DLT Efficiently Mitigates Settlement Risk in Foreign Exchange3 min read
Prior to its closure, the bank had received Deutsche Marks it had purchased in exchange for USD. However, due to time differences between the United States and Germany, Herstatt had not sent the dollars it used to buy the marks to its trade partners. As a result, many of the U.S. banks due to receive money were short on their books, and the Clearing House Interbank Payments System (CHIPS) was forced to shut down for 24 hours.
The effect of the delayed payment was so significant that the term “Herstatt risk” is now used synonymously with “settlement risk” to describe the likelihood that one party involved in a transaction will fail to deliver an agreed-upon security or cash in a timely manner. CLS Bank was founded in 1997 to help mitigate Herstatt risk in foreign exchange (forex) by stepping in as a trusted third party to accept currency from the parties trading and only releasing the bought currency after the sold currency is received.
Implementing distributed ledger technology (DLT) and blockchain solutions both reduces settlement risk and removes the need for a third-party intermediary. In doing so, the technology facilitates liquidity and near real-time settlement in forex.
Blockchain and DLT solutions to streamline forex
DLT refers to a database that is spread across multiple nodes and is accessible to all parties granted permission. Notable ways in which DLT optimizes foreign exchange while diminishing Herstatt risk include:
- Offering transparency in tracking transfers
- Eliminating the need for trusted third parties
- Enabling direct settlement
- Automatically executing agreements once terms are met
- Securely storing data which cannot be altered
With DLT, data is cryptographically stored on the blockchain, where the transformed data — known as a hash — is time-stamped and linked to previous and subsequent blocks on the chain. Once hashed, data on the blockchain is immutable. Such qualities make it nearly impossible for hackers to corrupt data because they would have to do so to all data on the blockchain.
Smart contracts, which feature terms of an agreement programmed into their code, facilitate transactions between two disparate parties. Once the terms of an agreement are met, the smart contract is self-executed. Thus, foreign exchanges can be settled instantly once the money from both parties is present, without the need for a clearing house or arbitrator.
Infrastructure for DLT
The key to successfully implementing DLT, blockchain, and smart contracts is having the right infrastructure in place and finding the right cloud partner. AWS is the most widely used cloud platform to support DLT and blockchain. It supports all major blockchain protocols while running workloads for enterprise companies across the globe.
As an AWS Partner Network (APN) Premier Consulting Partner, SoftServe is uniquely positioned to guide your cloud journey and ensure blockchain and DLT projects are secure and deployed within AWS Well-Architected best practices. We simplify your onboarding of cloud technology to reduce time to market and deliver value.
We understand that security is top of mind as you implement DLT solutions. Working on AWS, SoftServe:
- Performs security audits
- Develops smart contracts
- Identifies appropriate blockchain solutions
- Builds blockchain bridges
- Creates a secure sandbox environment for R&D
- Builds a full ecosystem of blockchain solutions
- Ensures a smooth cloud migration
SoftServe’s blockchain experts have years of experience providing solutions for our clients. Download our white paper, Blockchain’s Applications in Banking Beyond Bitcoin, to learn about other ways blockchain and DLT are transforming finance.