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Qian Yao, Science and Technology Bureau: Blockchain technology and new financial infrastructure reform

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How should technology regulation respond to the reform of the market-wide registration system and build a "standardized, transparent, open, dynamic and resilient" capital market?

Original title: "Technology Bureau Yao Qian: Blockchain Technology and new Financial Infrastructure Reform"

原文来源：《当代金融家》杂志2021年第9期

Blockchain technology originated in the global digital currency wave that started in 2009, but its impact on finance has gone far beyond the digital currency field. Basically, it creates a new type of value registration and exchange technology, which is another major leap forward after electronic ledger technology. If the paperless and electronic business processing of securities is the first financial infrastructure revolution brought by information technology, then the digitalization and decentralized business processing of securities may be the second financial infrastructure revolution brought by information technology.

1 Information technology progress and securities paperless, electronic development

The world's oldest verifiable stock was issued by the Dutch East India Company on September 9, 1606. It is printed on paper with a list of investors, issuers, amounts and other information, as well as the signatures of those involved. This is a deed of stockholder's equity, written in writing.

The disadvantage of paper securities is that the delivery of securities requires paper movement, which involves a series of operations such as printing, storage, transportation, delivery, sealing and endorsement, with many steps, long process and low efficiency. With the rapid growth of the trading volume of securities, paper securities became more and more unable to handle, and finally at the end of the 1960s, paper securities Crisis broke out in the history of securities. In 1968, 16 million shares traded daily on the New York Stock Exchange, eight times the 2 million shares traded daily in 1950. The slow delivery process resulted in a large number of orders not being delivered on time. The New York Stock Exchange had to shorten daily trading hours and close on Wednesdays to deal with a backlog of paper documents.

In order to solve the paper operation crisis, the European and American Securities industries have established the Central Securities Depository (CSD) system and the Securities nominal holding system. Through the form of multi-level third-party bookkeeping, non-mobile delivery of paper Securities is realized and the efficiency of Securities delivery is greatly improved. But securities are still paper-based, and the costs, risks and efficiencies associated with paper-based securities still exist.

By the end of the 1980s, the cost of computer storage and communication had plummeted, making paperless securities a real possibility. From the beginning of the issue of securities, electronic account books can be used to replace paper vouchers, and the whole business process adopts efficient electronic processing. In 1989, The paperless reform of securities was carried out in Australia. In 1992, 1995 and 2001, the UK issued three paperless Securities Laws to carry out paperless securities reform. Other countries include Finland, Norway, Estonia, Latvia and so on. When China's capital market was established in the early 1990s, securities were paperless, leading the world.

2 New Financial infrastructure "revolution" brought by blockchain Technology

In traditional financial infrastructure framework, Central Securities Depository (CSD), Securities Settlement System (SSS), Central Counterparty (CCP), Payment System, The functions of securities registration, clearing and settlement provided by PS are all in the form of third-party bookkeeping. CSD, SSS, CCP, PS and other central institutions add and subtract the balance of securities account or capital account on the central server, thus completing the transfer of securities and capital.

In the blockchain-based financial infrastructure framework, the wallet address replaces the account, the customer does not need to open an account in a specific central institution, its private key is generated locally, and then the public key is exported from it, and then the wallet address is changed, which is equivalent to opening an account for oneself, which is the primary difference. Second, distributed ledgers have replaced central ledgers. Each customer has an account book, and everyone shares and shares the account information together. Ledgers are like information disclosure in the securities market, which is open, transparent and traceable.

And all people can participate in bookkeeping, become bookkeepers. Third, in the form of value, the Unspent Transaction Output (UTXO) replaces the account balance, which is a publicly agreed value claim, rather than the number of third-party book entries. Finally, consensus algorithm replaces third-party endorsement in solving the "double flower" problem of value transfer. It uses economic incentive compatibility design to solve the fraud problem without trusted middleman.

In the age of paper media, the form of securities is paper vouchers, based on "characters"; In the electronic era, securities are paperless and based on "third-party electronic bookkeeping". In the digital age, securities take the form of trusted digital certificates, backed by "numbers", which we can call "digital securities".

It does not rely on third parties, the digital securities distributed ledger itself is CSD, SSS, a natural transaction reporting library (TR), or even PS. In addition to securities registration and settlement, smart contract technology can also be applied to code the current securities trading and CCP's business logic in the digital distributed ledger of securities and realize it with algorithms, so as to directly carry out decentralized asset trading and central clearing of both parties on the chain. This is a new financial infrastructure that can integrate securities trading, CSD, SSS, PS, CCP and TR.

At present, it is difficult to say whether the new blockchain-based financial infrastructure will necessarily have advantages over the traditional financial infrastructure, at least in terms of performance, there is a lot of debate. But there is no denying that it does provide us with a completely different financial infrastructure technology solution from the central model. In some ways, its advantages are remarkable.

Such as the anti-attack and robustness of the system. In the event of a node failure, the availability of the blockchain system will not be affected as long as the nodes necessary for the consensus algorithm are operational. Verify that the node can be restored regardless of the length of system downtime. Blockchain systems have advantages over the single point of failure risk of a central server. In recent years, exchanges such as Toronto Stock Exchange, Tokyo Stock Exchange, Singapore Exchange, Bombay Stock Exchange and NASDAQ exchange have experienced outages due to hacking attacks or technical glitches.

The most serious was a five-day cyber attack on the New Zealand Stock Exchange in August 2020, which forced multiple temporary interruptions to trading. The fully open and bare Bitcoin network system has not been down due to network attacks since 2009 and is highly stable.

