Depending on the headline of the day, cryptocurrency can be a villainous play for rookie investors (in the case of the Squid Game crypto scam) or a means of becoming an overnight billionaire (as with the “whale” who allegedly held on to US$5.7 billion worth of Shiba Inu crypto coins).

But beyond volatile cryptocurrency, blockchain technology can be harnessed by financial institutions, governments and other commercial enterprises to maximise economic activity. And as Covid-19 and other forces are galvanising the world of finance and moving financial services into a more fully digital era, blockchain technology provides a valuable solution to help resolve trust issues more efficiently via network computing.

However, to date, there is little research on the actual economic value of such applications in the realm of business. As such, Professor Qiang Cheng, Lee Kong Chian Chair Professor of Accounting and Dean of the School of Accountancy at SMU, investigated this issue in the context of asset-backed security (ABS) issuance in China. An ABS is a financial investment collateralised by an underlying pool of assets — such as a cash flow generated from debt like loans, leases and credit card balances. It is usually in the form of a bond or note, and disburses income at a fixed rate for a set amount of time.

“Some people regard blockchain as a hype, which I think is probably related to the volatility of Bitcoin prices over time,” shared Professor Cheng during the presentation of his research insights on “The Value of Blockchain Applications – Early Evidence from Asset-Backed Securities.”

“Because of the controversy surrounding blockchain applications, a lot of organisations have called for an investigation into the value of blockchain applications.”

He recently presented his findings at the inaugural Conference on Digital Transformation of Financial Markets 2021, which shed light on the economic value of blockchain and will help government agencies and businesses when they decide whether to use blockchain applications. Organised by SMU School of Accountancy Research Centre (SOAR), the event brought together leading industry and academic experts to provide insights into the issues and opportunities that may arise due to digital transformation.

Among other insights, Professor Cheng learned that ABS issued with blockchain technology have experienced a decrease of 31.4 basis points in the yield spread, a substantial saving for issuers. Here are five top takeaways on how blockchain applications have shown immense benefits in the area of ABS investment:

1. Need for blockchain application research
Currently, there is limited research in the real-world applications of blockchain, as institutions that accept Bitcoins and other cryptocurrencies are at an early stage of adoption. However, asset-backed securities (ABS) issued in China using blockchain provided Professor Cheng with an opportunity to examine the application of this technology.

Blockchain can address investors’ concerns about the quality of the underlying assets, as it could ensure that the information is reliable and that the issuer cannot change any information stored on the chain, thereby increasing investor confidence. The benefit of blockchain application is even greater for ABS with underlying assets that are less transparent to investors, such as revolving ABS.

2. Higher reliability, higher price
When investors have concerns about the quality of the underlying ABS assets, they are less inclined to buy the ABS — which drives down the price, and the interest rate that issuers have to pay goes up.

Blockchain can address the reliability of information about underlying assets on the chain, as the issuer cannot alter that information. As such, it plays a role in increasing the confidence of ABS investors, thereby reducing the yield or the interest rate of the issuance.

3. Build a reputation
Another benefit of using blockchain in issuing ABS is its ability to boost the reputation of a lesser-known credit rating agency. Hybrid rating agencies adopt a business model similar to that of auditors: the ABS issuers or firms, not the investors, pay the agencies. This can lead to a phenomenon of credit rating agencies tending to provide assessments that favour the ABS issuers, and thereby causing conflicts of interest. In fact, the lower the reputation of a credit rating agency, the greater the benefits of blockchain application in enabling the agency to gain credibility.

4. Ramp up asset quality
The benefit of blockchain applications is also greater for an ABS with underlying assets that are less transparent to the investors: For example, an ABS with a large number of underlying assets or revolving ABS — which involves issuers adding assets to the underlying asset pool over time. Investors may face difficulty in understanding the quality of the underlying assets of such products, and find blockchain applications useful in making an informed decision.

5. Reduce investor risk
The sponsor of a securitisation is usually required to retain a percentage of credit risk — typically 5 per cent — underlying its asset-back securities, along with other mechanisms to reduce the risk to investors or as part of a series of credit enhancement mechanisms. For example, ABS issuers may designate a third-party guarantor or provide more assets in the asset pool than the principal amount. Based on Professor Cheng’s research, it was found that blockchain applications have enabled issuers to lower their retained interest and the need for multiple credit enhancement mechanisms, due to enhanced transparency and a reduction in information asymmetry.

Professor Cheng concluded his presentation with two caveats: First, the number of ABS issued using blockchain application thus far has been relatively small, and as such it is still unclear whether the benefits are similar in the event of a more widespread application. Second, when the number of users of a blockchain is relatively small, the cost of running and maintaining the blockchain is low. The cost of using blockchain in, for example, a large initial public offering may outweigh the benefits. He therefore hoped the study will shed light on the economic value of blockchain applications, and help government agencies and businesses better decide on blockchain applications in the future.