Blockchain Business Scenarios

These days blockchain is a blockbuster at banks. Financial institutions are spending time and resources to find how much business they can gain by adopting this new technology. This hype on the bank side might not correspond to similar interest from corporates. Nor it is clear whether it creates similar business opportunities for either side. My ongoing research investigates how large is the (usual) gap between banks and their corporate clients, assessing how much the blockchain technology is part of the current domain expertise of corporate practitioners. It looks like, however, that banks and corporates are not the only involved.

The analysis of the initial results of my research suggests four[1] possible scenarios, not necessarily mutually exclusive:

Bank-to-Bank scenario: Banks will use distributed ledger based solutions for inter/ intra-bank purposes, keeping it totally transparent to corporate business users.

Banks are subject to tight regulatory pressures for interest-based business (e.g., loans and trade finance). Non-interest income transaction banking is not subject to such overly tight regulatory constraints, so payments and cash management services have become a renewed focus for banks. Banks are improving their efforts on payment transactions (e.g., via real-time payments solutions) to regain control of a business too long subject to disintermediation. The banking industry also focuses heavily on innovations in payments and even faster payment systems as banks are under big stress to contrast a significant threat from non-banking financial intermediaries that wave the flag of innovation as their major competitive asset.

Blockchain and bitcoins are very often considered intertwined and this de-facto perception poses a problem to banks: bitcoins are based on the premise that exchange of currency does not require financial intermediaries. This threatens banks in that very same space of payments transactions that banks are so hardly trying to conquer back. The analysis tells that banks are fighting against the adoption of bitcoins, and are intentionally directing attention to the blockchain infrastructure that they can better control. This control is made possible only if blockchains become private, so that the shared levels of trust ensured by proof-of-work are replaced by closed-group consensus of trusted parties. That is, the banks themselves.

In this scenario the SWIFT network could become the blockchain distributed network of nodes that enables federated permission-based blockchain via the use of consensus algorithms. The sort of solution adopted by Ripple Labs, which, by coincidence (is it really?) is a blockchain-based network that exchanges fiat currencies (and not bitcoins) to the joy of financial institutions.

Such private blockchain projects are not even close to resembling a blockchain as designed for the bitcoin community. Once again it will be subject to a centralized control by banks will little to no difference between building a private blockchain and the current model of centralized messaging network.

Bank-to-Corporate scenario: Transaction services running on the blockchain consensus distributed ledger will enable corporate users to benefit from the foundational characteristics of blockchain: speed, accessibility, and transparency, all values that inspire decisions made by corporate executives.

Banks foresee benefits for corporates by virtue of the applications running on the blockchain that will ripple down to the banks’ corporate clients. Consequently, before launching any blockchain-related program a bank must be very clear and extremely convincing in explaining its corporate clients what is in it also for them. Corporate involvement is necessary, so more time must be dedicated to educate and understand what the technology can bring to corps vs. developing only-for-banks technology and solutions.

So, if banks want to use blockchain as a solution to resolve their internal needs to gain more transactional efficiency they can do so, but they must also be prepared to explain to the external parties involved what is the extra effort needed and the connected benefits, so that these parties can build a cost-benefit analysis and decide whether or not they want to participate. A sign that this collaborative approach is still rather far from reality and that the race to blockchain appears to be yet very a bank-centric matter is the constitution of the R3 CEV distributed ledger initiative, whose members are only banks and Fintech companies. The R3 CEV website reads that “The R3 CEV team is made up of financial industry veterans, technologists, and new tech entrepreneurs.” No sign of corporate representative groups whatsoever.

In essence, any operation that involves the exchange of data between parties connected to banks has the inevitable consequence that those parties are also involved in the entire process, even if they have to just kick-off the transaction and all the rest being processed within the inter-/intra-bank domain.

