Smart Settlement

Abstract:

Blockchain technology is poised to streamline trade settlement. We build a model of intermediated trading with flexible time-to-settlement, search frictions, and counterparty risk. Longer trade-to-settlement time increases counterparty risk exposure. However, since intermediaries have more time to match buyers and sellers, liquidity improves. With imperfect competition, intermediaries specialize in either high- or low-default risk contracts. In equilibrium, they are able to relax price competition. Intermediaries' rents increase in the market-wide default rate due to larger scope for specialization. Further, intermediary specialization leads to excess supply of immediate settlement. Setting a unique time-to-settlement for trades in a given security improves welfare.

Link to SSRN