Tech

How can we bring trust back into financial markets with blockchain?

Last week, our CEO Frederik Gregaard, shared his insights on how blockchain could bring trust back into capital markets, through an opinion editorial in City A.M, a London-based financial newspaper.

Capital markets, those where debt and equity instruments are bought and sold, underpin our global financial ecosystem. But the technology underpinning the markets themselves is fraught with inefficiencies, eroding trust. Frederik discussed some important current themes around our capital market infrastructure, focusing on how central systems of record have typically led to trust issues for all market participants.

Recent events in our financial markets have proven that trust is more important than ever, and as power has been pushed to the edges, trust-gaps in our financial infrastructure have been exposed.

Here, we are going to explore what trust may look like on Cardano. We will also discover how we could deploy our existing and upcoming features to maximise trust and transparency in financial markets for all kinds of users.

In the Cardano ecosystem, we talk a lot about trust. On the surface, it is self evident that trust between transacting parties or actors within a system is a good thing. But in reality, achieving and maintaining trust is complex and difficult.

When finances, people’s livelihoods, and even individuals’ identities are involved, trust becomes a critical make-or-break success factor of services and companies.

Take for example a brand new app from a challenger bank. New on the scene, many would naturally wonder if a start-up could be trusted with their capital. While traditional means of proving trust such as regulatory approval can go a long way, it is still ultimately unknown how this new application will manage and protect your funds.

On the other hand, we have an ongoing erosion of trust in traditional and previously well regarded institutions by retail investors and everyday individuals. As Frederik touched upon in his recent article, the GameStop short squeeze coordinated by retail investors, and the ensuing market chaos, seriously damaged trust in our financial system. Moreover, it brought to light the lack of market integrity we currently have, with manipulation, pump and dumps, fake volumes, and front running become rife.

Lastly, we should also consider the impact on economies and geographies where trust in financial infrastructure has always been typically low — and for good reason. In emerging economies, where traditional financial infrastructure is scarce and communities are underserved, high incidences of fraud and corruption prevent trust from ever growing in the first place.

But many of these issues could be alleviated, or potentially made a thing of the past, through the adoption of blockchain technology and distributed ledgers of record. Let’s discover how this is possible.

As we mentioned in last week’s blog, where we examined the potential of permissionless blockchains to power CBDCs, the transparency of an underlying blockchain ledger could be instrumental in facilitating user trust.

As Frederik noted in his City A.M. op-ed, a lack of trust is often driven through an incomplete view of what is occuring behind the scenes. In the events surrounding GameStop and Robinhood, liquidity issues with post-trade processing clearing houses forced the popular broker to adjust margin requirements. This led to a public relations backlash for the broker.

Instead, if the entirety of post-trade processing was carried out through a public ledger like Cardano, asset movements and bottlenecks would always be visible on-chain. This would allow any participant to use a chain explorer to discover where asset flows were halted, reducing public attention and increasing user’s trust.

For new financial start-ups, gaining customer trust could be enhanced through using blockchain infrastructure to move and track asset flows. This would also enable customers to view custody methods of their deposited currency or assets.

Similarly, for interest generating products such as savings accounts, customers could verify that the investments their banking provider is making with their savings are ethical, and in line with their principles. This is currently a huge issue of transparency and trust, with some banks investing in fossil fuels and arms companies unbeknownst to their customers.

So, blockchain’s trust-boosting capabilities aren’t just applicable to financial markets and publicly traded assets. They can also apply to pension funds, banking products, savings products, and more. In emerging economies, where these financial products are scarce, the trust issue begins with onboarding.

Residents of developing nations often find it difficult to prove their identity and economic history to banks and financial institutions, and therefore have limited access to these services. Through a unified blockchain identity solution, such as Atala PRISM on Cardano, individuals could be empowered to create their own identity and financial history on the blockchain.

While trust in financial infrastructure in developed economies is advantageous, in developing economies it could be life changing. Access to financial services without the fear of corruption or fraud could transform the financial situation of an underserved individual or entire family — lifting generations out of poverty.

A blockchain-based solution would both provide access to financial instruments to underserved communities, and also reduce fraud and corruption by providing an immutable paper trail of transactions on-chain. In this manner, blockchain could help fight some of the worst trust issues in emerging economies and bring them financially closer to developed countries, facilitating global trust and movement.

A farmer in Ethiopia, for instance, could use access to blockchain-based financial instruments to elevate their farming from subsistence to commercial levels, freeing capital to send their children to a sports academy abroad, or provide access to better education.

Do you have an idea for increasing trust through a permissionless blockchain like Cardano? We encourage you to formalize your idea through a proposal in Project Catalyst. There are funds available to build solutions on Cardano, and those which focus on financial inclusion are especially welcome.

You may also wish to explore our financial smart contract devnet environment, called the Marlowe Playground. Marlowe is a special-purpose language for financial contracts on Cardano, allowing contracts to be written in the language of finance, rather than using a general-purpose language on the blockchain.

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