Enterprise Blockchains Now: A QuickStart Guide for Finance Professionals.
I know you’ve had enough.
Oh no, not another “blockchain intro”!
Let me explain. I come from a financial technology consulting background and I usually spend more time with the business than with the engineers.
On my journeys to explain blockchain to people in finance, I have concluded that one must leave the technical hat outside the conference room. We, financial technology consultants, sometimes struggle to do that, maybe because we fear that oversimplifying terms will lead to misconceptions. This is sometimes correct but I think that it is not the case with blockchain yet (for reasons that will need a separate post). In short, business people won’t always have the time or the capacity to hear about leading zeros while budget reports and cash forecasts await.
So, in this post, I will try to do the following:
- Give basic explanations in the most simple way
- Present a short summary of the current DLT-for-finance solutions landscape
- Tailor the writing to finance professionals and give my personal opinion on the subject
The terms blockchain, distributed ledger technology and DLT will be used interchangeably in this post.
Alright, let’s start. Can you explain the main idea with an example? I’ve seen a few explanations focusing on different stuff.
Ok. Think of the ERP module you use at work. Could be a treasury management system, an accounts payable system or a sales & distribution one, anything with a sub-ledger. The IT guys have made it airtight. Only you and your colleagues can enter and retrieve information, no external parties. This is company’s confidential data.
But actually, some of these data represent transactions and values exchanged with external entities. These are still confidential to the outside world, but not between you and your counterparty. When you pay a vendor for example, the payment amount is recorded on the ledger inside your airtight ERP, but this is also information which you share with the vendor. How do you share? Well, with invoices, emails, phone calls, hard copies, etc. You definitely not give the vendor any access to your ERP ledger. So, reconciliations must still be done, but outside each one’s ledger.
What if there was a way to record that common data on a shared ledger so that we don’t waste time with reconciliations and disputes? There you are…
Ok I got the example. Any technical terms I need to know?
This is the absolute minimum you will need to know:
❒ Distributed Ledger Technology (DLT): A technology architecture/concept under which multiple transacting parties (think companies, vendors, customers) share a common digital ledger over which they have common control. The ledger is updated with new transactions and data via an agreed consensus mechanism, without the need of a trusted central authority.
❒ Blockchain: A type of distributed ledger, where transactions are bundled in blocks and, via a consensus mechanism, are added to the ledger, forming a sequence (chain). Distributed ledgers which underpin the most famous cryptocurrencies (Bitcoin, Ethereum) are blockchains.
❒ Smart Contracts: Contracts written as computer programs which run on distributed ledgers and are executed when predefined conditions met. For example, an FX option contract, written in computer code and run on a distributed ledger would be a smart contract.
When does it make sense to use all these?
Just keep this in mind: Business networks with multiple, potentially distrusting, transacting counterparties, are blockchain use cases. Customers-vendors, banks-issuers-investors-regulators networks, etc.
What are the key benefits?
- Operational efficiency, time savings
- Cost savings
- Lower risk (litigation risk, settlement risk, FX risk, operational risk, depending on the business and the solution)
Where does this “crypto” thing come into play here?
Crypto stands for cryptography. Background: The blockchain idea was formulated for bitcoin. From this idea, enterprise blockchains were born. Bitcoin, as a digital asset, made it from concept to reality with a brilliant combination of computer science, finance, maths and cryptography.
Cryptography is paramount in the distributed ledger technology architecture. It secures the integrity of the ledgers and the validity of the transactions. So, whether it is the bitcoin public blockchain or your private enterprise distributed ledger network, cryptography is what it makes secure. How cryptography manages to do all these is an exciting subject by itsefl, but it is not for this summary post.
Does cryptography make blockchain transactions anonymous? Is anonymity a key point?
Well, not exactly. There are (still) a lot of misconceptions around that.
Let’s take a step back. Bitcoin, Ethereum and other blockchains are public. No, that doesn’t mean that “on the blockchain, everybody knows you are a dog”. Transactions on these public blockchains are pseudonymous and not anonymous. Your transactions and your accounts balances are there for everyone to see. But these accounts are just alphanumeric strings (see screenshot below). So, nobody knows it is you…until they find out.
But then, if privacy can be compromised in such a way, how will banks and other corporations use these blockchains?
They won’t use them. Or at least, not in this way.
The privacy question gave birth to what is called permissioned blockchains. The idea is again very simple: A permissioned blockchain is a private distributed ledger network where you need to be granted permission in order to become a member. The opposite is permissionless. As an individual, you can download any public, permissionless ledger (e.g. Bitcoin blockchain) and have a view of each and every transaction. You cannot do that in a permissioned blockchain unless you are a member. Think of a bank and its counterparties sharing a common, distributed ledger. They don’t want anyone to be able to view confidential transactions, so they set up a permissioned blockchain.
Ok, but I see there is again a privacy issue, albeit on a smaller scale: Won’t all members’ transactions with each other be visible to everyone in the same permissioned network?
No. The blockchain providers have developed solutions which make it possible to keep confidentiality within private networks at the transaction. You share only what you have to share and what you share is only visible to members with a legitimate interest (customers, investors, regulators, etc.).
How they made it?
In various ways, depending on the approach of the provider. Some rely on advanced cryptographic concepts and other on trusted hardware (such as Intel SGX). This can get very technical and it is not the aim of this post but it is important to know that there are different paths to transaction confidentiality.
So who are these blockchain providers?
