CSDonDLT - Blockchain - Capital Market rEvolution

Blockchain, the technology which has from the outset been expected to bring the potential of transforming and streamlining many business models, initially became popular in the financial sector solely in the realm of crypto-assets. The early enthusiasm did not really turn into solutions that would add genuine value to existing systems.

Nevertheless, its potential to enhance the transparency, security and efficiency of financial processes is increasingly recognised by institutions in the traditional sector. As markets strive to keep pace with the rapid development of technology, blockchain is opening up new opportunities for integration and innovation in capital market infrastructure. This is an obvious step towards digital transformation, combining the benefits of new solutions with established security and regulatory standards.

As a company where technology is part of its DNA, KDPW recognised the potential of DLT as early as 2017. KDPW is one of the first capital market infrastructure institutions in the world to design and deploy solutions and services based on blockchain. These include a system for running general meetings of joint-stock companies, including a remote voting option (eVoting), developed by KDPW. The solution was launched on the Capital Market Blockchain Platform, an innovative, open and secure infrastructure representing KDPW’s response to the growing needs of the market, particularly in the area of post-trade services.

KDPW is running its CSDonDLT project aiming to deploy distributed ledger technology in financial services by integrating it with traditional market infrastructure. Recently introduced EU regulations provide a strong impetus for research and analysis: the objective is not only to use distributed ledger technology as a driver of innovation in the capital market and its services, but also to initiate a discussion on the future European infrastructure. The actions taken by KDPW as part of the CSDonDLT project are described in a dedicated White Paper, a contribution to the debate on the potential use of DLT and an invitation extended to all market participants to collaborate in its development.

CSDonDLT is an innovative project charting a new course for the evolution of capital market infrastructure through the implementation of blockchain in post-trade services.

Faced with the growing complexity and intricate structure of traditional depository and settlement systems, where accounting records for financial instruments are maintained in separate systems operated by various market participants, KDPW has taken on the challenge of gauging to what extent solutions based on distributed ledger technology (DLT) can serve as a functional extension of the existing infrastructure. The project is founded on the concept of sharing a single, immutable and transparent ledger, accessible to all market participants, which expands the functions of the traditional settlement system with mechanisms previously used solely for crypto-assets.

Traditional capital market infrastructure can only be effective, efficient and secure at the cost of considerable complexity and centralisation of processes. Each transaction requires the cooperation of multiple actors and the reconciliation of data stored in separate IT systems operated by market participants. Such market architecture requires the reconciliation and continuous improvement of standards for interoperability, communication and data exchange between different players. Furthermore, the increasing number of transactions, their volume and value, and the number of new instruments, issues and investors, may increase operational and systemic risks for financial institutions, which must constantly engage in the replication and reconciliation of data and processes due to the fragmentation of their IT solutions.

In this context, as a new layer added to the settlement system in the capital market ecosystem, DLT represents a promising solution that could significantly improve the functioning of capital markets, enhancing efficiency, mitigating risks and reducing transaction costs. In DLT-based systems, securities can be transferred almost instantly as transactions are recorded in a distributed ledger without the need for complex reconciliation processes among multiple market participants.

At this stage, the CSDonDLT project focuses on the settlement of OTC transactions and covers the safe-keeping and free transfer of securities, as well as atomic settlement of transactions in the DLT layer. Its key feature is the ability to instantly settle transactions while simultaneously transferring rights to assets and recording them in a dedicated securities account in the blockchain network. In addition to giving investors full 24/7/365 access to their assets, this approach significantly improves operational efficiency and cost efficiency.

The project aims at full interoperability between the traditional depository and settlement layer and the DLT layer, which means that securities can be seamlessly transferred between the two layers without the need to develop dedicated separate migration strategies or resort to siloed solutions. This hybrid model ensures the complementarity and coexistence of both layers, which is crucial for maintaining the stability and continuity of the capital market. Market participants, including custodian banks and investment firms, can thus offer new services based on a distributed ledger while maintaining their traditional roles and functions.

From a technical perspective, CSDonDLT is based on a private blockchain network model running on the Ethereum Virtual Machine (EVM) in which only verified capital market entities participate. After joining the network, each of these entities manages its own blockchain node, enabling direct access to data and opening access to services provided in the DLT layer to their clients. The rules for recording data in the ledger, defined in the established consensus algorithm, are implemented in the proposed system using a Proof of Authority (PoA) model based on trust in designated nodes. This network model guarantees full control over data access, ensuring that procedures and processes are maintained, while retaining the advantages of blockchain technology, including decentralisation of registration and settlement and resilience to manipulation.

The implementation of the CSDonDLT project follows global trends towards the digitalisation and automation of financial markets, addressing the need to simplify and enhance the efficiency of existing processes, and it addresses growing needs for transparency and security. By deploying distributed ledger technology, KDPW is developing a modern solution that not only complements traditional market models (TradFi) but also paves the way for integration with the rapidly growing crypto-asset markets. As a result, CSDonDLT bridges traditional infrastructure and future-oriented financial models, giving market participants a unique opportunity to have the best of both worlds.

In summary, the CSDonDLT project represents an important step towards modernising the local capital market, opening the door to its further development and enhancing its international competitiveness.

By combining blockchain with the existing depository and settlement system, KDPW is creating a flexible, secure and regulatory compliant platform which could in the future form the foundation of a decentralised and shared ecosystem of financial services while addressing the need to integrate innovative solutions with traditional market structures.