Citigroup took part in a successful test of the record-keeping technology behind bitcoin. PHOTO: MARCOS BRINDICCI/REUTERS
Banks including J.P. Morgan Chase & Co. and Citigroup Inc. have successfully tested the record-keeping technology behind bitcoin on credit-default swaps, a move that could help it gain a foothold in mainstream finance.
The swaps are essentially insurance contracts that pay off if a bond goes bad, and the process of keeping track of the over-the-counter products can be a burden. Banks match buyers and sellers, transmit the trades via a service run by data provider Markit Ltd. and send a record to Wall Street’s central bookkeeper, Depository Trust & Clearing Corp.
The new test showed that a portion of that record-keeping task could be accomplished using “blockchain,” a common ledger that each party can view in much the same way that multiple users can work on shared computer documents.
DTCC will now discuss whether the results are strong enough to warrant using the technology for live trades or across a broader swath of credit-default swaps, a market with trillions of dollars in outstanding contracts.
“The ink is still drying on the results, but they are positive,” said Chris Childs, chief executive of the DTCC unit that oversees over-the-counter derivatives.
The test helps make the case for using blockchain in core Wall Street activities. While alternative currency bitcoin itself has been embroiled in legal battles and volatility, the underlying ledger—which can be edited anywhere and instantly validated—has drawn heavy interest from mainstream finance.
Big banks recently have invested teams of people and millions of dollars finding ways to apply private blockchains to cut out middlemen and save money. Barclays PLC on Wednesday announced a partnership with bitcoin startup Circle Internet Financial Ltd. to enable the digital-currency startup’s mobile app to send and receive British pounds and to swap them for U.S. dollars.
Analysts at Autonomous Research say using blockchain could cut trading settlement costs by a third, or $16 billion a year, and cut capital requirements by $120 billion. A recent report by Citigroup forecast that automation including blockchain could eliminate two million banking jobs, largely in processing, over the next decade.
The new test replicated a month’s worth of trades in the single-name credit default swap market, which has a total of $6.7 trillion in face value of outstanding contracts, not accounting for offsetting trades, according to DTCC figures. Electronic CDS agreements on individual servers were replaced with a record on a shared blockchain network.
The test included Bank of America Corp. and Credit Suisse Group AG, which worked with J.P. Morgan, Citigroup, Markit and technology firm Axoni, a new venture focused on applying the bitcoin technology of blockchain to banking.
Markit has about half-dozen active blockchain projects, but the CDS test is “the most real proof-of-concept going on,” said Jeffrey Billingham, vice president in Markit’s processing division and a lead in its “Chain Gang” testing blockchain uses. The test “revealed to everybody the ways you can improve efficiencies and minimize costs.”
Any live implementation of blockchain in swaps trading could be years away. DTCC says the next step is testing the appetite of other banks and regulators to use blockchain in the market. Some may be reluctant to make changes that threaten their own market share or introduce new complexity to current systems that have been tested and refined over the years.
DTCC, a bank-owned utility, will be an important player. It handles settlements for quadrillions of dollars worth of transactions. While bitcoin and blockchain were intended to eliminate the need for a middleman, DTCC has argued that U.S. regulators would likely still require oversight by a central body.
Regulators including the Federal Reserve, Commodity Futures Trading Commission and Securities and Exchange Commission say they are monitoring blockchain.
Last week, DTCC said it had separately started working with Digital Asset Holdings LLC, the startup led by former J.P. Morgan executive Blythe Masters, to see whether short-term lending arrangements between dealers known as repos could be settled using blockchain.
Write to Telis Demos at telis.demos@wsj.com
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