TradFi to Create Digital Bonds Trading Platform on Blockchain
[TL; DR]
CIB and SEB are examples of traditional financial institutions that aim to introduce crypto trading platforms for bonds.
The European Investment Bank (EIB) was the first financial institution to issue a digital bond in April 2021.
Blockchain bonds increase transparency and security in digital asset trading.
The issuance of digital bond trading is limited by lack of regulatory oversight and the possibility of cyber crimes.
Introduction
Debts play an important role in various economies as they help companies to access funds to start or expand their businesses. One of the popular debt instruments are bonds which borrowers issue to raise funds for their projects. As we know, a bond is a promise to pay someone in the future. Today, we discuss how digital bonds are set to revolutionize the financial sector.
TradFi Banks teams up to create digital bond
Although bonds are an integral part of TradFi, the legacy banks are planning to launch digital bonds on the blockchain. Swedish bank SEB and French investment bank Credit Agricole CIB, two of the most popular banks in Europe, have partnered to develop a platform on the blockchain which will create digital bonds.
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Companies will be able to create digital bonds on the platform which will increase efficiency and enable real-time data synchronization. In other words, the firms will use smart contracts to manage their digital bonds.
Digital bonds can exist on the blockchain - Financeautomate
Sobond, CIB and SEB‘s digital platform, will use the “Proof of Climate awaReness validation protocol, which enables users to reduce their carbon footprints. According to the team, Sobond will encourage the consumption of energy at a level similar to other non-blockchain based projects.
Basically, Sobond will reward nodes for minimizing energy consumption. To this effect, the team said, “Each node will be remunerated for its efforts according to a formula linked to its climate impact.” It is also important to note that Sobond will be the first blockchain protocol to use the Proof of Climate awaReness validation protocol.
CIB and SEB are not the first projects to produce digital bonds. The European Investment Bank (EIB) launched its digital bond on the Ethereum blockchain in April 2021. In fact, The EIB collaborated with Goldman Sachs, Santander, and Société Générale to issue and settle a two-year €100 million bond.
European Investment Bank Issued digital bond in 2021 - Reuters
The process of issuing digital bonds is very simple and understandable. The first step is to tokenize the bond. From there the bond issuer will approach investment banks. In return, an interested bank will create the term sheet which they will sign.
After that the blockchain trading platform will generate a masterbook which consists of bids and orders of interested investors. Transactions will occur once the completes the key steps.
The blockchain streamlines the bond issuance and sale process. Mainly, the process eliminates the paper-intensive procedure of issuing bonds that exists in the traditional financial sector. In the legacy financial sector fixed income securities such as bonds which are sold over the counter (OTC) involve manual paper work which is time consuming and laborious.
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The issuance of bonds on the blockchain is efficient and cost effective which should increase their uptake. Therefore, this increases viability and sustenance for the traditional financial banks.
Benefits of using the blockchain technology to issue and settle bonds
A digital bond is a bond which is issued and settled using the blockchain. It is a security with a fixed interest which borrowers use to raise capital for their businesses. There are corporate bonds as well as government bonds which people can trade.
Smooth issuance of bonds
The digital bond issuance process is smooth and automated which enhances efficiency and cuts costs. This is different from the traditional bonds which are time consuming to issue and settle. Also, there is a low chance of making errors when handling digital bonds.
There is transparency
The blockchain technology results in transparency when sharing data relating to liquidity, issuance documents, pricing and asset performance. This creates a fair and competitive market for bonds and other securities. Transparency helps the investors to make informed investment decisions.
Accuracy
The blockchain enables sharing and storage of accurate data since no one can change it. Apart from immutable data, the blockchain enables real time sharing of information to all interested parties. With digital bonds all market participants can access transaction updates at all times.
Cost reduction
In the traditional finance sector the issuance of bonds involves many parties. For example, there is a need for regulatory approval, registration and subion which involves a number of players. On the other hand, blockchain technology enables the decentralization of these processes since there are no intermediaries.
Higher liquidity
Tokenizing bonds lead to higher liquidity than in the traditional market. This is because the bonds can be fractionized and sold to many investors. Therefore, the digital bond issuers have access to a larger investor base than in the legacy financial sector. This makes the bidding process more competitive.
Better security
The use of cryptography enhances the security of the bonds.This is because there is no chance for a few individuals to alter the information about the bond that exists on the blockchain. With traditional bonds, the parties involved may misplace some of the important documents.
Challenges of digital bonds
The blockchain technology does not solve all the problems people encounter when issuing and settling bonds.
Lack of supporting regulation
There is no doubt that blockchain technology has the potential to make bond issuance efficient and transparent. However, the absence of the required regulation prevents businesses from investing in the technology. This makes the issuance of blockchain bonds risky and prevents its mainstream adoption.
Scalability
When there is a need for high volume issuance of bonds on the blockchain the processing becomes slower due the encryption, complexity and distributed nature. In addition to slower transactions the cost of processing digital bonds becomes high.
Security issues
Digital assets that exist on the blockchain are prone to cyber theft such as hacking. For example, the collusive nature of miners or network validators may result in 51% attacks resulting in loss of blockchain finance.
Conclusion
The new trend in TradFi where banks are willing to issue digital bonds is likely to increase efficiency and transparency in the sector. This is because digital bonds reduce the processing time, decrease the cost of crypto bond issuance and improve their security.
