Bonds Will Soon Come to the Blockchain

Using blockchain technology to trade, settle and clear financial securities is one of the most talked about applications for the distributed ledger technology in the financial services industry. Currently, several international securities exchanges are trialing the technology to improve the efficiency of their processes and to reduce operational costs. However, as of now, very few financial securities are trading on the blockchain. That is about to change as the digital asset exchange platform BlockEx is planning to issue “blockchain bonds” in the coming weeks.

Meet BlockEx

London-based blockchain startup BlockEx is developing an institutional grade digital asset exchange that allows for the creation, trading, settlement and clearing of digitized financial securities. BlockEx started out by providing a full-service white label cryptocurrency brokerage software but has since expanded into building investment platforms for institutional investors. Aside from its digital asset exchange platform, BlockEx is also building a fully KYC-compliant bitcoin exchange for institutional investors who want to gain access to this new asset class and provides full securities servicing and reporting services.

Bonds on the Blockchain

BlockEx’s new digital bond trading platform enables bond issuers to use smart contracts to determine a bond’s interest rate, coupon payments, payment dates, and maturity. To make the bond retail market-friendly, coupons can even be specified to be paid out monthly, weekly or daily. Furthermore, the platform will allow bonds to be sold directly from the issuer to the investors without the need for a bank to syndicate the bonds, thereby cutting out the intermediary to substantially reduce costs for the issuing entity.

Adam Leonard, CEO of BlockEx, stated: “Our concept is to make it easy for institutions to issue an asset. Our aim is to template as much of the process as possible. Whether it’s a $10m or a $1bn issue, a company can use the asset creation tool, pick documentation and get the money in just a single day.”

As security issuances involve lengthy legal documents, BlockEx is also in the process of engaging in partnership with a law firm to automate the documentation process to reduce the cost and time of issuing new securities.

Currently, around a dozen issuers are looking to issue bonds on BlockEx’s upcoming bond issuance platform according to the startup. The interested parties are predominantly small and medium-sized business that are looking to launch $10 to $50 million bond issues. Small issues of under $100 million dollars tend to find it difficult to enter the market as banks generally don’t bother with issues of smaller size and because the costs for the issuer of issuing a bond through a bank ranges between $200,000 and $400,000 according to BlockEx.

“With the digital asset tool, costs can be substantially less than half, or even a quarter of current costs, and the big added benefit is that it leaves the securities with a secondary market,” stated BlockEx CIO Aleks Nowak.

BlockEx has also engaged with several institutional investors interested in their bond origination and trading platform to ensure that there will be enough demand for the planned bonds issuances.

Why all Bonds Could End up on the Blockchain

The current bond origination process is document-heavy, lengthy and expensive for issuing companies as banks act as fee-charging intermediates in the bond issuance life cycle.

If an SME or a corporation wants to issue a bond as it requires debt financing for its business, it will talk to its relationship banks who will then recommend the issuing company bond terms that they can receive in the current market plus the fee that banks charges. Once the issuing company has agreed to the bond’s terms (coupon, maturity, payment schedule, etc.), the banks will syndicate the bond to institutional investors such as pension funds, mutual funds, hedge funds and private banks. In most cases, the demand for a new bond exceeds the bond’s issue size, which usually allows the syndicated banks to lower the interest rate of the bond to the benefit of the issuing company. In cases where there is not enough investor demand for the bond, the syndicating banks will take the remaining bonds on their trading books and sell them in the secondary markets in the weeks to follow the new issue.

Looking at this process, it is not difficult to see how the bond issuance lifecycle could be made substantially more efficient if issuing companies would be able to issue their bonds to investors directly as opposed to going through the lengthy process of dealing with a bank in the middle. Furthermore, the cost of issuing bonds could easily be slashed by more than 50 percent according to BlockEx.

The secondary market for most financial assets, such as stocks, commodities, and forex, is already fully electronic. The bond market has been slower to adopt this technological change due to the heterogeneity of bonds and the over-the-counter trading tradition in the bond market. However, institutional secondary bond trading platforms, such as MarketAxess, have gathered substantial moment in the last five years and electronic bond trading is starting to become the standard in today’s bond market. The bond traditional trading process of an investment manager selling bonds to a bank, which then sells the bonds on to another investment manager is slowly disappearing as electronic bond trading platforms allow investors to trade directly with one another.

The emergence of electronic bond trading also paves the way for the primary market (the market for new bond issues) to become fully digitized. Through developing a new issue platform that allows issuing companies to deal directly with investors using a technology, such as the blockchain, that allows for the secure recording, storing and transferring of data related to a bond transaction. Blockchain adoption will not only enable more issuers to come to the market but will also reduce costs and inefficiencies of the current state of the primary bond market.

It is not far-fetched to predict that within the next ten to 15 years that a large subset of bonds will be issued and traded on blockchain-powered electronic platforms, which will disintermediate banks and brokers and, thereby, make the bond trading process faster, more transparent and more efficient for issuers and investors.