Page 4 - FINAL CFA II SLIDES JUNE 2019 DAY 2

LOS 6.d: Describe financial applications of MODULE 6.1: FINTECH IN INVESTMENT MANAGEMENT
distributed ledger technology.

Distributed ledger: a database shared on a network so that each participant has an identical copy. It uses cryptography to
ensure only authorized network participants can use the data:

2 Types:
• Permissionless networks: All participants can view all transactions (Read Only). These have no central authority, hence the advantage of
having no single point of failure; thus removes the need for trust between parties to a transaction.
• Permissioned networks: Users have different levels of access (Read and Write), e.g. you can enter transactions while giving government
regulators permission to view the transaction history, increasing transparency and decrease compliance costs.

An example includes:
Blockchain: records transactions sequentially in blocks, using a cryptographically-secured “hash” that links or ‘chains’ each block to a
previous block The consensus mechanism requires some of the computers (called ‘’miners’) on the network to solve a cryptographic
problem. Mining requires vast resources of computing power and electricity, imposing substantial costs on any attempt to manipulate a
blockchain’s historical record. Doing so requires one party to control a majority of the network.

Financial applications of distributed ledger technology

Cryptocurrencies: a digital medium of exchange that allows participants to engage in real-time transactions without a financial
intermediary (typically reside on permissionless networks).
• Used for raise capital -companies sell these (‘’initial coin offerings’’) for money or other cryptocurrency. This reduces the cost and
time frame compared to a regulated IPO, and initial coin offerings typically do not come with voting rights. Investors should note that
fraud has occurred with initial coin offerings and they may become subject to securities regulations.

rd
Post-trade clearing and settlement: Automate many of the processes currently carried out by custodians and other 3 parties. Brings
real-time trade results for process that currently takes days for many securities; thus reduces trading costs and counterparty risk. But
inability to alter past transactions (Read Only) if there is problematic when canceling a trade is required.

Smart contracts: Electronic contracts (e.g. option contracts) that could be programmed to self-execute if ‘in-the-money.’’

Tokenization: Electronic proof of ownership of physical assets, such could replace the paper real estate deeds currently filed at
government offices.