Why Blockchain just might be the future of securitization
Securitization, the process of bundling assets together and selling them as
debt, has become one of the most important methods of funding corporate finance.
Blockchain technology might be able to bring these processes into the 21st
century by providing an unalterable record of every transaction, cutting down on
time-consuming regulatory paperwork, and improving security across the board.
Here’s how it could work.
What is securitization?
Securitization is the process of pooling financial assets together and turning
them into securities that are sold to investors. There are two types of
securitization, fixed income, and balance sheet. A residential mortgage is a
loan pool made up of a series of home mortgages which are then sold as
mortgage-backed securities. An auto-backed loan is a loan pool made up of a
series of car loans, which are then sold as auto-backed securities. In these
transactions, the collateralized asset is the property or asset which will be
paid if a default occurs. Securitized products can then be traded on secondary
markets, much like stocks and bonds of corporations. Collateral is of two types:
physical, such as property or automobile loans, or intangible, like intellectual
property.
How does blockchain facilitate it?
Blockchain has shown its potential in bringing transparency to many sectors and
is being used to solve problems across industries. One example is the financial
sector, which can help facilitate transactions and provide security by storing
records through a decentralized database. Blockchain, a type of distributed
ledger technology (DLT), can bring transparency to the process by providing a
tamper-proof record that cannot be modified. DLT eliminates any need for
intermediaries or centralized authorities, making it an ideal solution for
securing assets and monitoring transactions. Blockchain, according to the
Financial Stability Board, may offer efficiency in addition to lower risks for
clearing systems, like for instance for the repo market.
Applying blockchain in securitization
Blockchain technology is already used in a number of industries, including
banking and healthcare. Next, we can make securities trading better with the
addition of blockchain. Securitization may require more work and a more detailed
process on legacy systems, but with blockchain, the process could happen almost
instantaneously and with the same degree of security. Blockchain create an
immutable, encrypted digital ledger that makes fraudulent transactions more
difficult to execute. Because securitized assets are created by pooling loans or
other forms of debt, they are tradable. Then they are divided into tranches with
varying degrees of risk exposure (e.g., senior tranches have a lower risk level,
and junior tranches have a higher risk level). High-risk borrowers receive
higher interest rates on their interest payments than low-risk borrowers. It
allows lenders to take a level of risk they feel comfortable with while sharing
in the profits if things go well for all holders within the securitization
vehicle.
What are the limitations?
Due to their nature, securities are always limited. They can never meet demand
or provide a secure investment. Securitized assets are held by a custodian and
distributed through a network, which is why they’re called securities. Software
updates can change ownership records when the people in charge have bad
intentions. It’s impossible for someone with bad choices to hack into blockchain
systems since all the information doesn’t reside in a single place.
Final Thoughts and Opinions on the Future
Blockchain has been in need in the financial industry for quite some time, but
only now are companies figuring out how to use it to improve their efficiency.
There are many steps involved when trading assets like a mortgage or a car loan.
Blockchain simplifies the process and reduces redundancies, which should speed
up the trading process. In spite of this, a lot of work is left to be done. To
execute a trade on the blockchain, there has to be collateral to protect both
the vendor and the buyer, so they are each assured they will be compensated.
