What is blockchain securitization?
In blockchain securitization, all cashflow between the parties involved in the securitization process becomes recorded on the blockchain. This results in faster and more accurate cashflow reporting and greater transparency in executions, since every transaction becomes recorded and stored on the blockchain.
Abstract—This paper presents a blockchain-based Securitization Model, which simplifies the transactional methods. This paper elaborates upon integrating the components of Securitization with Distributed Ledger Technology (DTL) and provides a process flow of transactions occurring. The process led to the 2008 Financial Crisis became improved in terms of security and reliability. Using this revolutionizing model, securities, which were once considered opaque & risky, will now be informative and gauged accordingly, thereby smoothening the process of transforming non-tradable assets into tradable securities. This paper highlights how blockchain features, i.e., smart contracts, decentralization, authentication & immutability, will increase efficiency. Furthermore, the paper explores boons of the amalgamation, i.e., reduced risk, enhanced transparency, lower costs, proficient processes and robust authentication without compromising information asymmetry, high transactional costs and nebulous portfolio rating. The goal of this paper is to portray how the integration will augment the cardinal Securitization process.
Keywords—Blockchain, Consensus Mechanism, Decentralized, Distributed, Hash, Immutability, Smart Contracts, Securitization
I. INTRODUCTION
There are two main architectural approaches for a software system – distributed and centralized. Centralized software systems consist of nodes that are located and connected with one central node, which promotes coordination. On the contrary, distributed software systems consist of several linked nodes without any central control node. Blockchain’s primary architecture is based on the latter approach.
Blockchain’s appeal is derived from its ability to support transparent transactions, optimize business processes, reduce operating costs, improvements in collaborative efficiency, and develop a system that aids faceless transactions [1]. Additionally, it has negligible environmental consequences.
Blockchain technology, which was invented in 2008, has depicted the progression it can bring to different businesses. It has become a reliable and secure base for sectors such as healthcare, text communication applications, stock trading, supply chains and their management, and many more disparate sectors. The ideology of enhanced self-governance along with decreased centralized dependency is promising.
Customers, investors, and banks daily engage in the process of financial trade – which is in the form of loan
origination, global trade finance, stock and security trading, etc – to exploit the gaps in the current economy, leading to profits and boosting of economies. With the increase in number of transactions per day, the requisite for an efficient, smooth, and easy-to-use system has increased. This in turn has made incorporation of Blockchain technology an alluring alternative, especially for Asset Securitization.
Securitization is an epitome of financial instruments and products used by corporations to foster trade and commerce. From reduction in transaction time, overhead costs, and fraud risk to improvements in trust, credibility, and accuracy, the ambit of benefits achieved by the integration can be remarkable. By reducing reliance on third-party intermediaries & being able to track asset performances closely, there is an increased interest by investors in the secondary market. The espousing of Securitization with Blockchain will remove regulatory inefficiencies from the process and ignite an interest in securities initially considered opaque and high-risked. Also, utilization of smart contracts leads to consolidation and standardization of complicated agreements.
As is the case with applying any new technology, we must be prepared to battle the obstacles posed by it. Implementing a widely accepted and followed system with well-defined industry protocols needs to be formulated. Also, it must be ensured that all entities which are on-boarded on the network, leverage its boons.
The rest of the paper is organized as follows [3]. Section II expounds on Blockchain Technology, its types, and consensus mechanisms incorporated. Section III encompasses the Traditional Securitization Model. Section IV delineates the Blockchain-based Securitization process. Furthermore, Section V elucidates functionalities, benefits, and shortcomings of the integration. Section VI cogitates on papers which propose the use of Blockchain in handling finances. The paper is then concluded in Section VII. It also talks about the future scope of Blockchain in Securitization and other Financial Models.
II. BLOCKCHAIN
A. Distributed Ledger Technology
Distributed ledger technology can be considered as an agreement of copied, shared, and regularly updated digital knowledge geographically unfolded across multiple sites. There is no central administrator, unlike in centralized
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information. The database for the distributed ledger is extended throughout many nodes, which are nothing but devices, on a peer-to-peer network, where every device copies the ledger and updates itself. One of the many advantages is the lack of central authority. Once a ledger is updated, each node builds a new transaction, post which the nodes use the consensus rule to vote on the correct copy. Once a consensus has been decided on, this correct and latest copy is updated on every node.
