Accelerating adoption of distributed ledger in financial services: centralised versus de-centralised business models

Leaving aside the Bitcoin use case, is the story of Blockchain simply one of ‘hype’ and a lot of talk, with few genuine real-life use case examples currently in operation? This is the question that is most likely to be put forward by those questioning the adoption speed of distributed ledger technology.

We are still a number of years away from mainstream adoption of Blockchain in financial services but in 2017 the industry is likely to begin to move from hype to real solutions.

The digital age continues to redefine the way in which banking is conducted and it is widely anticipated that the shared distributed ledger technology commonly known as ‘Blockchain’ has the potential to completely transform the financial services industry. As with any new technology, the journey from potential to reality can be very challenging. What is clear is that there is huge effort and determination amongst banks and FinTechs to develop business and commercial models that will drive future widespread adoption of Blockchain.

Distributed ledger technology allows untrusted parties to transact with each other simultaneously with trust. It provides non refutable records of those transactions, and reduces the reliance on central counterparties to manage trust. With banks urgently seeking to reduce costs, the potential security, convenience and efficiency of Blockchain networks is a major driving force in the race to adoption.

However, scalability remains a significant concern and a barrier to adoption. Whether Blockchain can scale for certain high volume financial services use cases remains to be seen. Developments in establishing standards, governance and regulation need improvements, along with interoperability.

In August 2016, the IT research and advisory group Gartner announced their Hype Cycle for Emerging Technologies. It revealed that Blockchain is in the ‘Peak of Inflated Expectation’ phase. According to the Hype Cycle, it will be at least another five to ten years before Blockchain reaches mainstream adoption.

Blockchain adoption and progress in the Hype Cycle varies from industry to industry, but within financial services we can expect substantial development and rapid evolution to realise the large-scale benefits that have been identified.

If Blockchain is to achieve wide-scale adoption there are a number of commercial and technology barriers to overcome, all of which will take quite some time. Choosing the right business model to migrate to Blockchain therefore becomes critical.

Picking the right business model

We have identified eight potential distributed ledger adoption models, each with its own benefits and drawbacks. The key challenge is identifying which is the optimum model for the particular use case in question:

• Open sourced
• Licensed product (FinTech driven solutions)
• Platform-as-a-service
• Distributed peer-to-peer funded model
• Consortium based
• Existing centralised utility
• Adoption through a Service Provider
• Led by regulator or central bank

It is essential to establish what we define as a ‘platform’ and what we define as a ‘use case on a platform’. At present there is a gap between these definitions. Focussing on the success witnessed in other industries, it is clear that platform availability and the core ‘standards based infrastructure’, upon which Blockchain use case solutions need to sit, are best serviced at the earlier stages of maturity using an open source model. This creates the opportunity to more successfully evolve and grow use cases as there tends to be a wider set of participants (developer communities, market participants and consultants) that contribute to open source frameworks.

The point is that it is very difficult to create a successful Blockchain solution in isolation – success needs participation. There is extensive expertise within the market place, with market participants, developer communities and consultancies all being able to add significant value in defining and developing the functional building blocks that are needed for a robust solution.

Those use cases that sit on top of platforms need themselves to be correctly engineered in terms of business process, business standards, messaging, integration requirements, and data structures. With Blockchain there is an opportunity to make a step change in the way that financial services transact, and we would advise looking initially at the ‘big picture’ rather than specific operational processes, since in this way the arising use cases will ultimately deliver step change.  

The influence of incumbent centralised utilities

In driving Blockchain adoption the incumbent centralised utilities potentially have a crucial role to play, since they bring a wealth of expertise and understanding of the business requirements needed to drive distributed ledger adoption. Many are already collaborating in an industry-wide effort to evolve open source Blockchain technology.

One of the main areas in terms of products and use cases being proposed for Blockchain is in the payments domain. However, whilst there have been attempts to develop Blockchain technology, the rate of change is still relatively slow. Potential areas of conflict arise with payments, clearing and settlement, since centralised institutions such as utilities, exchanges and centralised counterparties dominate these areas and are naturally focused on protecting their market. There are limited drivers for change. I would encourage the centralised utilities to embrace distributed ledger disruption, and with their market dominant position lead the change for the greater good of the industry. In this way, when distributed ledgers start to become a reality they will a central part of the new approach and not be left behind.

The role of consortiums

These offer unique value in the distributed ledger marketplace, as by their very nature they encourage key participants (banks, market data providers, clearing and settlement entities etc.) to collaborate on Blockchain innovation. This is an essential requirement for driving the successful adoption of distributed ledgers, since, to quote Richard Crook, Head of Innovation Engineering at the Royal Bank of Scotland, “There is only so much fun you can have with Blockchain on your own!”.

R3 is one of the most high-profile consortiums that is driving the Blockchain innovation debate, although there are a number of consortiums based on shared interest, technology or market sector.

Licensed product (FinTech driven solutions)

The fastest route to market for Blockchain solutions will be through the FinTech community working together with banks. By their very nature FinTechs are driven to go-to-market as rapidly as possible with a commercially viable solution. Through our industry outreach programmes, such as CODE_N, we are seeing the most mature solutions emerging from key Blockchain focused FinTechs. We believe that in 2017 we may very well see one or two of these firms emerge with market changing solutions.

The future role of regulators

Alongside central banks and utilities, regulators also have a major role to play in the development and adoption of distributed ledger technology. Arguably, it is the impact on regulation and in particular the improvement in transparency and over-sight, that could be the defining benefit to the financial services industry of distributed ledgers.

In this era of ever-greater regulatory demands and pressures, how banks store, collate and aggregate data has become even more important. In the past decade many investment banks have removed large amounts of their cost base by driving towards single sources of data ‘truth’ inside the bank, be that in the form of reference data, trade data, counterparty data, or settlement data. Having a single source of data ‘truth’ can ensure a lack of duplication, greater efficiency and reduced costs, whilst also providing a single repository for when the regulator requires more reporting.

In the post trade settlement space, covering netting, confirmation, finance and risk control, the regulator continues to demand more and more data from the trading entities. With such large volumes of data, ensuring its provenance and accuracy becomes paramount. Use cases that drive the industry towards single sources of truth are what banks continue to seek. Greater collaboration with central banks and regulators through working groups, such as the R3 Blockchain consortium, appear to be driving standardisation and setting a path towards this.

In conclusion….

Whilst Blockchain may have reached the peak of its Hype Cycle, there continues to be huge levels of interest and excitement within the banking industry regarding its future potential.

The desire to move from multiple proofs of concepts towards real-life use case examples remains a strong imperative. The potential for distributed ledger solutions to reduce operating costs continues to be one of the biggest driving forces for change within the industry.

An open source approach is one of the most popular methods of driving research and development, and for building a growing community focused on Blockchain disruption, particularly at a platform level. However, we believe that commercially viable solutions, funded by the banks and venture capitalists, but delivered through propriety intellectual property based solutions by FinTech innovators, will be the most likely route for bringing viable products to market in 2017. Adoption of these products through a consortium based collaboration will then help accelerate the uptake and adoption of these exciting new services.