Case Study: Santander Bank Bond Issuance on Ethereum

Case Study: Santander Bank Bond Issuance on Ethereum

Santander Bank Bonds Issuance on Ethereum

Santander Group paved the way for the future of tokenized securities by issuing bonds on the ethereum blockchain. The Spanish multinational commercial bank and financial services company established in Madrid and Santander in Spain. They claim to be the first users of end-end blockchain technology to create a bond on the ethereum blockchain.

On September 12, 2019, Banco Santander announced that it had released the first end-end bond on a public blockchain. The USD, 20 Million bond, was issued on Ethereum blockchain, and another set of ERC-20 stood for the cash held in the custody account. As stated by the company, the move aims to make issuing bonds faster, easier and systematic.

The business was entirely run within the company and its subsidiaries. Santander Securities Services posed as the tokenizing agent, and cryptographic key custodian and Santander Corporate and Investment Banking (CIB) assisted in the issuance of the bond, as the dealer. They were supported by Nivaura, London based-technology provider to support the digitalization of issuance as well as by global law firm Allen & Overy for legal advice.

What is a bond?

A bond is a fixed income instrument issued by banks, companies and government to raise capital, from which investors earn a fixed income through interest over the period of the bond. The company or entity that sells the bond is called the ‘Issuer’ while ‘Investors’ buy these bonds. The issuer pays a fixed interest rate also called coupon rate to all its lenders. The loan must be paid back at a particular day (maturity date), and the amount paid back is called the principal.

Smart bond

A blockchain bond or a smart bond is a particular type of automated bond contract, that utilizes the potential of blockchain databases that can function as cryptographically secure yet open and transparent general ledgers. Blockchain allows data and funds to be transferred securely. Read more about security tokens here.

Tokenizing bonds

Bond tokenization is an implementation of blockchain technology which seeks to lower the various costs linked with bond issuance. Bond issuance is a lengthy procedure that involves multiple middle-men, giving rise to high costs and the uncertainty of human error. These are the typical pressure points in financial securities market that technological innovations are aspiring to resolve. As fixed-income security, bonds more often than not bear the lower risk and reduced inconsistent factors than equities, making the bond market an excellent point to begin achieving and improving new technology solutions. The idea is to apply blockchain technology to develop the bond market as a whole by upgrading data visibility, decreasing co-contractor risk, and refining operational efficiency. The notion of bond tokenization has grown in popularity over the last few years, and various reputable organizations have set in motion their own tokenized bond initiatives.

How does it work?

The purpose of tokenized bonds is to lessen the managerial process and cost by operating on blockchain technology for the digital issuance, trading and management of bonds. To publish tokenized bonds, the issuer’s company details are first placed on the blockchain as a digital record. Smart contracts are encoded on the blockchain with the terms of the bond issuance. Tokens are supplied to investors as digital forms of the bond. Once the bond is furnished, Santander Securities Services will cumulate the cryptographic keys to the digital currency, and each and every token will live on the Ethereum Blockchain.

Settling, marketing, and post-issuance bond action management–for instance, orderly payments of interest to investors – can be accomplished by smart contracts.

Another of Santander’s companies purchased the bond at the token’s retail price, so again, no independent investors were involved.

Two wallets are included with the bond tokenization procedure. Initially, an investor wallet mints the tokens, once the cash used to buy the bond is transported to an off-chain custodial account. The second wallet constitutes the issuer wallet that takes in the money from the bond contributor (in this case, a Santander subsidiary). Once the bond is issued; they use the tokenized money to support the off-chain custody monies.

The trading of debt securities is usually accompanied by a two-step “Delivery-versus-payment” (DvP) method. Firstly, the holder of the bond admits to hand over the asset to the buyer, who must, secondly, repay the owner with cash. Conventionally, this task requires the two parties to trust each other or make use of another trusted third-party.

Correspondingly, after paying market price for the tokens, funds are transferred to the blockchain. The maturity date of this pioneering bond is one year with the coupon rate at 1.98% paid out quarterly, and on the blockchain using a smart contract.

Advantages of tokenizing bonds

  • Increased Secured Data, not many Intermediaries

First and foremost, the utilization of blockchain comes with the potential to ‘reduce counterparty risk’ for DvP settlements. By making use of smart contracts, it is possible to settle essentially with any other party, without requiring a trusted intermediary. Once registered on the blockchain, financial data cannot be altered subsequently without the consent of the network. As a result, the record of bondholders on the blockchain is dependable. When exchanging bonds, buyers can ensure that the sellers possess the legitimate title of the bond by examining the blockchain. Blockchain is an ideal substitute for having innumerable intermediaries and bond managers since it is a disbursal, trustless, and immutable ledger. Administration of investor records will be much more systematic and simpler for issuers, and the transparency of bond transaction data will make it smooth and accessible for investors to generate informed investment judgments.

