Leung Cho Pan/123RF

Blockchain For Stock Markets: 11 Possible Use Cases

  • 26 October 2018
  • Sam Mire

A house of cards falls over easily.

WorldCom was once the second largest long-distance telecom company. With a market cap of $175 billion during the dot-com boom, it was proof of Wall Street’s potential to make investors rich quickly.

Then it happened. Barely noticeable cracks in WorldCom’s foundation became full-blown fissures.

WorldCom CEO Bernie Ebbers defrauded investors by reporting false profits of over $3 billion. Countless investors were left without savings and retirement money due to the company’s deceptive accounting practices.

This story is hardly unique. The notorious Bernie Madoff defrauded investors out of at least $17 billion. Italian dairy giant Parmalat forged countless documents to cover up $14 billion in expenses. Most people know the name Enron for all the wrong reasons.

So how can blockchain technology help fight our proclivity for greed?

The more consumer protections and transparency we bring to investment markets, the better. The blockchain could help deliver multiple investor safeguards.

The use cases start simple, by automating stock trading to cut out fees and middlemen, or logging trade histories and mandatory financial data on a blockchain to ease regulator access. This technology could even enable totally new asset classes for trade.

Blockchain for stock markets - Practical use cases

Reducing Intermediaries

Blockchain use cases for stock markets - Reducing Intermediaries

There are numerous middlemen between stock buyer and seller. A single trade might involve stockbrokers, depositories, banks, and clearing corporations. These intermediaries often help the markets function more efficiently, but they’re not all indispensable.

Consider brokers. Most online brokers require a minimum deposit to open an account. This is typically around $500 or $1,000, but sometimes as high as $10,000. Brokers may also demand stock trading fees, as much as $50 per trade. Then there’s other hidden charges, like the IRA closure fee and options fees.

These fees seem unjustified in a world where value and DIY are king. On survey found 10 percent of millennials would rather use the free digital trading platform Robinhood instead of paying a broker or using other fee-heavy trading platforms.

Certain blockchain-powered apps allow micro-investing, catering to more budget-conscious investors who are either unwilling or unable to purchase entire shares.

Emergent blockchain-driven investing platforms don’t come with the advice and strategy that an experienced broker can provide. They also aren’t as well-suited to the diversified portfolios that many investors seek. But they do provide a window into the future of blockchain-based trading platforms. They aim to lower the cost of investing by reducing who takes a cut of each transaction.

Built-In Regulation

Blockchain use cases for stock markets - Built-In Regulation

We know October 24th, 1929 as “Black Thursday” because investors sold 13 million shares on the New York Stock Exchange amidst tenuous financial times, triggering a full-blown panic.

In the depths of the Great Depression, roughly one-third of the non-farmer workforce was unemployed, suicide rates increased to 17 out of every 100,000 Americans, and the nation’s gross domestic product fell from $103.6 billion in 1929 to just $56.4 billion in 1933. This misery was brought on in large part by the failure of 9,000 banks lending money to irresponsible stock traders. Some level of insurance and regulation was needed to avoid a repeat of the Depression.

Over 85 years later, the financial sector still hasn’t shaped up. Perhaps blockchain technology will take the regulatory imperative out of traders’ hands for good.

Did I mention that the financial sector didn’t learn its lesson in 1929?

“Black Monday” — Black Tuesday, if you’re Australian — refers to October 19th, 1987, when the Dow Jones sustained a nearly 23 percent decline caused in part by overvaluation and market illiquidity. Then there’s the Great Recession, and the many mini-recessions before it. Regulation doesn’t have the luxury of sleep. But neither does technology.

Blockchain users can access a ledger remotely with the passkey. Traders could save money by permitting regulators some oversight into blockchain-powered trading platforms. Investors of all experience levels and financial means would avoid unforeseen legal consequences through real-time compliance. Greater oversight can also promote responsible trading practices.

Companies Trying to Solve This Problem

Simplifying Post-Trade Events/Settlement

Blockchain use cases for stock markets - Simplifying Post-Trade Events

We humans can’t comprehend the size of the global investing marketplace. The Central Clearing and Settlement System (CCASS) processed 1,526,623 securities trades in August 2018 alone. Those trades transferred a total of 200 billion shares. And CCASS only handles the Hong Kong financial market.

Efficient trades settle on the day of the transaction (T+0) or the day after (T+1). According to PricewaterhouseCoopers, we need more automation and more investment to obtain these idals. Some believe that blockchain-powered smart contracts are the way to do it.

Smart contract technology could replace ineffective, costly human oversight in blockchain-driven trading platforms. The contracts execute as soon as some prerequisite criteria is fulfilled, like a buyer and seller agreeing on a price point. Quicker trades mean shorter time lags. Shorter lags free up the equity needed to keep wheeling and dealing.  

Companies Trying to Solve This Problem

Automated Regulatory Mechanisms

Blockchain use cases for stock markets - Automated Regulatory Mechanisms

You might dislike the Securities and Exchange Commission (SEC). You might not care at all. If you work for them, odds are you’re a fan. Regardless of your stance on the SEC, it serves an important role in regulating the investment sector. They keep it from crippling the national economy. Blockchain technology may help regulators do a better job.

