The Case for Blockchain Efficiencies in Securities Markets

I came across an interesting paper on LinkedIn today. Entitled “Crypto and the Evolution of the Capital Markets,” this paper, written by Tuongvy Le and Austin Campbell, discusses how blockchain technology and cryptocurrencies could transform the way financial markets work. It compares the traditional stock market system to crypto trading and argues that blockchain offers a more efficient, transparent, and fair way to trade assets. Let’s break it down in simple terms.

What’s the Main Idea?

The paper says that the current way we buy and sell stocks and other financial assets (like bonds) is old, complicated, and inefficient. It was built decades ago when technology wasn’t advanced, so it relies on lots of middlemen (like brokers and clearinghouses) to make trades happen. These middlemen add costs, slow things down, and sometimes create unfair advantages for big players.

Blockchain, the technology behind cryptocurrencies like Bitcoin, can fix these problems. It allows people to trade assets directly, quickly, and transparently without needing so many middlemen. The paper argues that instead of forcing old rules on this new technology, we should create new regulations that let blockchain shine while addressing its risks. The central thesis is that blockchain technology can ultimately help financial markets to work better in the future.

How Does the Traditional Stock Market Work?

Imagine you want to buy shares of a company like Apple. Here’s how it works in the traditional system:

1. You Don’t Own Shares Directly: When you buy stock through a broker (like Robinhood or Fidelity), the broker buys the shares for you. They’re listed as the official owner, and you’re just a “beneficial owner” on their records. This creates a layer of separation between you and the company.
2. Lots of Middlemen: A single trade involves many players:
   
   • Brokers: They handle your order and charge fees.
   • Exchanges: Places like the New York Stock Exchange (NYSE) where trades are matched.
   • Market Makers: Companies that buy and sell stocks to keep the market moving, sometimes paying brokers to send them your orders (this is called “payment for order flow”).
   • Clearinghouses: They make sure both sides of the trade (buyer and seller) follow through.
   • Depositories: They hold the stock certificates (usually electronically) and update ownership records.
   • Transfer Agents: They manage the official list of who owns the company’s shares.
3. It’s Slow and Expensive: Even though trades seem instant on apps, they take a day to “settle” (officially complete). Every middleman charges fees, and the process is complex, which can lead to mistakes or delays.
4. Why So Complicated? Back in the 1960s, trading stocks involved physical paper certificates. As trading increased, brokers couldn’t keep up with the paperwork, leading to a “paperwork crisis” where trades failed, and some firms went bankrupt. To fix this, the government created a system with more middlemen to handle trades electronically, but it’s still clunky and relies on a few big companies (like the Depository Trust & Clearing Corporation, or DTCC) that control most of the process.
5. Problems with the System:
   
   • Cost: All those middlemen take a cut, making trading more expensive.
   • Opacity: It’s hard for regular people to see exactly how trades happen or if they’re getting a fair deal.
   • Unfairness: Big firms can pay for advantages, like better access to trading data.
   • Risk: If a middleman fails (like a broker going bankrupt), your money could be at risk, though there are protections like insurance.

How Does Crypto Trading Work?

Crypto trading, using blockchain technology, is much simpler and more direct. Here’s how it compares:

1. Two Ways to Trade Crypto:
   
   • Peer-to-Peer (P2P) Trading: You trade directly with another person using a decentralized exchange (DEX). A DEX is like an app on the blockchain that uses “smart contracts” (self-running programs) to match buyers and sellers. You control your own crypto in a digital wallet, and trades happen instantly on the blockchain.
   • Centralized Crypto Exchanges (CEXs): These are platforms like Coinbase or Binance where you create an account, deposit money or crypto, and trade. The exchange handles everything, similar to a stockbroker, but it’s still simpler than traditional markets.
2. How Blockchain Helps:
   
   • Direct Ownership: With crypto, you can hold assets in your own digital wallet, not through a middleman. If you trade on a CEX, you can withdraw your crypto to your wallet anytime.
   • Instant Settlement: Trades on a blockchain happen right away, not after a day. This reduces the risk that someone won’t follow through.
   • Fewer Middlemen: In P2P trading, you don’t need brokers, clearinghouses, or depositories. Even on CEXs, one platform handles most functions, cutting out extra steps.
   • Transparency: Blockchain records every trade publicly, so anyone can verify what happened. This reduces secrecy and unfair advantages.
   • 24/7 Trading: Crypto markets never close, unlike stock markets that operate only during business hours.

