Starting a Conversation about Blockchain and WealthTech

July 23, 2018

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What is blockchain technology? If your answer is Bitcoin, then you need to read the next few paragraphs.  If your answer is distributed ledger technology, and you know what that implies in terms of creating a trusted, single source of truth and eliminating the need for third-party intermediaries than you can probably skip the brief explanation.

What Is Blockchain/Distributed Ledger Technology?

Blockchain technology is a distributed ledger database architecture that provides the ability to share, replicate and synchronize transactions among members of a network. The distributed ledger records the transactions among the participants in the network.

These participants have agreed to the governance of the network and agree by consensus on all updates. No central, third-party mediator, such as a financial institution or clearinghouse, is required.

Every record has a timestamp and unique cryptographic signature or hash value creating a transparent, auditable, permanent history of all transactions in the network.  Any attempt to change a transaction, no matter how small the change, will result in a different hash value and creates a new transaction which requires consensus. Additional cryptographic signatures ensure the origination of the transactions.  And additional controls ensure that members can only view relevant transactions.

At its core, the system records the chronological order of transactions with all participants agreeing to the validity of transactions using the chosen consensus model. The result is transactions that are irreversible and agreed to by all members of the network.

Public versus Private Distributed Ledgers

A public distributed ledger is open to anyone who wishes to participate – Bitcoin and other cryptocurrencies are public ledgers.  The amount of computational required to maintain a public “blockchain” is enormous since it requires each participant or node to solve a complex cryptographic problem – the proof of work – to ensure all nodes are in concurrence.  The degree of resource intensity slows the number of transactions that can be processed without massive (and expensive) increments in computing power.

The privacy and security provided through a public blockchain are also far below the requirements of regulated financial services requirements.

Private blockchains are more secure, and much faster, requiring less computational power since the number of participants is limited.  They can economically handle significant transaction volumes in a highly secure environment.  Every blockchain project being researched, developed or implemented within the financial services universe is based on a private blockchain.

The Value

Utilizing private blockchain eliminates the need every for participant maintaining their own data.  Whether the blockchain is established extramurally – with outside business partners or intramurally between functional or line of business groups within a single business. It streamlines reconciliation and ultimately will enable reconciliation as part of the transaction process.

A single source of truth eliminates tremendous costs. Accenture published an analysis of global capital markets banks in 2016 which estimated savings from the use of a distributed ledger technology:

Financial Reporting   70%

KYC/On-Boarding     50%

Audit                         30-50%

Although it will be an incremental process, Blockchain can ultimately solve the data quality problem that every firm struggles with.

Where is Blockchain Valuable?

To determine whether your use case is a good fit for blockchain, IBM’s Blockchain primer recommends you ask yourself these questions:

  • Is a business network (either external or internal) involved?
  • Is consensus used to validate transactions?
  • Is an audit trail, or provenance, required?
  • Must the record of transactions be immutable, or tamper proof?
  • Should dispute resolution be final?

Is Blockchain DLT “for real”/here to stay?

In a single word, yes.  Investment by financial services firms in blockchain increased by 67 percent in 2017 from the previous year, up to a total of $1.7 billion according to Greenwich Associates. IDC estimates $945 million was spent on actual solutions (not R&D, VC or equity investments, etc.) Solution spending is projected to reach $2.1 billion by 2018 year-end.

Through 2017, the 10 largest US banks by assets have participated in $267 million in disclosed investments in six blockchain companies focused on financial services. This includes direct investment or partnerships with start-ups including Axoni, Chain, Digital Asset.  Investments continue to shift between private blockchains, public blockchains, and consortia. Overall,  more than 50 of the world’s largest financial services institutions have invested in external blockchain initiatives.

Besides the types of direct investment mentioned above, internal projects intended to become a standalone business like CitiCoin (Citi), Quorum (JP Morgan Chase) and SETLcoin (Goldman Sachs) and partnerships with DTCC, NASDAQ, Microsoft, and others are distinct, separate investments apart from internal R&D and development initiatives.  Overall, financial institutions own more than 20% of all blockchain related patents. The top 10 patent holders include BankofAmerica/Merrill Lynch, Fidelity Investments, TD, NASDAQ, Goldman Sachs and BoNYMellon along with Accenture and IBM.

A Recent IBM survey data found 91% of banks will be investing in blockchain solutions by the end of 2018.  With 66% of institutions expecting to be in production and running at scale with one or more blockchain solutions.

Considerations as you embark on the blockchain road

A lot more goes into designing a roadmap for exploiting the many use cases you will identify than the IBM questions. Applications of blockchain will differ by use case, each leveraging the technology in different ways.

Assets managed in a distributed ledger currently range from securities to prescription drugs to pork bellies to KYC data.   The agreed upon contractual terms used in governance include multiple rule sets and both AI and Bot technologies are being successfully integrated into the transaction flow.

Real-time securities settlement comprises a different network, different information and different assets than real-time trade surveillance, but both are possible using distributed ledger technology.

The same is true for regulatory trade reporting or sales surveillance (a regulatory agency may be part of a network.)  And initial onboarding and management of KYC data can comprise a separate but overlapping set.

Some of these networks may be purely internal, but to maximize the value of the data involved need the ability to share information with external DL networks.  The ability to share costs and the benefit of network effects of shared data will increase the value of the appropriately designed solutions

How do I establish my priorities regarding blockchain?

Blockchain has a long way to go, but how do you start, how do you think about vendors and current data integration, where does this fit in your infrastructure roadmap today?

Some key questions to ask yourself as you start:

  • Do my current solution providers understand blockchain/DLT and how to exploit it?
  • Where is my clearing firm headed? Will they become a Blockchain/DLT solution provider to supplant their current revenues/role in the settlement process?
  • How should I think about exploiting blockchain on an incremental basis?
  • Should my infrastructure roadmap contemplate cloud computing that includes blockchain/DLT technologies in conjunction with AI, robots and data analytics delivered through cloud services
  • What industry groups should I be aware of or participate in?
  • How do I evaluate joining or forming a cooperative network or consortium?
That is the primer.  Stay tuned.