Access to Information: Solving the Inequality in Derivatives Trading

Published March 13th, 2019 - 09:39 GMT
Centralised control perpetuates inequality in investing but the democratisation of information could offer a cure. (Shutterstock)
Centralised control perpetuates inequality in investing but the democratisation of information could offer a cure. (Shutterstock)

The world’s largest financial market - the derivatives sector - is worth approximately $1200 trillion USD in traded value… but you are not allowed a piece of the pie.

The archaic business model that drives the derivatives industry fundamentally excludes the majority of the population from getting involved. While there are some legitimate reasons for this selective approach, such as a desire to protect investors who have limited knowledge of how the derivatives market works, the system also prohibits, by default, many capable investors who are keen to get involved in derivatives trading.

Currently, there are just two ways in: either become an accredited investor or pay out hefty fees to advisors to make the decisions for you, while also transferring full control of your own investment portfolio to these middlemen. By all accounts, not an ideal state of affairs.

Now imagine if the average investor could gain unfettered access to the pivotal information usually reserved to traders, and regain full control of their investments. That’s just one of the possibilities offered by decentralised, multi-party derivatives trading. There will, of course, always be a place for financial advisors in the derivatives market, but in the future, engaging one will be a choice, not the only option available.

Lack of Transparency

One of the most critical flaws in the current centralised derivatives trading environment is the inherent lack of transparency for both the investor and the trader. Decentralisation, in the form of blockchain technology, could change this entirely. While the value of blockchain to the financial services sector, in the form of a decentralised ledger to record and verify all transactions, is clear, the added transparency that the technology provides could also be a boon to both accredited and amateur derivatives traders.

Currently, the institutional setup means the investor is not privy to information which the centralised providers have - crowd wisdom. This allows providers to overlay information from historical volatilities and prediction models, and augment it with crowd wisdom, giving them the power of knowing what everyone is doing, while the investor remains oblivious.

Decentralising investment in derivatives, and ensuring that everyone has access to the same quality of information, could fundamentally change the investment ecosystem by reducing the barriers to entry for many retail investors who are excluded under the current system.

In addition, ingraining verifiable transparency into the derivatives market could prove to be a better way of protecting vested parties by arming them with all of the information rather than simply blocking unaccredited investment participation, to begin with. Promoting this information exchange would offer a much more efficient and democratic alternative to the current derivatives trading model.

So, now that it is evident that the existing system would benefit from democratisation through decentralisation, how can this shift be realised on the world stage when systemic change occurs at a glacial pace?

Decentralising Legacy Industries

Although the technicalities of blockchain and decentralisation are fascinating (to a certain audience!) the really cool bits happen when someone figures out how to apply the tech to decentralise entire industries and the roles of the centralised players in it. The derivatives market is ripe for such decentralised disruption.

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A new breed of start-ups are combining their understanding of the key components of the centralised players’ role, and the purpose they serve, with decentralised technology, infrastructure, and authentication mechanisms to bring to life use-cases that eliminate the role of centralised industries where large corporations perform a specific role.

Applications in a legacy environment

Currently, any change or innovation related to blockchain technology occurs along one or all the three dimensions of decentralisation — authentication mechanisms; technology/infrastructure and core/industry role decentralisation.

The first two dimensions create a trustworthy environment for entire industries to operate on. The applications of the two dimensions can easily be spotted within existing industries and their processes. Any avenue where security of data, or transparency in transaction execution is a must, is by default ready for a blockchain or Distributed Ledger Technology (DLT) implementation. Considering the over-exposed society in which we live, and the risks we have become all too aware of regarding data security and transparency in recent years, it could be said that this encompasses every field in existence today. Some implementations are already on their way in other areas too, especially in the fields of supply chain and ingredient provenance in the healthcare and food industries.

Although perceived by some as marginal, such improvements and innovations could and will in the near future, have a significant impact in terms of driving unprecedented levels of security, transparency and consumer confidence, especially when put to work in large corporates and industries. Particularly in financial regulation, regulators will not need to be convinced of any required changes to enable such a leap in productivity and efficiency. The unquestionable information will speak for itself.

While these scalable initiatives mean huge gains, they fall significantly short of true innovation, which would bring about the complete transformation of entire industries.

To argue the case for decentralised derivatives trading, there are three key factors that need to be addressed - the ease of participation, access to crowd wisdom, and most importantly keeping the incentives intact while solving for unquantified risks. Those who continue to play the centralised role will, in time, face compliance and regulatory issues if they fail to adapt.

Increased security, access to scalable resources and valuable information to trade, and a massive reduction in the cost of transacting are just some of the ways in which people can benefit from decentralised derivatives. While many proclaim that the future is decentralised, the opportunity for disruption of the derivatives market is imminent.

By Vaibhav Kadikar

The views and opinions expressed in this article are those of the author and do not necessarily reflect the views and opinions of Al Bawaba Business or its affiliates.

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