Community
Blockchain (distributed ledger) technology is at the height of the hype cycle. VC funding so far has exceeded $1 billion. Banks, payment and clearing systems, government agencies and service providers have also invested strongly. Many of the largest banks are exploring, experimenting, testing and even piloting blockchain applications.
So will blockchain mirror the Internet in its revolutionary impact on banking? Let’s not get ahead of ourselves. There is no question that blockchain has genuine promise in certain areas of banking.
But even R3 CTO Richard Gendal Brown has reservations. See his recent “getting real” comments on R3’s new Corda platform. R3's Corda is designed as a secure, reliable and fast mechanism for exchanging financial contracts. Many banking transactions are explicitly or implicitly contractual in nature. So Corda's approach is a promising one.
Parallels with Internet Payments
I am reminded of the earliest days of Internet payments (mid- to late-1990s). Financial Services Technology Consortium (FSTC) was an important player in exploring this brave new world. In 1997 I created and led the initial design phase for an FSTC project called Bank Internet Payments Server (BIPS). This was designed to simplify correspondent banking. Its goal was low-cost, same-day payments, both domestic and cross-border. It deployed XML-based message standards, strong authentication and encryption. It also included mechanisms for non-repudiability of payment instructions.
BIPS expressed the hope that the Internet would simplify payments. This in turn would drive out infrastructure cost. As a result, urgent and non-urgent payments would be accessible to consumers and businesses of all sizes. Although US-based, the vision was global.
In practice the vision was hardly realized at all. Payments infrastructure actually became more complex, duplicative and expensive. And for customers, payments remained expensive for same-day, and slow for lower cost.
Through the 2000s, banks implemented web-based, and then mobile-based payment mechanisms. SWIFT initiated a switch to XML-based messaging and TCP/IP protocols. Today, initiating payments over the Internet (web and mobile) is commonplace. Yet the initial promise of the Internet to simplify payments infrastructure was not realized. Payments initiation is certainly easier and more convenient. But clearing and settlement is still complex, duplicative, slow and expensive in most countries around the world.
What went wrong?
Was it a bad idea? No.
Was the need overstated? No.
The Internet payments infrastructure idea had many of the challenges facing blockchain implementations today. They include scalability, lack of (or too many) standards, and a variety of internal bank barriers to adoption. Above all, universal adoption of new bank processing infrastructure is extremely difficult to accomplish.
Still, the blockchain experiments being carried out are interesting and potential useful. They will help with clearer business case statements, and identification of which projects are more viable on a large scale.
Blockchain Applications Being Tested (Not Just Talked About)
Before we go on, we should note that the examples given here are experiments, not production-ready solutions. Regulators are involved in some of them, but have not blessed them. Some are being tested with real data, but at only a fraction of required volumes. Testing is mostly of the positive nature (will it work under good circumstances). Rigorous testing of exception and problem situations will be much more difficult. Changes will be required to operations, customer service, product development and regulatory compliance. These are being chatted about in corridors, but not comprehensively reviewed. In other words we are still in a laboratory environment.
Any list of banking industry driven trials of blockchain applications currently under way would be out of date by the time you read it. Every week at least, there is a new press release announcing a prototype, proof of concept or pilot application for blockchain. In a quick scan of the literature, I came across announcements for nearly 30 trials just completed, or still going on.
Application trials are heavily dominated by trading, but also several other areas of application. In the following brief sections, the links give examples but are by no means exhaustive.
Securities
In the area of securities trading, there are many publicized trials (and no doubt many more behind closed doors). Trials include the entire trading lifecycle, from issuance to clearing to settlement to reporting and compliance. Instruments being tested include low-volume equities, bonds, commercial paper. Exchanges conducting tests include those in Japan, Korea and Australia. The include many banks, individually or in partnership. They partner with several infrastructure players, including DAH, Nomura, Currency Port, Chain, Fujitsu, Eris, Ethereum.
None of this is surprising. Trading activities need all the things distributed ledger technologies provide. This includes speed, non-repudiability, security, and transparency. Delays in trading cycles create significant counter-party risk. This may have contributed to the late 2000’s financial crisis, though see below for some risks associated with trading too fast.
Payments
In the payments world, banks have been looking for ways to simplify, speed up and reduce cost of payments of all kinds for decades. The European Banking Authority has announced plans for instant 24x7 Euro zone payments. The Federal Reserve has (rather late in the day) awarded a project to McKinsey to assess proposed ways to modernize the US payments networks.
So it is not surprising that banks and payments providers are looking at blockchain for payments clearing and settlement. However, trials are not far advanced, other than in non-fiat digital currencies like Bitcoin. There are experiments in several areas: P2P payments; crypto-currency settlement (into and out of fiat currencies); mobile FX exchange; internal digital rewards currencies; and settlement of spot and forward FX contracts. All these trials represent limited learning exercises, rather than full blown proofs of concept.
Arguably the most significant payments trial in terms of potential systemic impact is cross-border clearing and settlement by RBC and Ripple. But real implementation even of a pilot is surely years away.
Credit
In the credit world, applications tend to have a trading flavor. For example, JP Morgan Chase and DAH are experimenting with loan sales. A small group of banks are working with the DTCC, Markit and Axoni in a trial trading Credit Default Swaps. This could be a great example of derivative trading.
RBC decided to look for a safe and easy way to introduce a blockchain-based product to the market. They are considering trials of a card loyalty platform.
International Trade
Export and import transactions can be very complex. They are unwieldy, prone to errors and delays, and vulnerable to use in Terrorist Financing and Money Laundering. Banks provide financing to the import or export party in the form of Letters of Credit. These bridge the funding gap between manufacture and delivery.
In an international trade transaction, many contractual documents are exchanged. This includes (among others) invoices, bills of lading, and insurance certificates. Digitization these documents, and exchanging in a distributed ledger environment, could help with several existing challenges.
Several banks are experimenting with and testing the use of blockchain for portions of the trade life cycle. Standard Chartered Bank and UBS are partnering with an initial focus on invoices. Bank of America and an unnamed bank are also starting experiments yet to be described.
Financial inclusion
One interesting question is whether distributed ledger platforms can help with financial inclusion. This is the global drive for relevant, accessible and affordable financial services for the very poor. In general, driving down infrastructure and transaction processing costs will help. But there are specific areas of focus as well.
Digital currencies are interesting in economies where the poor do not have easy access to brick and mortar bank branches or even ATMs. Several companies are exploring possibilities, but generally outside formal banking.
An acute challenge in many countries is the difficulty of proving collateral ownership, particularly land. Many countries do not have a reliable land registry. As a result, fraudulent claims of ownership are rife, with the result that banks are not able to trust in loan collateral. Factom is a startup experimenting with use of a distributed ledger to record land title. They are starting with a national land registry in Honduras in partnership with Epigraph. Property title searches are complex and costly in most countries. This is especially true. with commercial properties. A distributed ledger approach could have a significant impact on real estate lending.
Compliance
There is not much in the way of real world compliance trials yet, but this area will become hotter. In particular the KYC and CDD phases of AML regulations are more and more burdensome and error-prone. As an example, a global distributed ledger for financial transactors would be tremendously helpful. SWIFT has initiated a KYC registry service, which is in use by a number of banks. It is likely they will consider blockchain as an underlying technology in the near future.
An Exercise in Realism – Barriers to Adoption
R3’s Richard Brown stresses a key element of overcoming the hype, saying
“The reality is that solutions based on selecting the design first and then trying to apply it to arbitrary problems never work out well.”
The worst possible outcome would be huge investment in solving the wrong problem.
Even if we have the right problem, and a great technology solution for it, we have a very long way to go. Several barriers have yet to be overcome, as several organizations have expressed. Here are some of the key issues to be addressed:
There are others, but you get the idea.
Wrapping Up the Blockchain Hype
Blockchain, including the distributed ledger, smart contracts and associated technologies, is an exciting idea. There are, in fact, many major business problems that result from inefficient infrastructure. Blockchain may offer viable solutions for some of these.
The experimentation makes a ton of sense. It will lead to a much better understanding of the capabilities and limitations of blockchain in all its varieties. It will also encourage the beginnings of thinking about what it will take to put these solutions into production.
In the end there will be a few compelling business cases. The best of these will be compelling to all parties, and these are the ones that will be implemented. Which ones will they be? Sorry, I’m not a gambling man!
This content is provided by an external author without editing by Finextra. It expresses the views and opinions of the author.
Paula Hunter Executive Director at Mojaloop Foundation
23 August
Shiv Nanda Content Strategist at https://www.financialexpress.com/
22 August
Alexander Boehm Chief Executive Officer at PayRate42
Alex Kreger Founder & CEO at UXDA
Welcome to Finextra. We use cookies to help us to deliver our services. You may change your preferences at our Cookie Centre.
Please read our Privacy Policy.