Finance:Smart bond

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Short description: Type of an automated financial bond that uses the capabilities of blockchains

A smart bond (or blockchain Bond) is a specific type of an automated bond contract that uses the capabilities of blockchain databases that can operate as cryptographically-secure yet open and transparent general ledgers. This is sometimes referred to as Distributed Ledger Technology (DLT).[1] It is one of a class of financial instruments known as a smart contract, "a computerized transaction protocol that executes the terms of a contract."[2]

This is in contrast to the traditional issuance process for bonds which can be a lengthy and highly technical process, which involves many intermediaries and stakeholders with sometimes conflicting objectives. A general lack of standardization in the primary markets increases information asymmetry and results in inefficient pricing, high costs, and long settlement times in the secondary market.[3]

Blockchain bonds have the ability to potentially revolutionize financial capital markets by creating a decentralized database of unique digital assets. Securities using blockchain technology will be able to cut out the various middlemen that are present in a bond transaction and lower fees.[1]

Issuers of bonds could be able to completely automate the entire bond issuance process through blockchain bonds. This would potentially result in shortened settlement and transaction times as well as greater transparency for the issuer in transactions. The increased transparency and automation of the process would remove the need for intermediaries and therefore generate increased savings for issuers.[4]

History

As of July 2021, the International Capital Market Association has listed the following blockchain bonds:

Smart Bond Issuances (as of August 2021)[5]
Issuer Sale Date Par Amount

(USD Millions)

Issuance Blockchain Country
Commonwealth Bank of Australia January, 2017 N/A N/A Private Ethereum Australia
Daimler AG June 28, 2017 111 1-year Bond Private Ethereum Germany
Fisco August 10, 2017 0.813 3-year Bond Private Ethereum China
Sberbank May 18, 2018 12 Commercial Bond Hyperledger Fabric Russia
World Bank August 24, 2018 108 2 Tranche "bond-i" Private Ethereum Australia
Société Générale April 18, 2019 112 5-year Covered Bond Public Ethereum France
Santander September 12, 2019 20 1-year Bond Public Ethereum Spain
INVAO September 27, 2019 20 10-year Bond Public Ethereum Lichtenstein
Bank of China December 3, 2019 2,800 2-year Bond Proprietary Blockchain China
Bank of Thailand September 11, 2020 1,600 Savings Bond IBM Blockchain Thailand
Union Bank of the Philippines December 7, 2020 190 3 and 5.25 year Dual Tranche Bond Proprietary Blockchain Philippines
Vonovia Investment Bank January 13, 2021 24 3-year Bond Stellar Blockchain Germany
Société Générale April 15, 2021 6 Autocall, Euro Medium Term Notes Tezos Public Blockchain France
European Investment Bank April 27, 2021 121 2-year Bond Public Ethereum France

As early as 2014, banking executives were speaking publicly about the ability of blockchain technology to trigger significant "simplification of banking processes and cost structure."[6]

(As of 2015), UBS was experimenting with smart bonds that use the bitcoin blockchain[7] in which "risk free interest rates and payment streams [could be] fully automated, creating a self-paying instrument."[8] The Huffington Post reports than an announcement of the UBS smartbond service is expected in 2016.[9]

In 2018, the World Bank mandated the Commonwealth Bank of Australia for the world's first blockchain bond.[10]

On 28 November 2018, United Arab Emirates based Al Hilal Bank executed the world's first Blockchain Sukuk (Islamic Bond) on the Ethereum blockchain.[11] Blockchain was used to transact a secondary market deal in Al Hilal Bank's $500 million Senior Sukuk, maturing September 2023. This was the first time Blockchain technology was utilized in the execution of a Sukuk transaction. The technology was built by Swiss-based blockchain developer, Jibrel AG.[12]

Characteristics of Smart Bonds

DLT bonds involve a distributed database maintained over a network of computers connected on a peer-to-peer basis, so that participants can share and keep identical, cryptographically secured records in a decentralized manner. Operation of a DLT network can involve the use of a public or private network that may contain digitally represented assets. Network participants conduct and verify transactions. This would eliminate the need for a centralized ledger maintained by a third party.[13]

A blockchain bond is first issued in tokenized form into a digital asset ledger. Then, an investment bank creates a digital term sheet as part of a smart contract and receives the sign off from the issuer of the bond. Bids and orders from investors are recorded in the master book. The issuer, using Know Your Customer (KYC) details provided by a gatekeeping intermediary adds investors to the bond's blockchain. Tokens, representing cash or security are used to determine investor portfolio value. The deal reaches financial close after signing. Finally banks act as token keepers and transfer money or debt instruments to the beneficiary accounts.[3]

Applications of Smart Bonds

Many of the transactions using DLT have been experimental in nature over the past three years.[14] Debt capital markets are looking at blockchain as a technology that will potentially disrupt the status quo. Blockchain bonds could add new efficiencies in the way that capital markets traditionally operate.[15] Past experiments in DLT transactions show that blockchain can be used to increase reporting transparency, reduce the number of intermediaries, and reduce the length of the settlement process.[3]

