Blockchain banking perspectives
By: Sergey Golubev, Сергей Голубев
Tags: Banking, Smart Contracts, Blockchain, Finance, Dlt

Blockchain banking perspectives

Total forecast

It is all around financial services. The implementation of blockchain has encouraged solid investment into a variety of protocols that meet payments systems’ gateway for privacy and permissions. We can highlight the most probable future use cases outside of cross-border payments, problems that need to be fixed, and potential changes in regulation in the long-term corridor. All major big banks are challenging payment solutions in the next few years. Blockchain features are most complementary to the processes involved in running a payments system. They are fit appropriately 100%. That explanation is likely to offer the highest return to investment in the future. In the near term, there will be greater adoption of stablecoins, mainly fiat-backed. This will be driven by Facebook’s Libra, and projects such as Fnality and JPMorgan’s stablecoin. It seems to be so. Central bank digital currencies will be a reality, with the PBoC set to be the first issuer later this year (according to their press releases). After China, other central banks will copy the decision as well. Interoperability across blockchain platforms will be improved. The differences between the major blockchain protocols remain significant, but there is an open dialogue for collaboration and research into how assets on different chains can co-exist together. Today it is a problem. Some time ago we saw the deployment of multi-cloud blockchain, which is likely to result in successful cross blockchains pilots in the coming years as well. Regulators will become more innovative in their approach to managing fintech innovations from new, small companies, and incumbent financial institutions. Here the SEC supposed to be the pioneer. Otherwise, some other institution will be the leader. Regulators may try to start forming their own consortia in blockchain trend for fintech. So where and how banking can implement blockchain know-how?

· In trade finance

Most bank experts are stating that almost all options are open for the industry. They identify trade finance in particular as an area in which they expect blockchain to make significant strides within

few upcoming years. Because DLT offers significant benefits of speed, transparency, and the freeing up of capital. In most cases of blockchain utility. Several famous use cases in which bank consortia have developed already capabilities in this area include We.Trade, a blockchain-based platform that was developed in 2017 by nine banks (Deutsche Bank, HSBC, KBC, Natixis, Nordea, Rabobank, Santander, Société Générale, and UniCredit) to simplify cross-border trades. A similar platform, Batavia, was developed from a proof of concept initiated by UBS and IBM in 2016 and brought onboard the Bank of Montreal, CaixaBank, and Commerzbank as additional partners. We.Trade and Batavia were both built on the Hyperledger Fabric platform (supposed to be the best for these issues) and merged their trade finance blockchain platforms in 2018. Other trade finance blockchain initiatives include Marco Polo and Voltron, which use R3 Corda’s framework, and komgo, which is based on Quorum. Yet problems persist in the trade finance application as well. Some experts note that if they were to build a system like it would only work if we were on both sides of the international trade and both clients agreed to use it, which does not always work out. There are also issues of scale, with third parties warded off by the prospect of centralised, scaled international trade. As a result, trade finance is not as close a prospective application as cross-border payments, but one on which banks are working intensively right now without loud public promotion.

· In Securities — eternal hype

Blockchain could facilitate the issuance of securities such as corporate bonds. Currently, issuance and payment of cash flows are largely tracked and performed on a manual basis. The immutable nature of blockchain transactions can help automate certain procedures in the bond life cycle via pre-determined smart contracts. For instance, issuance of bond proceeds can be done on a parametric basis, which is instantaneously activated once specific trigger conditions are met. In 2018, the World Bank issued bond-i, the first public bond created and managed via DLT. This two-year blockchain bond was managed by the Commonwealth Bank of Australia, raising $80m in its first issuance. There is likely to be a similar issuance in the future. It is not a bad perspective.

· In asset tokenisation

Thanks to technology, there is now an ecosystem for regulated digital shares of any asset in any asset class to be issued and traded on the open market by an accredited individual or legal entity.

