Blockchain is transforming financial services
but its potential as a business enabler is
much wider. Mike Jones reports
New kid on the block
T
HE CONCEPT OF blockchain has come a long
way since it first emerged as the technology
that underpins the pioneering virtual currency
Bitcoin.
Initial suspicions around a system that facilitated a
totally new form of transactional structure were not
helped by the early popularity of Bitcoin among users
of the so-called Dark Web.
However, those quickly evaporated when major
financial institutions around the world realised its
potential and effectively legitimised both blockchain
and latterly Bitcoin itself.
And while the popularity of Bitcoin itself persists
despite often wildly fluctuating values and increased
competition from a swarm of imitators since it
launched in 2008, it is blockchain which is the true
Bitcoin success story.
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Also referred to as distributed ledger technology,
blockchain is set to become the system of choice
as banks and other financial companies around
the world look to enhance security and trust in
multiple transactions and reconciliations taking place
simultaneously.
In the process it has become one of technology’s
biggest growth areas, spawning myriad new business
opportunities. From logistics to IP protection, supply
chain to diamond provenance, the uses for blockchain
go way beyond its original roots in virtual currency.
Yet while the buzz around blockchain grows
increasingly loud, the evolution remains in its relative
infancy. The enormity of its potential as a business
enabler has seen investment in the technology soar
over the last year or so.
In its most basic form blockchain is a decentralised
TECHNOLOGY > BLOCKCHAIN
electronic ledger which appears in duplicate form
on thousands of computers worldwide. It is a peer
to peer network where records are known as blocks,
with each one timestamped and linked to a previous
block. This means that data in a block cannot be
altered retrospectively, enhancing both security and
transparency.
In effect it provides a layer of certainty which has
never before been seen, particularly in the complex
and fast moving world of international finance as Keith
Bear, vice president, financial markets IBM explains.
Blockchain, he says, “is all about taking advantage of
what the technology offers in terms of trust”.
“Across financial services, if you are one party
dealing with another there is always an issue in terms
of the level of trust that might exist in the network,” he
says.
“And because trust is never absolute you end up
having to reconcile – my view of the world versus your
view of the world.
“What the distributed ledger technology does is
to allow us to have one view of the world which is by
definition the same based on all the parties that are
part of that network.
“Fundamentally that makes a significant change
when you consider large international banks may have
thousands of people involved with reconciliations of
various forms and types based on different versions of
the truth - so the potential has always been very large
in terms of what it can deliver in that respect.”
Further, while ledgers are shared they also have high
levels of privacy due to the sophisticated cryptography
in place to ensure only authorised parties have access.
“In a financial services environment that is pretty
critical,” says Bear.
“Inherent in this model is that you have the means
of establishing agreement as to what is on the shared
ledger. When a transaction comes along it is not
good enough for one party to say this is a version of
the truth, therefore for it to be a version of the truth
for everybody, there has to be agreement among
the participants in the network that this is the truth.
Therefore there needs to be a consensus mechanism.”
An additional feature of blockchain is the means
to be able to execute so-called smart contracts
on individual nodes within the network which are
essentially the same contract at each node. “This
enables you to do in financial services terms, financial
executions or specific transactions that take place
which are essentially the same on every element of
the node itself,” says Bear.
With so many compelling elements it is hardly
surprising that blockchain is taking off – and while there
is still some way to go before it becomes established
practice, change is happening very quickly.
“All the major activity has taken place in the
last six months,” says Bear. “If we were having this
conversation in Q2 [of 2016] we would be talking
about experiments. Now we are talking about largescale production.
“Given that kind of trajectory it is going to be
fascinating to see what will be happening in a couple
of years’ time, simply because of what is going on at
the moment.”
Research by IBM and the Economist Intelligence
Unit undertaken in 2016 on the adoption of
blockchain technology showed that of 200 financial
institutions surveyed, 14% of them were planning to
implement blockchain into production by the end of
this year. The overwhelming majority (70%) expect to
be in production by 2020 at the latest.
