The Blockchain Spheres Coming Up Together - Part 1

Although Blockchain seems to be have dived into the “through of disillusionment” -downhill side of the “hype cycle” (1), and is now commonly bashed across the financial press, high profile projects run on Distributed Ledger Technology (DLT) are reaching production stage in 2018.  These are clear reminders that the revolution of the financial industry operations has started, and that there is no coming back. The financial industry sets out to reinvent most of its operations and hopes to reap huge benefits for it. Questions are: Where will it start? Who will be the early winner(s)? How to prepare for it? Surely a financial institution cannot embark now on a 3 year transformation project without factoring in a fast progressing technology that can fundamentally change the way it engages with all counterparties, clients and even regulators. 

This paper identifies the priority domains (spheres) where Blockchain is most likely to emerge as a driver of change, and the likely impact on the IT architecture of financial institutions as the new technology will pervade. In the first part of the document, we identify the main concentrations of activities and the projects emerging as the first occurrences of Blockchain brought to production. The second part of the document projects the impact that distributed ledgers and collaborative networks are likely to have on the architecture of software applications and on IT strategies across the financial industry.

Note: This document is focused on business cases and their operational implications. It willingly sets aside all rhetoric regarding which technology or provider is likely to prevail.

PART 1: THE BLOCKCHAIN SPHERES COMING UP TOGETHER

As the dust of the overhype settles around the best prototypes, real-life business operations carried out on Blockchain emerge. They seem to concentrate within specific domains where patents are being filed and competition intensifies. Those spheres of DLT activity, are quietly coming together as a self-assembling puzzle. Looking close enough, we could see the looming fabric of the new financial industry; it’s change happening in real-time.

The associated domains of trade finance and supply chains constitutes the first and largest sphere at this time. The stakes are very high, for logistics giants and merchant bankers to secure their share of the US$20tn annual global trade market. Project Batavia, driven by IBM and 5 banks, is live and already shipped cars and textile across Europe.  Maersk tests new processes promising a sharp reduction of shipping costs. Indian bank ICICI has put 250 corporate customers on a Blockchain designed for international trade. HSBC, who recently processed a soybean shipment for Cargill with ING, estimates a reduction potential of 44% of shipping time and 30% of related costs (2) for the Asia-Pacific business. With figures like this, we can expect the key players of the supply chain and trade finance businesses to quickly join or create DLT-based networks and either way adapt to the new approach. At stake is not a mere competitive edge; it’s surviving the reshuffle.

The second major sphere of DLT activity is the world of securities settlements. From the announcement early this year by the Australian Stock Exchange (ASX) replacing their legacy settlement and registry infrastructure with a distributed ledger, to the Toronto Stock Exchange (TMX) feasibility tests for integrated settlement and payment, or the pan-European LiquidShare project, Blockchain has gained a systemic importance. Starting in Australia in 2021 (3), and likely followed around the world, trade executions will automatically trigger delivery, payment, registry updates and other post trade services. We would hardly imagine it otherwise. Not surprisingly, custody (KAS Bank, Standard Chartered), proxy voting (Broadridge), and related services on DLT are already being tested. 

Fund management and fund distribution constitute a third sphere of activity. In June 2017, UK-based Calastone has announced the opening of a live Distributed Market Infrastructure, ready for migration of its transaction network, 1400 clients across 35 countries, by 2019. The firm estimates that embracing the new technology could potentially save US$2.7bn per annum (3) of costs to the global fund industry.  

A fourth sphere of activity relates to loan issuance, processing, syndication and debt lifecycle management. In addition to the Finastra led initiative going live with 7 large banks on a DLT-based syndication platform, debentures have been issued by JPM and National Bank of Canada, corporate loans by BBVA, using Blockchain technology. The stakeholders claim to reduce the process from days to hours, as well as operational gains, better transparency and improved security. Several other projects in syndication or loan settlement add to those most visible initiatives. As benefits can now be measured, competition will intensify. Here too, the trend appears irreversible. 

We would like to think of payments, especially cross-border payments, as a fifth sphere of intense activity, but aren’t crypto-payments a part of every sphere, a universal enabler? Any transaction requires a bilateral agreement on at least the object, amount and date of the transaction. This has traditionally been a pure front-line, pre-settlement operation. One key advantage of DLT is to simultaneously involve the back-office to process transactions as they are being dealt by the front-line, thus simplifying operations and freeing liquidity (or capital) a lot earlier. Therefore, instant payments against the evidence of a settlement are a massive benefit within any Blockchain setup. This is where crypto-currencies come in. 

Combining crypto-wallets and smart contracts on a same platform is a key benefit of the Ethereum approach. Using their own currency (XRP), RippleNet claims more than 100 clients and makes inroads in Asia -where cross-border payments are more challenging than in a US Dollar or Euro-based economy. There is intense competition in this field. JPM unveiled a patent this month, and CUledger announced a new platform project based on Hashgraph, a new technology evolved from Blockchain. Whether crypto- or fiat-, the transactions of the future will involve currencies that allow for cross-border, instant, irrevocable settlements. 

Likewise, DLT-based KYC and client authentication should eventually become a common part of all offerings. Here, the most visible projects have been driven by authorities, such as the Monetary Authority of Singapore (MAS), or the State Bank of India, for example. There also have been initiatives from bank groups in SE Asia and Japan, but the private registries and vendors of KYC services remain distinctly prudent with the new technology so far.  With KPMG estimating the potential cost reduction between 25% and 50% (4), it is not difficult to see why. While aggregated spend numbers are very dispersed, KYC remains by all standards a big cake to share. An average medium to large size bank spends in excess of US$ 100m a year on KYC and client on-boarding costs. Moreover, brokers, funds, corporates, employers, all keep scanning the same individuals time and again, for different purposes. Budgets explode but fines keep rising and there still seems to be room for progress in operational efficiency. It still takes 26 to 32 days to onboard a new customer, a new partner or a new employee. In other words, it is not a question of if but when and how KYC will go mainstream on Blockchain. Two scenarios seem possible at this stage. The first one would see one of the registry providers trying to catch the first move advantage; for example, MarkIT recently announced a partnership with US-based Cambridge Blockchain. The other scenario is that of self-sovereign identity works on Blockchain to eventually encompass KYC and obsolete the registries (Decentralized Identity Foundation, Sovrin Foundation). Either way, DLT has a long way to go in this domain.

So what do exchange traded security settlements, loan syndication, cross-border payments and voting rights carried out on Blockchain have in common? They all consist of dramatic simplifications of post transaction processes, reducing internally the number of necessary points of action and control, and modify the roles of external intermediates. Most importantly, they are the living proof that a revolution is undergoing, which does not merely consist of a new technology but a new mapping of interactions between industry participants, sometimes among direct competitors. Tasks are re-defined and timelines synchronised. A new breed of enterprise applications, data needs and services should logically grow out of the new, collaborative workflows.

The first part of this paper has highlighted domains where Blockchain is most likely to emerge as a game-changing reality, or already has. In the second part of this paper, Working with Distributed Ledgers, we will review how the new approach changes the needs for enterprise and data services, and how it may shape a new breed of IT system architectures.

References

(1)   Hype cycle for emerging technologies (Gartner 2017)

(2)   Reuters, May 14th, 2018

(3)   CHESS replacement New Scope and Implementation Plan, April 2018

(4)   Calastone, Financial Times, February 2018

(5)   KPMG blockchain KYC utility

(6)  Banking & Finance, October 2017