Chips off the old blockchain

Financial institutions are clearly interested in the potential of the blockchain. Speaking to Banking Technology before Sibos, many senior financial services executives identified the blockchain as a key discussion point for this year’s event. Arindam Das, head of HSBC Securities Services, Middle East and North Africa, said: “Blockchain has a profound impact for the securities industry. It will be one of the key themes at Sibos and I want to learn more about it and how it will affect our business.”

For banks, the main appeal of the technology is that it can act as a system of record: reliable, granular and irreversible. While the distributed ledger could be applied to any number of areas in theory, one of the most promising in the near-term is immediate payments. The key to making that happen is Ripple, which is a real time gross settlement (RTGS) system, currency exchange and remittance network built on a distributed ledger. Launched in 2012, Ripple claims to enable “secure, instant and nearly free” global financial transactions of any size, with no chargebacks.

With Ripple allowing faster payments, other companies have seen an opportunity to capitalise on that in some of the more lucrative areas of banking. These include cross-border payments, of which global remittances reached $583 billion last year. For example, Earthport launched a distributed ledger service in August 2015, which ties Ripple’s near-time potential with Earthport’s cross-border payments service that makes international payments using local automated clearing houses (ACHs).

“Our view is that the real value [of blockchain technology] comes out in cross-border payments,” says Daniel Marovitz, formerly of Deutsche Bank and now president of Europe at Earthport. “With the addition of distributed ledger in our toolkit, users will be able to go to nearly instant payment. So rather than T+1 or same day, which is what happens in most markets, we will be able to do it within minutes.”

Earthport uses a combination of Ripple to record the transaction and its own prefunded accounts to provide the liquidity and the FX rate to make the transaction happen as quickly as possible. But the opportunity doesn’t necessarily end there. Joram Borenstein, vice-president at Nice Actimize, says other examples of the possible uses of the blockchain include faster settlement and clearing, stronger identity validation and time-stamping for compliance purposes. In addition, the removal of the human factor in settlement may result in lower costs, better quality and improved customer service as well as more transparency and trust.

The blockchain’s transparency and decentralised ledger have the potential to bolster financial institutions’ reputations, he says. “Identity validation is one application of transparency. Sharing basic identity information with a specific party would not disclose one’s identity to the entire world (the process for which can peruse the entire blockchain’s transactional history as it wishes) but can instil confidence in a specific party or individual who might otherwise not trust a given financial provider or counterparty.”

But perhaps the most compelling business case for the blockchain is the promise it holds as a means of compliance with the exacting demands of financial services regulators. Borenstein notes that regulators in the major economies have begun to weigh-in with regard to how these technologies will be regulated, taxed and monitored. “The technical underpinnings of cryptocurrencies and the blockchain infrastructure protocol represent a potential watershed change in how financial services products and technologies are used, distributed, monitored and regulated,” he says. While the changes that these technologies bring will not happen overnight, it is entirely possible that the way consumers transact, how their identities are verified and how financial institutions themselves interact, charge fees and more will undergo dramatic changes before the end of the next decade.

“Traditional financial services organisations recognise the potential of these technologies and know they can’t be caught off guard,” he adds. “Those institutions that grasp these changes, speculate intelligently about how to work with them and ultimately are able to turn these ideas into new profitable business models, will be the ones that ultimately reduce the risk to their institutions and identify new sources of growth.”

Nevertheless, it would be naïve to imagine that the full implications of blockchain technology in financial services have been realised, or that every financial institution understands exactly how it will use the technology. Some banks are interested in using the technology beyond payments, in other areas such as capital markets. Whether the potential ever will be fully realised in these areas remains to be seen, since the industry is still at an early stage in the development of practical applications that can be used directly by banks.

“Will blockchain be as transformational as they say?” asks José Placido, head of client development and strategy at BNP Paribas Securities Services (BNPPSS). “There’s been a lot of talk about it in payments but what about its impact on securities services? It could be applicable.” BNPPSS is focused on analytics and reporting and Placido says regulators will have an interest in how banks approach this. “Clients will demand us to be much more digital and more comprehensive in our data. This is an issue that is raised in boardrooms and there is a lot of momentum behind it. We are all at phase one, investigating it and making recommendations.”

The uncertainty on the further implications of the distributed ledger feeds through into discussions between banks and vendors. Earthport’s Marovitz says many financial institutions are working on projects, the outcome of which they don’t necessarily know or even if the technology can be turned into a viable business tool. Obstacles remain to be conquered before the technology can become ubiquitous.

He says conversations with the main banks globally tend to follow a similar pattern: they agree that distributed ledger technology is interesting and that it might have a transformative effect on financial services such as payments and trade finance. They also have staff working on proofs of concept based on distributed ledger. However, none of them knows whether it will be able to migrate from proof of concept to live use of the technology with customers.

What holds back projects such as these is not difficult to discern: as with any new technology, banks want to be sure both that it will deliver measurable benefits and also that it will not invalidate their compliance. To take the cost first, the issue is partly circular. Marovitz likens it to purchasing a fax machine but having nobody else on the same network, in which case the ‘fax machine’ is nothing more than a lump of plastic sitting on a desk.

“It comes back to the business case and how quickly other institutions around the world will also come to a positive view around the business case,” he says. “That’s because the Ripple network, which is the distributed ledger technology that we are using, depends on there being a network. There needs to be a whole ecosystem of players out there that agree to use the technology.”

With Barclays, Bank of America, Citigroup and Goldman Sachs already exploring the uses of the blockchain, it may not be long before that time comes.