The main players are the ones outlined below:
R3
R3 is a consortium of more than 200 companies. Their DLT solution is Corda. R3’s clear focus is the financial services industry and Corda offers a platform to write and host the industry’s contracts and transactions on a distributed ledger.
Hyperledger
Hyperledger is a hub under Linux foundation. Hyperledger’s most mature blockchain framework is Fabric. There is a growing number of software firms which develop solutions based on Hyperledger Fabric, addressing different supply chain issues such as food safety and conflict diamonds tracking. Hyperledger Fabric has been used in financial services pilot projects.
JP Morgan
JP Morgan needs no introduction as a firm. Quorum is the Bank’s DLT solution for the financial services industry. JPM’s team followed a different approach: Quorum is built as a version of the public Ethereum protocol with a focus on privacy and confidentiality of financial transactions.
Digital Asset
Digital Asset is a company building distributed ledger technology solutions, focused on regulated financial institutions. Digital Asset’s interesting approach distinguishes from its competitors because of the development of a modelling language, DAML, with which the firm’s applications are built.
Ripple
Ripple is primarily targeting the remittances business posing a direct threat to the current SWIFT business model. One of Ripple’s solutions, the xRapid, uses a native token, XRP, to settle payments. You couldn’t miss XRP in the news a few months ago, as its price saw a meteoric rise in 2017.
That’s all?
No. The above are the most well-known providers, with a global reach. There are other, smaller yet impressive, players in the DLT market for financial services. Some notable ones are Axoni and SETL, two DLT-focused capital markets technology firms. Nivaura, on the other side, is successfully testing public blockchains for financial transactions with the FCA’s approval, showing that permissioned networks might not be the only way for the industry.
Which is the best one?
There is no answer to that. Each company has taken its own approach. Some are very much alike, some other are fundamentally different. Time will show. It has been a common practice for financial institutions to test more than one frameworks in order to see the best fit
So, there is a fierce competition and a battle among networks until the winner prevails?
Not exactly. Right now, it seems that there won’t be a “winner-takes-all” situation. First of all, the different DLT providers, not only they have different approaches on how they build enterprise blockchains, but some differ on their focus. For example, Ripple has not (yet) attempted to present a solution for bond issuance. They are focused on payments and they are very strong in that with a very mature solution suite.
Secondly, the main potential customers of the blockchain providers have diversified their exposures. Citi is a member of both Hyperledger and R3 while being invested in Digital Asset. JP Morgan is also invested in Digital Asset while developing its own solution, Quorum. Large corporations, from banks to consultancies and software companies have chosen to be stakeholders in two or more different blockchain initiatives.
The market enjoys a healthy competition while efforts are being made on cross-protocols collaboration and standardization.
Any worth mentioning use cases recently?
Lots. A few recent examples below:
- On April 26, BBVA announced that it became the first global bank to issue a loan using distributed ledger technology.
- National Bank of Canada announced the issuance of a $150m Yankee bond which was simulated in Quorum blockchain with JP Morgan.
- R3 has been involved in a series of projects with its members banks. One of these projects involved the issuance of euro commercial paper with ABN Amro, Commerzbank, ING and KBC.
- Australian Securities Exchange, ASX will replace their clearing and settlement system with a DLT solution developed by Digital Asset.
- Santander launched a mobile app for cross-border payments which uses Ripple’s distributed ledger technology.
That’s impressive. What’s the flip side?
- Critics argue that this is all hype. Head over to the Financial Times and you will find out that most opinion articles are doubling down against blockchain. The main argument is that the incumbent architectures, which are based on trusted, central authorities, have served capitalism well and there is no compelling case to replace them.
- More testing is required. The current DLT offerings are getting more mature but they are still being developed based on the lessons learnt from proof-of-concept projects. Some solutions, with less business and regulatory complexity, are ready for production. Solutions in capital markets are taking baby steps towards adoption.
- With the abundance of DLT solutions, another issue has emerged: Interoperability. If different solutions pick up market share, they will need to be able to communicate between them. If not, the efficiency gains will be eliminated. Creating siloed information will make no sense for the DLT case. Imagine having to use two or three different platforms for capital markets and another two for payments without being able to transfer value and information to one another. Nope.
- Even if all technical issues are solved, the regulatory hurdles will knock the door. In fact, they have already started knocking. Fortunately, some regulators, such as the FCA in the UK and FINMA in Switzerland, have been very open-minded and welcoming of blockchain innovation by drawing guidelines and setting sandboxes. However, these initiatives are at an early stage and more countries will have to follow suit.
What’s your opinion?
Despite the legitimacy of some criticism, I do not believe that this is all hype.
But for me, the most interesting thing about blockchain is not among the common bullet-points list of immediate efficiency benefits. What I find most exciting about it, stems from what Marco Iansiti and Karim R. Lakhani describe as a foundational technology, in their Harvard Business Review article “The Truth About Blockchain”:
Blockchain, as a foundational technology, will need a lot of time to take hold because it fundamentally changes the way we do things. The exciting part about this is that there might be ways of doing things which we haven’t yet thought of. For example, it is now common knowledge that cross-border payments in the blockchain will be able to settle in seconds as opposed to days and this will save us time and money, but what will be the long-term effect? Will correspondent banking look the same after that? Will lightning-fast payments generate new business models?
An exciting road ahead!
Thanks for reading 😊 For any questions or angry comments on the subject, feel free to get in touch:
