Fintech: Blockchain moves from hullabaloo to hard graft
In the second half of 2015 hype around the potential for shared ledger technology to transform banking rose to a peak. Now comes the hard work as banks and fintech companies seek to put test cases into actual use. As the first practical applications begin to emerge, Euromoney surveys the banking market to ask what’s next for the blockchain.
Euromoney published an in-depth investigation in November of banks’ sudden enthusiasm for putting all manner of core businesses – payments, securities clearing and settlement, bond issuance, derivatives trading, even the arranging of syndicated loans – onto blockchain, or shared ledger, technology.
A blockchain is an immutable and secure digital record of transactions shared between users in any marketplace and verified by consensus among them.
It seemed that the blockchain was the right answer at the right time: a promise to banks confronting the need to replace antiquated and end-of-life IT systems coinciding with high pressure to cut costs, that there might be a more efficient, cheaper shared utility on which they could dump a lot of their data and processes.
Euromoney invited banks, their clients, technology providers, law firms, regulators, industry bodies and other interested parties to answer questions about the likely impact of the blockchain on financial services and the speed with which it might come into regular commercial use.
We present here the verified responses from 118 institutions that took part in our poll, the biggest two groups being banks and technology companies, with a distinct set of replies from law firms and then a large group of others, comprising asset managers, corporate treasurers, regulators, trade bodies, exchanges and consultants.
More than half of all respondents think blockchain technology will transform banking fundamentally, while another third think it will be an important technological tool for improving efficiency, though perhaps not utterly disruptive.
Only one in eight think that either it is just hype and will not have much effect or that it should be characterized just as one new technology among many others.
Two thirds of all respondents believe that most business will be done on permissioned blockchain networks, created, controlled and verified by industry incumbents, with less than one in 10 believing that the public blockchain behind bitcoin – the only one currently up and running – will be the main venue for wholesale financial transactions.
Not a single respondent from any bank believes that banking business will go on the bitcoin blockchain.
Asked which businesses are most likely to be transformed by the blockchain, 11% suggest trading of securities as smart contracts, 14% suggest clearing and settlement and 18% payments, with 12% suggesting different use cases.
Among the use cases put forward by respondents with whom Euromoney conducted follow up interviews are remittances, invoice financing and bill discounting – where the distributed ledger could be a mechanism both for establishing the provenance of an original invoice and then for verifying exchange of beneficial ownership between the SME that first submitted the invoice and a bank lending against it – and commodities trading.
But the biggest support by far, at over 40% of all respondents, is for the notion that the blockchain will have a big impact on all these areas and more besides.
There are disparities between the groups of respondents. More than two thirds of fintech companies think the blockchain will transform banking fundamentally, with 16% saying it could mark the beginning of the end for banks. Only 4% of bank respondents are quite so pessimistic, while just 40% think blockchain will fundamentally transform their industry.
Just over half of bank respondents admit to being late to the blockchain party, but they still believe that consumers of wholesale financial services will prefer to use them rather than start-ups, while 40% think the blockchain will further strengthen the banks by allowing them to offer better service at lower cost.
That would come as some blow to the early pioneers who created the bitcoin blockchain and clearly have little love for the banks.
As to the period of time over which the truth will out, there is more common ground. Among banks, 41% of respondents think the first commercial applications of blockchain technology are 12-18 months away, with just over one third saying they might be five years away. None have applications in current production. Among fintech firms, fully one quarter of respondents say they have applications in operation today or will have within the next three months.
A source at one bank tells Euromoney that big announcements that could mark the impending transformation of certain wholesale banking business segments will come soon. Even he, however, is wary of the hype around blockchain, however. “By mid-2015, if you looked across the biggest 35 or so banks in the world they might each have devoted $500,000 to testing use cases for the blockchain,” he says.
Despite all the rumours, banks are not stupid. They can see the potential for the distributed ledger to disrupt them and they plan to pay close attention to it, but they’re not going to torch their existing systems and build anew at the cost of hundreds of millions of dollars each, just because of bitcoin has won a few million users.
“Right now, most of those banks will be budgeting up to $5 million next year to test against blockchain,” the bank source says. “That’s a big market for bitcoin developers to chase. But remember that blockchain is competing for internal budget and senior management attention against other buzzword technologies, like big data and robotic software. I would say that the blockchain now has about two years to prove itself inside the big banks, or it will fall flat on its face.”
