Behind the scenes, a new computerized plumbing system is being readied to revolutionize the securities world.

Hyped, Blockchain (aka distributed ledger technology) is a Broadway musical that has received rave reviews before actors practice their places on stage and musicians play the score to see how it sounds.

Mary Jo White is in awe.

“Blockchain technology has the potential to modernize, simplify, or even potentially replace, current trading and clearing and settlement operations,” the Securities and Exchange Commission Chair told Stanford University’s Center on Corporate Governance in March.  

Two months later, Commodity Futures Trading Commission Commissioner Christopher Giancarlo said blockchain could be the biggest technological innovation in the financial services industry and financial market regulation in a generation -- or more.

Last month, Federal Reserve Governor Lael Brainard called the technology “compelling.”

This month blockchain is certain to take a starring role in the SEC’s initial forum on fintech.

Blockchains are the progeny of quants, yet kindergarten concepts of blocks and chains are relevant to understanding the wizardry.

Instead of green and red wooden blocks chained together in Lowell Elementary School Room 101, everyone in a blockchained securities market would get to play with blocks strung together of unchangeable information on transactions for everything from stocks to bonds to derivatives on exactly who bought what, when and from whom.

Together, in this classroom (excuse me, market), everyone would have access to the same blocks and would agree they are red or green or made of wood or plastic.

In the vision of blockchain:

• The entire trading process from start to settlement is shrunk from three days to minutes or virtually instantaneously, freeing up investors’ and traders’ capital and promoting liquidity.

• With peer to peer trading possible, the decades long march of the cost of a trade to zero would take a giant step forward.

• Compliance costs could be cut dramatically since contract terms would be quicker to find and it would be easier to see if they have been fulfilled.

• Trading settlement costs could shrink too. One estimate: by a third or $16 billion.

• The often complex obligations between buyers and sellers in debt securities, stock options, warrant and derivatives could be executed quickly and automatically through “smart contracts.”

• Investor confidence would be increased, since investors could tell when corporate insiders and raiders are buying and selling since blockchains expose their identities.

• Confidence in the integrity of the marketplace would also be increased since companies would lose much of the ability to manipulate earnings through backdating sales or pushing operating expenses into the future since there would be irreversible, time-stamped transactions.

“A lot of financial advisors make their money through relationships with asset management companies. That may be much more difficult to do in the future. The technology will raise questions whether investors need to have investment companies involved at all in executing and settling their trades,” said New York University Stern School of Business Finance Department Chair David Yermack, who gave what may have been the first major presentation to the SEC on blockchain.  

Be prepared for muddier, less elegant realities to intrude.

Yermack is predicting chaos will be the order of the day in the next 10 to 15 years as blockchain winners and losers and systems get sorted out.

“In theory, there is one giant ledger and every asset is on that ledger. There could be thousands of ledgers. You may have some Apple shares on one ledger. Some on another. Who is going to say you got the best price?" said Rob Palatnick, chief technology architect for Depository Trust and Clearing Corporation (DTCC).

He warned a retail investor could have the same asset on different ledgers and may have to connect to several ledgers to see all their assets.

While the names of buyers and sellers would be exposed in each trade on a blockchain, a raider could still operate surreptitiously by using a shell company or companies for the transactions.

There is a chicken vs. egg dispute among blockchain proponents: a regulatory framework or the action.

Alan Cohn, the attorney for the Blockchain Alliance, wants Congress to let blockchain innovators play in a “sandbox,” free from federal oversight for a six-month regulatory holiday to let their ideas hatch unimpeded.

“The problem is you could have a very innovation friendly approach by one regulator and very traditional, stiffer approach by another,” said the trade group counsel.

At the same time, other blockchain believers contend deep-pocket financial institutions are too chicken to place big money into blockchain until they have the safety, certainty and blessing of a regulatory regime.

While companies from start-ups to over century-old financial institutions are putting money into blockchain, no one is making hard bets on when it will become ubiquitous for securities practitioners.

But coming up soon, government bonds could be traded faster and cheaper.

Asset managers will be able to just hop on a blockchain and execute a trade without interacting directly with multiple bond leaders, forecasts K&L Gates FinTech Group and Investment Management Group attorney Todd Gibson.

In five years, two apps could be commonplace, said Eric Piscini, Global Blockchain leader at Deloitte.

One would be to let a block chain-enabled broker affiliated with a block chain-enabled bank to onboard a new customer who has a relationship with the bank in a few minutes instead of five days.

“Instead of asking the customer 20 questions, she’d just have to ask two or three, like how much risk are you willing to take,” said the Deloitte blockchain expert.

The other half-a-decade-away business-as-usual application for blockchain in the securities industry would be in proxy voting.

A heavily paper process would become online. Shareholders couldn’t vote twice and companies would know in real time who has voted, Piscini said.

The first use of blockchains in stocks and bonds is likely to be in the over-the-counter markets, which have more functions done manually and more complex contracts and counterparty risks than the other markets, McKinsey & Co. predicted last December.

Asset-backed securities, precious metals and unregistered securities are often viewed as prime candidates for blockchained markets as are private securities which are largely on paper sent between owners on FedEx jets and trucks.

Blockchain could substantially reduce the number of legal disputes between investors and securities professionals on the “he said, she said” execution details of trades since there will be a record all parties agree on that can’t be altered.

However, this heightened level of trust will still leave plenty of avenues for litigation and arbitration, said Denis Rice, a member of the American Bar Association Cyberspace Law Committee.

“Blockchain does not deal with suitability or unsuitability or fraud or disobeyed orders as in, “I told you to buy Apple and you bought Samsung,” he explained.

While blockchain could eliminate much of the existing sources of revenue for investment advisors and broker-dealers through reducing the needs for investors to use them as middlemen, growth opportunities loom.

The bright side of blockchain for asset managers, according to Blockchain Revolution author Alex Tapscott, is the potential for increased revenue from more low wealth investors and establishing new markets.

Since investors could trade directly with each other or at least with much less intervention by middlemen, brokers would spend less of their time on the clerical aspects of trading and more on the intellectual joy and challenge of using their brains for analysis.

“Investors thirst for information will not die,” prophesied Rice.