State Street announced Monday it had completed a margin calculation process for a live trade of a 30-day foreign exchange (FX) forward contract with Vanguard using blockchain technology and smart contracts to automate the collateral settlement.

The $100,000 trade between the $303 billion State Street, and the investment company Vanguard as counterparties was a pilot project by State Street using fintech Symbiont’s distributed ledger technology Assembly, said Nicole Olson, State Street’s vice president State Street Digital.

“An FX forward, in this case, it’s just a contract to trade U.S. dollars versus the euro with the counterparty, and in this case the principal amount was $100,000,” Olson told Bank Automation News. “Since it was a pilot, we kept it at a de minimis amount, but a real amount so that there was skin in the game.”

A distributed ledger is a database spread across multiple locations or participants. Blockchain is a subset of distributed ledger technology, in which the database is distributed across blocks. Each block has a storage capacity and, when filled, it links to a previously filled block to create a “chain” of blocks.

The trade also used smart contracts to instantly settle collateral.

“One of the other things that we solved for is that participants will typically enter in the trade and track the trade in two disparate systems; so State Street will have a system and Vanguard will have a system,” Olson told BAN. Hopefully those calculations match, but they might not, and so in the case where those calculations do not match, and that results in a recon, so we have to figure out why.”

Resolving disparate calculations typically involves people, phone calls and opening data sources to decipher why there is not a match, Olson added.

Smart contracts are self-executing programs stored on a blockchain that trigger when conditions are met to automate the transfer of money or other services.

“We said, ‘What if we take all those variables, put them on the blockchain and agree to those variables,’” Olson explained. “Once those variables are on the blockchain, the cool part is, is that parties have agreed to those variables already. Now they become data that can drive smart contracts.”

Once the parties agreed to the settlement process, smart contracts can monitor the process associated with the transaction and automatically trigger collateral settlements, or money transfers, when the process conditions are met.

“The smart contract can automatically value this FX forward on a daily basis,” Olson said. “The smart contract can also say, ‘The trade is based on this mark to market, we need additional collateral, State Street or Vanguard, and this is how much we need.’”

The use of smart contracts also results in a risk reduction.

“Because we’re able to agree and mark to market those contracts daily, we’re able to then understand any variation margin requirement to properly and in almost real-time collateralize that trade,” Olson said. “Both counterparties are perfectly collateralized at all times, so that’s a significant reduction in risk.”

The blockchain-based solution is also applicable to other kinds of trades that require collateral, she added.

For the pilot, the trade ran on both State Street’s existing systems and through the blockchain. The next step is to integrate and scale the new solution, then gradually transition off older systems, Olson said. After that, State Street plans to roll out the product to additional clients through application programming interface (API) integration or a user interface.

“We spent a lot of time thinking about: How do we scale the solution and how do we make it approachable for our clients,” Olson said. “We need to do it in a way that that meets our clients where they are on the adoption curve.”

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