Issue of Securities through Blockchain Technology

Dr. Devendra Jarwal

Assistant Professor
Department of Commerce
Motilal Nehru College
University of Delhi

Issue of Securities through Blockchain Technology

Introduction

The global economy is recovering slowly from slowdowns and setbacks. Similarly India
has witnessed a confident investment environment accompanied by robust macro-economic
indicators, moderate inflationary pressures, balanced foreign direct investment inflows,
administrative and anatomical reforms administered by the government reposed the investors’
confidence and fascinated investment to the fast growing Indian Capital Market. Indian stock
market escalated new heights boarded on positive domestic and global investment sentiments.
This surge in capital market has led to numerous securities transactions compelling regulators to
devise mechanism through adopting new technologies to enable companies to handle such
voluminous transactions with greater transparency and accuracy. World leading economies have
indicated use of block-chain technology in securities market as panacea to handle all this aspect
of growing capital market. In a very simple language, blockchain is a public record book
allowing millions of people to stay connected with the record book. For instance, if we desire to
transfer our dematerialized shares to someone we need to transfer it though depository
participants who act as intermediary between transferor and transferee. With the use of
blockchain technology we can transfer shares straight to the transferee. This is the convenience
and benefit of blockchain as the entire group members are connected to the block; an individual
change will impact the concerned account of the related members. Given the extent of cyber
securities threats, the blockchain technology will act as insulation to the transactions between the
concerned members and it shall be nearly impossible for the cyber hackers to hack anybody’s
ledger and commit data breach. If anybody attempts to data hacking then he has to hack millions
of computers/ gazettes which are connected to the blockchain concurrently which is quite
impractical. Blockchain never concede manipulations leading to greater transparency and better
corporate governance. Blockchain enters the changes tamper proof on real time basis(Chandra,
Kumaran, & Mishra, 2018).

Objectives of the Study

• To understand the blockchain technology and its uses in capital market

• To analyze the scope of blockchain technology in Indian Capital market

Electronic copy available at: https://ssrn.com/abstract=3435751

Review of Literature

Despite the numerous benefits of the blockchain technology, its usage in financial
transactions is at an inception stage and many new avenues for this technology is yet to explore.
Although a number of banks and financial institutions, including the nation’s largest bank,
the State Bank of India are engaging towards implementing this technology, actual usage
instances are still very few and not satisfactory at all. Chandra, el.al (2018) argued that
blockchain technology will reinvent the financial service system and will bring revolutionary
changes in financial scenario of the global economies. It contains many advantages to the
regulators and stakeholders and all its features must be utilized for greater benefits of the vibrant
capital markets.

A blockchain is a progressive list of records known as blocks which are linked to each
other through cryptography. Each block has a cryptographic hash of the previous block, a
timestamp and transaction data commonly represented as a Merkle tree. By structure, a
blockchain is defiant to changes of the data as it involves cryptographic coding and decoding. It
is an open and distributed account that can record transactions between two parties efficiently
and in a verifiable and permanent way validated by almost all the participants or nodes (Lansiti
& Lakhani, 2017). For to be used as a distributed ledger, a blockchain is simply regulated by
a peer-to-peer network collectively complying with a protocol for inter-node communication and
validating new blocks for making chain type structure in the existing blockchain. As soon an
entry is recorded, the data stored in any given block is difficult or impossible to be altered
retroactively without alteration of all subsequent blocks, which requires consensus of the
network majority. So manipulation of data is considered almost impossible in the blockchain
network. Although given the breach proof technology regime, blockchain records are not
unalterable as any technology is not fully secure yet blockchains may be considered secure by
design and exemplify a distributed computing system with high Byzantine fault
tolerance. Decentralized consensus has therefore been claimed with a blockchain (Lunn, 2018).