  • Diminishing Settlement Risk

An innovative feature of blockchain technology is a time-bound conditional payment which allows a transaction to be executed only if specific conditions are met within a particular time-frame. Both on the issuer’s side and investor’s side the bond is made available on the blockchain in the form of token and cryptocurrency respectively but are locked by encryption. Since the data is encrypted, no one can cut it down to obtain important information unless they possess a specific key correlated to each piece of information. If both the parties verify the viability of the transaction before the deadline, the tokenized bond is delivered to the investor and the cryptocurrency investment is delivered to the issuer at the same time. If the investor pays the principal amount, managing their end of the bargain, but the issuer fails to supply the tokenized bond, the investor’s funds have naturally recurred back to their digital wallet at the deadline. There is no jeopardy of one party being deceived if the other party defaults–the trade either happens in totality or not at all. The participants no longer need to trust their peer to complete their end of the deal or pay a third party (who might also defraud both the investor and the issuer) to enforce the contract. This technology could eradicate the demand for escrow agents in the settlement process.

  • Smart contracts are Automated and increase execution speed

Issuances of tokenized bonds are made attainable by smart contracts coded on the blockchain. Smart contracts are computer protocols which comprise the terms of a legal accord precisely written into the code. When the terms of the contract are satisfied, smart contracts are carried out automatically without the need for enforcement by a third party. It accelerates the operational aspects that are the current labour-intensive manual issuance process.

After company information and bond issuance details are computed, the terms and conditions of the bond, which consists the principal amount, coupon rate, and maturity date, can be encrypted into smart contracts to operate on the blockchain.  Smart contracts can also be coded to supervise the post-issuance process, including the periodic distribution of interest payments to bondholders and the repayment of the nominal value upon the bond’s maturity date.

Investors gain tokens in return for payment, which permits them to receive fixed income from interest and the principal amount of the bond upon maturity. The payment process can be automated by making use of blockchain: issuers can transmit stable coins immediately to the bondholder’s wallet address. The use of smart contracts is time and labour saving to the issuance process and eliminates repetitive steps.

Limitations of tokenizing bonds

A restriction of current blockchain technology is the disparity between liberty to participate and secure governance. Levels of access and governance are the fundamental distinctive factors between public and private (or “permissioned”) blockchains. 

The approach of decentralization is certainly achieved by the public blockchain network, as anyone can partake in the public blockchain by certifying or adding data to it. Moreover, unless there is a direct transaction between the participants, there is no need to reveal their identities. There is no sole administrative body which holds power over the transactions, and the transactions can be viewed anonymously by the participants.

One problem is that public blockchain platforms such as Ethereum at present do not grant selective sharing and confining of sensitive transaction data, which is a crucial aspect in the financial transactions. Private blockchain networks such as Corda and T2S allow such deliberate information sharing.

Private blockchains are only accessible to familiar and authorized participants and are not completely decentralized as they are still governed and operated by specific bodies. Private blockchains let on a greater degree of management in information sharing, but, on the other hand, participants are incapable of tracking transaction records on a private blockchain as they would on a public one. Utilization of private blockchains alone would do little to relieve the problem of information asymmetry that decentralization set out to resolve.

Prevalent Predecessors of Issuance of bond on the blockchain

Previously the World Bank issued a similar blockchain bond, but they did not use the public blockchain, Ethereum. The world bank’s settlement instrument is a cash event and is called “bond-i”. The issuance is run on a private version of the Ethereum blockchain.

In April 2019, Societe Generale SFH, a group of Societe Generale, published the bonds to itself. They issued a 5-year covered bond on the Ethereum public blockchain, making use of “OFH tokens” (viz. A security token). No outside buyers were allowed to participate, and it was set up for cash payment, not a cryptocurrency. Santander was not the first to issue bonds on a public blockchain but efficiently substantiated it.

Conclusion

Blockchain is a technology which accelerates the profound digital transformation of the financial sector allowing its participants to progress and be more efficient. One conclusion that can be drawn from this research is how the banking world is gradually but undeniably coming around to having confidence in public blockchains like Ethereum, for instance. With entities now issuing bonds on the blockchain and by tokenizing assets, people might witness a strategy out of this negative plight that the central banks, governments and other corporations have pulled us and themselves into. The fact that both the issuance and settlement occur entirely on-chain, and that the set of intermediaries associated is significantly reduced through automation, Santander’s application of blockchain technology to mend income instruments is an evident improvement to existing financial systems.

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