There was the $20 million settlement with a Colorado-based biopharmaceutical company for misleading investors about a developmental cancer drug. There was the indictment of US Congressman Chris Collins for alleged insider trading. And there was a settlement with Elizabeth Holmes and her notoriously defunct company, Theranos.

But there are also countless shady investors who get away with outright criminal activity. Somehow Bernie Madoff went unflagged despite numerous warnings. His consistently sky-high returns defied belief even in the biggest bull markets. It’s clear that the SEC needs all the help it can get to monitor the constantly shuffling markets. Algorithms to detect anomalies, potential fraud, and suspicious trading could do wonders for the Commission.

Human regulators are critical as overseers of financial transactions, but blockchain-based trading platforms could serve as support by flagging suspicious transactions. Traders who can recognize potentially suspicious patterns and teach blockchain-powered machines to flag them would have an invaluable resource at their disposal, and it doesn’t even take a salary.

Companies Trying to Solve This Problem

  • tZERO – Developing blockchain system (DLR Software) to help keep securities compliant. 

Establishing a Market for Security Tokens

Blockchain use cases for stock markets - Establishing a Market for Security Tokens

Some called 2018 “the year of the security token.” SEC-compliant cryptocurrencies are a big deal, but they have yet to really go mainstream.

There are unanswered key questions about the viability of secondary market trading and lingering regulatory ambiguity. This uncertainty hasn’t blocked startups from issuing security token offerings (STOs), and for good reason — they make money.

Filings related to token sales continue to rise. There have been 93 such filings since August 2017, and May 2018 saw 15 token-related filings with the SEC. It was an all-time record.

This cooperation between startups and the SEC indicates lots of momentum for security tokens. Successful STOs have shown investors are willing to sink capital into security tokens. Harbor/R-token raised $28 million in April to “re-engineer” private securities for blockchain technology, while financial services company VRBex sought $100 million in its April STO. With easier sales, fewer legal hurdles, and clearer trading practices, security tokens have emerged as the safest bet in token investing.

Security tokens issued through STOs have obvious appeal. Startups and investors see them as a simple way to exchange financing now for returns later. But many security tokens are illegitimate in some form or fashion. A marketplace much like a stock exchange for verified security tokens would lend more legitimacy to STOs. Think of this concept as the difference between the penny stock market and the New York Stock Exchange (NYSE). Penny stocks are the Wild West of investing — if you get burned, that’s on you. Regulators are far more active in the NYSE. This reputable marketplace would drastically advance the cause of STOs.

Facilitating Dividend Payments

Blockchain use cases for stock markets - Facilitating Dividend Payments

A dividend is like the cherry on top of a rising-stock-price sundae. Well-regarded stocks like Apple (AAPL), Exxon Mobil (XOM), and Microsoft (MSFT) all pay dividends to shareholder delight.

Dividends account for a significant portion of returns, though this percentage varies by the market. An analysis of the S&P 500 shows that dividends may increase the typical investor’s total returns by 50% on a $1,000 investment. The majority of stocks pay dividends, and cash on hand is music to an investor’s ears. As is the case with any payment, the money can’t come fast enough. Companies could save time and money by implementing automation in the dividend payment process.

Blockchain smart contracts create self-executing payments to release dividends to shareholders more quickly and cost-effectively.

Companies Trying to Solve This Problem

Token-Facilitated Micro Investing

Blockchain use cases for stock markets - Token-Facilitated Micro Investing

Sometimes a stock falls outside the typical investor’s budget. Without micro investing, this category of investment will remain prize jewels for the rich.

Berkshire Hathaway, the brainchild of investing legend Warren Buffett, is worth over $300,000 as  March 2019. Most of us would have to put our homes up as collateral to buy a single share.. You’d be surprised at what price an unsexy company’s stock can command. Take AutoZone Incorporated. Your neighborhood auto parts retailer and repair shop trades around $652.

Then you’ve got your usual suspects leading the market. These are the stocks that investors look back on and say, “If I only knew….”. Amazon is going for $1,653 per share at the time of writing, while a share of Google can be had for $1,170. Stocks at these price points rarely demonstrate value for the everyday investor.

Security tokens don’t have this issue. They can be broken into smaller increments, so virtually any investor can claim a share. There are relatively untested apps for micro investing in traditional stocks (see: the Stash app). But ICOs laid the groundwork for STOs, which will offer SEC-compliant micro investing.

Fundraising and Asset Management

Blockchain use cases for stock markets - Fundraising and Asset Management

Fundraising says a lot about a publicly traded company.

Tesla’s management has admitted that it often runs negative cash flow. Even if the public weren’t privy to such an admission, Tesla’s relatively frequent return to the fundraising table would have clued investors in. Elon Musk’s electric car company raised $270 million in capital in 2010, $451 million in 2012, and over $18 billion total between 2010 and 2018. Experts don’t expect Tesla to be cash flow positive for quite some time.

