The potential applications of blockchain are not limited to the financial sector. Cryptocurrencies are but one aspect of blockchain technology leverage. In my opinion, the value won’t be in crypto-currencies (given regulatory scrutiny), but in smart contracts, or smart ID. In general, blockchain technology has potential when:
- Proof of ownership is important and this ownership needs to be transferrable.
- There is a lack of trust between parties.
- There are many bilateral relationships and parties on the market.
- There are different types of assets that interact.
- These assets move across organisational boundaries.
- Processes are highly manual or paper-based.
- Processes have many steps, intermediaries and handovers.
- You need to capture all elements of history in support of a contract or in support of an Identification request (imagine every single event in your life being recorded on a ledger)
Suggested applications include bringing transparency to global supply chains, particularly for high-value and/or potentially controversial products such as diamonds. Everledger is a permanent ledger for the certification and transaction history of diamonds that can track diamonds that have been stolen or mined in conflict areas such as the Democratic Republic of Congo. The technology could also be used to ensure than food products are organic; to create digital assets ranging from stocks and bonds to frequent flyer miles; audit trails for healthcare; to create tamper-proof digital identities, and to keep track of electricity production on a distributed grid where homes are both producers and consumers of energy. It could even be used to make elections harder to rig.
Four stage roll-out
- In my opinion, the mainstreaming of the technology will advance in four stages, starting with internal purpose-built distributed ledgers that operate within enterprises.
- This would be followed by the adoption of blockchain by a small subset of banks, insurance companies, companies, governments, etc. as an upgrade to manual processes, starting with assets that are traded infrequently and manually over the counter. This would help participants to agree on standards and protocols for booking and transfer with relatively little investment.
- Next would come the conversion of inter-dealer, intra-company, intra-contract settlements, which would help to solidify the standardization of products, followed by large-scale adoption across buyers and sellers.
Recommendation for the short term
- Assess the impact on your business and plan for the long term.
- Participate in consortia and work with regulators. The pay-off for cooperation over co-opetition maybe industry utilities and faster development cycles.
- Capture the internal ledger opportunity: This would give individual firms the opportunity to test new technology on systems already being revised and develop expertise without concern for network issues.
- Go after post-trade and manual processes. These can yield significant workflow benefits and be less disruptive to business models.
CAVEAT (and potential bottleneck) – Co-operation is paramount
Blockchain is not a technology that will enable one organisation to come up with a new category killer product or process that will give it an advantage over its rivals. Rather, its success “will require co-operation among market participants, regulators and technologists”. The greater the number of businesses around the table, the greater the blockchain’s impact will be.
SOME USE CASES
- Using blockchain to disrupt the payments business is an obvious area of interest. Many have started thinking about blockchain technology with a payments use case in mind. However, experience has shown us that it is not that easy to change this very complex and sometimes costly business. Before we see any implementation of blockchain technology in payments we will need to solve a number of ‘market problems’.
- Many experiments have shown us that technically a great deal is possible. Yes, we can connect and share ledgers. Yes, we can instantly send and verify a transaction. Yes, we can create payment chains that cut out several intermediaries. But the difficulty with payments is that the asset ‘money’ is one of the most regulated assets we have in the world. These regulations are part of the reason current processes are what they are and simply introducing new technology with disruptive potential will not change the requirements for banks.
Many regulations are also there for a good reason, to manage risks between parties, to manage risks that are of a larger scale (systemic risk) etc. What blockchain technology does is show how things could be different and force us to have those discussions. But in the end it all boils down to the acceptance of whatever virtual currency, or virtual representation of a fiat currency, is traded on a blockchain. Acceptance not only by regulators but also by other banks, by organisations and consumers.
In the world of cross-currency payments, the model is complex. As the distributed fintech company Ripple says: “International interbank funds transfers rely on a series of correspondent banking networks which introduce multiple layers of fees, counterparty risk, and settlement delays”. This is mainly due to the fact that trust relations need to be created by banks bilaterally. A blockchain brings the advantage that banks can create trust towards an entire network.
I do believe that adoption will happen in several phases, where inter-bank payment solutions being adopted before full peer-to-peer solutions. In part, this is because a certain level of trust already exists between banks and other financial institutions, while that trust has not yet been established in the peer-to-peer economy. Where trust exists, blockchain can improve transparency and bring operational efficiencies.
Further, we can distinguish between use cases that we as banks can influence ourselves and try to lead the market, while there are also cases where we need other parties along the value chain (including regulators and central banks) on board. So in this area we need to look for use cases that are at the moment very costly, have a high tendency to fail or are highly complex (like international payments with the many correspondent relationships) and that have the potential to be scoped in such a way that banks can actually have an influence or solve the issue themselves. These use cases might be feasible in the short term.
Finally, we will look for what brings the highest value to solve first. Whether that is by cutting costs, increasing simplicity or creating whole new business opportunities. One reason why payments will not be the first area that benefits from the blockchain is its relative simplicity, at least in the euro area, where there are well-defined standards and rules under the SEPA regulations and a single regulator in the European Central Bank, creating an environment of trust. The processes are fully straight-through-processing and the number of parties involved is limited and includes a proficient central clearing and settlement mechanism. The product offering is mature and on-par with client demands so the advantages of implementing a blockchain are less obvious.
