SEC’s New T+1 Rule: How Blockchain Can Push Financial Markets Even Further

On February 15th, 2023, the Securities and Exchange Commission (SEC) adopted new rule amendments to cut the settlement cycle in half for most broker-dealer transactions. This would shorten processing times from T+2 (trade date plus 2 days) to T+1, starting on May 28th, 2024.

• Beyond stocks, this also includes corporate and municipal bonds, ETFs, and some mutual funds.
• Canada and Mexico both switched to a T+1 transaction cycle on May 27.

This move is the latest step in modernizing Wall Street and enhancing the efficiency and security of financial transactions. These rules are expected to streamline the process of transferring ownership of securities, reducing settlement times and minimizing risks associated with delayed settlements.

“For everyday investors who sell their stock on a Monday, shortening the settlement cycle will allow them to get their money on Tuesday. Shortening the settlement cycle also will help the markets because time is money and time is risk. It will make our market plumbing more resilient, timely, and orderly,” - Securities and Exchange Commission Chair Gary Gensler said in a statement on May 21.

For those in the blockchain world, cutting this time in half may still seem like a long time, as we’re used to near-instantaneous settlements. Therefore, it’s difficult not to look ahead already and consider blockchain technology as an emerging solution to push the settlement landscape even further. This article explores the implications of the new settlement rules and how blockchain can play a pivotal role in shaping the future of financial markets.

Timeline of Stock Settlement Changes

However, those accustomed to trading in traditional finance are excited about this improvement. But really, we’re returning back to the settlement time we had over 100 years ago.

What benefits does a shorter settlement offer?

Following the 2021 Gamestop frenzy led by retail, which jump-started the meme stocks (meme coin) era of finance that persists today, the need for counterparty risk mitigation and capital efficiency enhancement became apparent (Reuters). Robinhood halting markets during the Gamestop frenzy is a case in point - counterparties struggle to keep up with liquidity needs.

"Shortening the settlement cycle... will help the markets because time is money and time is risk," - said SEC chair Gary Gensler.

The risk that Commissioner Gensler is likely talking about is counterparty risk.

What is Counterparty Risk?

Counterparty risk occurs when one of the parties in a transaction cannot fulfill their end of an agreement. The longer it takes for a trade to happen, the more risk one party will be unable to complete the transaction.

For example, consider an investor who buys shares of a company's stock on margin (using borrowed funds). If the broker who provided the margin loan encounters financial difficulties and cannot fulfill their obligations, the investor might face significant losses. This risk is higher with brokers who have weaker financial health or lower credit ratings, which might lead to higher interest rates on margin loans from these brokers to compensate for the increased risk.

However, a shorter settlement time decreases the window of vulnerability in this instance.

Franklin Templeton’s Disruptive Technology Views: How Public Blockchains Will Truly Integrate DeFi into TradFi

Franklin Templeton released a report in April 2024 highlighting the inherent problems of settlement delays. The report argued that payments can only be exchanged for goods, services, or assets once a full transaction is settled.

“Moreover, the technology infrastructure that today’s participants use usually involves delayed settlement. This means that the transfer of securities and collateral can take place several days after the agreement of the transaction, requiring parties to post additional collateral or margin for protection. These excess costs and associated settlement or liquidity risks often result in capital inefficiencies that could be minimized by leveraging DeFi features, such as instant settlement and automated loan reversals for unfilled margin calls,” - the authors of the report state.

Since payments cannot be exchanged for assets, goods, or services until the transaction is fully agreed upon, this creates delays in settlement that often require the posting of collateral to help ensure the ultimate success of the transaction.

How Blockchain Can Improve Instant Settlement Time for Traditional Finance

By leveraging blockchain, the financial industry can achieve greater transparency, reduce counterparty risks, and ensure faster, more secure settlements.

If a blockchain transaction took a full day to clear, we’d be eagerly refreshing our wallet browser and checking the block explorers like a New Yorker on their first day at a new job looking down the subway tracks for a train to arrive. When will it come?

Blockchain can provide instant settlement time for traditional finance transactions. At its core, blockchain technology adds transparency and immutability and enhances default protection (e.g., automatic loan reversal).

Let’s take a look at blockchain settlement times. In blockchains, settlement is referred to as finality. Unlike traditional finance, where a central entity determines settlement as final, blockchains do not have such an entity. Instead, blockchain settlements achieve only probabilistic finality. This means a final settlement is never guaranteed, as there is always a minimal chance of reversal. However, the likelihood of this happening decreases significantly after a certain period.

From the comparison above, it is evident that the settlement times of the chosen blockchains are significantly faster than those required by stock exchanges. Even Bitcoin provides relatively quick settlement times in comparison.

However, settlement time is not the only criterion to consider when evaluating blockchain as an alternative to existing systems. For instance, the New York Stock Exchange (NYSE) processes 1.5 million daily trades. Based on the current transactions per second (TPS) capacity, Bitcoin could handle up to 604,800 transactions per day under ideal conditions, while Ethereum could manage up to 10,281,600 transactions per day. Both blockchains cannot scale on their base layer alone and would require layer 2 solutions to handle such traffic.

In contrast, Kadena can handle 50 TPS per chain, scaling up to 1,000 TPS with its current 20-chain configuration, resulting in 86,400,000 daily transactions under ideal conditions. The key advantage of Kadena is its ability to scale to any demand by adding more chains to the network using graph theory, setting it apart from other blockchains.

We have addressed the challenge of scaling a Proof of Work (PoW) blockchain while preserving the key attributes that make Bitcoin resilient: decentralization and security. Our PoW network, like Bitcoin, is decentralized, with miners distributed globally and no central governing authority. Kadena maintains security through its robust consensus mechanism, and additionally, it becomes even more secure as the network scales.

In Conclusion

The recent reduction in stock settlement time from T+2 to T+1 marks a significant improvement in traditional finance, aligning it more closely with the near-instantaneous settlement times familiar to the blockchain community. Improved settlement time reduces counterparty risk, enhances capital efficiency, and represents a return to practices from nearly a century ago. Blockchain technology, particularly Kadena’s blockchain, offers even greater advancements in settlement times with its unique security, cost-effectiveness, and compliance capabilities. As the financial world continues to evolve, integrating blockchain could pave the way for instant, transparent, and secure transactions that could lead us into T+0.