This guest article was written by Stanislav Efremov, Chief Operations Officer at ICM Capital LTD.
First of all, I would like to thank Avi Mizrahi for organizing the Trading Technology Panel during the IFX Expo in Cyprus. I myself on behalf of ICM Capital together with top executives from other companies have shared our views about the future of the market. During the panel I touched on the topic of blockchain technologies and how they may affect the market in the nearest future. I am glad to see the topic was very interesting to the wide audience as I have received a number of follow-up questions from our direct clients, institutional partners and technology-based companies around the world.
Let me summarize my own view about the market nowadays as it is vital to identify the existing problems and then I will try to answer your questions about the future expected changes. I will mention mainly problems related to electronic Spot Forex market although issues described also relate to Spot Metals, OTC (over-the-counter) contracts for futures, indices, commodities and exchange-based contracts.
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We can see that electronic Spot Forex market is very popular around the world as major products are very liquid and quite volatile, tradeable 24*5 with opportunities to trade using high leverage provided by brokerage houses. At the same time I can see some drawbacks of the Spot Forex market as settlement even for fully electronic non-deliverable contracts is not instant and typically T + 2 measured in days; institutional liquidity during rollover periods can disappear; swaps are charged once a day; there is no market during the weekends and some public holidays. No need to mention high settlement and prime-brokerage fees and all that adds costs to the end retail clients.
There were good reasons to set such rules around 20 years ago at the very early stages of the electronic brokerage market but I can see opportunities to simplify the rules now on both the retail and institutional sides. This can be achieved by introducing instant financial contracts with direct client to client matching without involving brokerage houses or other third parties.
In an ideal world the client will have an opportunity to trade various financial instruments including OTC and exchange-based contracts 24 hours seven days a week; swap charges can be charged within the day based on the leverage and exact timing the client holds the position; there will be no rollover period and market will be liquid all the time; the settlement will be almost instant and at no additional costs; that also means the overall cost of trading for clients will be reduced with close to zero spreads and low commissions.
I do hope blockchain-based or other technologies can help us to improve the market to this level. The blockchain technology is very powerful as it not only provides DLT (Distributed Ledger Technology) but can also be a technology behind clearing and settlement of any financial assets, notary services and also decentralized databases storing both public and classified information.
How can blockchain technology change the way trade settlements work?
There will be no need for third parties who currently help with the aggregation of small trades and reconciliation between institutional partners. There are already existing technologies which allow the clearing of 99.99% transactions within 1 hour but I hope in just three years the clearing will be peer-to-peer and immediate. Such technologies will also help to reduce the counter-party risks as each party would be exposed for a shorter period of time to the risk of the default of the other party. Besides, the technology will reduce the need of collateral as collateral funds can be fully utilized all the time.
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It is important to note that there are open discussions about settlement, trading and other blockchain-based technologies as major banks have formed an R3 blockchain consortium. Some banks have already moved it to a different level by offering SETLcoin, CITIcoin and by agreeing to reduce the settlement time to T+1 originally with possibilities to reduce it even further. Another important article to read is the European Securities and Markets Authority report on the application of blockchain technology for the securities markets (link to full ESMA PDF).
How will blockchain technology change the way retail trading works?
As I mentioned above even retail traders will have access to full range of OTC and exchange-based contracts using a single trading platform. Profits/losses of the trade can be instantly converted to any currency including wide range of crypto-currencies and that will also minimize transaction fees and times.
There are already a number of fintech start-ups operating with this model; some of them have already allocated millions in funds to develop and promote technologies around the world. Please refer to projects like Lykke founded by one of Forex pioneers Richard Olsen; GateCoin, CoinPlug. At the same time new technologies can create highly customized products such as forward contracts and swaps.
What will be the role for retail brokers if anyone can just trade directly on a blockchain?
We can already see that the most successful brokers become fintech companies themselves and blockchain is one of the new technology trends to implement. Brokers will adapt to new client to client trading in order to minimize transaction, execution and settlement costs and to promote new trading platforms to their clients. Brokers can also be active market makers and provide leverage to their clients.
Can a trader get leverage if he is not using a broker?
Technically some other participants can use smart contracts to provide peer to peer credits to end retail clients. Brokers and banks can also operate in the same mode and once again swaps can be charged within a day based on the amount of borrowed money and exact exposure to the market.
What must the industry do to adapt to the coming disruption?
There are still a number of questions to discuss including how the new smart contracts will operate, how to create initial liquidity in these new markets, possible security issues etc. ICM Capital has already had a few internal meetings to brainstorm how new technologies can change our world and how the company can benefit from the new opportunities. I would say that companies with a strong technology background still have a chance to develop and promote their internal technologies and become leaders in these new markets.