Smart bond (finance)

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A smart bond (or blockchain Bond) is a specific type of an automated bond contract that uses the capabilities of blockchain databases that can operate as cryptographically-secure yet open and transparent general ledgers. This is sometimes referred to as Distributed Ledger Technology (DLT). [1] It is one of a class of financial instruments known as a smart contract, "a computerized transaction protocol that executes the terms of a contract." [2]

Contents

This is in contrast to the traditional issuance process for bonds which can be a lengthy and highly technical process, which involves many intermediaries and stakeholders with sometimes conflicting objectives. A general lack of standardization in the primary markets increases information asymmetry and results in inefficient pricing, high costs, and long settlement times in the secondary market. [3]

Blockchain bonds have the ability to potentially revolutionize financial capital markets by creating a decentralized database of unique digital assets. Securities using blockchain technology will be able to cut out the various middlemen that are present in a bond transaction and lower fees. [1]

Issuers of bonds could be able to completely automate the entire bond issuance process through blockchain bonds. This would potentially result in shortened settlement and transaction times as well as greater transparency for the issuer in transactions. The increased transparency and automation of the process would remove the need for intermediaries and therefore generate increased savings for issuers. [4]

History

As of July 2021, the International Capital Market Association has listed the following blockchain bonds:

Smart Bond Issuances (as of August 2021) [5]
IssuerSale DatePar Amount

(USD Millions)

IssuanceBlockchainCountry
Commonwealth Bank of Australia January, 2017N/AN/APrivate EthereumAustralia
Daimler AG June 28, 20171111-year BondPrivate EthereumGermany
FiscoAugust 10, 20170.8133-year BondPrivate EthereumChina
Sberbank May 18, 201812Commercial BondHyperledger FabricRussia
World Bank August 24, 20181082 Tranche "bond-i"Private EthereumAustralia
Société Générale April 18, 20191125-year Covered BondPublic EthereumFrance
Santander September 12, 2019201-year BondPublic EthereumSpain
INVAOSeptember 27, 20192010-year BondPublic EthereumLichtenstein
Bank of China December 3, 20192,8002-year BondProprietary BlockchainChina
Bank of Thailand September 11, 20201,600Savings BondIBM BlockchainThailand
Union Bank of the Philippines December 7, 20201903 and 5.25 year Dual Tranche BondProprietary BlockchainPhilippines
Vonovia Investment BankJanuary 13, 2021243-year BondStellar BlockchainGermany
Société Générale April 15, 20216Autocall, Euro Medium Term NotesTezos Public BlockchainFrance
European Investment Bank April 27, 20211212-year BondPublic EthereumFrance

As early as 2014, banking executives were speaking publicly about the ability of blockchain technology to trigger significant "simplification of banking processes and cost structure." [6]

As of 2015, UBS was experimenting with smart bonds that use the bitcoin blockchain [7] in which "risk free interest rates and payment streams [could be] fully automated, creating a self-paying instrument." [8] The Huffington Post reports than an announcement of the UBS smartbond service is expected in 2016. [9]

In 2018, the World Bank mandated the Commonwealth Bank of Australia for the world's first blockchain bond. [10]

On 28 November 2018, United Arab Emirates based Al Hilal Bank executed the world's first Blockchain Sukuk (Islamic Bond) on the Ethereum blockchain. [11] Blockchain was used to transact a secondary market deal in Al Hilal Bank's $500 million Senior Sukuk, maturing September 2023. This was the first time Blockchain technology was utilized in the execution of a Sukuk transaction. The technology was built by Swiss-based blockchain developer, Jibrel AG. [12]

Characteristics of Smart Bonds

DLT bonds involve a distributed database maintained over a network of computers connected on a peer-to-peer basis, so that participants can share and keep identical, cryptographically secured records in a decentralized manner. Operation of a DLT network can involve the use of a public or private network that may contain digitally represented assets. Network participants conduct and verify transactions. This would eliminate the need for a centralized ledger maintained by a third party. [13]

