On August 18, 2017, the Bank of England (BoE) released a report suggesting that distributed ledger technology (DLT) may be a disruptive force to the securities settlement industry, and arguing that, in the absence of regulation, monopolization is likely to occur.
The report, titled "Staff Working Paper No. 670: The Economics of Distributed Ledger Technology for Securities Settlement," detailed the current ecosystem of post-trade processes facilitated by central security depositories (CSDs), including notary functions, account maintenance, and settlement. It also broke down the various processes of blockchain and distributed ledger technology as they relate to securities settlement, including trustless consensus mechanisms, executable distributed code contracts, and access rights for public and private blockchains.
Overall, the BoE’s report made three points: (1) how to properly operationalize DLT to maximize its benefits is an unresolved issue; (2) public authorities and regulatory bodies need to facilitate cooperative efforts for researching and developing DLT; and (3) if a DLT or other technological solution offsets existing methods for securities settlement,
"it is likely to be characterized by network externalities and decreasing average costs. This suggests that the industry may well retain its high degree of concentration. It is possible and likely that a small number of CSDs will be replaced by a small number of DL network providers and as a result future settlement services may be associated with some form of monopoly pricing. This, in turn, means that regulators could play a role in either ensuring more competitive outcomes or otherwise in regulating the industry so as to minimize deadweight losses and/or the unequal distribution of economic surplus."
The BoE recognized that there is little or no incentive on the part of a monopoly holder to innovate as it already dominates the market. However, monopolies are incentivized to innovate due to pressures from efficient FinTech companies. According to the report, "when FinTech start-ups entered into the post-trade space with DL proposals that promised lower costs and increased efficiency for the end users, the monopoly became contestable (with the possibility of end-users migrating to lower-cost solutions) and the incumbents became incentivized to innovate even if it was just to keep away potential competitors."
To avoid another monopoly among a niche of FinTech startups, the BoE suggested regulators play an active role by funding collaborative efforts. It also said that central banks and government agencies can work with private institutions to create financial market infrastructures conducive to the development of DLT.
DLT has yet to cause a massive disruption of the securities settlement market, but when that happens, regulators will need to work hand in hand with emerging service providers to forge a fair and competitive marketplace.