B. Blockchain Architecture
Blockchain ledger has three basic concepts: transaction, block, and chain. The “transaction” in Blockchain is not restricted to trading. All the valuable information can act as a transaction to be broadcasted in the blockchain network. The blocks are storage units to record transactions, which are created and broadcasted by those users authorized by consensus mechanism [4]
The process becomes initialized by the creation of a transaction between two participants over the same distributed ledger. The creation of the transaction implies creation of smart contracts. This is followed by the smart contract verification, which abides the consensus mechanism followed by the participants of that network. Once verified, it should be stored in a block, after which the block is given a hash. On completion of the transaction, the smart contracts execute themselves to meet the terms of the transaction.
Participants of the Blockchain have two keys, one public and one private, which help perform transactions and produce a secure digital identity reference. Transactions are verified and added to the peer-to-peer network by using this digital signature.
C. Blockchains and its variants
Blockchain can be categorized into three types – Public Blockchain networks, Consortium Blockchain networks, and Private Blockchain networks. In public blockchains, anyone can participate and join the consensus process. Contrarily, private blockchains are networks where only a single organization has authority over the network. Lastly, Consortium Blockchains are semi-private blockchains wherein multiple organizations govern the platform. Access is only granted to a specified set of nodes. In this scenario, access will be granted to banks, investors and smart contracts governing special purpose vehicles and rating agencies.
TABLE I. TYPES OF BLOCKCHAIN [5]
A consensus mechanism is used to validate the blocks appended to the chain. It is a predefined, agreed validation algorithm, which maintains the integrity of the transactions occurring on the chain, even in the absence of an authoritative third party. It also aids in synchronization and setting the chronological order of the chain.
TABLE II. CONSENSUS MECHANISMS [5]
In the diagram, the transactions that occur in one complete cycle of the Securitization process. The current process involves the intimate involvement of intermediaries such as credit rating agencies, guarantee & governing bodies, Special Purpose Vehicles (SPV), and many more.
A borrower and lender decide upon the loan agreement. The issuer/originator pools together many such loans and places them in an SPV. The SPV structures these pools into securities. Audit firms and rating agencies review the pools. These agencies are asked to evaluate the securities and provide a credit rating. The securities are then brought to market, where investors have the opportunity to purchase these securities depending upon their risk-reward predilections. A trustee and rating agencies monitor these transactions.
The current process’s cost is higher than the process that utilizes Blockchain technology, as this process involves more people. There are multiple parties involved in monitoring and keeping track of the transactions. This cost is eliminated when adopting Blockchain technology as the technology takes care of these tasks. Moreover, as multiple people are involved, the process is lengthier and takes longer in contrast to the overall turnaround time of the integrated method.
B. Pain Points in the Traditional Model
• Information Asymmetry – The issuer of the securities knows much more about the accuracy and originality of the security being sold as compared to the investor
• Layering of Costs – Each step involves due diligence. Each party creates an additional hedge/risk cover
• Portfolio Rating Frozen in Time – Loan portfolio and underlying tranches are rated at a point in time and in due course do not appropriately reflect the underlying asset or the economy
• Long Timeless and High Transactional Costs – Each step is substantially manual with lengthy timelines, high costs, and near-zero inter-operability across systems
IV. INTEGRATION OF SECURITIZATION WITH BLOCKCHAIN TECHNOLOGY
A. Securitization Architecture
Blockchain is an elegant and solitary technology. Over the years, it has gained enormous traction to become the cornerstone of various sectors. Nowadays, when the goal is to reduce human interference, automation is catching speed. Blockchain also focuses on complete automation, Blockchain aims to automate away the centre [15]. Using this decentralized property and other technological advantages have cultivated transparent connections between faceless participants. Hash functions, smart contracts, consensus mechanisms, and peer-to-peer networks are the cardinal benefits of this decentralized technology.
