More and more participants in the global financial system grasp the potential for a shared, secure and immutable database for tracking changes in ownership of financial assets to provide big cost savings and efficiencies but also to disintermediate many of them entirely.
A recent study by Autonomous identifies an annual cost in the G7 markets alone of $54 billion for the clearing and settlement of securities by layers of counterparties including custodians, clearers and brokers that the distributed ledger might replace with a cheaper and more secure system.
That sounds like great news if you are one of the participants that survives to take advantage, not so good if you are the once-trusted middleman that the blockchain makes redundant.
Driven by an urgent need to cut costs to boost their shrunken returns, fear of new fintech disrupters and mindful of the threat of disintermediation, the world’s biggest banks are now bidding to adapt the blockchain so that it delivers a more efficient version of the existing financial system to which they are central, rather becoming the foundation for a new one in which they have no role.
R3 CEV, which is coordinating a consortium of 45 of the world’s largest banks to build applications for the blockchain, has unveiled first details of its Corda shared ledger platform. It says that Corda is heavily inspired by and captures the benefits of blockchain systems, without the design choices that make blockchains inappropriate for a heavily regulated banking industry. It does away with the notion that all participants on a blockchain can see every transaction, restricting access to those that are party to each. Corda achieves consensus between firms at the level of individual deals, not at the level of the whole market.
Executives at the ASX now investigating potential use of blockchain technology as the underpinning for Australian cash equities – one of the biggest experiments now underway – have made a similar choice.
Perhaps even more important, R3 CEV is close to signing up a number of central banks and regulators to its experiments, a key breakthrough in the struggle to adapt and adopt this revolutionary technology. So far, central banks have produced voluminous research on the blockchain but not done much open experimentation with other parties. If they can be brought on board in experiments designed to preserve banks at the core of the payments system while aiming to achieve cost savings from resilient, scalable and secure shared infrastructure, banks will be delighted.
Charley Cooper, managing director of R3 CEV, tells Euromoney that at a development cost in the single-digit millions of dollars each, to secure annual cost savings measured in the hundreds of millions of dollars and more each, the blockchain may be the best single investment the big banks ever make.
But it’s worth bearing in mind that the banks are paying to develop a technology that might yet undo them. Central banks are attracted to digital central bank money issued on a distributed ledger partly as a means of control – it would certainly make it easier to tax wealth through negative interest rates and ultimately could replace the cash banknotes that are a tool of the informal and criminal economies.
Yves Mersch, ECB
Both Yves Mersch, executive board member at the European Central Bank, and Ben Broadbent, deputy governor for monetary policy at the Bank of England, have recently raised the issue of the basis on which central banks might restrict access onto a distributed ledger for central banks’ digital cash. For now, central banks, as holders of commercial banks’ reserve deposits, are the trusted middlemen that ease flows between private banks. But if central banks move to issuing digital fiat currency on the distributed ledger, why should that be closed to non-bank financial firms, other corporations and even to individuals?
If those users of financial services could have accounts with the central bank, it’s a certain bet that deposits would flow out of private banks now subject to bail-in and into central banks during times of stress. If deposit-taking were to become as unreliable as wholesale funding, that would threaten the banking system’s ability to extend credit to the real economy – its very raison d’etre.
For now, it looks like banks are doing a smart job in trying to capture the benefits of blockchain while avoiding its existential threat. But this new technology will be testing the brightest and best minds in the industry for years to come. And no one yet knows how it will reshape global finance