A blockchain bond is first issued in tokenized form into a digital asset ledger. Then, an investment bank creates a digital term sheet as part of a smart contract and receives the sign off from the issuer of the bond. Bids and orders from investors are recorded in the master book. The issuer, using Know Your Customer (KYC) details provided by a gatekeeping intermediary adds investors to the bond's blockchain. Tokens, representing cash or security are used to determine investor portfolio value. The deal reaches financial close after signing. Finally banks act as token keepers and transfer money or debt instruments to the beneficiary accounts. [3]

Applications of Smart Bonds

Many of the transactions using DLT have been experimental in nature over the past three years. [14] Debt capital markets are looking at blockchain as a technology that will potentially disrupt the status quo. Blockchain bonds could add new efficiencies in the way that capital markets traditionally operate. [15] Past experiments in DLT transactions show that blockchain can be used to increase reporting transparency, reduce the number of intermediaries, and reduce the length of the settlement process. [3]

Legislative Considerations

Legal and regulatory uncertainty around the use of DLT are one of the key challenges to its wider adoption. Regulation is generally neutral to technology[ citation needed ] however regulators in different countries have adopted different approaches to the use of DLT in financial markets. [14]

In North America, as of 2019, there were 28 different DLT related regulations that have been adopted at the state level. Bills enacted in Arizona, Illinois and Maryland provide a legal definition of DLT/blockchain as well as clarifying the legal status of smart contracts. Other bills have provided support for the development of blockchain technology. [16] [ needs update ]

Related Research Articles

<span class="mw-page-title-main">Digital currency</span> Currency stored on electronic systems

Digital currency is any currency, money, or money-like asset that is primarily managed, stored or exchanged on digital computer systems, especially over the internet. Types of digital currencies include cryptocurrency, virtual currency and central bank digital currency. Digital currency may be recorded on a distributed database on the internet, a centralized electronic computer database owned by a company or bank, within digital files or even on a stored-value card.

Sukuk is the Arabic name for financial certificates, also commonly referred to as "sharia compliant" bonds. Sukuk are defined by the AAOIFI as "securities of equal denomination representing individual ownership interests in a portfolio of eligible existing or future assets." The Fiqh academy of the OIC legitimized the use of sukuk in February 1988.

A smart contract is a computer program or a transaction protocol that is intended to automatically execute, control or document events and actions according to the terms of a contract or an agreement. The objectives of smart contracts are the reduction of need for trusted intermediators, arbitration costs, and fraud losses, as well as the reduction of malicious and accidental exceptions. Smart contracts are commonly associated with cryptocurrencies, and the smart contracts introduced by Ethereum are generally considered a fundamental building block for decentralized finance (DeFi) and NFT applications.

<span class="mw-page-title-main">Bitcoin</span> Decentralized digital currency

Bitcoin is a protocol which implements a public, permanent, and decentralized ledger.

<span class="mw-page-title-main">Cryptocurrency</span> Encrypted medium of digital exchange

A cryptocurrency, crypto-currency, or crypto is a digital currency designed to work as a medium of exchange through a computer network that is not reliant on any central authority, such as a government or bank, to uphold or maintain it. It is a decentralized system for verifying that the parties to a transaction have the money they claim to have, eliminating the need for traditional intermediaries, such as banks, when funds are being transferred between two entities.

<span class="mw-page-title-main">Bitcoin network</span> Peer-to-peer network that processes and records bitcoin transactions

The Bitcoin network is a peer-to-peer network of nodes which implement the Bitcoin protocol. The protocol itself implements a highly available, public, and decentralized ledger. The nodes verify that each update to the ledger follows the rules of the Bitcoin protocol.

<span class="mw-page-title-main">Ethereum</span> Open-source blockchain computing platform

Ethereum is a decentralized blockchain with smart contract functionality. Ether is the native cryptocurrency of the platform. Among cryptocurrencies, ether is second only to bitcoin in market capitalization. It is open-source software.

