BLOCKCHAIN: Are we nearly there yet? And, more importantly, where are we going?
Over the past two years, a lot of time, effort and money have been dedicated to blockchain or distributed ledger technology (DLT) experimentation. The challenge no longer revolves around what a firm or an industry can do with the technology. Rather, the next undertaking is centered on how companies, government and regulators can leverage the technology to improve how they operate. This article explores the state of blockchain as firms across industries evaluate differentiated use cases that, rather than disrupt, conceptually add value to their businesses, clients and investment support.
As a technology that has come into existence with the creation of Bitcoin, which is still nascent, blockchain has seemingly become a household term. Yet in many respects, it is still unproven as companies and industries expand the use and application of blockchain in all directions. Trading and securitization have given way to applicability around operations, administration and compliance. Within finance, industry groups across insurance, real estate and title services, healthcare and global shipping have become active in creating consortia and exploring proofs of concepts (POCs) globally. Whatís more, blockchain is gaining wider appeal among governments and regulators as they explore how to use it within their own organizations and regulate it for external application.
These trends underscore just how multidimensional the blockchain landscape has become, although it is far more diverse to navigate beyond finance and DLT.
The key challenge facing organizations today goes beyond simply understanding what they can do with this technology. The focus has shifted to how organizations should apply the technology to optimize their operations. This can only be done by dismantling and reimagining the differing elements of the associated value chain and infrastructure. At the end of the day, firms need to recognize that blockchain is fast becoming a broadly generalized, umbrella function that serves as a conduit to the following differentiated capabilities:
HERE COMES BLOCKCHAIN AS A SERVICE
Developing and utilizing blockchain internally and externally is one way to generate value from blockchain and DLT. It can help firms understand the issue they’re trying to resolve in order to realize blockchain’s core value and avoid becoming tied to a single approach or vendor.
For example, let’s say you are a chief risk officer. You want to know in real time that everything in your purview is compliant and audits are consistently supervised. Because you want to share information in a transparent way, you’ll need a holistic view at the parent company level. That’s a major challenge for many firms with today’s internal architecture. Using blockchain values specifically for enterprise internal architecture across a firm’s business units would help solve for industry-wide issues, including:
- Lack of real-time information
- Abundance of centralized ledgers
- Growing amount of resources spent on maintaining multiple systems (and people physically logging in to those systems)
- Slow, batch-oriented exchanges of information between internal and external systems, and the related time-consuming and collectively redundant verifications, affirmations, reconciliations and middlemen/outsourcers involved
Further, financial institutions want to have a singular view of what’s happening across their entire organization. Blockchain allows for data, information and analytics to be most efficiently shared across the organization to minimize spend while maximizing usage.
As a result, blockchain as a service (BaaS) has emerged. Similar to the shift toward platform as a service (PaaS) or software as a service (SaaS) delivery models, BaaS will gain wider appeal. As different companies and vendors continue to make blockchain technology functionally available, other organizations can have it coded and built for them to help optimize and automate systems, processes and business unit operations.
BaaS is taking on several specific commercial angles, including:
- Distributed ledgers, such as external peer-to-peer-networks
- Distributed databases, like internal cross-business networks
- Blockchain protocol data structure design (i.e., how a company would define transactions and blocks)
- Consortium management and related protocol creation
- Smart contract programming and oracle implementation
- Node creation and management
- Related software, system and architectural model design
What’s Next: Smart Contracts
Across the financial industry, smart contracts are gaining more attention. From a simple, conceptual perspective, smart contracts are computer protocols that facilitate, verify or enforce the negotiation or performance of a contract that make a contractual clause unnecessary. As smart contracts can emulate the logic of contractual clauses, organizations can utilize them to create self-executing processes stored on a blockchain to orchestrate business events in a faster and seamless way while mitigating risk and automating processes.
Smart contracts complement a blockchain ecosystem by utilizing DLT as an accelerator and extension to enable the blockchain to go beyond multiple parties using a single ledger in a real-time manner. In turn, this allows internal and external processes and agreements to be executed as quickly as possible. Conversely, this would have massive implications around reverse automating necessary verifications as they relate to anti-money laundering (AML) and know your client (KYC) requirements.
Blockchain technology combined with smart contracts can enable automation points to confirm specific events such as obtaining a price for a trade and verifying a collateral call or the terms and triggers managing the collateral relationship. They can potentially eliminate manual touch points and automate processes to remove institutional and operational risk. At the most basic level, financial firms could look at a normal trade and minimally seek to automate the matching and reconciliation of the trade, as well as corporate actions or credit events, confirmations and collateral management.
The Broad Potential of Blockchain
Firms can use blockchain to improve efficiencies through the creation of a peer-to-peer network. One key area gaining more attention is trade repositories. For instance, a trade repository could potentially evolve from inherent batch processing and reconciliation to real-time verification or synchronization. The industry could have almost instant insight into information companies share to ensure data is the same on both sides of the tradeóno matter who is verifying or reconciling it. Blockchain could offer the ability to achieve this en masse and in a normalized fashion across a process.
