Decentralized Financial Market Infrastructures

Abstract

Financial market infrastructures (FMIs) have evolved as core elements of highly intermediated financial markets partly due to the technological limitations of the time when they were first architected. Organizations and firms were unable to share records without having to entrust a single party to manage them; hence this phenomenon of intermediation has led to significant information silos. Simultaneously, it has driven the structure of business models, as well as regulatory supervision and oversight, in ways that furthered intermediation and also created a misalignment of incentives and risk taking between entities now categorized as systemically important financial institutions (SIFIs) and systemically important financial market infrastructures. Over time, this consolidation has led to highly concentrated FMIs and with it, concentrated risks. Some of these risks go beyond the credit risks of just one or two institutions, becoming instead systemic risks that are continuously monitored by regulatory bodies based on coordinated sets of principles and guidelines including the 2012 Principles for Financial Market Infrastructures from CPMI and IOSCO.

Over the past decade, advances in public key cryptography, hash functions, virtualisation, distributed consensus, multiparty computation, and peer-to-peer networking have led to experimentation around record sharing between erstwhile competitive firms. Over the past five years, a series of independent efforts has chaperoned regulatory requirements into a digital, automated state that enables secure information sharing in full compliance with the law, while simultaneously enabling market participants to mutualise infrastructure that would otherwise be run by a single trusted party. With these developments, many of the services that centralised intermediaries currently provide could potentially be replaced by decentralised infrastructures or decentralised financial market infrastructure (dFMI). dFMI also enables a change in business structure, where a re-alignment of incentives can take place such that those firms taking risks can fully bear the consequences of these risks.

Keywords: financial market infrastructure, clearing house, central counterparties, payment systems, securities settlement systems, CCP, CSD, dfmi, blockchain, distributed ledger, operational risk, governance