Blockchain has become the buzzword in finance. Why has it captured so much attention, what is being done with the technology today and where is it going in the future?

Blockchain has created a buzz in financial services unlike anything else in recent memory. Since being introduced to the technology through the rise of Bitcoin, the industry has been awash with talk of blockchain and its potential impact. Some see this technology as a cure for all ills; others fear the unknown and the disruption it might have. One thing everyone agrees on is that blockchain is here to stay.

In brief, the blockchain is a distributed database that irrevocably records and confirms the ownership and transfer of a digital asset. Although this does not sound especially exciting, it has the potential to be revolutionary, bringing increased transparency, speed, trust and reduced costs in the financial ecosystem and beyond.

Despite the promise of blockchain, it would be remiss not to highlight that the industry has a long way to go before the benefits can be realised. Legacy processes, technology and thinking are not easily changed. The transformation will therefore not occur overnight – but the industry has set a course for the road ahead.

The emergence

The story of blockchain begins in 2008, when Satoshi Nakamoto, the alias of a still unknown computer programmer, pressed the button that unleashed Bitcoin into the world. This was a seminal moment in finance. The launch of Bitcoin highlighted that technology had advanced to a point where a fully digital currency could be created and exchanged directly from A to B without the involvement of traditional financial institutions, central banks or governments.

Yet the initial reaction to this game-changing technology was muted outside of the realm of technology enthusiasts. It was not until 2011/12 that Bitcoin began to make the headlines as the crypto-currency increased in value and was accepted as a method of payment by a limited number of merchants.

From this point on, interest in Bitcoin began to gain momentum, due in part to several high-profile negative news stories. These included the use of the currency on the Silk Road – an online black market – and the criminal investigation into the collapse of Mt. Gox, the largest Bitcoin exchange at that time. Although these stories brought Bitcoin into the public consciousness, they may have proved a death knell for the ambitions some had for it to replace fiat currencies as corporates, banks and other traditional institutions quickly moved to distance themselves from the crypto-currency.

As the financial industry moved away from Bitcoin, it quickly became apparent that all the attention had been focusing on the wrong aspect of this technology. The most interesting opportunity is not in the token of exchange, but in the underlying technology that facilitates the exchange.

“This was an eye-opening moment for the industry,” explains Anthony Macey, Head of Blockchain R&D at Barclays. “Blockchain provides a more efficient and transparent way of exchanging digital assets and this plugs a gap that we all knew existed in the digital age of banking. Once this became apparent, we, like many other banks, quickly began to explore the improvements the blockchain could drive in financial services. We identified 45 use cases initially, and this very quickly expanded to over 100.”

Also important, according to Macey, was the work done by fintech companies to expand upon the technology and principles of the Bitcoin blockchain to create more advanced solutions better suited to the complex nature of financial services. Macey highlights Ethereum as being especially innovative as it has enabled logic (smart contacts, for example) to run on top of the blockchain, creating a host of new opportunities for the banks to build new solutions.

Banks did not begin working overtime on blockchain just because of the potential opportunities though; they also did it out of fear. “The emergence of blockchain was the first time the banks were really nervous about the disruptive impact of a new technology,” says Macey. “It was clear that it could create a new way of working that could potentially eat into their margins. They had to act.”

The rest is very much history. Today, nearly every bank has a blockchain strategy and hundreds of fintechs are exploring a seemingly endless array of use cases for the technology. As a result, money continues to pour into blockchain – a total of US$1.4bn was invested in blockchain start-ups in 2016, according to PwC. Blockchain is truly a global phenomenon.

The era of exploration

Despite all the talk, blockchain is used very little in financial services today, at least on a commercial scale. The technology has therefore had little impact on corporate treasury professionals. Consequently, a degree of blockchain lethargy has entered the profession and it is no longer front and centre of every discussion.

Discussions relating to blockchain are coming to the fore again, however. Over the past six months, several banks have announced the completion of proof of concept (POC) experiments and pilots that utilise blockchain technology. “These are exciting developments,” says Paige Penze, Director, Head of Business Development in Innovation, Global Transaction Services at Bank of America Merrill Lynch (BofAML). “Completing these experiments is helping us properly highlight the benefits of the technology and frame the path to commercialisation.”

The recent announcements by the banks also show that they are taking a more focused approach to blockchain experimentation. In transaction services, the main areas of focus are cross-border payments, correspondent banking and trade finance.

In the trade finance space, the banks are having particular success. BofAML, working alongside its client, Microsoft, have recently completed a POC for standby letters of credit (SLOC) issuance, for example. The objective was to demonstrate that blockchain/smart contracts can streamline the inherently paper-based and inefficient SLOC process.

Barclays is another bank using blockchain in the trade finance space. Working with fintech partner Wave, the bank completed a blockchain trade finance transaction between Ornua (formerly the Irish Dairy Board) and Seychelles Trading Company. The ‘world first’ transaction utilised the blockchain to allow all parties involved in the transaction to see, transfer title and transmit shipping documents and other original trade documentation with complete visibility. “This eliminated many of the issues created by the legacy process,” says Macey. “It really highlights the impact this technology can have in this space.”

