image: SMU Professor Qiang Cheng's research on the asset-backed securities issuance setting in China provides empirical evidence on the value of blockchain applications. view more
Credit: Singapore Management University
SMU Office of Research and Tech Transfer - If you have been following banking and investing in the past decade, you will probably be familiar with 'blockchain'. Often mentioned in relation to Bitcoin, you may even think that they are synonymous or use them interchangeably - but they are not the same thing. Blockchain is the technology that underpins Bitcoin; Bitcoin is just one of the many applications of blockchain technology.
So, what exactly is blockchain technology?
"Blockchain is a cryptographically secure ledger. It maintains a reliable, sharable and time-stamped record of transactions, ownership, and rights," explains Professor Qiang Cheng, Dean of the School of Accountancy at SMU.
"While cryptocurrencies are the most well-known applications of blockchain, companies and governments have started, or plan to use this technology in other areas, such as product tracing by e-commerce firms, property registration and record keeping by local governments, and processing of equity transactions by the Australia Stock Exchange." Professor Cheng is currently investigating whether the use of blockchain generates value for the users.
Documenting blockchain value
Blockchain has attracted a lot of attention in the past decade because the technology has been evident in reducing risk, stamping out fraud, and bringing transparency in a scalable way. It was developed specifically for Bitcoin in 2009 but has since been leveraged to drive innovation and increase efficiencies in new domains such as real estate, healthcare, and politics. Some people believe it has the potential to change systems across industries for the better, while others say it is just hype.
"It is unclear at this stage whether the nascent technology generates any value for the firms," posits Professor Cheng. "That is why our research is so important and timely."
Given the cost of implementing blockchain technology and the limited talents in this area, Professor Cheng believes that it is critical to empirically document the economic value of blockchain applications. "To our knowledge, there is no academic publication that provides rigorous empirical analysis of the economic value of blockchain applications in a commercial environment or financial markets."
Professor Cheng recalls his conversation with an e-commerce firm in China which had started using blockchain for Asset-backed Securities (ABS). "They were not clear about the true value of the technology. They were using blockchain because it was new and therefore fashionable, and because they have already developed the technology."
Professor Cheng and his team, which consists of Lee Kong Chian Professor of Accounting Xia Chen (Co-Principal Investigator) from SMU School of Accountancy and Associate Professor Ting Luo (Collaborator) from the Department of Accounting at Tsinghua University, have recently been awarded a Ministry of Education Academic Research Funding (AcRF) Tier 2 grant to study the value of blockchain applications in the financial market. Being one of the first projects to do so, Professor Cheng is convinced that whatever the findings turn out to be, they will be important to organisations such as the Chinese e-commerce firm, as well as governments that are exploiting the economic impacts of the technology.
The basis of the research
ABS was chosen mainly for practical reasons, Professor Cheng tells the Office of Research and Tech Transfer.The researchers collected data of securities in China that used blockchain and those that were issued without the use of blockchain. "It allows us to investigate whether ABS issued through blockchain technology are valued differently by the market from those that are not."
ABS are bond securities with interest and principal payments backed by a specific pool of underlying assets such as mortgages and credit card loans. It suffers from shortcomings such as information asymmetry and credit rating inaccuracy and agency problems - the two issues that Professor Cheng is investigating in ABS issuance.
The researchers compare the yield of the ABS (the interest rate paid by the originator) and its issuance cost. "If blockchain truly has positive economic benefits - reducing information asymmetry about the economic value of the assets - then it should result in a lower yield and issuance cost, since information symmetry is the most important factor for both variables," says Professor Cheng.
"The results will be important to market participants involved in both the issuance and purchase of ABS because issuing ABS with lower yield and lower issuance cost is beneficial to all market participants."
Information asymmetry in transactions is a situation where one party has more or better information than the other, creating an imbalance of power in transactions. Professor Cheng believes that ABS issuance using blockchain can address information asymmetry effectively. Compared to traditional ABS issuance, blockchain-based securities have all underlying assets recorded on blockchain where market participants have access to the ledger.
"The trustee, the law and accounting firms, the underwriters - everyone has the same set of information as the originator. There is transparency and thus a greater ability to evaluate the quality of the underlying assets."
The use of blockchain also reduces the reliance on third-party verification of the underlying asset quality. To reduce information asymmetry, the originators rely on a third party such as rating agencies, to evaluate the quality of the underlying assets. However, third-party verification can only reduce information asymmetry to a certain degree, because they only evaluate the quality of a random sample of the underlying assets provided by the originators. In addition, the sellers pay for the third party's services, leading to agency problems such as inflated ratings or rating shopping.
The hypothesis is that since information asymmetry is a key determinant of the yield and the issuance cost of ABS, blockchain can reduce its yield and issuance cost. "Our preliminary results show this to be true: the interest rate or yield of ABS issued using blockchain is found to be lower than those that use traditional means," says Professor Cheng.
Relevance in Singapore
In collaboration with Temasek, the Infocomm Media Development Authority (IMDA), and the Monetary Authority of Singapore (MAS), blockchain technology firm ConsenSys issued the report "Singapore Blockchain Ecosystem 2019" on the use of, the investment in, and legislation and policies on blockchain applications in Singapore. The report describes the private sector's and government's ambition in developing blockchain technology. It predicts that Singapore will witness an annualised increase of 32.5 percent in blockchain market size from US$201 million in 2022 to US$ 1,889 million in 2030. The actual growth will be affected by the perception of the value of blockchain applications.
Both companies and government agencies in Singapore are actively investing in blockchain technology and investigating its applications, says Professor Cheng. For example, 1exchange (1X) obtained the approval from the MAS to operate its private securities exchange. It is the first regulated private securities exchange built on a public blockchain. Given the early stages of these applications, its value remains to be seen.
Due to the cost of developing and applying the blockchain technology, it is critical to understand the economic value of applying the technology in various areas. To wit: the return on the investment to justify the implementation of blockchain, argues Professor Cheng. "To this end, the evidence in this project can contribute to the debate on the value of blockchain. Evidence of positive value can certainly fuel greater interest, investment, and growth in the blockchain market in Singapore and beyond, and vice versa."
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By Grace Segran