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WFE Study Reveals Impact of Blockchain Settlement Latency on Market Liquidity and Costs

May 28, 2024

John Lothian

John Lothian

Executive Chairman and CEO

May 28, 2024

Elmhurst, IL (JLN) — Pedro Gurrola-Perez, head of research at the World Federation of Exchanges (WFE), discussed the findings of a recent research report on the impact of Distributed Ledger Technology (DLT) settlement latency on market quality during an interview with John Lothian News. The study, titled “The Effect of DLT Settlement Latency on Market Liquidity,” reveals significant implications for the financial industry, particularly in the context of blockchain technology.

Gurrola-Perez emphasized that the research challenges the notion that democratizing and disintermediating clearing and settlement processes through blockchain can be achieved without affecting market quality. If you take away central counterparties (CCPs) and central securities depositories (CSDs), you’re removing the trusted entities that guarantee ownership and settlement integrity, he said. Blockchain aims to bring trust in a trustless network through mechanisms like proof of stake or proof of work, but this introduces settlement latency and uncertainty.

The WFE’s research, which used blockchain mining power as an instrumental variable, found that DLT settlement latency significantly lowers market liquidity and increases transaction costs. The uncertainty in settlement timing impacts liquidity and price, making trading more costly, Gurrola-Perez said. 

The study highlights that the variability in settlement latency is driven by factors beyond the control of platform owners or participants. Mining power can fluctuate randomly, affecting the timing of transaction validation, Gurrola-Perez said. This randomness can delay settlement, causing traders to hesitate and reducing liquidity. Additionally, the lack of certainty in final pricing affects traders’ ability to execute optimal trades.

The implications of these findings are twofold. For current blockchain platforms, users must be aware of the limitations in market quality. For entities planning to adopt DLT, the research underscores the need to consider market design carefully. Future platforms must either minimize settlement latency or choose a DLT structure that avoids these issues, such as permissioned DLTs, Gurrola-Perez said.

The report has garnered significant attention from both the cryptocurrency and traditional financial sectors. It highlights the need for a balanced and thoughtful approach to new technologies, recognizing the trade-offs involved, Gurrola-Perez said.

The World Federation of Exchanges, headquartered in London, represents over 250 market infrastructure providers globally, advocating for fair, transparent, and efficient markets.

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