And the openness and universality of the system. The traditional financial infrastructure is not only closed, but also divided, beggar-thy-neighbor, inefficient and costly in information exchange. The new financial infrastructure based on block chain is not restricted by traditional account system and closed network, and has stronger financial inclusion. It can connect all parties in the same network and integrate various financial infrastructure functions, which is unified, seamless, ubiquitous and inclusive. It can play a positive role in retail, cross-border, off-market and other scenarios with high segmentation and significant pain points.

3 Concept of new financial infrastructure based on block chain

The new financial infrastructure based on block chain has attracted wide attention from the securities industry. The Australian Stock Exchange, for example, plans to replace its existing electronic settlement system with a blockchain-based system. The Swiss Stock Exchange proposed to establish a Digital asset Exchange (SIX Digital Exchange, SDX) based on blockchain technology.

The Depository Trust and Clearing Corporation (DTCC) has experimented with blockchain-based post-processing of securities repurchase transactions. Germany's national blockchain strategy proposes to promote the issuance and trading of securities based on blockchain technology starting from digital bonds. However, compared with the global digital currency wave in full swing, the application and exploration of blockchain technology in the securities industry is a little cold.

It should be said that in the securities industry, the exploration of new financial infrastructure based on blockchain has just begun. How should it be built? How to design the technical scheme of different securities? How to develop corresponding business processes and operations? What's the key point? How to play the positive role of blockchain technology in specific scenarios? Will traditional financial infrastructure institutions cease to exist? What are the new roles? What are the risks of the new financial infrastructure? How w should it be regulated? These questions are still vague.

Therefore, a systematic and complete theoretical framework is needed to guide the practical exploration of new financial infrastructure based on block chain. This section proposes the basic framework of a new financial infrastructure based on blockchain (see Figure 1).

DLT - CSD books

As a new generation of value registration and exchange technology, blockchain technology is most likely to be first applied in the field of securities registration and settlement. That is to keep the securities trading and clearing process unchanged, with the front end still in charge of trading by the stock exchange, the central counterparty (CCP) in charge of clearing, and the back end transformed into a blockchain-based securities registration and settlement system (DLT-CSD). This is the basic framework. The basic framework makes little change to the existing financial market infrastructure. DLT - CSD books may contain at least the securities registration and clearing institutions, securities exchanges, securities companies, commercial Banks, securities issuers (listed companies), investors, the central bank, securities regulators, such as 8 node types, with exactly the same with traditional CSD financial infrastructure functions, only fundamental changes have taken place in its implementation.

Securities depository and securities account

All securities held by securities holders shall be kept in CSD when listed and traded. In the traditional CSD mode, CSD opens an account for each investor, and the security interests held by the investor after the security is deposited are reflected as the account balance in the CSD ledger, while in dlT-CSD mode, the traditional security account becomes the wallet address, and the security correspondingly becomes the encrypted digital asset stored in the distributed ledger. Encrypted digital assets point to the investor's wallet address, which can only be opened by the investor's private key. The private key is very secret, local elliptic curve algorithm, from which the public key is derived, and then do two hash operations, and then do a data coding integration, produce a long digit, is the wallet address.

Securities registration and settlement

Securities registration is the identification of securities holding conditions, including initial registration, registration of changes (that is, securities settlement) and withdrawal registration. First, change registration. Traditional CSD records the ownership and change of securities in the form of increase or decrease of account balance, while in DLT-CSD, the flow of numbers is the flow of value. Digital securities are directly transferred point-to-point without relying on third-party intermediaries. The specific process is as follows: the payer first gets the wallet address and public key of the payer, encrypts the security transfer message with the public key of the other party, and then signs with its own private key to broadcast the whole network. After the whole network receives the security transfer information, consensus verifies the address from which the security transfer message is sent and the wallet address to which the security transfer message is to be transferred. Finally, the security receiver uses the private key of its wallet address to unlock the security transfer message and obtain the security.

For initial registration and withdrawal registration, DLT-CSD can adopt dual signature mechanism in order to guarantee the implementation of relevant regulatory policies such as public offering and securities registration. That is to say, only after the issuer of securities, securities supervision department and notary of the two parties signed, the issuer of securities can initiate initial registration and exit registration. However, the registration of changes initiated by transaction transfer or non-transaction transfer may not be signed by securities regulatory authorities and notary public.

Centralized transaction transfer does not change the existing post-trade settlement business chain. After the transaction order is cleared by CCP, it will be sent to dlT-CSD account book, which will be signed and confirmed by the settlement participant, and the securities transfer instruction will be submitted to DLT-CSD account book for registration of change. Between DLT-CSD system and PS system, the atomicity and finality of securities settlement and capital settlement are realized through the bond coping mechanism (to be elaborated in detail later).

The company service

Traditional CSD services for listed companies include access to the register of securities holders, distribution of rights and online voting services. In dlT-CSD's environment, these services can be automatically executed by smart contracts. As a ledger node, the issuer of securities automatically obtains a list of securities holders; The same as the initial registration, the issuer of securities through the double signature mechanism, dividends and other rights and interests distribution; Since the distributed ledger itself is a voting system, network voting can be carried out directly on DLT-CSD ledger.

4 conclusion

Digital technology means that the new financial infrastructure based on blockchain is feasible and controllable, and supervision is more accurate, so it is normative. Blockchain ledgers are hard to forge, hard to tamper with, traceable and easy to audit, so they are transparent. It makes financial services more open and dynamic, but it is also more fault tolerant and resilient based on trusted technologies. Therefore, it is a new type of financial infrastructure that meets the five standards of "standard, transparent, open, dynamic and resilient", with unlimited potential and promising prospects.

| this article only for the academic research point of view. Does not represent the work unit opinion