By Peter Shen, Head of Technology Strategy and Innovation, SGX
Singapore Exchange Limited (SGX) is Asia’s leading market infrastructure, operating equity, fixed income, and derivatives markets to the highest regulatory standards. As a global multi-asset exchange, we believe that technology is fundamental to power the transformation of critical financial-market infrastructures.
Blockchain is a frequently misunderstood technology, yet it is also one of the most promising areas of innovation today for specific use cases that involve transactions at scale. Smart contracts and distributed ledgers (DLT) have great potential to fundamentally transform capital markets, making financial transactions and processes more transparent, resilient, and less costly.
SGX has conducted significant experiments with blockchain technology. Operating a blockchain infrastructure in a highly regulated and mission-critical environment is a daunting prospect. Working with the Amazon Web Services (AWS) Professional Services team, we were able to move our existing Hyperledger Fabric application to Amazon Managed Blockchain within days. Amazon Managed Blockchain eliminates much of the effort required to configure and manage the blockchain infrastructure stack, and enables us to focus on creating value for our customers.
A Process of Evolution
For more than 500 years up until the early 1970s, traders recorded transactions on paper. It was a true paper trail; a chain of promises written on scraps of paper and reconciled into physical ledger books. People would gather in coffeehouses and, eventually, purpose-built venues that looked like arenas or trading pits, where orders were shouted or signaled by hand gestures.
In the last century came automation, ticker tapes, and the age of computers, which saw markets move online, led by the exchanges. Gone were the couriers scurrying around the financial centers carrying briefcases of stock certificates, replaced by giant mainframe computers and terminals.
Today, exchanges have evolved into highly organized and regulated electronic marketplaces that facilitate transactions for financial products across all asset classes—from equities to fixed income to currency and commodity derivatives.
Ultimately, exchanges are in the business of trust and our obsession with technology is to create trusted platforms for our customers. Companies, investors, banks, and other market participants trust us to provide a fair, orderly, and transparent venue for price discovery and risk management. Without this trust, we would lose our business. With electronic trading, we have digitalized information and some of the transaction workflows. Blockchain could be the breakthrough that will digitalize the trust itself, codifying rights and obligations in a consistent and coherent way, creating a truly digitalized marketplace end-to-end.
The Cloud Journey
At SGX, we have decommissioned our mainframes and migrated away from legacy architecture onto modularized platforms supporting open APIs. The next step for us is to leverage cloud technologies to optimize and scale our infrastructure, but more importantly to be able to distribute our services and market data more effectively to our customers.
Unlike many of the e-commerce ecosystems, financial institutions today still operate very heavy datacenter footprints. Over the years, the need for highly secure and mission-critical environments has led to overbuilt networks and infrastructures that cater to peak demand but operate at low efficiency. Batch processing and manual reconciliation still plague most types of financial transactions, and compounded by localized infrastructure, hamper the growth and innovation required to keep pace with the rapidly changing needs of investors.
Transitioning critical on-premise infrastructure to be cloud-ready requires careful planning and execution. AWS has been a key partner for us in our cloud journey, but can we do more for our customers and drive innovation and growth for the ecosystem?
Turning the Ledger Inside Out
Blockchains are not suitable or necessary for some use cases, but they hold extraordinary promise for many types of financial market transactions. Smart contracts are ideal for digitally modeling the complex business inter-relationships between market participants, with built-in reconciliation and an immutable chain of record. Just as the early mainframe computers freed exchanges from manual processes, blockchain could be a catalyst for the next phase of our evolution.
We have been collaborating with the Monetary Authority of Singapore (MAS) on Project Ubin , a series of industry-level projects to explore the use of blockchain for digital money in the clearing and settlement of payments and securities. Last year, SGX led the development of Project Ubin DvP. DvP stands for delivery versus payment transactions and is a clearing and settlement mechanism. It applies when payment is required before or upon delivery of a security. Today, the DvP process requires information to go back and forth across disparate systems and many parties. With Project Ubin DvP, we successfully achieved interledger connectivity and settlement finality, proving DvP of a digital currency and a tokenized asset on two separate ledgers, on a trade-by-trade basis, such as digital Singapore Dollar against Singapore Government Bonds and Chinese Depository Receipts.
