The absence of settlement infrastructure is a major problem that is currently holding back the market. Settlement infrastructure refers to the systems, institutions, and procedures that facilitate the transfer of ownership of assets from one party to another. These include things like clearinghouses, custodians, settlement agents, and other intermediaries that help to ensure that transactions are executed smoothly, efficiently and with confidence. Without this infrastructure, the market is unable to function at its full potential, and this is a problem that needs to be addressed.
The lack of settlement infrastructure can be traced back to the early days of the market when transactions were done on a one-to-one basis. Back then, the market was small, and the risks were low. However, as the market grew, and transactions became more complex, it became clear that a better system was needed to manage risk and ensure that transactions were executed efficiently.
The absence of settlement infrastructure poses several challenges to the market. One of the most significant challenges is the risk that transactions won’t settle. Settlement risk is the risk that one party fails to deliver the asset or payment on the agreed-upon settlement date. This risk means that parties to a transaction cannot be certain that they will receive what they expect, which creates uncertainty and reduces confidence in the market.
Another challenge is the high cost of settling transactions. Without infrastructure, settling transactions requires significant time, effort, and resources. Parties must manually reconcile trades, confirm settlement instructions, move assets, and exchange cash. This process is time-consuming and requires a high level of expertise, which makes it expensive.
These challenges have significant consequences for the market. For one thing, they limit the number of participants who are willing to trade. Investors and other market participants are reluctant to enter a market that is characterised by high risk and high costs. This results in a smaller pool of potential buyers and sellers, which reduces liquidity.
Liquidity is essential to the functioning of any market. It is the degree to which assets can be bought or sold without significantly affecting their price. In a market with high liquidity, many buyers and sellers exist, and assets can be traded easily and quickly. This creates a tight bid-ask spread, which means that buyers and sellers can execute trades at prices that are close to the market price. When the market lacks liquidity, it is much harder to buy or sell assets, and prices can be more volatile.
Finally, the absence of settlement infrastructure limits the potential for innovation in the market. Settlement infrastructure is essential for creating new financial products and services that meet the changing needs of market participants. Without this infrastructure, it is much harder to create and deliver new products that can add value to the market.
The good news is that the industry recognises the importance of settlement infrastructure, and there are ongoing efforts to improve it. One such effort is the development of centralised clearinghouses. Clearinghouses act as intermediaries between buyers and sellers, they help to reduce counterparty risk by guaranteeing settlement, and they streamline the settlement process by providing a single point of contact for all parties to a transaction.
Another important development is the growth of digital settlement platforms. These platforms use digital tokens or blockchain technology to automate the settlement process, reducing the need for intermediaries, and streamlining the settlement process. Digital settlement platforms offer many benefits, including faster settlement times, lower costs, and greater transparency.
Finally, there is a growing awareness of the importance of standardisation in settlement infrastructure. Standardisation refers to the creation and use of standardised practices, procedures, and technologies across the industry. This can help to reduce fragmentation in the market, eliminate redundant processes, and streamline settlement.
In conclusion, the absence of settlement infrastructure is holding back the market. Settlement infrastructure is essential for managing risk, reducing costs, increasing liquidity, and facilitating innovation. Without it, the market cannot function at its full potential. However, there are ongoing efforts to improve settlement infrastructure, including the development of centralised clearinghouses, digital settlement platforms, and increased standardisation. These efforts are essential for ensuring that the market can continue to grow and evolve, meeting the changing needs of market participants and supporting the health of the economy as a whole.
The lack of a crypto bank settlement layer is causing severe liquidity problems for the crypto market, according to Ram Ahluwalia, the CEO of PeerNova. In traditional finance, clearinghouse firms such as the Depository Trust and Clearing Corporation (DTCC), the Chicago Mercantile Exchange (CME), and Intercontinental Exchange (ICE) act as intermediaries between buyers and sellers, taking on the counterparty risk of every trade and providing confidence and security for market participants. However, there is no centralized clearinghouse infrastructure in the crypto market, which has led to significant challenges for market participants, who are forced to assume counterparty and settlement risk. This has resulted in a drying up of liquidity, making it difficult for traders to find counterparties and execute trades.
Ahluwalia argues that the crypto market needs a crypto bank settlement layer, which can provide the same security and confidence as traditional clearinghouses. This would allow market makers to settle instantly with counterparties, without taking on any counterparty or settlement risk. It would also help improve market stability and facilitate efficient trading, which would benefit the crypto market as a whole.
Although there are blockchain-based systems such as Signature Bank’s Signet that offer instant settlement, Ahluwalia raises an interesting question regarding relying solely on blockchain technology for settlement. Compliance with sanctions screening laws issued by organizations such as the Office of Foreign Assets Control (OFAC) is one major issue. The lack of a banking settlement layer means market makers are responsible for ensuring compliance with these laws, which increases their risk.
Overall, Ahluwalia believes that the need for a 24×7 bank instant settlement layer is critical in the context of the 24×7 crypto market. The loss of critical market infrastructure like Sen and SigNet has highlighted the importance of having a reliable settlement layer in place. In the absence of a centralized clearinghouse, having a reliable settlement layer is crucial for market stability and unlocking liquidity.
Although there are challenges associated with relying on blockchain technology for settlement, there is no doubt that blockchain has the potential to revolutionize the settlement process. With continued innovation in the blockchain space, we may see new solutions that address the challenges currently faced by the crypto market. In the meanwhile, market participants will need to continue managing their counterparty and settlement risk in the absence of a centralized clearinghouse infrastructure, which will impact liquidity and impede growth.