Securitization involves entities such as loan originator (or bank), customer, and investor. Their activities encompass –
• The customer places a request to create an asset. The originator creates the asset, and the customer receives the loan amount.
• Originator transfers assets to the asset pool. Asset pools are divided into securities with the help of credit rating agencies and SPVs.
• An investor places an order to buy these securities and makes the payment. The security is transferred to the investor.
• The investor can then sell the security after a certain period and receive the investment along with interest.
Fig. 3. Sequence Diagram of the Securitization Process 
B. Securitization Flow using Blockchain
Transaction flow of the integration of Blockchain and Securitization.
An electronic asset gets created and timestamped when the borrower and lender agree upon the terms and conditions for the loan. This cannot be edited unless there is a new consensus among the parties.
A smart contract is created which stores the pertinent code of relevant information. Delays or defaults in payments are added to the smart contract with timestamps to influence future servicing decisions.
All the loans are pooled together and transferred to a SPV by the issuer. The SPV makes it into securities and records this transfer on the Blockchain.
These securities are referenced by rating agencies, trustees, and other relevant third parties to perform the assessment.
A new smart contract is created that includes the transaction of the securities, which is layered over the SPV, and the smart contract developed for the SPV itself.
In order to handle discrepancies, a rating monitoring software is added to the Blockchain to keep in check the security performance with the expected cash flow.
Blockchain is used to create market platforms to interoperate the use of Blockchain with transactions. These transactions are done by investors who could directly trade securities on this platform.
When securities are created and traded, this information is constantly updated and stored on the Blockchain with appropriate access to all relevant parties.
V. INTEGRATION FUNCTIONALITIES, BENEFITS AND SHORTCOMINGS OF THE INTEGRATED MODEL
A. Functionalities of the integration
The principles and main functionalities that undergird blockchain technology in securitization are as follows: • Streamlining the Securitization Process by removing third-party delays, increased accessibility, and enhanced understanding of the available securities in which one can invest.
- Gateway to invest in opaque securities. Securities once considered inaccurate, facile, and illegitimate can now be verified and unadulterated.
- Blockchain is a decentralized ledger which means that authorized participants, at the same time, have access to identical information across a public network of nodes.
- An algorithm which allows users to reach an agreement about one systematic state of the network to synchronize the ledger via a global election is consensus validation.
- Blockchain networks consist of smart contracts that execute themselves. This, in turn, reduces the costs of transactions and allows the settlements of bills to take place automatically.
- Cryptography can also be termed as hash functions. The data is stored in a highly encrypted form by incorporating a complex cryptographic algorithm to securely store and process transaction data across the network.
- Only after verification are transaction added in the chain. These transactions are immutable and irreversible once they are recorded.
B. Benefits of the integration
The benefits of the integration of Blockchain and Securitization –
• The issuer of the security and the investor have similar information about the security. This means that the buyer makes the purchases with complete knowledge, and this tends not to influence their decisions, succumbing to the issuer’s benefit
• The process of securitization becomes completely transparent when using blockchain. This makes it easy to trace transactions related to the security, creates both reporting and underwriting to be efficient that leads to decreased expense and delay
• Due diligence is not required at each step as the elements of the process are embedded in the block itself
• The use of smart contracts makes the transactions more secure and reduces surplus transaction costs
• The process is semi-automated which reduces processing time, costs and increases interoperability across systems
C. Shortcomings of the integration
Shortcomings of the integration of Blockchain and Securitization –
• Data security and privacy: Sensitive information is spread among multiple nodes as Blockchain adopts a distributed structure, and thus privacy issues may arise.
• Blockchain is a relatively new technology: It is a nascent technology that has not been fully vetted yet and has not proved to have undoubtedly reliability.
• Regulatory and legal problems: Regulators will take time to approve this integration as they need to consider multiple factors such as financial institutions, legal shifts for smart contracts, etc.
• Lack of resources to migrate to Blockchain: Start-ups or low-profitable corporations might not be able to bear the initial costs of changing internal data systems and work processes to prepare for integration with Blockchain.
