WFE Warns of Market Quality Risks with Faster Settlement Times via DLT

WFE research warns that faster settlement times via DLT could harm market quality by increasing transaction costs and reducing liquidity. Policymakers and market operators must consider these trade-offs before implementation.

London, UK – The World Federation of Exchanges (WFE) has issued a cautionary report stating that adopting distributed ledger technology (DLT) to achieve faster settlement times could adversely affect liquidity and increase transaction costs.

Global exchanges and policymakers have been exploring the use of DLT for years, attracted by its potential to significantly reduce settlement times. However, the WFE research highlights that the inherent latency in DLT settlement introduces uncertainties due to factors such as overall mining capacity and block validation speed.

The report reveals that using DLT, settlement latency can vary by over three minutes, leading to a 3.9% increase in transaction costs and a 4.5% increase in price impact. This latency and uncertainty make it more challenging for informed traders to execute strategies efficiently, thus deteriorating pricing efficiency and discouraging investor participation.

“The trade-off between near-instantaneous settlement and market quality must be carefully considered,” warns Kaitao Lin, Senior Financial Economist at WFE. “Our research shows that without trusted entity oversight, DLT introduces uncertainties that impede liquidity.”

The WFE emphasizes the critical role of Central Counterparties (CCPs) and Central Securities Depositories (CSDs) in overseeing and guaranteeing the settlement process, thus reducing uncertainty and maintaining market quality. Policymakers and market operators, including both regulated exchanges and crypto platforms, are advised to weigh these trade-offs thoroughly before implementing DLT-based settlement systems.