A newly published report from the European Central Bank and the Bank of Japan argues that distributed ledger tech (DLT) could be used to create new securities settlement mechanisms, including “cross-chain atomic swaps” between unconnected ledgers.

The findings are the result of the central banks’ joint DLT research initiative, dubbed Project Stella, which was launched in December 2016.

Intended to “contribute to the broader debate around the usability of DLT,” this particular phase of the project examined “how the delivery of securities against cash could be conceptually designed and operated in a DLT environment.”

The report focuses on the delivery versus payment (DvP) securities settlement method, in which assets are linked such that the transfer of one asset is executed if and only if the transfer of the other asset also occurs – this is also referred to as “atomicity.”

Researchers designed three prototypes using three platforms: Corda, Elements and Hyperledger Fabric. According to the report, they found that DvP could be executed in a DLT system with cash and securities on both a single ledger and between separate ledgers.

“Conceptual analysis and experiments have proven that cross-ledger DvP could function even without any connection between individual ledgers – a novelty which does not exist in today’s set-up,” the report states, going on to explain:

“Functionalities such as ‘cross-chain’ atomic swaps have the potential to help ensure the interoperability between ledgers (of either the same or different DLT platforms) without necessarily requiring connections and institutional arrangements between them.”

However, the report also cautions that cross-ledger DvP systems could add complexity and operational challenges to the settlement process. For example, DvP transactions between unconnected ledgers would necessitate “several process steps and interactions between the seller and the buyer,” it says.

Likewise, such systems could affect transaction speed and “require the temporary blockage of liquidity.” The lack of system synchronization could also “expose participants to principal risk if one of the two counterparties does not complete the necessary process steps,” the researchers added.

Indeed, the conclusion that the technology isn’t ready to replace settlement systems was highlighted in last September’s report on Project Stella.

As such, the report concludes that “further analysis on the safety and efficiency of individual approaches [to applying DLT to DvP arrangements] is warranted,” in addition to a full legal analysis, which is beyond the scope of the existing project.

Connected chains image via Shutterstock