Said to be comparable to the advent of the internet, “the Blockchain protocol threatens to disintermediate almost every process in financial services”. No doubt therefore why so many of the world’s largest investment banks (Citi, Barclays, UBS, GS, JPM, to name but a few) are investing heavily in, and working hard to develop standards and utilisation protocols for, this revolutionary disruptive technology. To truly understand the impact Blockchain may have on the Financial Services Industry, we must first explore the concept behind the hype, its array of practical uses, and potential user-base. This article aims to take a dive into this new world of distributed ledgers, and, in answering 4 key questions, help light the path toward better understanding a concept, often over-burdened by noise from the media, etc.
- What is Blockchain?
Bitcoin, an innovative crypto-currency, burst onto the Financial scene in late 2008/early 2009, met mixed reactions: those who dreamt of an unbounded potential, and those who condemned straying from the tangible norm. Seven years on, Bitcoin is still slowly gaining the confidence of global Financial Markets, where instead the focus has shifted to the technology behind Bitcoin, known as Blockchain.
Blockchain is the digital software code that could revolutionise the way banks, clients, and market infrastructure providers support securities, derivatives, loans, bonds, and other financial instruments. Many market participants and commentators believe Blockchain technology could yield truly transformative changes to the cost base of the industry by reducing processing and storage costs. However, given the disruptive nature of the software, there is clearly uncertainty about what can really be achieved and in what timeframe.
The concept of a Blockchain is that every participant in the market holds an immutable record of all the transactions in that market which is updated in real time based on the network between users time stamping transactions by hashing them into an ongoing chain of hash-based chains. These can be defined as public (no restrictions to read/write accesses to the blockchain data), or private (access to data is limited to pre-defined list of users), but also categorised as permissioned or permissionless (relating to access rights to transaction processing). Essentially it is a distributed ledger that can only be updated upon consensus within the network. Whenever a transaction is made, the specific detail of that trade is broadcast onto the market and updated into the myriad of separate digital ledgers held by each participant. In effect, market participants will operate their own transparent, self-updating central trade repository.
What are the benefits of Blockchain in the context of Financial Markets Infrastructure?
Decentralising the administrative infrastructure surrounding the recording and verification of trades, and reducing transaction costs, while cryptographic rules surrounding the technology ensure its integrity and chronological order, are arguably the key elements to Blockchain’s success.
The application to Financial Markets support processes is potentially enormous:
- FX currency payment, netting and settlement
- Securities issuance and transfer – creation of unique identifiers, transaction tracking and asset segregation including securities clearing, settlement and asset servicing
- Exchange traded and OTC derivative transaction matching, reporting, clearing and settlement
- Syndicated Loans issuance and settlement
- Smart Contracts – the use of self-executing contractual clauses triggered by pre-programmed conditions
Such application across the lifecycle of transactions would fundamentally disrupt the existing central market infrastructure providers as well as all market participants who connect to these infrastructures. It could exponentially accelerate processing timeframes, for example moving from trade date plus 20 days to intra day in the case of Loans settlement.
- Who could develop Blockchain, and how is its user-base made up?
While the full extent of its benefits are still being discovered, key players from across the Financial Services industry are flooding in to be part of the numerous industry initiatives seeking to profit from this technological leap. Investment banks are pairing up with a host of FinTech start-ups, as it is clear that this is not an instance of first-mover advantage monopoly, but rather a case of finding and supporting the right technological offering for specific industry use cases.
As it is essentially an open source code base anyone can develop it. There are a number of competitors in the market: Clearmatics, Digital Asset Holdings, Eris, Ethereum, itBit, Magnr, R3, SETL, Symbiont to name but a few. The winners will be those that deliver a solution to a key area of the market and attract broad market participant adoption, whether this is a process, function, asset class, sector and or region.
- Will Blockchain be successful?
The challenge to the success of Blockchain is the ability to deliver wholesale change across the Financial Markets Infrastructure from the trading of a contract or instrument through to all of the lifecycle processes required to support that contract. With the World Economic Forum predicting the tipping point for Bitcoin and Blockchain as 2027, the sequencing of these changes and market participants’ ability to adopt and keep up with these changes will be equally critical to its success.
With mounting publicity and support behind the Financial Services partnerships, it is now time for these market pioneers to prove out their theories. Sceptics will remain hesitant until we see a widespread practical application, for example to even the most complex of derivative contracts. What is sure is that we, as an industry, must keep pushing forwards to make, what is a widely accepted but conceptual range of potential use cases, a tangible change to mission-critical processes.
Although many of the market limitations and issues we are tackling today will remain on the agenda for industry development forums, the blueprint for Financial Markets infrastructure is changing. The current fragmented infrastructure reliant on complex and legacy technology will not be able to survive in the next phase of the financial system. However, like all new markets ubiquity and liquidity will be critical, without this, the revolution will be some way off.
 World Economic Forum – The Future of Financial Services: http://www3.weforum.org/docs/WEF_The_future__of_financial_services.pdf