This tokenisation of securities will help banks significantly reduce global trade costs. A tokenised economy offers the potential for a more efficient system where frictions are removed in the creation, buying, and selling of tokens. Major banks find that tokenisation could make the financial industry more accessible, cheaper, faster and easier, thereby possibly unlocking trillions of euros/dollars (whatever) in currently illiquid assets, and vastly increasing the volumes of trades. In the coming years, traditional players will have the opportunity to meet the demands of a token economy by providing a platform for storing tokens, or assuming the role of a trusted intermediary if a decentralised solution is not enough. In the near term, there is a need for appropriate regulation, and for it to be aligned across jurisdictions. In 2019, significant technological advances in the security tokenisation industry improved speed, security, transparency, and the immutability of records. Bank experts believe the industry may take time to mature, going to blockchain 10.0 in the nearest future. You will see more token-based solutions, greater issuance of tokens, and passing of tokens between different blockchains. All of this will increase the value.

· In clearing and settlement financial operations

Banks see clearing and settlement as another important use case. DLT could expedite the clearing and settlement of assets where large and complex multiparty transactions occur regularly. Stock exchanges and other financial institutions dealing in frequent, high-volume exchanges of securities and derivatives have experimented with blockchain platforms in their settlement process. In 2017, Goldman Sachs was granted a patent for SETLcoin, a transaction settlement system based on blockchain. The Nasdaq stock exchange successfully completed the first blockchain-based securities transaction platform via Linq in 2015. As you see, industry sharks are taking precursor steps towards continuous 24-hour settlement, in other words, the establishment of a genuine global settlement. Current real-time gross settlement systems have limited operating hours. Continuous-Linked Settlement, a platform operating as an international multi-currency clearing system on a payment-versus-payment settlement mechanism, is limited by the fact that transactions can only occur in specific time windows, such as when two countries central bank RTGS systems are running concurrently. Using blockchain would allow for continuous PvP and delivery-versus-payment settlement globally. At least it seems to be so.

However, experts caution that this is still in the early stages and that there are a whole series of policy issues on the back of the idea of 24-hour settlement. This application of blockchain would massively ease payment settlement (by minimizing risks), although it would probably create pressures in other places, such as liquidity management. This is one other area in which banks expect significant progress over the next years, conditional on productive engagement with regulators and other policy-makers. Other experts elaborate on the systemic benefits of moving away from a regional settlement to a global settlement. This allows financial sector to massively deactivate risks in the system effectively.

· In Know-Your-Customer and identity

Blockchain can bring greater transparency and efficiency in complying with KYC obligations. Verifying consumer identities is a ubiquitous requirement across financial service providers to prevent funding of criminal activities, anti-money laundering, and illicit flows of funds. KYC checks across institutions and jurisdictions are burdened by effort duplication. The unique digital identity of each participant in a blockchain network can help streamline authentication processes across a shared KYC infrastructure. This can create opportunities for implementing tamper checks, proof of origination, and designated acknowledgment in business-to-business processes.

But what the banking sector and innovators in blockchain have to do in order to be the fintech leader? The most common opinion:

· Institutionalists have to lead blockchain economics

Many representatives of the financial sector expect that at a national level, one or two strategically important financial institutions would drive significant blockchain production over the next several years. Probably in the short term, use cases will be conditional on the bank’s expertise and confines. Some big corporates will create their own ecosystem, including moving money cross-border, bringing suppliers and buyers on to the chain. On the one hand, this will be the fastest case for implementation. On the other hand, the banks try that consortia that have multiple parties including possible regulators, customs, or government officials, such as the letters of credit or certainly in the logistics industry, will take longer to gain traction.