Cross-border payments is another area earmarked for improvement using the blockchain. Ripple is a fintech that has made a big splash in this space through a mixture of interesting technology and impressive marketing. Traditional players have reacted in kind, with SWIFT announcing that it will be experimenting with blockchain as part of its global payment innovation (gpi) initiative. Banks such as BNP Paribas have also announced the completion of successful pilot blockchain payment transactions with their clients.

Taking a slightly different approach to blockchain innovation, Citi recently launched its ‘bridge to the blockchain’ solution in partnership with NASDAQ. In brief, the solution is essentially a protocol that links the ‘traditional’ financial ecosystem to the ‘new world’ – in this case, NASDAQ’s Linq platform for private markets securities.

In Australia, meanwhile, local banks are making good progress using blockchain technology. Commonwealth Bank of Australia, for instance, announced earlier this year that it has built a blockchain for debt capital markets which has been tested by Queensland Treasury Corporation for the issuance of semi-government bonds. The benefit is that it can eliminate settlement risk because the solution links the transfer of title with the payment, meaning that the transaction is executed and settled instantaneously. Other local lenders, ANZ and Westpac, have also successfully used blockchain instead of paper for bank guarantees on commercial property leasing.

Building blocks

The next step for all of these projects is full-scale commercialisation. However, there is some way to go before this can happen. Predictions about how long this might be range from two years to a decade or more – essentially nobody is sure.

A big reason for this is that regulation and law is yet to catch up with the technology. Although there has been some progress made in making financial laws and regulations more ‘digitally native’, there is a long way to go, with some countries still not accepting any form of digital documentation. Without regulatory and legal innovation, much of the technological evolution will be useless outside of small scale tests like those we are seeing today.

It is encouraging to see that some regulations are taking the lead. The Bank of England in the UK, for example, has been very interested in exploring and experimenting with blockchain. The Monetary Authority of Singapore is another progressive regulator, actively embracing blockchain and seeing how it can be used to make doing business in the country more efficient.

Away from the regulatory and legal issues, there is also the question of whether there is a blockchain currently suitable for commercialisation. Paul Thwaite, Head of Transaction Services at NatWest and the Royal Bank of Scotland, does not think there is. “There is no blockchain platform that is currently considered to be finance or business grade,” he says. “However, the platform evolution evident today suggests that we are moving further away from the original libertarian Bitcoin blockchain.”

Blockchain provides a more efficient and transparent way of exchanging digital assets and this plugs a gap that we all knew existed in the digital age of banking.

Anthony Macey, Head of Blockchain R&D;, Barclays

Barclays’ Macey thinks that the Corda platform built by R3 – the blockchain consortium – is one of the closest to becoming a platform fit for purpose in financial services. But even when such a platform exists, there are challenges for the banks when it comes to using it. “Let us assume that the R3 platform works, is scalable and ready to go live – what do you do then?” he says. “You can’t rip out the legacy banking system overnight – even minute parts have to be changed slowly. A big bank can’t risk any disruption to businesses. This is the biggest risk posed by adopting blockchain and thus is the biggest obstacle to large scale commercialisation.”

BofAML’s Penze adds to this point. “We are not going to replace our legacy systems with blockchain overnight,” she says. “It will be a slow and steady process, allowing us to iron out any issues before we expose this technology properly to our clients.”

What about the cost of all this IT work? Asks Peter Farley, Senior Strategist, Capital Markets at Finastra. “To adopt blockchain in a meaningful way, the banks will need to change all the technology in their back offices,” he says. “This is a big issue for many banks, especially the global banks with a large monolithic IT stack looking at blockchain as a cost saver. In reality, IT budgets will need to increase before blockchain allows them to reduce – if this is possible at all.”

Farley also highlights the sporadic nature of blockchain development at present – something reflected by everyone Treasury Today Asia interviewed for this article. “The whole ecosystem is very fragmented,” he says. “This needs to be brought under control sooner rather than later, otherwise there will be many different systems that exist which will not integrate very well, making it hard for blockchain to deliver on all its promise.”

More to come…

Despite the challenges that need to be overcome before blockchain becomes ubiquitous in the commercial banking space, it is likely that this will happen.

But exactly where and how blockchain will be used remains to be seen. An educated guess would be that trade finance will be first, with payments to follow soon after. The impact this will have on treasury also remains up for debate. The hope is that it will usher in a brave new world where low-cost, automated solutions are the norm. On the other side of the coin, some fear the fragmented development will create an even more complex world than the one that exists today. In reality, it is likely to be somewhere in between.

What timeframe do you most likely expect to see your organisation adopt blockchain as part of an in production system/process?

Source: PwC’s Global FinTech Survey 2017. Base: 578 respondents.