But perhaps Musk — and the heads of other publicly traded companies who require capital — could execute fundraising even more efficiently and cost-effectively by adopting blockchain technology next time.

Companies who need money a pinch can sell stock directly to the public at any time. Though the investors get future returns on that stock, the company has a sure-fire way to raise money. Blockchain’s value comes from its ability to conduct fundraising sales and agreements without any middlemen involved. It dispatches cost-effective and immediate smart contracts to execute the transactions, saving money and time without sacrificing quality.

Companies Trying to Solve This Problem

  • aXpire – Blockchain powered software and analytics platforms for the asset management industry.  

E-Voting for Bond and Stockholders

Blockchain use cases for stock markets - E-Voting for Bond and Stockholders

*see Blockchain in Corporate Governance for more in-depth use cases for corporate voting

When was the last time you attended a shareholder meeting?

Probably never, right?

Blockchain can help make the annual general meeting of shareholders (AGM) a more practical, remote affair — a relevant affair, even. Say you’re a creditor of the Venezuelan government, which owed $60 billion in bond repayments to global creditors in November 2017. How would you feel about attending a bondholder meeting in the war-torn, poverty-stricken Venezuelan capital? In case you’re on the fence about President Nicolas Maduro’s proposal to host his government’s bondholders in Caracas, consider that the city’s murder and kidnapping rates rival those of actual warzones. Maduro’s plan is simply poco realista — unrealistic.

Being impractical doesn’t actually differentiate Maduro from the organizers of most shareholder meetings. The blockchain allows secure participation in meetings by shareholders in remote locations. This tool would make it easier than ever for shareholders to participate. Many in-person shareholder meetings are a formality, if not a complete joke (Caracas?!). This could change if managers implement blockchain technology to allow remote participation without the threat of of hacking

Companies Trying to Solve This Problem

Tracking Securities Lending

Blockchain use cases for stock markets - Tracking Securities Lending

Securities lending isn’t widely understood by the general population — a shocker, I know. Traders lend ETFs (which are packaged securities like stocks, commodities, andbonds), or a commodity within the ETF to other parties in exchange for collateral. These borrowers are often selling a stock short.

The total market for ETFs (exchange-traded funds) totaled nearly $3 trillion as of April 2017. They’re a popular investment, as they mitigate the risk of owning any single stock, bond, or commodity and have a strong record of returns. Financial institutions have sound strategies for lending out these ETFs to create additional low-risk revenue streams for investors. But they’re not all safe returns and sunshine. Using technology to hedge ETF investment with technology could become critical as market conditions worsen.

At least five ETFs are heavily invested in the sort of leveraged loans that led to the last financial crisis. But for ETF managers making sound investment decisions, lending securities to short sellers is a low-stress proposition with potential upside.

These trades can be a source of additional revenue for the lender, and can let short sellers sell a stock that they don’t technically own.

Tracking the prices of these ETFs is important from both a buyer’s and seller’s perspective. Blockchain-powered platforms can track the values and status of borrowed ETFs, and trigger the issuance of collateral (through smart contracts) if the short seller becomes overleveraged.

Companies Trying to Solve This Problem

Blockchain-Powered Mutual Funds + Crypto ETFs

Blockchain use cases for stock markets - Blockchain-Based Mutual Funds + Crypto ETFs

If you’re going to invest on your own, it’s best to go in with eyes wide open. Blindfolded dart throwing is no investment strategy.

Just take ETFs versus mutual funds as an example.

Investopedia says an exchange-traded fund (ETF) is “a marketable security that tracks a stock index, a commodity, bonds, or a basket of assets.” By comparison, a mutual fund is “an investment vehicle made up of a pool of money collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments and other assets.”

While they both contain diversified equity types, ETFs trade like common stock. Mutual funds operate similarly to a hedge fund — your money is in it, and it’s up to the manager to provide returns.

Some of the largest mutual funds include Primco Total Return ($263 billion in assets), Vanguard Total Stock Market Index Fund ($190 billion), and The Growth Fund of America ($115 billion). Many investors are comfortable with steady returns from these diversified investment funds.

Now imagine that these funds or ETFs were comprised of tokens and blockchain-reliant companies. Bundling diversified asset classes through the common thread of blockchain technology could bring newfound benefits. Tokenized ETFs and mutual funds could lower the cost of entry for investors currently priced out of desirable funds. Micro investing is a trend that will eventually impact ETFs and mutual funds for the better.

Companies Trying to Solve This Problem

  • Numerai – A financial data innovation shop incentivizing the creation of an artificial intelligence-driven hedge fund.
  • Nasdaq – Using blockchain to facilitate the purchase and sale of mutual funds.
About Sam Mire

Sam is a Market Research Analyst at Disruptor Daily. He's a trained journalist with experience in the field of disruptive technology. He’s versed in the impact that blockchain technology is having on industries of today, from healthcare to cannabis. He’s written extensively on the individuals and companies shaping the future of tech, working directly with many of them to advance their vision. Sam is known for writing work that brings value to industry professionals and the generally curious – as well as an occasional smile to the face.