He thinks it will prove itself but gives a sense of the internal politics. “Senior bank managements are more interested in cutting people right now than incumbent software systems, so its initial use might be in the less technology heavy business, not in securities trading and settlement.”
Guy Halford-Thompson, co-founder of Blockchain Tech Ltd (BTL), a builder of blockchain applications which listed publicly on the venture board of the Vancouver stock exchange in November, tells Euromoney: “Banks are telling us ‘give us an actual use case that we can implement right now’. "Well we are working closely right now with a number of financial institutions in Canada and overseas, including banks, payroll providers and traditional remittance companies, with a prototype remittance platform called Interbit which uses blockchain technology to drastically reduce the cost of sending remittances across borders.”
Halford-Thompson expects the system to be fully operational within months. “Remittances is a big, important market in which to establish the usefulness of blockchain technology without disrupting banks’ core systems,” he says. “The key, we believe, to achieving customer penetration and ultimately mass adoption, is absolutely not to inconvenience the customer in any way. The customer may go to his or her bank as normal to initiate sending the remittance and not know or care that the Interbit technology on which that payment is transferred overseas is blockchain based.”
He adds: ‘It is also a way potentially to increase the corridors for remittances and enable payments into countries that are not heavily banked in Africa, southeast Asia and South America.”
Halford-Thompson believes forward-thinking banks will start using blockchain technology first in non-core areas of operations and then slowly over time, adopt it more widely into scheduled system upgrades across their businesses.
“When we talk to customers in the UK, we seem now to be just passing the point when it was important for them to say they were doing something on the blockchain. What’s important is that the service has use and value,” he says. “If it happens to be on the blockchain, then great. But it’s just a technology. No one will tell you they are building a website that you can put on the internet, and, over time, upgrading bank systems and putting them on blockchains will go the same way. It will simply be implied.”
It's important for banks to realize just how much other related industries are excited by the blockchain. Among the biggest issues confronting banks today are: identifying customers, complying with know-your-customer requirements, establishing that individuals opening bank accounts are who they say they are and are not on any government agency watch list, and also securing against fraud. Banks’ systems are under constant attack from hackers.
Some of the leading companies looking at identity are already embracing the distributed ledger.
Gareth Stephens is head of new proposition development at GBG, a leading identity data intelligence company that has been operating for 25 years, now with some 6,000 business customers and, it claims, the capability to validate the identity of 4 billion people across the globe.
Stephens presented the company’s use of the blockchain at a meeting at techUK in London in November. “When we think of what identity verification will look like in 2020, we think the blockchain will be a very big part of that,” he says. “Right now, the same customers are getting their identities confirmed time and time again by different companies all doing their own checks. Our thought with the blockchain is that a decentralized, immutable ledger might allow customers to get their identity verified only once and then let them use that verification many times.”
He adds: “Of course customers should be allowed the choice. If they want to regularly input their identity verification data many times, they should still be allowed to do that.”
Behind this vision is the troubling realization, confirmed in recent months by hacks into businesses ranging from Ashley Madison to Talk Talk, that online security based on customers inputting user names and passwords is now hopelessly inadequate as a protection against identity theft and fraud. At the same time, as identity specialists become larger, they themselves may offer a tempting golden horde for hackers to raid.
The encryption technology at the heart of the bitcoin blockchain, which is where GBG is now developing shared ledger applications for multiple uses of one-off identity verifications to be delivered via mobile phones, is more secure than any password. And the decentralized nature of the ledger also becomes an advantage, not least in the sheer cost of data storage.
“We think that, before long, on websites that today ask for user names and passwords, customers will see a few icons of preferred digital identity verifiers,” says Stephens. “They will be able to click on the one on which they have already complied with all the passport, address and utility bill verification requirements, and the business they are trying to use will then be able to take whatever already-verified identity checks they require to on-board that customer.”
For now, it seems inconceivable that banks could ever outsource KYC checks to other banks or a third-party supplier. They demand to see original documents, not scanned copies. The liability, if a third-party verifier has been bamboozled with copies, and a bank that relied on its verification then does business with what turns out to be an individual on a US-government sanctions list, could be a very hefty fine.
But at some stage regulators themselves may see value in the blockchain and even encourage its use.