STANDARD VIEW
“There was a lot of debate in the middle of 2016
as to whether this [blockchain] was just about
experimentation – no-one was actually prepared to
pull the trigger,” says Bear. “So the figure of 14% was
quite interesting at the time as a statement.”
Crucial for the next stage of blockchain to work is
standardisation and regulation.
Currently, there are two dominant technologies R3’s
Corda, which is focused purely on financial services
transactions, and the Hyperledger Fabric - which is
predominantly aimed at FIs but also offers applications
across a wide range of industries and sectors.
IBM is one of the founding members of the
Hyperledger Project and the consortium also includes
the likes of JP Morgan and Airbus.
“What Hyperledger does is bring together all these
participating institutions to create a standard view of
the fabric itself,” says Bear.
To emphasise the sharing ethos around blockchain,
he points out that R3 is also a member of the
Hyperledger Project.
“The way that Hyperledger Project works is that
it is an organisation under the auspices of the Linux
Foundation which supports a number of individual
fabrics within it,” Bear says. “Over time these fabrics
may coalesce or if you are a participating institution
you can pick the fabric that is most appropriate. The
point is the organisation and the open governance is
the means by which future strategy is dictated.”
Bear says there are currently three fabrics in the
“Incubation” phase of the Hyperledger Project – the
most popular known as The Fabric (to which IBM
contributed some 45,000 lines of code), which will
shortly become “Production Ready” – with another
being Saw Tooth Lake supported by Intel and a third
called Iroha.
“Other fabrics may come in,” Bear says. “There is an
incubation process and the way this is likely to work in
an open governance model is that the best pieces of
THERE WAS A LOT
OF DEBATE IN THE
MIDDLE OF 2016
AS TO WHETHER
THIS [BLOCKCHAIN]
WAS JUST ABOUT
EXPERIMENTATION
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the fabric will come together and the community will
decide what is the most effective route forward.”
“This represents a very significant investment from
the parties to help drive the adoption of a common,
consistent and open source approach to drive
Blockchain adoption.”
While consensus is ongoing around the technology
itself, a parallel discussion is taking place with regulators.
“One of the inherent things the technology provides
is transparency and trust which, superficially, from
a regulatory point of view has to be a good thing,”
says Bear.
“So the regulators in general have been very
positive and supportive of what the technology brings.
Regulators that have provided an opinion and some
have stated that blockchain technology itself doesn’t
need to be regulated; it is really the processes and
how they might use distributed ledger technology that
may be more subject to regulation.”
INCREDIBLY INSIGHTFUL
There are, however, issues which exist. “The classical
one if you are using blockchain in a settlement
context, what happens at the point of settlement
finality when settlement has actually happened but
for whatever reason one party is in dispute with the
other?” says Bear. “Is what is on the blockchain at that
point a legally viable statement of fact? Technically
it is but is it true from a legal and regulatory point
of view? So the question of settlement finality is
something where the law to some extent has to catch
up with what the technology enables, because you are
talking about a different environment to what exists
today in the markets.”
The transparency of blockchain is a distinct
advantage from a regulatory perspective.
“One of the blockchain network participants can
be the regulator, so they have complete visibility and
transparency about what is going on, which they don’t
have today because that is typically based on post
factum reports that are provided which may or may
not be accurate depending on the systems and the
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processes supporting them. There is a direct benefit to
market transparency in the race for that.”
While many businesses are still getting to grips
with the possibilities of blockchain, IBM has already
introduced the technology into some of its processes.
Something Bear calls “quite a statement on its maturity”.
IBM implemented a blockchain network using
Hyperledger aimed at reducing the number of days to
resolve invoice-related disputes in its global financing
business. Six months into the process and Bear says it
is on track to reduce resolution time from 40 days to
fewer than 10.
“This has been incredibly insightful as it shows what
it takes for us to run a blockchain network because
this is a very different environment as you can imagine
to a master-slave relationship in a traditional IT
environment,” says Bear. “This is one of the earliest
examples in production which is proving very helpful to
understand the major steps you have to go through in
terms of the design and development of the business in
this production-critical, industrialised environment.”