Bhattacharrya (2018) explained that in the blockchain design each participant is

represented as a node in the network and maintains the same set of ledger(s) to record to same
sets of data. Transactions are stored by every participant on a consensus basis making it a
trustworthy data as it is acknowledged by all the nodes including admin and auditor of the
network. This curtails the requirement for expensive reconciliation processes among the
participants and delivers faster settlement as the transaction is recorded as well as information
exchanges on real time basis. The blockchain network can be arranged in a flexible way to
accomplish the objectives of security settlement in any permutation and combinations. In this
system nodes may be assigned different roles or permissions like few may have ability to
propose changes and few will have to validate the proposal to effect change and some nodes may
act as auditors which will have supervision capability only. The admin shall be vested with right
to give access to the system and administer dispute settlement and regulatory reporting
mechanism.

Electronic copy available at: https://ssrn.com/abstract=3435751

Significant Blockchain Applications in the Capital Market

In a major breakthrough in the month of July, 2019 YES Bank has handled the issuance
of a Commercial Paper of one billion rupees through blockchain technology for Vedanta Limited
and it is first of its kind in India. Moreover it is also the first time in Asia that a Commercial
Paper has been digitally issued through blockchain network. Blockchain technology may be used
in fair value accounting and historical accounting as well. In the blockchain network, the
intermediaries get eliminated and investors may take decision on real time basis on the
information accessed through transparent recording of transactions by the nodes participating
under the blockchain technology. NASDAQ has already successfully implemented securities
transaction for Chain.com through implementing this technology which is popularly known as
Nasdaq Ling Blockchain. The Australian Stock Exchange has employed US based blockchain
Digital Asset Holdings to prepare and maintain distributed ledger technologies for clearing and
settling trades and related payments. The list of usage of blockchain technology is growing in
financial as well as capital market world over.

Blockchain Technology in Capital Market

Under the blockchain technology, as soon as a deal is entered in the network its message
is transmitted to all the nodes participating in the network, whether it is public or private
network. In case of private network, only permitted set of participants are entitled to take part
and only few have right to validate using their private keys. The proposal entered is transmitted
to all the nodes in the network for authorization under certain norms which can be validated
through public keys. After adequate affirmation checks, each node sums up the transaction that
had executed recently and combines them into a block which will be added to the blockchain.
Each node, through exhaustive search mechanism attempts to find a key to a Proof of Work
algorithm, which would confer the block valid. In this race among all the nodes tries to find the
key to this puzzle, once a node wins in finding the key, it broadcasts this new block to all its peer
nodes in the network. Each of these then performs the independent authorization cum recording
of a new block. This safeguards that only validated blocks are added to an existing chain. The
digital wallet of the receiver is then updated and the transaction is complete. Each block does not
only keep record of the current transaction, but also the history of all previous transactions,
starting from the original one. A block cannot be amended once it becomes part of the chain. As
the database in blockchain is shared, integrity of the datasets is important, and it is being
maintained by an agreement among all the participating nodes through mutual consensus
verification protocol, to update their records collectively. This verification method not only
protects against any cyber threat, but also ensures that no single point of failure exists in the
blockchain (Bhattacharyya, 2018).

Electronic copy available at: https://ssrn.com/abstract=3435751

Figure 1: Current model for an institutional trading in capital market

Purchaser

Broker/ Dealer
Company/ Share
Stock Exchange Transfer Agent

Broker/ Dealer Seller

In the traditional system as depicted in the picture above where a seller needs to sell her
share then she has to approach stock exchange through broker or depositary participant in case of
depository system. Broker then finds the purchaser and settles the deal through clearing house.
The settlement of payments also takes place through the broker. In the traditional format, as soon
as buyer seller meets the transaction becomes their individual transaction and company only
effect the transfer of shares on the demand made by the parties especially the buyer on producing
transfer documents. Shares are accounted in the securities account book or members’ register for
which Company or share transfer agent is responsible for accounting of the shareholders.

