Digital Dives
Imagine it’s November 1973. The U.K. entered the European Economic Community at the beginning of the year. The Paris Peace Accords have been signed, putting an end to U.S. involvement in the Vietnam War. Billie Jean King recently defeated Bobby Riggs in tennis during “The Battle of the Sexes”. Pink Floyd’s Dark Side of the Moon is the top selling album. In New York City, the first handheld mobile phone call is made by Martin Cooper of Motorola and the ribbon cutting ceremony for the World Trade Center was carried out weeks ago. There are other headlines, which echo rather familiar today:
Eclipsed by these more memorable happenings, two foundational Financial Market Infrastructure providers (FMIs) were also inaugurated. SWIFT (Society for Worldwide Interbank Financial Telecommunication) was officially founded in May 1973. It was established by 239 banks from 15 countries with the purpose of creating a shared global messaging service to facilitate international bank transactions. In September of that same year, the DTCC (Depository Trust & Clearing Corporation) was established to centralize and automate the clearing and settlement of securities transactions in response to the “paperwork crisis”. During that time, large value securities certificates were physically transported so frequently and in such significant volume that financial institutions and investors were at high risk of fraud and loss. Both organizations were a response to the challenges posed by growing global economic integration and the need for improved efficiency and assurance in financial communications and securities processing.
Contrary to common belief, SWIFT doesn't move funds. Instead, it sends payment orders which need to be settled by the correspondent accounts that institutions have with each other. Today, it connects over 11,000 financial institutions in more than 200 countries. Similarly, DTCC doesn’t custody assets in the traditional sense. As a Central Securities Depository (CSD), the group maintains an electronic ledger that records the ownership of securities for financial institutions. Therefore, it can efficiently record transfers, corporate actions (like interest payments, dividends, stock splits, etc.) and even provide value-add services, like risk management solutions through the National Securities Clearing Corporation. Last year, DTCC cleared $2.50 quadrillion in securities transactions.
While they operate in different areas, SWIFT, DTCC, and other CSDs, are integral to the smooth functioning of the global capital markets, facilitating communication and transactions among institutions. They interact with one another as part of the broader network of financial services, especially in cross-border transfers that involve securities movements and international payments. The organizations may also collaborate in the context of regulatory reporting. The important takeaway is that the two groups are essential pillars of the global financial system, with integrations across all the major players.
Despite being massive organizations, both SWIFT and DTCC have cultures of innovation. The former has been adapting to the changing financial landscape by embracing new technologies, improving transaction speeds, and collaborating with fintech firms. The latter has made consistent efforts to incorporate blockchain technology as part of a broader digitization initiative, with the intent of reducing settlement times and enhancing recordkeeping efficiency. Two weeks ago, DTCC announced the acquisition of Securrency Inc., a leading developer of institutional-grade, digital asset infrastructure. With this deal, the organization will “fast-track development of its enterprise digital asset platform to unlock the power of institutional DeFi.” Recently, SWIFT, DTCC, and a dozen other financial operators participated in a pilot program to conduct a series of experiments involving tokenized asset transactions.
SWIFT and Chainlink began their partnership in 2017, back when the latter still operated under the name of “SmartContract.com”. For the unfamiliar reader, Chainlink operates a decentralized network of data oracles, which provides secure sources of off-chain information to blockchain applications. Their latest innovation, the Cross-Chain Interoperability Protocol (CCIP) is a conception that permits for messaging and token transfers across different blockchains, both public and private. In addition to leveraging an enhanced lattice of data oracles, CCIP employs a Risk Management Network of operators who monitor for malicious activity or other anomalies. The objective is to provide a standardized communication layer whereby applications can securely send/receive information and value across an increasingly disparate landscape of blockchains.
In a way, CCIP aims to integrate some core functionality of SWIFT (messaging) and CSDs (transfers and record keeping) as it relates to the network of blockchains, an arena where the team has proven its capabilities for several years. Because, the incumbent communication and settlement layers of the traditional financial tapestry are deeply integrated into the global banking and institutional investment ecosystems, partnering with Chainlink can provide a much less onerous path to experimenting with tokenized assets. By combining their infrastructure, the groups avoid having to build everything from scratch themselves.
Today, if a European investor wants to place an order to purchase a U.S. security, they’d initiate the transaction through their bank/brokerage, who communicates the trade to their counterpart on the other side of the Atlantic. To fund the transaction, the buyer’s bank would use the SWIFT network to send a secure message to the American bank, detailing the amount to be transferred. The U.S. institution would then confirm receipt of the message and availability of shares. It also verifies the transaction details and currency exchange rates if required. The funds would then be sent through the correspondent banking system. The DTCC, through its links with European counterparties or settlement systems, facilitates the transfer of share ownership from the seller to the European investor. They’d also ensure necessary reporting is done for compliance purposes.
The processes above and the relationships that underlie them are profoundly engrained. Integrating CCIP with the key infrastructure providers, enables the benefits of blockchain without causing much disruption to the processes of the incumbent financial institutions. After an expression to purchase an asset from the Source Blockchain, the relevant banks would still send/receive a SWIFT message, but this time it would also be interpreted as a signed blockchain message, getting picked up by CCIP and communicated to the Source Blockchain. DTCC would step-in to effectively move the asset to the counterparty’s wallet on the Destination Blockchain in a legally binding manner. Given the nature of the technology, a record of the transactions would be inherently available. In this case, the SWIFT message can also involve the transfer of capital, which eliminates the slow process of moving through the correspondent banking system. Check out this video to learn more (47-minute mark for specifics) or this one for a more general discussion (both highly recommended).
This is only a single and significantly simplified example to keep this note relatively short. CCIP has a broad variety of potential use cases. However, I think it’s important to highlight that leaders in technology and financial infrastructure have come together to leverage blockchain technology at the institutional level. Let’s jump on a call if you’d like to dig in further. Even in the depths of the bear market we’re seeing top banks and asset managers conduct novel transactions using blockchains. This has been driven by the desire of their clients to transact in tokenized assets, an opportunity which Bernstein has estimated could be worth $5T by 2028. Given the regulatory uncertainty, many are electing to use private chains, which has the potential to accelerate heterogeneity in the ecosystem. Traditionally this could cause friction, but CCIP is built to operate in such an environment.
The headlines of 1973 seem to stand out as particularly impactful, but the truth is, we’re always making history. Just as the introduction of SWIFT and DTCC went under the radar 50 years ago, I think the recent collaboration on tokenized asset settlement between banks, critical FMIs and Chainlink will be regarded as a new paradigm for financial primitives when we look back. Hopefully it doesn’t take half a century!
At Aquanow, we help institutions unlock the potential of digital assets, so if you or anyone you know is considering this functionality, then please get in touch. We’d be glad to leverage our expertise to help you outperform.
If you want to contribute to the web3 movement, Aquanow is on the look for curious and motivated folks to join our team. Feel free to reach out directly or check out the current openings here.