<span class="mw-page-title-main">Nxt</span> Cryptocurrency

NXT is an open source cryptocurrency and payment network launched in 2013 by anonymous software developer BCNext. It uses proof-of-stake to reach consensus for transactions—as such, there is a static money supply. Unlike Bitcoin, there is no mining. NXT was specifically conceived as a flexible platform around build applications and financial services, and serves as basis for ARDR (Ardor), a blockchain-as-a-service multichain platform developed by Jelurida, and IoTeX (cryptocurrency) the current steward of NXT as of 2021. NXT has been covered extensively in the "Call for Evidence" report by ESMA.

<span class="mw-page-title-main">Counterparty (platform)</span> Cryptocurrency platform

Counterparty is a peer-to-peer financial platform and distributed, open source Internet protocol built on top of the Bitcoin blockchain and network. It was one of the most well-known "Bitcoin 2.0" platforms in 2014, along with Mastercoin, Ethereum, Colored Coins, Ripple and BitShares.

A blockchain is a distributed ledger with growing lists of records (blocks) that are securely linked together via cryptographic hashes. Each block contains a cryptographic hash of the previous block, a timestamp, and transaction data. Since each block contains information about the previous block, they effectively form a chain, with each additional block linking to the ones before it. Consequently, blockchain transactions are irreversible in that, once they are recorded, the data in any given block cannot be altered retroactively without altering all subsequent blocks.

Digital Asset is a financial technology company founded in 2014 by Sunil Hirani, Don R. Wilson, Yuval Rooz, Shaul Kfir and Eric Saraniecki. It builds products based on distributed ledger technology (DLT) for banks and other financial institutions.

Hyperledger is an umbrella project of open source blockchains and related tools that the Linux Foundation started in December 2015. IBM, Intel, and SAP Ariba have contributed to support the collaborative development of blockchain-based distributed ledgers. It was renamed the Hyperledger Foundation in October 2021.

A decentralised application is an application that can operate autonomously, typically through the use of smart contracts, that run on a decentralized computing, blockchain or other distributed ledger system. Like traditional applications, DApps provide some function or utility to its users. However, unlike traditional applications, DApps operate without human intervention and are not owned by any one entity, rather DApps distribute tokens that represent ownership. These tokens are distributed according to a programmed algorithm to the users of the system, diluting ownership and control of the DApp. Without any one entity controlling the system, the application is therefore decentralised.

A distributed ledger is the consensus of replicated, shared, and synchronized digital data that is geographically spread (distributed) across many sites, countries, or institutions. In contrast to a centralized database, a distributed ledger does not require a central administrator, and consequently does not have a single (central) point-of-failure.

A cryptocurrency wallet is a device, physical medium, program or a service which stores the public and/or private keys for cryptocurrency transactions. In addition to this basic function of storing the keys, a cryptocurrency wallet more often offers the functionality of encrypting and/or signing information. Signing can for example result in executing a smart contract, a cryptocurrency transaction, identification or legally signing a 'document'.

Distributed ledger technology law is not yet defined and recognized but an emerging field of law due to the recent dissemination of distributed ledger technology application in business and governance environment. Smart contracts, which are also enforceable legal contracts and were created through interaction of lawyers and developers, are called smart legal contracts.

A blockchain is a shared database that records transactions between two parties in an immutable ledger. Blockchain documents and confirms pseudonymous ownership of all transactions in a verifiable and sustainable way. After a transaction is validated and cryptographically verified by other participants or nodes in the network, it is made into a "block" on the blockchain. A block contains information about the time the transaction occurred, previous transactions, and details about the transaction. Once recorded as a block, transactions are ordered chronologically and cannot be altered. This technology rose to popularity after the creation of Bitcoin, the first application of blockchain technology, which has since catalyzed other cryptocurrencies and applications.

Decentralized finance offers financial instruments without relying on intermediaries such as brokerages, exchanges, or banks by using smart contracts on a blockchain. DeFi platforms allow people to lend or borrow funds from others, speculate on price movements on assets using derivatives, trade cryptocurrencies, insure against risks, and earn interest in savings-like accounts. DeFi uses a layered architecture and highly composable building blocks. Some applications promote high interest rates but are subject to high risk. Coding errors and hacks have been common in DeFi.