Electronic copy available at: https://ssrn.com/abstract=3435751

Figure 2: Blockchain model for trade in securities

Admin

Validator Validator

Each node is
connected to
each other
through
Blockchain

Proposer Validator

Auditor

The above picture explains the transfer of securities under the blockchain technology.
Each participant is represented as nodes having role as proposer, auditor, admin and validator.
Information on shareholders structure is comprised form the Digital Share Certificate hosted in
the blockchain network. Company’s authorized executive will have access to all shareholders’
information. Once a shareholder decides to sell all or part of her shares, a small contract is
broadcasted on the blockchain and all other shareholders are automatically informed about it.
Instead of physical form as in traditional system, the share transfer contract shall be in digital
form to be signed by digital signature certificate by the parties using their public and private keys
using cryptography. Once the contract is signed, the company gets automatic notification from
the blockchain network and shareholder structure is being updated automatically. The member’s
register will be automatically updated and it will also eliminate the system of book closure
system as currently adopted by the companies to send notices for general meeting and
declaration of dividends. The blockchain technology may also be used for e-voting by the
members of the company which lead to greater participations by the members in the decision
making for the company.

Indian securities market

The broad-based benchmark indices S&P BSE Sensex and Nifty 50 registered its growth
record in 2017-18 and this year was considered as truing point of Indian Capital market, as they
gained 11.3 per cent and 10.2 per cent respectively against their closing at the end of 2016-17.
This is also the first time that corporate bonds has crossed over the traditional bank lending. As
per the annual data for 2017 published by World Federation of Stock Exchanges (WFE), NSE is

Electronic copy available at: https://ssrn.com/abstract=3435751

secured the first place among the World exchanges in index options and at second place in stock
futures, when exchanges are ranked on the basis of the number of contracts traded or executed.
Mutual funds industry recorded substantial growth during the year 2017-18. Backed by strong
inflows of foreign institutional and domestic investors along-with increased participation of retail
investors, the AUM of MF industry increased to rupees 21.36 lakh crore at the end of March
2018 as compared to rupees 17.54 lakh crore registered at the end of March 2017. The rising
global equity markets and accommodative global liquidity conditions coupled with positive
business sentiment in India attracted foreign portfolio investors (FPIs) with investments to the
extent of US$ 22.6 billion (Annual Report, 2018). Thus given the rising trend and volume the
Indian capital market has potential and necessity to adopt blockchain technology quickly as soon
as possible. Blockchain technology is also useful in corporate governance compliances. The
information is entered and recorded in real time basis thus leading to transparent and quick
sharing of information among the stakeholders and regulators. Similarly the capital structure is
available all the time to track the promoter’s contribution and to identify the parties who are
manipulating the capital market through bogus deals. It will also minimize the insider trading
and unwarranted moves in the stock market.

Conclusion

Blockchain technology should be adopted to achieve greater transparency and easy

handling of voluminous transactions in the capital market. It has numerous benefits as discussed
above. However we are not certain about its potential operational risks and cybercrime threats.
Better way is to have systematic study in this regard and initiate with some pilot projects to
implement this technology in gradual manner. The digital illiteracy is also posing a problem in
adopting current computerized securities market supported by blockchain technology. New
technology always make current technology redundant causing financial burdens on the market
players to unnecessarily bear the cost of new technologies thus we need to study the financial
implications of adopting blockchain technologies. Since securities market should be adequately
regulated to protect the investors the question of regulations and legislations are also required to
look into with broad prospective. Still we must think positive to adopt this technology at the
earliest and utilize operational efficiencies being offered by the blockchain technologies.

Bibliography

(2018). Annual Report. SEBI.

Bhattacharyya, D. B. (2018). How Blockchain is Transforming Capital Market. Larsen & Toubro.

Chandra, S., Kumaran, & Mishra, R. K. (2018). Blockchian Technology - An Exploratory Study on its
Applications. The Management Accountant , 37-41.

Jarwal, D. (2017). Digital Economy and India. Chartered Secretary , 55-77.

Electronic copy available at: https://ssrn.com/abstract=3435751

Lansiti, M., & Lakhani, K. M. (2017, February). The truth about blockchain. Harvard Business Review .

Lunn, B. (2018, February 10). Blockchain may finally disrupt payments from Micropayments to credit
cards to SWIFT. Retrieved July 10, 2019, from www.dailyfintech.com:
https://dailyfintech.com/2018/02/10/bitcoin-will-finally-disrupt-the-credit-card-rails/

Electronic copy available at: https://ssrn.com/abstract=3435751