The Ubin DvP prototype design allows a trusted Recognized Market Operator (RMO) such as SGX to maintain a pivotal role to monitor and facilitate the network, and also enable the participating financial institutions to join the same blockchain network with the ability to share a common, transparent ledger for processing trade-related transactions efficiently. In Singapore’s context, SGX, together with the industry, has recently moved from T+3 to T+2, shortening the settlement cycle by simplifying post-trade settlement processes and reducing risk exposures. Blockchain could enable us to compress the settlement cycle even further for specific asset classes, while also retaining the flexibility to provide for variable settlement cycles in accordance to market demand and regulatory requirements.
Blockchain as a Managed Service
When we first started working on blockchain and getting deep into Hyperledger Fabric and smart contracts, we deployed the nodes onto physical servers, connecting them together with Ethernet cables to form the network. However, we quickly realized that running this type of architecture inherited all the problems of our existing world and would be very difficult to operate and scale. For an exchange business, the overheads of operating and maintaining the blockchain network consumes valuable resources, but adds very little value to our customers.
The true differentiator is in the blockchain application, not the mechanics of the ledger. Coding smart contracts to accurately and efficiently represent real-world business transactions is the key factor that will drive transformation in financial markets.
These factors led to our work with AWS to move our existing investments in Hyperledger Fabric to Amazon Managed Blockchain. Amazon Managed Blockchain offers businesses the opportunity to eliminate the heavy-lifting typically required in setting up the infrastructure stack. This allows us to focus on adding business value and not worry about managing or scaling the underlying platform. In just a few clicks, we can have a functioning blockchain network up and running and easily invite our partners to join the network. This significantly changes our deployment model and takes blockchain one step closer to mainstream adoption.
The underlying concepts of blockchain and distributed ledgers have been proven to work very well for suitable use cases. Although there is a lot of evidence to suggest that we are on the brink of finding the way forward, certain challenges remain ahead of us before blockchain can become accepted as a mainstream technology, specifically in financial markets. These fall into three broad categories, listed in increasing order of difficulty: technical capability, regulatory acceptance, and adoption.
The technical challenges of developing stable, deterministic, and consistent consensus mechanisms are gradually being resolved. We have also seen the results of recent tests that demonstrate a blockchain network’s ability to handle high transaction workloads. Encryption alone is not enough to address data privacy, so new techniques are being developed. Using Hyperledger Fabric as an example, channels and private data collections can secure transactions between parties such that the data is not exposed to all members in the network. Services like Amazon Managed Blockchain make it easy to create and operate networks, lowering the bar for experimentation and adoption for critical systems.
Depending on the jurisdiction, the codification of rights and obligations into smart contracts will require a different regulatory paradigm. Some of this is not directly related to blockchain, but broader digitalization as a whole. For example, the legal requirement for wet signatures for certain transactions will limit the functionality of smart contracts. Others are directly related to the effective governance and control of digital money and assets. One thing is certain: supervision and oversight of blockchain networks place a much higher premium on the technical competency of all parties involved.
Adoption is a much more challenging problem for financial markets. Today, there are no established standards for blockchain technology. While many industry working groups are trying to form an agreed operating standard, no real consensus has been achieved, partly due to competing interests and also a general lack of common understanding as to what blockchain can and cannot do. In many ways, interoperability becomes much more significant than outright standardization, as it is quite evident by now that there will be many blockchain networks, each serving a specific purpose for a specific customer group. However, based on our tests, we see Hyperledger Fabric as a robust blockchain framework to run a variety of financial services workloads.
In financial markets, blockchain not only enables more efficient transaction models, it also creates a new digital asset class that can change the way funds are raised and distributed, unlocking liquidity and facilitating borderless transactions. While progress has been made on many fronts, we will need to further address technology standards, interoperability, and regulatory readiness as we continue towards greater adoption of blockchain. These are opportunities for more collaboration across the industry in the future.
Leveraging Amazon Managed Blockchain with Hyperledger Fabric, we were able to quickly build a platform and work with our partners to build a better interbank payments platform. We believe the service is a significant step in the right direction for mainstream blockchain adoption. SGX is committed to harnessing emerging technologies, working together with key technology partners like AWS and also with our customers to bring value and growth to the ecosystem.