The tendency of banks to design innovative technologies and oversee corporate needs and reaction has a very recent testimonial with the bank payment obligation (BPO). This is a (supposedly bank-only) payment obligation agreement that binds participating banks to commit on making payments upon the verification of certain pre-established conditions. The BPO is however—practically—still at the starting grid because banks are waiting corporates to demand for BPO-related services, while corporates are almost totally unaware of what the BPO is and not sure why they should demand for it. Not that the benefits to corporates are insignificant. Problem is that banks have dedicated time and effort to find the internal inter-/intra-bank rules of engagement and process execution guidelines that they have “forgotten” to tell their corporate clients what is expected from them and what are the positive consequences when embracing the BPO.

The entire blockchain-based innovative solution set is running the same risk: It is not sufficient for banks to say that blockchain is the underlying infrastructure that runs bitcoins, and that while bitcoins are “bad” the infrastructure is “good”. Neither is sufficient to drive the attention away from cryptocurrencies to the benefits of cross-border payments with blockchain-based protocols like Ripple. These solutions are always illustrated as if only banks were involved, with other entities (e.g., companies) completely agnostic of why those transactions have been launched in first place and only expected to be happy to save money because some “magic” from their bank has cut transaction costs.

On the contrary, companies are very wary of the implications of what may happen when changing the way they interact one with another (and payments or FX transactions make no difference), and stay focused on what those changes imply in their daily operations and workflows.

I very recently interviewed 95 corporate executives, 66 of which supply chain (i.e., operations) and treasury managers, with the remaining respondents coming from IT, legal, and sales. When asked if they were familiar at all with the term “blockchain”, more than 80% answered “No”. Among supply chain representatives more than 90% were those totally unfamiliar with the term. Among treasurers the percentage dropped to 61%, not much encouraging either.

Supply chain management and treasury practitioners are good proxys to understand the technology needs of a company. So if they are not aware of blockchain, chances are that neither is their company. Which means that banks (and Fintechs) will have a hard time to promote the use of blockchain (and turn it into a business opportunity) unless they first generate awareness and a solid business case for corporate clients.

Corporate-to-Corporate scenario: Corporates will start working on blockchain projects for mission-critical (i.e., niche) applications, while waiting for the “big thing” to occur. Banks may not have any role to play.

It is a fact that corporates are late to take on the blockchain debate and such lack of awareness may be the symptom of simpler lack of interest. After all banks are all over blockchain because bitcoin was the wakeup call for them and shook them up to the point that made them active and keep wide eyes open.

It all began when among Cyprus' banks, desperate for a bailout, a proposed rescue plan called for a one-time levy of 6.75% on all personal bank deposits under 100,000 euros. Although Cyprus' parliament rejected that bailout plan, Cypriots (and especially non-Cypriot foreign depositors—e.g., Italian, British, Spanish, Russian) feared their personal funds could be raided to pay off bank losses and raced to withdraw their money. Only to find that banks had closed to prevent more panicked withdrawals. To circumvent the dramatic situation some depositors took their bet on turning their fiat currency into bitcoins to unlock and withdraw their deposits out of the country. For this chosen alternative the value of the bitcoin rose 57% in one week alone, having an immediate shocking impact on banks. Sort of an asteroid hitting the earth and causing the extinction of dinosaurs.

Another possible explanation of such slow corporate uptake is that one of blockchain’s value propositions (if not the main one) is that buyers and suppliers can connect directly and form online networks, removing the need for middlemen. Smart contracts running on the blockchain should automatically detect trigger events along the trade value chain and instruct parties on actions to take to comply with contractual obligations.

This sets the blockchain as the enemy of all intermediary operators in a business-to-business (B2B) environment.

A B2B relationship is made of a sequence of buyer and supplier pairs, with a relatively high level of trust between the two. While the level of trust could be nil (or very ow) between an exporter and an importer that are at the edges of the B2B value chain, certainly this is not the case between the pairs that connect these parties. So if each pair of B2B value chain intrinsically trust each other, what additional contribution could a blockchain bring?

Furthermore, there is a clear shift to trade on open account terms and open account business is increasing in market share[2]. Open account occurs when a seller ships the goods and all the necessary shipping and commercial documents directly to a buyer who agrees to pay the seller’s invoice at a future date. Open account is typically used between established and trusted traders. That has compelled the banking industry to seek to re-engage with buyers and suppliers by developing a value proposition based on the blockchain aimed at meeting the needs of traders operating on these open account terms.