Having said that, the idea of industry-wide payments and settlement infrastructure that is based on trust, cryptography and transparency has an immense attraction. Therefore you see that many banks are working on use cases in this area. Both defining what this ideal end state could be, while at the same time defining what intermediary steps we can already take. To do this the market has to assess the technological maturity on the one hand and the ‘market maturity’ on the other. However, there are many inherent advantages to using blockchain for payments. In general, the technology offers lower transaction and operational costs; increased processing speed; risk reduction; transparency; and traceability.
More specifically, in an ideal situation, these are some economic advantages for the Euro payments system, including:
- It removes the need for a central clearing mechanism.
- It removes the need for Target 2 settlement if the regulator accepts the blockchain positions as real money and adopts the blockchain as its payment system.
- Banks’ liquidity positions are continuously updated and banks and regulators can create automated business rules in the form of smart contracts, leading to more control.
- Full real-time view on all transactions for the regulator instead of aggregated reporting afterward.
- Potential for a peer-to-peer payments system where the entire four-corner model is on the blockchain.
- Widespread applications of blockchain technology in banking.
Trade finance is another area where technology could disrupt the industry.
Trade finance has traditionally been a paper-intensive process but it is possible to use blockchain technology to digitise and authenticate records. This can result in trade transactions that are secure with digital records of related data visible to various participants in the trade transaction. The technology could shake up one of the most conservative parts of the industry if banks and companies seize the initiative.
On top of that, due to the highly paper-based process, compliance is an important issue. The blockchain – and more specifically smart contracts – can enable compliance to be enforced upfront instead of being verified after the transaction. And when auditors or regulators would be part of this blockchain, reporting becomes completely transparent and real-time. This presents advantages for regulators as well.
When the technology is combined with the development of the Internet of Things, its potential increases even further. For example, a container arriving at a port could be scanned and provide the trigger for the shipping company to be paid and ownership of the container transferred, as part of a smart contract agreed in advance. Evidence: IBM’s collaboration with Maersk in support of tracking containers using IoT and Blockchain.
Meanwhile, in securities transactions, post-trade clearing and settlement are slow and expensive, involving many actors including global and local / sub-custodians, central counterparties (CCPs) and central securities depositories (CSDs). Settlement of a securities transaction typically takes two days, often longer, to complete. And then there is even risk of a failed settlement at the last moment. This presents a big risk and even costs to all parties involved. Blockchain and the distributed ledger have the ability to securely and transparently move securities in seconds or minutes, with automatic clearing and settlement upon trade execution.
Any area where there is plenty of paperwork across industries offers potential for the blockchain to improve operations.
Barriers to adoption
Besides finding the best use cases to start with and finding out where blockchain can bring real value, there are still some technical issues that need to be solved before we can apply blockchains on a large scale.
First of all, before wide adoption of blockchain in, for example, international payments, issues of scalability and privacy need to be addressed. This is easier said than done because no single legal framework exists that covers the full spectrum of blockchain technology. On top of that, there are differences between jurisdictions around the world, increasing the difficulty of applying the correct laws and regulations. New frameworks must develop around privacy, right of claim and consumer rights.
The industry needs to thoroughly analyse privacy and data protection risks and incorporate them in the implementation of any blockchain use cases. eIdentity validation services will be crucial to facilitate the spread of blockchain solutions, and here banks can play a significant role as banks are still seen as organisations that can be trusted.
Scalability and latency limits must be addressed to ensure high volume applications of blockchain technology such as payments. For payments, discussions around settlement finality and thus the acceptance of assets on distributed ledgers by central banks and regulators is fundamental to large scale adoption. On top of that, blockchain is not always the best or cheapest solution available and while it will take significant time to gain large scale adoption within the industry, it could mean that we have to run two infrastructures in parallel. TCO is an important factor to take into account as well.
While opportunities are as plentiful as the questions still to be answered, you should want to be part of this development and future solutions for industry.
The main priorities at the moment are:
- To define a strategic framework to identify real opportunities of blockchain technology.
- Across the various business lines of the bank giving interested companies a way to prioritize efforts, while at the same time increasing knowledge and awareness within the business.
- To work on a variety of use cases that have the potential to solve real issues on the short term as well as technical experiments to further test the possibilities of the technology in general.
- To involve main stakeholders both internally (legal, compliance, risk) and externally (regulators, partners, peers, industry associations, banks) to address the ‘hard problems’ and work towards industry-wide improvements.
Blockchain will be a disruptive force in not just the financial sector, but in every sector. It is already possible to see where it might have an impact, in areas ranging from payments to settlements to smart contracts and e-identity.
Blockchain technology is based on such different principles that it forces us to rethink the way organisations, processes and markets work. It has the potential to fundamentally change the way we think about ownership, money and risk management. It has been said before, but this development is not about simply ‘putting a blockchain on it’ to make things more efficient. Blockchain technology is not the solution for everything which is why I recommend you focus on defining where there is real business value. In my opinion, technology has the ability to make a difference in many layers of the financial (or any) industry, if we work together and carefully design solutions. This requires time, experimentation and concentration. I expect to see short-term-focused solutions to slowly grow into more integrated and complex use cases, step-by-step proving the value of this technology.
One thing that is obvious, though, is that it is not a technology that one player can develop on their own in the hope of winning advantage over rivals. Rather, its application will help the whole industry but only if all participants work together. This is happening in initiatives such as the R3 consortium and that work must continue in 2018, allowing the industry to move closer to sector-wide standards for blockchain. Ultimately, like mobile, like the Internet, and like computers before that, blockchain is not the thing. It’s the thing that enables the thing. As such, if it is developed collaboratively, it can help the entire industry and its customers.