Introduction
The growing adoption of distributed ledger technology (DLT) and digital assets in global financial markets has made the need for interoperability standards clear to market participants.
The Enterprise Ethereum Alliance (EEA) recognizes the need for collaboration among stakeholders, including financial institutions, technology providers, and regulatory bodies, to drive standards development. This collaborative approach is essential for creating a seamless, secure, and efficient ecosystem that can support the diverse needs of the global financial system.
The EEA Cross-chain Interoperability Working Group is dedicated to standardising interoperability, one of the most important areas in blockchain and distributed ledger technologies (DLT). It defines DLT interoperability as the ability to transfer digital assets from one DLT network to another, send and receive messages across DLT networks, and initiate actions across DLT networks.
About the EEA DLT Interoperability Specification
The Enterprise Ethereum Alliance (EEA) Distributed Ledger Technology Interoperability Specification aims to establish a secure and efficient framework for interoperability between different blockchain networks, focusing on enterprise applications. This specification addresses the need for various blockchain platforms to interact and transact seamlessly, especially in complex and regulated sectors like financial services and supply chain management.
It is designed to support enterprise blockchain networks using diverse underlying technologies (for example, EVM and non-EVM networks), facilitating complex multi-chain ecosystem deployments involving assets, payments, and securities transactions. The open standard prevents fragmentation across different vendor implementations.
Case Study: Delivery versus Payment (DvP)
The context of this case study is a Delivery versus Payment (DvP) use case involving a basket of securities traded between two banks and settled via HQLAX, Fnality International and Adhara, leveraging Corda and Ethereum DLT technologies.
The delivery leg of the trade is managed by HQLAX, which operates on a private permissioned Corda network. The payment leg of the trade is managed by the Fnality Payment System (FnPS), which runs on a private permissioned Ethereum network.
In a nutshell, securities are managed on a private permissioned Corda network, and cash is managed on a private permissioned Ethereum network. Settlement is coordinated between HQLAX and the FnPS using the crosschain function call protocol described in the Enterprise Ethereum Alliance (EEA) DLT Interoperability specification.
Benefits of DLT for DvP
Real-Time Settlement: DLT can significantly reduce the settlement time for securities transactions. Traditional systems often require several days for clearing and settlement, whereas DLT enables near real-time settlement, improving liquidity and reducing counterparty risk.
Improved Efficiency and Lower Costs: DLT can reduce the need for intermediaries by automating and streamlining the settlement process, leading to lower transaction costs and higher operational efficiency.
Reduced Reconciliation Costs: In a DLT-based system, all parties can access a shared ledger that updates in real-time. This shared truth reduces the need for costly and time-consuming reconciliation processes common in traditional systems.
Reduced Counterparty and Settlement Risk: The simultaneous exchange of securities and payment in a DvP model minimises the risk that one party will fail to deliver the security or the payment. DLT further enhances this by ensuring that transactions are executed at precise moments in time and only when both parties meet their obligations.
Digital Representation of Assets: DLT allows for the digital representation of cash, securities, and physical assets, as well as ownership of these assets, making them easier to divide, transfer, and trade on digital platforms.
Overview
Summary: Delivery versus Payment (DvP) settlement between two banks, where securities are managed on a private permissioned Corda network by HQLAX, and payments are handled on a private permissioned Ethereum network by Fnality. The coordination of settlement necessary to achieve DvP across the two DLT networks is facilitated by smart contracts compliant with EEA DLT Interoperability Specification.
Target Customers: Banks, Financial Institutions
Technology: R3 Corda, Hyperledger Besu
Product Type: DLT Interoperability solution
Launch Date: H2 2024 (subject to UK regulatory approval)
Production Phase: Pre-production
Notable Partnerships: Fnality, Adhara, HQLAX, EEA
Leveraging the EEA DLT Interoperability Specification
The DvP implementation focuses on a settlement process where the delivery of securities occurs on a private permissioned Corda network if, and only if, the corresponding payment was made on a private permissioned Ethereum network. This is based on a leader-follower approach in which Corda is the leading network.
The DvP intraday repo trade settlement process makes use of earmarks. Assets are placed on hold with the intent to transfer them to the receiving entity for which they were earmarked. This only happens after receiving sufficient proof that a previous step in the DvP flow was executed correctly.
Key Takeaways
Interoperability between two DLT networks: The case study demonstrates a successful implementation of DvP using two different DLT networks: Corda for securities and Ethereum for payments. Crosschain interoperability is made possible via an EEA-compliant crosschain function call protocol, including cryptographic proofs, to enable a secure DvP settlement flow across the two networks.
Benefits of DLT in securities transactions: DLT offers several advantages over traditional systems, including real-time settlement, improved efficiency, lower costs, reduced reconciliation costs, and minimized counterparty settlement risks.
Atomic settlement: Atomicity of this settlement process removes counterparty (or Herstatt) risk from settlement, also ensuring settlement finality.
Ownership transfer without asset movement: The actual securities do not move between HQLAX's Corda-based network and the FnPS's Ethereum-based network; instead, asset ownership is updated on each respective network. This demonstrates how DLT can enable efficient transfer of ownership at precise moments in time without the need for physical movement of assets.
Conclusion
This case study demonstrates the transformative potential of DLT in advancing securities transactions and payments. By leveraging the unique strengths of different DLT networks, such as Corda for securities and Ethereum for payments, and ensuring seamless interoperability through open standards like the EEA DLT Interoperability Specification, this implementation showcases a new paradigm for efficient, secure, and cost-effective financial transactions.
The successful execution of DvP in testing, in preparation for production in the second half of 2024 (subject to regulatory approval), using private, permissioned Corda and Ethereum networks, facilitated by the collaboration between HQLAX, Fnality, and Adhara, highlights the tangible benefits of DLT in action.
Case Study Participants
Adhara are leaders in Digital Cash and DLT solutions for Commercial Banks and FMIs — designing solutions to help clients engage with a variety of new digital settlement layers and business platforms.
Fnality International, founded in 2019, is developing a series of regulated, DLT-based wholesale payment systems in key jurisdictions. In December 2023, the Sterling FnPS became the World's first regulated DLT-based wholesale payment system, settling in digital central bank funds.
HQLAX is an innovative financial technology firm that leverages DLT to bring game-changing efficiencies to the securities finance and repo industry.
Report prepared by QualitaX on behalf of the Enterprise Ethereum Alliance DLT Interoperability Working Group.