Why Is Blockchain Better?

The paper lists several advantages of crypto trading over traditional markets:

1. Cheaper: Fewer middlemen mean lower fees.
2. Faster: Trades settle instantly, so there’s less waiting and less risk.
3. More Transparent: Everyone can see trades on the blockchain, making it harder for big players to manipulate the system.
4. More Accessible: Anyone with internet access can trade crypto, unlike stock markets that often require brokers or special permissions.
5. Flexible: Smart contracts can be programmed to do complex things, like automatically enforcing trade rules or setting up escrow accounts.
6. Safer System: Blockchain doesn’t rely on a few big companies, so it’s less likely to fail if one part breaks.

What Are the Risks of Crypto Trading?

Crypto isn’t perfect, and the paper points out some challenges:

1. Smart Contract Bugs: If the code in a smart contract has a mistake, it could lead to hacks or lost money, and there’s often no way to undo it.
2. Losing Your Keys: If you lose the password (private key) to your crypto wallet, your money is gone forever. There’s no bank to call for help.
3. Market Manipulation: Some traders can exploit blockchain’s transparency to cheat others, like “front-running” (jumping ahead of your trade to profit).
4. Illegal Activity: Crypto’s anonymity can attract bad actors, like money launderers, though many platforms now check identities to prevent this.
5. Volatility and Costs: During busy times, blockchain networks can get slow, and fees (called “gas fees”) can spike.
6. CEX Risks: If you trade on a centralized exchange, your crypto is held by the platform. If the exchange gets hacked or goes bankrupt, you could lose your money. Unlike stockbrokers, there’s no federal insurance like SIPC for crypto (though some states have protections).

What Happened in the 1960s to Create Today’s Stock Market?

The paper dives into history to explain why our stock market is so complex. In the 1960s, trading stocks was a mess because everything was done with paper certificates. As more people traded, brokers couldn’t handle the paperwork. This led to:

• Trades failing to complete (called “failed deliveries”).
• Brokers losing track of who owned what, causing delays in paying dividends.
• Some firms even stealing or misusing customer money.

By 1968, the problem was so bad that the NYSE had to close one day a week to catch up. Many brokers went out of business. This “paperwork crisis” pushed Congress to pass laws in the 1970s that:

• Created electronic systems to track ownership without paper.
• Set up big clearinghouses (like DTCC) to manage trades.
• Added protections like insurance for customers if brokers fail.

But these fixes made the system more complex and gave a few big companies (like DTCC) a lot of control, which the paper says isn’t ideal.

What Should We Do About Crypto?

The paper argues that crypto is a chance to rebuild financial markets from scratch, but we need smart rules to make it work. It suggests:

• Don’t Copy Old Rules: The stock market’s rules were made for a time before computers. Crypto needs new rules that fit how blockchain works.
• Balance Benefits and Risks: Keep the good parts of crypto (like speed and transparency) while addressing risks (like hacks or scams).
• Think About the Future: As more traditional assets (like stocks or bonds) move to blockchain, the lessons from crypto will shape how all markets work.

The paper mentions two proposed laws (FIT21 and the Lummis-Gillibrand Act) that try to create rules for crypto, but it says we should focus on the “plumbing” (how trades happen) rather than just arguing over whether crypto is a stock or a commodity.

Why Does This Matter?

The authors believe blockchain isn’t just a fad—it’s the future of finance. If we get the rules right, markets could become:

• Fairer: Less control by big firms, more power for regular people.
• Cheaper: Lower fees mean more money stays in your pocket.
• Safer: A system that’s harder to break or manipulate.
• More Open: Anyone, anywhere can participate.

But if we mess it up with bad rules, we could lose these benefits and end up with another clunky system like the one we have now.

In Summary

The traditional stock market is like an old, complicated machine with lots of parts that don’t always work well together. Blockchain is like a sleek, modern tool that can do the same job faster, cheaper, and more openly. The paper explains how we got stuck with the old system, why crypto is better, and what risks we need to watch out for. It’s a call to rethink how financial markets work so everyone benefits, not just the big players.