The general notion of cryptocurrencies in Europe denotes the processes of legislative regulation, distribution, circulation, and storage of cryptocurrencies in Europe.

Colored Coins is an open-source protocol built on the Bitcoin 2.0 that allows users to represent and manipulate immutable digital resources on top of Bitcoin transactions. They are a class of methods for representing and maintaining real-world assets on the Bitcoin blockchain, which may be used to establish asset ownership. Colored coins are bitcoins with a mark on them that specifies what they may be used for. Colored coins are also considered the initial step toward NFTs built on top of the Bitcoin network.

References

  1. 1 2 "How Blockchain Could Disrupt Banking". CB Insights Research. 2021-02-11. Archived from the original on 2021-08-04. Retrieved 2021-08-20.
  2. ↑ Tapscott, Don (2016). Blockchain revolution : how the technology behind bitcoin is changing money, business, and the world. Alex Tapscott. Toronto, Ontario, Canada. ISBN   978-0-670-06997-2. OCLC   919014174. Archived from the original on 2021-08-23. Retrieved 2021-08-20.
  3. 1 2 3 Pana, Elisabeta; Gangal, Vikas (2021-04-23). "Blockchain Bond Issuance". Journal of Applied Business and Economics. 23 (1). doi: 10.33423/jabe.v23i1.4064 . ISSN   1499-691X. Archived from the original on 2021-08-20. Retrieved 2021-08-20.
  4. ↑ "Digitizing Bonds on the Blockchain". Goldman Sachs. Archived from the original on 2021-08-20. Retrieved 2021-08-20.
  5. ↑ "New FinTech applications in bond markets". International Capital Market Association . Archived from the original on 2021-04-27. Retrieved 2021-08-20.
  6. ↑ Irrera, Anna (2014-10-27). "UBS CIO: Blockchain Technology Can Massively Simplify Banking". Wall Street Journal . Archived from the original on 2016-04-28. Retrieved 2016-05-27.
  7. ↑ Ross, Rory (2015-09-12). "Smart Money: Blockchains Are the Future of the Internet". Newsweek . Archived from the original on 2016-07-10. Retrieved 2016-05-27.
  8. ↑ Wigan, David (2015-06-11). "Bitcoin technology will disrupt derivatives, says banker". IFR Asia. Archived from the original on 2016-06-29. Retrieved 2016-05-27.
  9. ↑ Seaman, David (2016-08-10). "Ethereum: Here Come The Big Banks". Huffington Post . Archived from the original on 2016-08-12. Retrieved 2016-08-11.
  10. ↑ "World Bank Mandates Commonwealth Bank of Australia for World's First Blockchain Bond". The World Bank. Archived from the original on 22 April 2019. Retrieved 22 April 2019.
  11. ↑ "Al Hilal Bank Executes World's First Blockchain Sukuk Transaction". 2018-11-26. Archived from the original on 2021-06-07. Retrieved 2021-06-07.
  12. ↑ "Abu Dhabi's Al Hilal Bank uses blockchain to sell sukuk in secondary market". Reuters. 2018-11-26. Archived from the original on 2021-06-09. Retrieved 2021-06-09.
  13. ↑ "Blockchain Basics: Introduction to Distributed Ledgers". IBM Developer. Archived from the original on 2021-08-20. Retrieved 2021-08-20.
  14. 1 2 "ICMA Distributed Ledger Technology (DLT) regulatory directory". www.icmagroup.org. Archived from the original on 2021-02-26. Retrieved 2021-08-20.
  15. ↑ "Société Générale blockchain issuance a sign of things to come". International Financial Law Review. 16 May 2019. Archived from the original on 2021-08-20. Retrieved 2021-08-20.
  16. ↑ Varrall, Rowan (20 December 2019). "DLT-related legislation and regulatory frameworks in capital markets" (PDF). ICMA. Archived (PDF) from the original on 20 August 2021. Retrieved 20 August 2021.
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