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 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.”