· Blockchain has to integrate with other technologies

The common opinion that the challenge will be to link the blockchain to other technologies like advanced analytics and data analytics. DLT is not the only technology that offers potential and so to derive the added value of DLT systems, it needs to work in a holistic manner. At the same time, banks perceive that the disruption from DLT should not be rapid (banks are conservatives by its nature). The success of use cases will depend on linking new systems in some way to legacy infrastructures, databases, and technologies as soon as possible. The banks share thoughts that the transition from the current infrastructure towards a new level — doing double costs because building this is not only building an ecosystem and financial transaction at a time, but also getting all the players on board and making sure that in the next 10 years, everybody will still need to work with the old system. This is a big investment and a leap of faith towards the future. From that point of view, we’re (customers) very much aware this transition phase will take a lot of time because we will need to work in parallel, as the old world and the new world for many years to come. When institutions look to blockchain solutions, they view the technology as a component of the solution, and not the solution itself. DLT can be better leveraged in combination with other technologies, and the industry is looking at implementing such solutions which can work jointly with the internet of things and artificial intelligence. A survey by Gartner, a US-based research company, found that 75% of organizations that are implementing IoT technologies have already implemented blockchain or plan to do so by the end of 2020.

· Prompt success will fuel wider adoption and popularity

The success of one use case is likely to drive the adoption of others across the industry. As more of the industry understands, what the core components are around consensus and mutability, whatever, then there are many additional services that can be added to what that is increasing the value. Therefore, as adoption increases, the maturing technology can help solve challenges of cross-platform interoperability.

What is in the future? What scenario?

The progression of blockchain as a technology is an evolutionary process. Since 2008, there has been a significant jump in the number of features that blockchain can support, especially the introduction of complex smart contracts, the ability to scale, and the possibility to integrate with other developing technologies. Blockchain’s capacities will expand in the coming years as well, with no doubts. Many blockchains and DLT experiments today are about scalability and transaction capacity. The complex, encryption-based, and distributed nature of blockchain transactions can be lengthy to process traditional payment systems, and therefore requires more advances in engineering and processing speeds. Under common known Buterin’s scalability trilemma, in which only two of three attributes can be attained, is the main core task for success: decentralisation, security, and scalability. A core technological challenge for these users will be one of scalability. The resources to quickly process information exchanges across an international network are lacking. While public blockchains like bitcoin have prioritized decentralisation and security over scalability — leading to low transaction capacities — appropriate enterprise-grade blockchains for payments will need to perform similarly, if not better, than their incumbents. How many enterprise blockchain and DLT overcome these trade-offs will be an important consideration influencing wider adoption in the financial industry. Common bank decision for blockchain adoption is business case driven only. Still, businesses will be keen to improve scalability and speed without compromising on the privacy provided by decentralised ledger keeping. Enterprise blockchain consortia must balance these two concerns. Blockchain solutions need to prove that one can have a privacy solution which is on the one hand, so that other parties on the forum definitely can observe the effects of these transactions that other parties are doing, and that this does not have an impact on the performance on the scalability and speed at all. Consortia working in financial services are likely to select scalability and security, foregoing some of the decentralization in favour of having central nodes responsible for oversight to implement KYC and AML.

Aside from implementation, another important issue is whether cost reductions from adopting blockchain technology can outweigh its operating costs. For instance, the energy cost required to power blockchain computations and the storage costs for nodes could be significant depending on the protocols and consensus mechanisms powering the platform. Avoiding computationally intensive processes such as mining and proof-of-work in favour of cost and energy-conscious protocols will be essential in scaling up blockchain to handle frequent, large-scale transactions. As it stands, developing, implementing, and maintaining a blockchain-based system will require a careful cost-benefit analysis of the advantages and trade-offs which a specific blockchain platform delivers to a well-defined use case only. When selecting potential blockchain-related solutions, banks have several options, with both incumbents and new players developing new technological services that employ blockchain and DLT. Some, such as JP Morgan Chase and Goldman Sachs, are opting to develop in-house capabilities. Resolving these trade-offs is an essential step towards the genuine widespread adoption of blockchain solutions.

