Smart Clearing House

Traditional Clearing House Definition

A clearing house, in traditional finance terms, is an independent institution formed to facilitate the exchange of securities, commodities, or derivatives. The clearing house stands between two broker firms by taking the opposite side of each party and thus reduces the risk of either party honoring its trade settlement obligations.
Yellow leverages Layer-2 chains for a clearing house implementation on-chain.
The clearing house enters the picture after a buyer and a seller execute a trade. Its role is to accomplish the steps that finalize, and therefore validate, the transaction. In acting as a middleman, the clearinghouse provides the security and efficiency that is integral to stability in a financial market.
A traditional Clearing House is tasked with five crucial roles that add stability, security and transparency to markets;

1) Clearing & Finalizing Trades

This is the principal role of the clearinghouse. It means that all trades that the exchange reports are up to the required market standards and that each participating party is able to fulfill their commitment. Once a trade is “cleared” it means the trade is completed. i.e. the buyer has paid for the goods and the seller has delivered the asset.

2) Settling Trades and Netting Margin Accounts

Besides its function as an overseeing body the clearinghouse also drastically reduces the number of payments between parties through a process called Netting. Brokers usually commit thousands of transactions a day. Settling each transaction would be a logistical nightmare. Netting allows brokers only to pay for the actual outstanding balance of their trading account.

3) Margin Accounts & Payments

Margin accounts are accounts that the brokers hold with the clearinghouse. The amount required to be held on these accounts is often defined by mathematical formulas that take into consideration the risk of the broker's open positions. The margin amount is the collateral that a broker needs to maintain at all times to ensure his open positions.
If the broker can’t meet the margin obligation the clearinghouse has a set procedure to either reduce or liquidate the position, called partial or full close-out.

4) Asset Delivery

At the agreed time of exchange, the clearinghouse ensures that the seller delivers the money and the buyer transfers the asset in question.
If the required margin amount exceeds the balance the clearinghouse will issue a margin call, i.e. a request to top up the account.

5) Reporting

The clearinghouse is also tasked to report all activity to oversee regulators and governing bodies. This facilitates the oversight since controlling entities don’t have to work out the activity of each broker but instead can view the market as a whole.
It further allows for analytical data such as market depth, flows, trends, and other statistical measures that are important for all market participants.

Benefits of a Crypto Clearing House

Despite the stakeholders in Crypto being slightly different from traditional finance, the introduction of an independent Layer-3 clearinghouse helps to mitigate the problems of;
Market Fragmentation by connecting smaller brokers, market makers, and exchanges cross-chain and cross-network
Market Depth & Liquidity by aggregating liquidity and order flow between all participants
Conflict of Interest whereby many traditional crypto exchanges not only act as a marketplace but at the same time act as market makers, liquidity providers, and custodians.
Overall the introduction of a dedicated Crypto Clearinghouse will de-risk the existing landscape and open the market for new participants while at the same time comforting regulators.
Liquidity aggregation helps smaller, specialized exchanges and brokers to offer better pricing and handle larger trade volumes.
Clients from large exchanges will be able to trade additional token pairings for which they otherwise would have to move custodied assets.
By holding margin accounts with the clearinghouse, brokers and exchanges can use margin netting to allow for a more efficient use of capital.
This greatly reduces the risk of overexposure and helps to streamline liquidity management and capital efficiency.
The Clearing House can accurately report order flow data to regulators and thus lower the reporting burden for traders and brokers while at the same time increasing the safety and transparency of the marketplace, as well as helping to identify and exclude bad actors.
Yellow Network brings these functionalities by using cutting-edge state channel technology and settlement via smart contracts.
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Traditional Clearing House Definition
Benefits of a Crypto Clearing House