowed bad actors to sap funds from collateralized asset pools, and even founders (or anonymous Chefs) emptying their projects treasury. For blockchain to facilitate and settle transactions of regulated assets, it needs to have safeguards and fail safes that protects consumers and investors.

Dusk Network: The bedrock for digitized securities

In this article we’ve shown the enormous market potential of Dusk Network. Dusk Network is designed specifically for the tokenization of regulated assets, and to support financial applications. Successfully penetrating only a fraction of these markets would already mean a great deal both in terms of bringing valuable propositions to the world of blockchain, and daily transaction volume.

So far we have seen how current decentralized finance solutions and blockchains are ill-equipped to uphold the strict requirements posed by regulated markets. Conversely, Dusk Network is purposefully designed for the trading of regulated securities. Dusk Network provides stakeholders with the necessary tools for securities compliance and reap the benefits of digitization. By working together with regulators, industry leaders, exchanges, and financial institutions we plan to make decentralized finance 2.0 a reality.

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