Identifiers and other kinds of reference data used in regulatory reporting could also be issued multi-laterally on a blockchain network for end users. That means legal International Securities Identification Numbers (ISINs) and other instrument reference data would originate on a blockchain for firms to then assess. This kind of application may potentially lead to savings for firms that must constantly upgrade their reference data platforms, while also easing the dependencies on current ID and numbering agencies.
Local operating units (LOUs) that issue LEIs might become redundant if there were a large-scale DLT process backing LEI generation. The use of oracles and nodes automating these processes and their related communication and retrieval removes the dependency on a governing body or group. That gives equal access to multiple groups issuing identifiers onto a blockchain and multiple consumers of that information.
Growing Regulatory Scrutiny and Vendor Ecosystem
As the blockchain landscape evolves, it will become increasingly crowded from a regulatory and vendor perspective.
Regulatory bodies and governments are in the process of expanding their understanding of the technology and identifying how it should be regulated. Their responses and opinions have been varied as these entities try to comprehend how it can be deployed in different areas of finance. One example involves the Government of Singapore, which is currently working on a POC using blockchain technology to identify insider trading.
Elsewhere, the European Securities and Markets Authority (ESMA) is more skeptical, taking the positon that a potential danger for misuse and collusion may exist should the technology be used in the wrong manner. On the other hand, the incoming Commodities Futures Trading Commission (CFTC) has openly stated that it sees great promise in the technology.
The current blockchain vendor landscape, as it pertains to the financial industry, has become blurred and filled with:
(a) One-off, specialized startup technology providers with unproven track records and different approaches to their architecture and application potential
(b) Huge global consulting companies offering vague technology accelerators and expertise while aiming to form consortia
(c) Open source platforms from the worldís most respected computer companies such as Microsoft and IBM
(d) Private bank labs such as JP Morgan and Citi Bank, as well as Northern Trust, Credit Suisse and State Street
(e) Global open source platforms or platforms-of-platforms, most notably Ethereum and Hyperledger
Functionally, the industry ends up with a growing ecosystem that includes companies providing traditional code and software in an effort to organize consortia or get clients to adopt specific platforms. These companies effectively provide assembly kits or start platforms, telling potential customers to use their information and build whatever they want. In addition, open source groups and private companies work together with independent parties and other consortia to build more specific POC software and functionalities.
However, each one of these is using different coding, functionalities and languages, which provides their own unique value. As organizations continue experimenting with POCs and reviewing case studies in a very scattered and congested marketplace, itís important for them to distinguish between blockchain as a concept, blockchain vendors, and the issues they are attempting to solve.
A Promising and Sustainable Future
The complexity of the blockchain landscape and related technologies, system and hardware migrations and upgrades means widespread implementation is still years away. A complete understanding of the ever-evolving blockchain landscape and clear focus on what firms are actually trying to remedy within their organizations (e.g., current-state architecture issues and transparency) can help drive the industry closer to optimal implementation.
Where possible, organizations and other industry participants should take a hands-on approach to learn about this divergent landscape. Like any application or software provider, blockchain vendors and open source platforms must be evaluated on quality of service and build, ease of engineering and differentiation of complimentary and/or enhanced services. Complicating matters further still, many vendors have begun offering “freemium” versus “premium’ versions of their platforms. Premium represents an enterprise-ready application replete with additional vendor service and support guaranteeing higher volumes of more robust transactions processed in less time with theoretically unlimited bandwidth constraints (although limits have yet to be reached or defined).
Many will find it difficult to argue the technicalities of something still being hypothesized and theorized within a market that is not yet ready to fully consume and utilize it. Regardless of value and need, and simultaneous to the continued advancement of the underlying technology, there is still a long way to go. In 2018, the industry will likely find out if blockchainís bubble bursts, if it breaks through or goes bankrupt, and whether blockchain itself will become a bubble or a collection of bubbles.
Thus far, the year 2017 brought the launch of the first production blockchain network: a private equity-based, admin-functioned DLT supporting a client in Switzerland with one local regulatory node Northern Trust built in conjunction with IBM. While much is in progress, 2017 will clearly end still inundated in POCs and promising announcements.
The most probable outcome is one that is multi-phased, with a busted bubble of blockchain POC investment and excitement, followed by a sober few years of research and investment, then a five- to 10-year period of actual industry adoption. Blockchain will take a similar path as social networks, cleared derivatives, the internet and other advancements, with about a 10-year period between initial introduction and critical-mass acceptance and maturity. This means blockchain is not a fad, and competitive interest from the largest technology providers will continue to increase.
So what’s the real forecast for blockchain in the short term? The beginning of distributed ledger, theorized more holistically and meaningfully with respect to applications in government, healthcare, retail, real estate, insurance and beyond. Mortgage servicing, land rights and global supply chain management are where some immediate promise, as well as many hurdles, lie.
No matter what, true industry-wide disruption—or full-scale adoption and migration—will most likely take 10 to 20 years. Undoubtedly, adoption will occur from all directions as advancements will be realized separately and independently across distributed ledger, decentralized networks, smart contracts and more.