Deepening the Secondary Market: Integrating Trade Credit into Market Clearing with the Cycles Protocol

TL;DR

This paper presents the Cycles Protocol, a novel distributed clearing mechanism that enhances secondary market liquidity by integrating trade credit into formal settlement without increasing counterparty risk.

Contribution

The Cycles Protocol introduces a multilateral, non-novation-based clearing system that leverages double-entry accounting to unlock hidden liquidity and extend market clearing capabilities.

Findings

Enables balance sheet compression without redistributing risk.

Can be applied as a compression layer between existing clearing systems.

Facilitates incorporation of trade credit liquidity into formal settlement.

Abstract

Current post-trade clearing systems rely almost exclusively on cash or cash-like collateral, leaving vast reserves of short-term liquidity embedded in trade credit outside formal settlement infrastructures. A key barrier to integrating this liquidity is the near-universal dependence of clearing services on novation, which imposes institutional overhead that restricts accessibility and limits the range of obligations that can be brought into settlement. This paper introduces the Cycles Protocol: a distributed, multilateral clearing mechanism based on double-entry accounting and atomic cycle execution that maximizes balance sheet compression. Unlike novation-based clearing, Cycles does not redistribute counterparty risk; it can thus be applied generally to existing financial networks, without any change in counterparty relations, allowing it to complement existing clearing systems and Central Counterparties (CCPs). By representing commitments as edges on a unified directed graph, Cycles surfaces liquidity hiding within existing network structure. We focus here on two applications of Cycles to deepening secondary market liquidity: first, as a compression layer between existing clearing participants and CCPs; and second, as a means to incorporate the liquidity of the trade credit network into formal settlement, extending market clearing beyond financial obligations and into real-economy financing.