Digital business models

Full steam ahead for OTC trading thanks to blockchain

Thanks to blockchain technology, the existing complicated and error-prone securities trading outside of the stock exchange is to become simpler and quicker. Swisscom is playing an important role in this development.

Texts: Urs Binder, 14 February 2017

Trading in non-listed securities (OTC trading) outside of the stock exchange is difficult, fraught with risks and takes time. Now, all that is set to change: The “OTC Swiss Blockchain” consortium, founded in autumn 2016, is developing a standard for electronic OTC trading based largely on blockchain technology, under the auspices of the Institute for Financial Services (IFZ) at Lucerne University of Applied Sciences.

“Swisscom SCM contributed a significant part of the concept and programming work,” remarks Matthias Niklowitz, analyst at digital banking think tank eForesight. “One sticking point was the ability to guarantee the anonymity of transactions. The blockchain is actually transparent, but the identity of customers within securities trading ought only to be known to a small group of authorised parties.”

Technology for confidentiality and compliance

Therefore, there was no way that a public blockchain could be used. Instead, the consortium is working with a private version of the Ethereum blockchain. The blockchain, however, is only part of the solution. The entire flow of transactions with all documents is stored in an encrypted manner in a distributed database based on the IPFS protocol (InterPlanetary File System). To this end, a special encryption middleware was developed.

For regulatory compliant trading, there must also be a guarantee that the transactions cannot be manipulated. This is exactly where the blockchain comes in: For every encrypted IPFS file, a hash value is retained, immutable, in the blockchain, together with an attribute that specifies the status of the transaction, from “open” to “registered”. The private nature of the blockchain, together with the encryption module, guarantees that the customer’s identity remains confidential.

Project well on the way

The aim of the research project is to create an open system standard for Switzerland as a financial centre. The standard should simplify and accelerate OTC trading with Swiss shares by means of automatic transaction matching, while also satisfying regulatory requirements (MiFID II, FinfraG / EMIR). The consortium is already imagining something like real-time trading: “Clear and settle trades in less than a minute”, the consortium announces on its website. A process that takes considerably longer today.

According to Matthias Niklowitz, the technical foundations have already been laid. He says that the solution is now being tested and improved in practice, step by step – something that is made easier by the fact that no existing systems need to be replaced. Swisscom generally attaches great importance to blockchain technology, as Niklowitz emphasises: “Swisscom considers blockchain technology to be extremely promising; its potential is huge. We use projects like these to gather experience in order to be able to play a leading role later.”

Blockchain research supported by the federal government

The “OTC Swiss Blockchain” consortium not only involves Swisscom, but also Zurich Cantonal Bank, banking service providers SIX Group, Inventx and Incore Bank and ti&m. Research and development is being done as part of a research project funded by the Swiss federal government’s Commission for Technology and Innovation (CTI). At the beginning of 2017, the consortium was able to announce that it had made a real breakthrough in solving the anonymity problem.