So, if open account transactions are founded on trust and keep banks out of the picture, why should corporate trade partners want to get them back with a blockchain? Since open account transactions are based on the principle of trust between parties, why the need for a trustless distributed ledger technology?

Innovation happens in bursts as it was with the internet that became popular when two “asteroids” hit the consumer world: emails and the web browser. Such disruptive effect has not yet occurred in the world lived by corporates. While the bitcoin was the killer app (i.e., the “asteroid”) for banks, nothing is there yet for corporations.

If this is the case then little or no demand for blockchain-based applications can be expected by corporate users. Maybe the most aware of the technology are financial directors and corporate treasurers, for the simple reason that they are frequently exposed to banks and therefore absorb the inherent dynamics. These corporate representatives expect changes in payments, securities trade, and bank clearing. However, all have concerns that the blockchain discussion is moving too fast. The corporate side of the equation need to see first a consolidation of the different players that populate the crowded space of blockchain applications (see The Global Landscape of Blockchain Companies in Financial Services). The need for standards and regulation is the next call.

Machine-to-Machine scenario: The blockchain remains completely transparent to “human” business users, and it will be deployed to develop solutions tied to in the internet of things (IoT[3]) domain.

The principle that the blockchain is the “enemy” of all intermediary business entails that the blockchain ensures a digitized and automated compliance checking process. Digitization hence extends from financial instruments and documents to the entire workflow of the processes that generate, manage, exchange, and store these digital assets (i.e., blockchain “tokens”).

Digitizing a process workflow requires the digital integration of all trading parties’ ERPs with the core systems of the issuing and receiving banks. The process workflow pervades also document preparation, checking, and exchange. The secured trusted environment created by the blockchain protocol prepares for an end to end digital trade lifecycle. Along the digitized workflow are event points that trigger decisions based on the parties involved. For instance, the event of purchase order being issued may trigger the need for the buying party treasury system applications to forecast a cash outflow to pay for the goods purchased; the supplier’s system will be triggered to plan for the necessary working capital to cover procurement, manufacturing, warehousing, and shipping of goods; banks’ systems will be alerted that a possible request to finance the supplier’s working capital needs; freight forwarders will start booking cargo space in advance to get best price conditions; insurers will prepare to price shipping and credit insurance policies.

The blockchain creates a connectivity platform that supports an events-based workflow of digital assets exchange, and controls the flows of information among all parties involved. The set of digital assets required in the workflow is predetermined based on the process, and corporate and banking systems use that information to decide what to share on the distributed ledger database.

In this machine-only scenario the blockchain is the TCP/IP equivalent to automatically identify, direct, and manage digital assets between machines. It works best if it remains transparent to humans. For instance, blockchain-based applications can automate the exchange of invoices between machines that buy and sell digital goods (e.g., available energy, space on a truck, machine time, and spare parts). All of which represent the foundational elements of the IoT.

In the machine-to-machine scenario the blockchain gets rid of human interaction and puts machines to work with each other. Paradoxically, the blockchain can work best when it removes intermediaries. In a human-to-human relationship this is difficult to accomplish. Not between machines.

It is even possible that the real success of the blockchain business scenario will be one in which the distributed ledger database takes the form of a new TCP/IP protocol, transparent to humans but essential for machines and computers

[1] There’s actually a fifth business scenario: The bank-to-third-party. This is when banks engage with third party intermediaries to trade commodities or to operate in marketplaces of financial instruments (e.g., securities, bonds, investment asset classes). For simplicity—and regretfully to the dismay of “purists”— I opted to incorporate this business relationship in the bank-to-bank scenario since no corporate relationship is contemplated.

[2] Rethinking Trade and Finance, Chamber of Commerce, 2014 (http://tinyurl.com/gvw462a)

[3] The IoT is the network of physical objects or "things" embedded with electronics, software, sensors, and network connectivity, which enables these objects to collect and exchange data.