But regulators will still keep an eye on decentralized paradise

Regulatory approaches to blockchain in financial services are incomplete today and significant upgrades are needed, both at global and domestic level. So would the network operator be outsourced to a technology company, or would for example a structurally important institute such as an exchange, central securities depository, or regulator operate the network? This has several options from a business and political perspective. Here are obvious several concrete ways in which regulatory processes can become more efficient for productive innovation. From one side, banks suggest that regulatory sandboxes need to do a better job of producing successful cases for participants. Firms in a sandbox tend to be isolated, which makes it hard to transition elements of the sandbox out into a working environment. Some sandboxes do not necessarily have this final aim in mind — the goal of any participant is to get out of the sandbox and into the market, and regulators must make this easier for them. This ties in to a second necessary improvement, which is brought into production, it should be easier to move along to other parts of the value chain after entry. Innovators and bank consortia primarily use sandboxes as an entry point — once they identify a concrete case where blockchain can add value, they establish an ecosystem with critical mass to apply to this case. In common words, the central challenge is to destroy that entry point step through value creation. Once that has been achieved, moving up the value chain into areas like servicing is difficult, and more should be done to make preparing for this transition part of a sandbox.

Developing global standards and achieving further clarity in key regulatory areas is also a much sought after step. The evolution of the industry is unclear and some clarity on regulations would help define the space to act. For example, with safekeeping of crypto-assets, the method for storing, controlling, and handling private keys is an important question that would clarify the definition of digital custodial services in soon future. Consortia will have to consider important tradeoffs to improve their functioning and appeal as a management tool for enterprise DLT solutions. One of these has to do with the question of size. While large numbers of banks collaborating are essential to create a shared infrastructure network, there are downsides to a large membership. In the early stages of blockchain and DLT development, the merits of membership must be weighed alongside the pace of collaboration and the balance of decision-making power. While consortium size is a necessary factor, excessively large membership at an early stage could prove cumbersome for implementation. Getting all parties together is important in the end-stage. But you can only be successful and gain interest from all the different parts if you start with sufficient core coverage. So that is why you need to participate in a consortium. Maintaining interest and focus among consortium members — who are also natural competitors — is essential. Should projects seem less relevant or slow for their preferences, members may feel compelled to look elsewhere to newer consortia, bringing with them experience and information. For instance, Morgan Stanley, Santander, Goldman Sachs, and JP Morgan have all left R3 to embark on different blockchain projects. Because they still continue to monitor other initiatives because they don’t want to be like a monkey and looking only at the consortium that we chose. This is an actual bank logic.

Banks’ interest in consortia is focused on their utility to drive fresh ideas and co-operation between members. If for example, some initiate group has new blockchain initiatives, then we can use the network [consortium] to create fuel for a new DLT project, or prototypes that we would like to develop. Use cases that are relatively simple to design and implement, and which are combined with already tested technological solutions such as cryptocurrencies, are likely to find early adoption (for example, adding a digital currency payment option for wallets and cross-border payments). Multi organizational projects intended to reduce organizational complexity and reconcile multiple databases would be another possibility.

Financial services are extending this kind of collaboration to trusted counterparties to reduce costs through private blockchains. Truly disruptive blockchain solutions that depart from existing business practices carry a high potential for future growth, but their heightened complexity and need for stakeholder collaboration (such as elaborate financial instruments and smart contracts) will probably delay their adoption. There remains considerable regulatory uncertainty around blockchain and DLT. As such, consortium-based approaches are likely to persist as a means for enterprises to overcome first-mover risks.

As a result some possible conclusions

Blockchain offers the greatest perspectives for cross-border payments, in terms of ROI (return on investment), efficiency gains, and the mitigation of pain points. That is the main use case for banks and financial sector that will dominate in their blockchain strategies over the next years. The next is just possible follow up steps to disseminate the DLT use cases in banking:

· Do not stop building a business case — experimenting with sandbox modeling

· Joining the consortium — A bank may use membership as an opportunity to learn and see how to approach the technology, and structure projects from a resourcing perspective

· Appropriate underlying technology and implementation

· Growing the ecosystem requires co-opetition

· Meeting regulatory compliance

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Sergey Golubev (Сергей Голубев)

EU structural funds, ICO/STO/IEO projects, NGO & investment projects, project management, comprehensive support for business.