Blockchain Technology Will Profoundly Change the Derivatives Industry –

As the hype and pessimism around converge toward reality over the next several years, one certainty emerging among Wall Street and Main Street traders is that advancements in platform technology will profoundly change how commonly used securities known as derivative contracts will be traded. The distributed ledgers inconceivable just a couple of years ago are on the precipice of ushering in a new era of innovative financial engineering and precision in risk management.

Wall Street firms are beginning to tinker with blockchain and smart contract technology that will allow buyers, sellers and central clearing houses of derivative trades to share information, such as KYC (Know Your Customer), in real time across various distributed ledger platforms unleashing incredible efficiencies.

Last month it was reported that Barclays tested a blockchain platform called Corda, developed by the bank consortium R3. Electronic documents that served as derivative contracts were pre-populated with standardized values, which, one day, will allow the contracts to be hashed out between counterparties, traded on an exchange across multiple and then cleared and settled instantaneously.

Derivative contracts are financial instruments that derive their value from some underlying asset, such as stocks, bonds, commodities or even interest rates. Derivative contracts have become increasingly fundamental in effectively managing financial risk and creating synthetic exposures to asset classes. For example, airlines use future contracts, a form of derivative, to hedge against fluctuating oil prices . Hedge funds use options, another form of , to speculate in questionable company stock without baring the cost of purchasing a large number of shares. Derivative contracts typically have shelf lives of 30-day increments.

Industry leaders expect distributed ledger infrastructure to foster new approaches to financial engineering, enabling financiers to customize derivatives consisting of individual cash flows to meet precise needs in terms of timing and credit risk. According to a report produced by Oliver Wyman, a management consulting firm, blockchain-enabled derivative contracts could be financed by issuers selling their own instruments that match the cash flows they expect to achieve, “in essence creating swaps without the need for balance sheet intermediation.” Traditional swap agreements are traded over the counter.