VI.RELATED WORK
| Sr. No. | Paper Name | Paper Synopsis | Drawbacks of Existing System | Blockchain Integrated Method |
| 1 | Design and Implementation of a Loan System Based on Smart Contract [7] | The paper talks about a loan system which utilizes Blockchain technology to innovate an automated loan signing system. This system uses decentralization and immutability to connect customers and loan originators, and complete the loan process. | Involvement of third party, Payment delays, Multiple versions of the truth, Duplicative bills. | The system uses Ethereum Blockchains and Ethereum Virtual Machine smart contracts. This system implements three main required functions – borrowing, lending and repayment – in an application that facilitates the loan process. In such a system, smart contracts play the role of a loan contract. |
| 2 | Application of Blockchain in Asset Backed Securitization [8] | The paper analyses the leading issues in the asset backed securitization process. It then proposes a blockchain integrated method which involves on boarding of vital entities on the consortium distributed ledger. | The authenticity of the underlying asset quality, information asymmetry, data processing and crediting, unable to meet rapid expansion needs. | An originator registers a new blockchain and imports the asset on the ledger. The ledger is then updated by entities such as credit rating agencies, guarantee agencies, SPVs. After updating, the final Blockchain is accessible by the investor to carry transactions. |
| 3 | RemBit: a blockchain based solution for remittances to Ethiopia [9] | The paper proposes an innovative payment solution aimed at improving the remittance flows by exploiting the potential of blockchain technology. | Long and slow transaction times, Lack of transparency, High transaction costs, Insecure system prone to money laundering. | The sender’s cryptocurrency will be converted into the recipient’s country’s fiat currency. The transaction is verified using a decentralized peer-to-peer network. Security services have specialized access to verify any suspected activities. Furthermore, the adoption of advanced cryptographic methods ensures transaction security. |
| 4 | Blockchain Application in Food Supply Information Security [10] | To demonstrate how blockchain technology can be used as a large-scale collaboration platform, the article uses the PEST analysis approach. Following that, a blockchain integrated supply chain strategy is proposed, which will aid in the tracking of providers of contaminated goods and services. | Manual contract creation, faceless dealers, delayed timeline, delayed payment. | All entities on the distributed ledger are added to the blockchain. Supplier, manufacturer & processor, seller, customer, and appreciation are among the entities. A private and public key is given to each entity. Furthermore, the consensus must validate every transaction recorded on the blockchain. The transactions are monitored by the administrative department. |
| 5 | ChainIDE: A Cloud Based Integrated Development Environment for Cross-Blockchain Smart Contracts [11] | The authors suggest ChainIDE, a cloud-based solution for creating Blockchain-based smart contracts on a variety of blockchain systems. Furthermore, cross-chain creation of smart contracts on several blockchain systems is possible without the need to spend time setting up an environment. | The system is time consuming, the Setup process is slow, developing a cross-chain is very expensive. | They set up a cache so that uncompiled code would be stored if the Internet went down. Cloudflare is used to speed up the compilation process in some network conditions. Furthermore, as long as they have an Internet connection, users can program on any digital device without having to prepare created environments. |
VII. CONCLUSION
In this paper, we presented how Blockchain technology can become used to transform the Securitization process. We looked into understanding blockchain technology, its types and consensus mechanisms. We then moved to comprehend the Traditional Securitization Model, its drawbacks and how Blockchain has streamlined transactional processes, in the financial domain. Further, an in-depth analysis of the integrated model and its functionalities, benefits and shortcomings carried out. The aim of this paper, which is to describe the benefits of integration, is justified.
The integration of Blockchain technology to the cumbersome Securitization process has laudable benefits ranging from tamper-proof and decentralization to the removal of third-party entities and trustworthiness. Blockchain can become imitated to result in novel results in processes such as healthcare, supply chain management, syndicated loans, voting, etc. Blockchains’ heterogeneous features such as smart contracts, distributiveness, consensus validation, real-time review and updates, transparency and much more discrete functionality will enable Blockchain built applications to flourish and become an inveterate part of their established systems.
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