Distributed ledgers are slowly but steadily working their way into mainstream financial applications. That means the time has come to understand how blockchain works—and to take the technology more seriously, says Esther Pigg.
Despite all the hype surrounding it, blockchain—or “distributed-ledger technology” (DLT)—remains a complicated mystery to many. Here is a simple description I find helpful in explaining what blockchain is.
Imagine there is a spreadsheet (ledger) that is duplicated (distributed) thousands of times across a network of computers (nodes). The spreadsheet is constantly reconciled (by miners) and immediately updated across its thousands of instances whenever a new transaction (block) is added. The spreadsheets are permanent, public, and verifiable (proof of work).
This is notable and important because:
– All transactions are verified and approved by consensus among participants in the network, making fraud much more difficult;
– The full chronology of transactions that take place is tracked, allowing anyone to trace or audit prior transactions;
– The technology operates on a distributed platform, rather than a centralized one like those used by most countries’ banks, providing more resilience to hacks or outages.
Secure by design makes blockchain potentially suitable for recording events, contracts, medical records, and other records-management activities like identity verification, transaction processing, or even voting. More broadly, blockchain technology can be applied to any multistep transaction where traceability and visibility are required.
With the global financial world getting smaller by the moment, this has great potential for generating revenue and reducing costs, particularly in the areas of cross-border payments, securities trading, and compliance.
Blockchain Projects And Proofs of Concept
For now, real-life uses of blockchain technology are still limited, but financial institutions and fintechs are exploring blockchain use cases for banking and payments. Proofs of concept, innovation-lab experiments, and controlled pilots are under way with selective back-office and customer-facing solutions. Here are some notable projects currently in play:
– The Bank of England plans to rebuild its Real Time Gross Settlement system so it can interface with private business and platforms using DLT;
– HSBC is testing blockchain suitability for trade finance. Working with ING, it issued a letter of credit to U.S. agriculture firm Cargill for a shipment of soybeans. A transaction that normally requires 10 days to clear was completed in 24 hours;
– JPMorgan Chase’s blockchain unit tested a new application to handle financial instruments, having recently phantom-issued a $150 million, one-year, floating-rate Yankee certificate of deposit;
– Mitsubishi UFJ Financial Group is partnering with Akamai Technologies to develop its own blockchain for payments with the twin goals of processing transactions in under two seconds each and processing 1 million transactions per second;
– Nasdaq introduced its next-generation Financial Framework, which allows for blockchain integration as part of its core services, to its exchange and interchange clients. SIX Swiss Exchange is an early adopter;
– SWIFT, the Belgium-based international financial-messaging organization. successfully conducted a DLT proof of concept for Nostro accounts (a bank’s account in a foreign currency in another bank) reconciliation with 34 banks. It has also conducted several other proof-of-concept experiments as part of its global payments-innovation service.
The financial industry is primarily starting with private collaborative blockchain networks to ensure customer information remains private and safe from hackers and other threats to the ecosystem. With the tremendous pressure to demonstrate regulatory compliance, secure solutions like DLT may become a crucial component in reducing compliance costs in the years ahead.
Blockchain’s “distributed” technology can be useful in back-office tasks such as transaction and contract reconciliation to enable faster updating and more accurate recordkeeping. Blockchain can cut the cost of daily checking and re-checking of transactions and chains of ownership, which has the potential to save financial institutions in terms of head count and man-hours.
Banks are starting to dip their toes in these waters, and notable pilots are focused on reducing the cost and complexity of cross-border payments. These transactions are traditionally full of friction and manual processes. Banco Santander SA, for instance, is reported to be using a blockchain-based technology for its recently launched international money-transfer service One Pay FX.
Still A Ways Off
One common trend of thought is that the transition to a blockchain-driven financial-services world is imminent. The reality is that DLT is very promising but has some way to go. Visa Inc., which is often the benchmark against blockchain, can supposedly handle up to 24,000 transactions per second (TPS), while larger institutions like stock exchanges can execute up to 80,000 TPS. Currently, Bitcoin can handle seven TPS and Ripple/XRP roughly 1,000 TPS. Several blockchain projects have a goal of surpassing 1 million TPS but their ability and timetable for such scale remains unclear.
Most organizations must keep their existing infrastructures in place as they work to identify specific use cases and problems that DLT can solve. For example, by combining the best of blockchain and the best of traditional payment rails, we may be able to not only reduce friction but unlock new areas of revenue growth in cross-border payments. Several DLT projects are working to reduce the time and costs of settlement. Once those barriers are lowered enough, we can expect to see much greater payments volume and revenue as a result.
Shaping the Future
Yes, there are still many questions to be answered about blockchain uses and governance. However, waiting for blockchain perfection could mean missing an opportunity to help shape the technology.
To understand how blockchain can enable the financial industry to become more efficient, resilient, and reliable requires both continued research and real-life applications and pilots. Together, we are learning the real advantages of this new technology—and the future opportunities are constantly unfolding.
—Esther Pigg is senior vice president of product strategy, banking and payments at Fidelity National Information Services (FIS), Jacksonville, Fla.