Blockchain has become one of the most talked about topics in finance with an estimated $1.7 billion* invested in Blockchain ventures to date. But what is it? At a very high level, Blockchain is an electronic ledger of transactions that is continuously maintained and verified in “blocks” of records. The ledger is shared between parties on a server and protected from tampering using cryptography. Blockchains allow encrypted data transactions on anything (contracts, money, medical records etc.) to be instantly shared between parties. Blockchain is also talked about as a DLT (Distributed Ledger Technology).
Why the hype in Capital Markets?
Why would Blythe Masters, the former JP Morgan banker who created the Credit Default Swap (CDS), call Blockchain the most important technology since the development of the internet?
The potential for mutual distributed ledgers to transform settlements and clearing, and subsequently save billions, by eliminating trade inefficiencies and the need for trade insurance, is real. Its predicted that distributed ledger technology could reduce a banks infrastructure costs by $15 – 20 billion a year by 2022. These cost savings would be extremely welcome as banks continue to struggle in boosting profitability. Blockchain can also be used in other parts of the bank included KYC / AML and could be a very powerful tool for regulators – some regulators are offering banks safe sandbox environments to understand the risks involved but will ultimately require cross border regulatory sign-off which leads me to my next point.
Technology itself does not address the key challenge in applying distributed ledgers to achieve the final prize. The key issue to achieve these types of cost savings and efficiencies is co-operation amongst the banks and governance. Blockchain, like the Euro, requires unification around central systems and getting competing banks to agree on governance, data sharing and storage is extremely difficult. Changing the mindset from centralised to decentralised business models is a profound shift. Questions such as who dictates and enforces the rules of the system, and how do we deal with issues when things go wrong all need answers. Governance is key and the real innovation is compliance and adherence to a central standard or protocol – a process of assimilation.
Due to the scale of governance required to drive value through Blockchain, I predict we will see real breakthroughs in concentrated markets – where concentrated leaders can easily set up standards and governance with less issues aligning incentives and cost sharing. Dubai is a great example where they are investing heavily in how to use Blockchain technology across the UAE. We are starting to see some real-world applications (e.g. ASX with equities, Nasdaq / Citi for private securities, DTCC for CDS trades, Euroclear for the London gold market etc.) but there are issues outside technology that need to be addressed to turn the hype into a real market changer.
PS – As the UK/I Capital Markets Blockchain lead, please reach out to discuss any issues related to Blockchain and how I can help or bring together groups / synergies across banks and regulators.
*according to data tracked by industry media company Coindesk