Legislative Considerations

Legal and regulatory uncertainty around the use of DLT are one of the key challenges to its wider adoption. Regulation is generally neutral to technology[citation needed] however regulators in different countries have adopted different approaches to the use of DLT in financial markets.[14]

In North America, as of 2019, there were 28 different DLT related regulations that have been adopted at the state level. Bills enacted in Arizona, Illinois and Maryland provide a legal definition of DLT/blockchain as well as clarifying the legal status of smart contracts. Other bills have provided support for the development of blockchain technology.[16][needs update]

References

  1. ↑ 1.0 1.1 "How Blockchain Could Disrupt Banking" (in en-US). 2021-02-11. https://www.cbinsights.com/research/blockchain-disrupting-banking/. 
  2. ↑ Tapscott, Don (2016). Blockchain revolution : how the technology behind bitcoin is changing money, business, and the world. Alex Tapscott. Toronto, Ontario, Canada. ISBN 978-0-670-06997-2. OCLC 919014174. https://www.worldcat.org/oclc/919014174. Retrieved 2021-08-20. 
  3. ↑ 3.0 3.1 3.2 Pana, Elisabeta; Gangal, Vikas (2021-04-23). "Blockchain Bond Issuance" (in en). Journal of Applied Business and Economics 23 (1). doi:10.33423/jabe.v23i1.4064. ISSN 1499-691X. https://articlegateway.com/index.php/JABE/article/view/4064. Retrieved 2021-08-20. 
  4. ↑ "Digitizing Bonds on the Blockchain" (in en-US). https://www.goldmansachs.com/insights/pages/from_briefings_10-june-2021.html. 
  5. ↑ "New FinTech applications in bond markets". International Capital Market Association. https://www.icmagroup.org/Regulatory-Policy-and-Market-Practice/fintech/new-fintech-applications-in-bond-markets/. 
  6. ↑ Irrera, Anna (2014-10-27). "UBS CIO: Blockchain Technology Can Massively Simplify Banking". Wall Street Journal. https://blogs.wsj.com/digits/2014/10/27/ubs-cio-blockchain-technology-can-massively-simplify-banking/. Retrieved 2016-05-27. 
  7. ↑ Ross, Rory (2015-09-12). "Smart Money: Blockchains Are the Future of the Internet". Newsweek. http://europe.newsweek.com/smart-money-blockchains-are-future-internet-329278. Retrieved 2016-05-27. 
  8. ↑ Wigan, David (2015-06-11). "Bitcoin technology will disrupt derivatives, says banker". IFR Asia. http://www.ifrasia.com/bitcoin-technology-will-disrupt-derivatives-says-banker/21202956.article. Retrieved 2016-05-27. 
  9. ↑ Seaman, David (2016-08-10). "Ethereum: Here Come The Big Banks". Huffington Post. http://www.huffingtonpost.com/david-seaman/ethereum-here-come-the-bi_b_11439206.html. Retrieved 2016-08-11. 
  10. ↑ "World Bank Mandates Commonwealth Bank of Australia for World's First Blockchain Bond". http://www.worldbank.org/en/news/press-release/2018/08/09/world-bank-mandates-commonwealth-bank-of-australia-for-worlds-first-blockchain-bond. Retrieved 22 April 2019. 
  11. ↑ "Al Hilal Bank Executes World's First Blockchain Sukuk Transaction". 2018-11-26. https://www.alhilalbank.ae/en/news/2018/november/al-hilal-bank-executes-the-worlds-first-blockchain-sukuk-transaction.aspx. 
  12. ↑ "Abu Dhabi's Al Hilal Bank uses blockchain to sell sukuk in secondary market". 2018-11-26. https://www.reuters.com/article/al-hilal-sukuk-blockchain/abu-dhabis-al-hilal-bank-uses-blockchain-to-sell-sukuk-in-secondary-market-idUSL8N1Y11PH. 
  13. ↑ "Blockchain Basics: Introduction to Distributed Ledgers" (in en-US). https://developer.ibm.com/tutorials/cl-blockchain-basics-intro-bluemix-trs/. 
  14. ↑ 14.0 14.1 "ICMA Distributed Ledger Technology (DLT) regulatory directory". https://www.icmagroup.org/Regulatory-Policy-and-Market-Practice/fintech/icma-distributed-ledger-technology-dlt-regulatory-directory/. 
  15. ↑ "Société Générale blockchain issuance a sign of things to come" (in en-gb). 16 May 2019. https://www.iflr.com/article/b1lmx9t6wz3f7z/soci233t233-g233n233rale-blockchain-issuance-a-sign-of-things-to-come. 
  16. ↑ Varrall, Rowan (20 December 2019). "DLT-related legislation and regulatory frameworks in capital markets". https://www.icmagroup.org/assets/documents/Regulatory/FinTech/DLT-related-legislation-and-regulation-201219.pdf. 




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