The possibilities for blockchain are seemingly
endless, with Bear citing uses around crowd sourcing
as an example of what can be achieved. Options
increase further when it is linked to other new
technologies such as the Internet of Things.
Bear says that blockchain and IoT integration could
be highly effective in the shipping industry.
“We see a large complex supply chain when we go
through the various steps – from the banks’ point of
view, the letters of credit and parts of the financial
element of the supply chain, all the way through to
customs and ports and physical containers,” says
Bear. “So being able to integrate IoT technology into
TECHNOLOGY > BLOCKCHAIN
that will help with validity, verification and validation.”
This, he says, should stop ships being delayed
before they can load or unload their cargo.
“Supply chain efficiencies are now so advanced
that sometimes the paperwork is slower than the
transportation,” Bear says.
“You end up with log jams in the supply chain
where they cannot physically import because they
are waiting for the paperwork to catch up. In those
environments there is no single organising body –
as you are dealing with different elements such as
customs, tax, regulation, quality control, provenance
and all those things.
“Part of the [blockchain] design is if you get the
smart contract part right you can trigger automatically
things such as break payments, early payments,
payments for early delivery etc. You can build those
in so if you can prove the goods have physically
arrived at the port and are ready to be transferred
to the handler and you can swipe a container and it
identifies the goods that started on this process, then
it can trigger a payment or transaction that can then
move it on.”
COST OPTIMISATION
There are also major opportunities for the insurance
industry around blockchain.
“Blockchain combined with Big Data could make
it possible to fulfill the historical role of insurers in a
much more efficient way,” says Matthieu Caillat, CEO
France, AXA Corporate Solutions.
“Pricing feeds on mass data. Financial transfer can
be done in peer to peer mode without intermediation
by a central clearinghouse. Reliability is guaranteed
by capitalisation and indemnification can be
automated, based on data that are generally accepted
as reliable rather than reliance on the insurer’s
willingness to compensate (which, conversely, is not
commonly accepted).”
Caillat concedes this is not without its challenges.
“Viewed from this perspective, it might seem that an
insurer could be replaced tomorrow by an algorithm,”
he says. “The reality is very different. But while there
are many barriers to achieving this level of disruption,
the rapid pace of these technologies and their
popularity should compel insurers to quickly review
their positioning and ability to evolve.”
Despite its obvious advantages, insurers and others
adopting blockchain need to take care because it is still
relatively new, according to cyber crime specialist Peter
Hacker, co-founder of Distinction.Global.
“Blockchain technology is really at the beginning,”
says Hacker. “The key discussions are around
transparency and security and cost optimisation. In
terms of where we are for the insurance industry and
the banking industry you are effectively replacing
a more centralised database with blockchain
technology, so you have to think about the price and
opportunity.
“Key when you are introducing new technology
like blockchain, particularly when using new codes
and languages, is you have to stress test. There are
going to be challenges around this for the insurance
industry, the financial services industry, the banking
industry - particularly because of the different
methodologies used.
“From a security point of view I would compare it to
a boxing fight – you might be knocked down but you
get back up. You have to discover flaws.”
Taken at face value blockchain technology is robust,
versatile, transparent and in theory an ideal platform
for users and regulators to operate with confidence. It
also has, says Bear, “extreme levels of security” which
make hacking incredibly difficult.
While not impossible – the scale of the challenge
for hackers is as follows: Every node in the system
has to be hacked at precisely the same moment with
precisely the same information. Also, everything
is timestamped and in the new consensus model
there is one node that orders all the transactions. So
every aspect of the hack has to be in sequence which
requires a high degree of sophistication.
“On top of the inherent security features within the
straight architecture and the technology there are
additional things you can do and it is a question of
the sensitivity of the projects in the first place and the
level of security that is most appropriate in the first
place in line with that,” says Bear.
“The security is improving, the cryptography is
improving, the trust and transparency are improving
so there are benefits there. If done well in terms
of design, it will be better than current state
environments – but not, of course, risk-less.” n
REGULATORS IN
GENERAL HAVE
BEEN VERY
POSITIVE AND
SUPPORTIVE
OF WHAT THE
TECHNOLOGY
BRINGS
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