Revolutionary changes to complex systems often have humble beginnings. Double-entry bookkeeping, for instance, grew from a minor section of a Franciscan monk’s mathematics encyclopedia in 15th-century Venice to the foundation of modern accounting. Now, blockchain, a system that allows connected computers to maintain a single updated ledger, seems poised to restructure stock exchanges, the core infrastructure of capital markets.
Blockchain “might seem like a trinket for computer geeks,” observed IBM CEO Ginni Rometty. “But once widely adopted, it will transform the world.” A bold prediction, but there are many who would agree; according to a 2017 report by Bain & Co., 80% of surveyed financial market participants say distributed-ledger technology will be transformative and expect their firms to begin using it by 2020.
Increasingly stock exchanges, an essential engine of capital markets, have been looking to distributed-ledger technology, such as blockchain, to streamline complex procedures. The benefits are manifold: simplifying cumbersome, multi-layered processes, reducing IT costs and reducing risk. Implementation is already underway. In the past year, we’ve seen the Australian Securities Exchange announce the adoption of blockchain technology and the State of Delaware confer its blessings.
Delaware takes the lead on blockchain
In 2017, Delaware passed legislation allowing corporations to maintain shareholder lists, and other corporate records, on the blockchain. This is a significant milestone. Delaware is the de facto corporate capital of the U.S., with more registered corporate legal entities than residents, representing two-thirds of U.S.-listed companies. While many businesses had already begun experimenting with blockchain uses for issuance, execution and settlement, they can now move forward with confidence under clear regulation. In his 2016 keynote address, Gov. Jack Markell said Delaware was “delighted” to have the “opportunity to help lead the way in promoting blockchain technology and its growing role in digital commerce.”
As CoinDesk observed, “this is likely to pave the way for the entire life cycle of a share – the issuance, custodianship, trading, shareholder communication and redemption – to be enacted on a blockchain.” Enthusiasts see this as the way forward for stock exchanges, reducing the transactional costs associated with brokers, custodians and clearing houses.
Dole Food Co. and the case for distributed-ledger technology
Cleaner data might also lead to less litigation. In 2015, Dole stumbled in a class action lawsuit that some commentators believe blockchain could have prevented. The trouble began in 2013 when CEO David Murdock took the company private, resulting in a lawsuit from shareholders, who felt that Murdock had purposely driven down the value of the company so that he could purchase it at a low price. Dole lost the resulting class action and was ordered to pay out to claimants who held approximately 36 million shares, based on the centralized stock ledger. Subsequently, holders of approximately 49 million shares submitted valid claims for payment. Commentators have suggested this significant ledger discrepancy resulted from a stock ownership and custodial system that fails to address today’s securities trading realities.
No company wants to learn critical information about itself and its shareholders through a lawsuit. In Dole’s case, the presiding judge suggested in his memorandum opinion that “distributed ledger technology [e.g., blockchain] offers a potential technological solution by maintaining multiple, current copies of a single and comprehensive stock ownership ledger.”
Rethinking core infrastructure
As CoinDesk observed, the current structure of capital markets, despite its complexity, “essentially has the same conceptual backbone as in the 17th century,” when equity exchange was based on paper signed with ink and quill. Despite the move to digital, modern stock exchanges are still based around numerous steps, requiring complex and often duplicated processes, and the cost of trusted intermediaries. Blockchain technology could potentially replace trust in third-party brokerages with mathematical proof of a transaction having taken place. The Economist has described it as “a machine for creating trust.”
Beyond increasing the speed of trading and settlement processes, blockchain could also be harnessed for shareholder voting systems. Indeed, there seem to be implications across all corporate record-keeping and corporate equity exchange.
Even with all this potential, businesses should proceed with caution. Few companies will have the resources and skill set to lead in the vanguard of this revolution. Still, as a corporate lawyer who is active in the financial-technology space, I see the potential in blockchain for businesses in B.C. New technology is an invitation for us to rethink standard practices. Short-term “hype” is likely just that. But when we think of the implications in five, 10, 20 years, the word that comes to mind is “revolutionary.”
While I don’t have a crystal ball when it comes to blockchain, we will be following these developments closely in our EKB Fintech Blog.
Kelly Samuels is a partner and business lawyer at EKB.