Faster, cheaper, confidential and compliant: Blockchain’s promise for Collateralised Stock Loans

Since stock exchanges and margin lending were first introduced, collateralised stock loans (CSLs) have been used by those keen to unlock the value of equity holdings without having to sell.

From entrepreneurs financing their day-to-day spending, to family offices and high-net-worth individuals using them as part of sophisticated wealth management strategies, CSLs have long enabled people to access liquidity and avoid capital gains tax, all while retaining ownership of their shares. If the stock value drops below a certain threshold, the lender typically issues a margin call, requiring the borrower to add more collateral to cover the debt, or the borrower can walk away and forfeit the shares, but the goal is always to prevent liquidation. On the other hand, if the borrower repays the loan, they still benefit from price appreciation.

Challenges facing traditional financial systems

The above may sound relatively simple, but in reality it’s a process traditional financial systems have struggled with over the years.

Aside from stock market crashes affecting the entire concept, CSLs have faced massive operational inefficiencies, mainly due to the fact it relies on intermediaries such as brokers and clearinghouses, which introduces a huge amount of friction and cost.

Regulatory inefficiencies also increase the time and cost of processing CSLs, as compliance with AML (Anti-Money Laundering), KYC (Know Your Customer), Basel III capital requirements, and SEC or EU regulations all create a large administrative burden.

Finally, the process is far from instant, and as the old saying goes, “time is money”. Public stock loans typically settle on a T+2 basis, while in cases of high-volume trading or market volatility, processing delays can be much longer.

To further add to this complexity, as well as being able to use CSLs on public shares, they can also be used against private securities. While conceptually similar, the latter is far more challenging due to the illiquidity and lack of market pricing for the collateral. This means they require more extensive legal and administrative work to transfer or collateralise, which slows down transactions and drives up costs even more, with investors often facing exit fees of 1-3%+, typically in mutual funds.

A major source of complexity in traditional CSL infrastructure is also simply technical: data related to ownership, collateral, identity, and transaction history is spread across siloed databases that don’t natively communicate with each other. These systems lack interoperability and offer very limited programmability. As a result, most of the logic required to execute, verify, and settle a stock loan is enforced not by code, but by human operators, compliance teams, and legal processes. This reliance on manual coordination slows everything down, increases costs, and creates points of failure.

CSLs are due for an upgrade, could blockchain be the answer?

With this particular area of finance in clear need of change, blockchain technology looks like a promising saviour. One of the most exciting ways this is happening is through stablecoins, which are digital currencies linked to real-world money like the US dollar. These stablecoins make it possible to use tokenised assets, like shares turned into digital tokens, as collateral directly on the blockchain.

Because everything happens onchain, the whole lending process can be:

• Faster: as everything runs on the same financial backend - the blockchain - settlement times are much faster. In fact, through smart contracts (automated code on the blockchain), we can achieve instant/near-instant settlements vs the days or weeks for transactions to clear via traditional financial systems.
• More efficient: tokenised stock loans can be settled onchain without intermediaries, removing any bottlenecks previously caused by clearinghouses.
• Automatically compliant: Smart contracts can also enforce compliance automatically, ensuring AML/KYC rules are met before a loan is even executed.

Barriers to adoption

While there is certainly undeniable potential for blockchain’s use in this area of finance, there are a number of hurdles yet to overcome before we see widespread adoption.

Firstly, there’s a lot of hesitation from traditional banks and financial institutions. They rely heavily on their role as intermediaries in the lending process; facilitating loans, managing risks, and controlling the flow of capital is all a key part of their business model. Blockchain’s ability to cut them out is obviously an issue for them. As well as being worried about losing power over their customer relationships, financial institutions are also concerned about the regulatory uncertainties surrounding blockchain and cryptocurrency technologies.

Secondly, investors themselves have concerns around the transparency, privacy and confidentiality aspects of the blockchain. At the same time, regulatory bodies need some level of transparency to ensure compliance with financial laws, which is causing hesitation from them too, with many financial organisations often preferring their own local regulations as they’re typically better suited to their needs.

Finding the right balance here is a challenge. Blockchains are inherently transparent, which for the investor, in the case of something like CSLs, is actually a drawback. As anyone in finance will know, confidentiality is crucial to protect trading strategies and prevent competition from gaining an advantage. The fact that transparent data is not adapted to financial markets means that excessive visibility - exposing details like stock positions and transactions - presents a possible risk, potentially allowing competitors to front-run trades or manipulate the market.

There are also security worries. Blockchains themselves are incredibly secure when smart contracts are written properly, but unfortunately a lot of smart contracts are poorly designed, which is where new cybersecurity risks, such as hacks, oracle attacks, and smart contract vulnerabilities come into play. This is not a failure of the blockchain itself, but is still affecting user confidence.

Improving confidentiality on the blockchain

‘Compliant confidentiality’ may seem like an oxymoron, but there is technology aiming to do just that and some already in use that improve privacy onchain. These cryptographic techniques include:

• Multi-Party Computation (MPC): allows multiple parties to collaboratively compute a function over their private inputs without revealing them to each other. In the context of blockchain-based CSLs, MPC can play a role in ensuring security, privacy, and trust - however, there are limitations. Because MPCs’ data is split and shared among multiple parties, this increases the risk of exposure if one party is compromised.

• Zero-Knowledge Proofs (ZKPs): ZKPs can be used to prove that a borrower owns sufficient collateral without revealing the exact amount or the stock itself. However, ZKPs add a lot of complexity. They have limited flexibility for complex computations, which means stock loan assessments would still require off-chain processing, again potentially exposing sensitive data. With ZKPs, you also lose blockchain composability - the “Lego feature”.

• Fully Homomorphic Encryption (FHE): enables you to process data blindly without having to decrypt it. This ability opens the door to ‘compliant confidentiality’, meaning it allows investors to secure loans against tokenised stock without revealing their full financial history or holdings - for example, a lender could assess a borrower’s creditworthiness and stock collateral value without ever seeing the raw financial data, reducing risks of information leaks. It also means loan terms can be computed on encrypted data, allowing confidential price discovery and negotiations, and preventing market manipulation. But crucially, it allows regulators to audit encrypted data when necessary to meet compliance requirements while preserving data confidentiality. Regulators can still decrypt and audit data if required, but routine transactions remain private.

The future of CSLs

Blockchain has certainly demonstrated its ability to unlock instant liquidity, but widespread acceptance from investors, financial institutions and regulators will all hinge on balancing privacy and accessibility - and of course accessibility. FHE may enable confidential transactions and computations on encrypted data, but privacy-enhancing tools like this one must be accessible and easy to implement within blockchain ecosystems if we want to see adoption at scale.

With this in mind, blockchain-based CSLs would require decentralised applications (dApps) that can integrate privacy features seamlessly. Here, new and emerging protocols such as fhEVM are already working to provide the developer-friendly infrastructure needed to build privacy-preserving lending, settlement, and collateral management systems directly on the blockchain.

With progress on the accessibility front underway, I believe that with the right blend of encryption, decentralisation, and regulatory collaboration, blockchain-based CSLs could soon become the norm, providing a faster, cheaper, more efficient, and more secure alternative to traditional stock loans.