Suits join the hoodies with blockchain push
Cost savings and low returns drive lenders into working with system underpinning bitcoin
Early bitcoin enthusiasts hailed the cryptocurrency as a revolutionary way to sideline banks in a libertarian drive to upend the traditional order of capitalism.
Since then the banks have fought back. Nowadays most people attending conferences about the blockchain technology that underpins bitcoin are more likely to be wearing suits than the hoodies and ripped jeans of a few years ago.
Having kept their distance from bitcoin, fearing the risks of fraud and criminality, big banks now see huge potential benefits from harnessing the blockchain to make the existing financial system more efficient.
“In today’s banking world, it is all about cost savings, as they are all struggling with low returns and that is why they are all locking on to the blockchain,” says Richard Lumb, head of financial services at Accenture.
The latest example of big banks organising themselves to exploit the potential of blockchain technology came this week with the announcement that four big lenders have teamed up to develop a “utility settlement coin” — a new form of digital cash.
The four banks — UBS, Santander, Deutsche Bank and BNY Mellon, which are working with UK broker ICAP and developer Clearmatics Technologies — stress that they are not creating a new cryptocurrency.
Instead, the system they are developing uses blockchain technology to create different coins that are each directly convertible into existing currencies deposited at central banks. In essence, it is a way of putting dollars, euros and pounds on the blockchain.
While other digital cash projects are being examined by banks — such as Citigroup’s Citicoin or Goldman Sachs’ “SETLcoin” — this is the first time several institutions have teamed up to create a digital cash utility for use in financial markets.
So how does it work? And what problem is it trying to solve?
The coins are stored on a network of computers, all of which must approve that a transaction has taken place before it is recorded in a “chain” of computer code. Cryptography is used to keep transactions secure and costs are shared by members.
Details of transfers are recorded on a ledger that anyone on the network can see, eliminating the need for a central authority, which is why the technology has also been dubbed a “distributed ledger”.
The aim is to speed up clearing and settlement in financial markets by allowing institutions to pay for securities, such as bonds and equities, without waiting for traditional money transfers to be completed in the so-called delivery-versus-payment process.
Four of the world’s biggest banks are collaborating on a new blockchain project to transform the way securities trades are processed, with the aim of making it cheaper and safer. Patrick Jenkins asks Martin Arnold, the FT’s banking editor, to explain what’s behind the development.
By switching clearing and settlement of financial markets on to a distributed ledger, the banks hope to do away with much of their costly back office operations that process trades and keep records up to date. Quicker settlement should also free up capital that banks hold against trading risk.
Hyder Jaffrey, head of fintech innovation at UBS, says: “Every bank, exchange and clearing house, we all have our own sets of the same data, which get out of sync and have to be updated and reconciled.”
“The distributed ledger is the first technology which could implement a shared golden copy of that data,” says Mr Jaffrey. “If you have that breakthrough you can really see how that would be revolutionary in the financial world.”
Total savings from using blockchain technology in payments, securities trading and regulatory compliance could reach $15bn-$20bn a year by 2022, according to a recent report by Santander, Oliver Wyman and Anthemis.
The consortium behind the universal settlement coin is aiming for a commercial launch by early 2018, by which time it expects to add many new members to its ranks, which are being kept small to retain flexibility.
It plans to spend the next year winning over central banks and regulators, whose support is essential for the project to succeed. Central bankers are warming to the idea of digital currencies and some, such as the Bank of England, are actively working on creating their own — so they are likely to be supportive.
The project, however, still faces many challenges. One is transaction speed. Bitcoin is often criticised for being unable to scale up because its blockchain can handle only about seven transactions a second, as opposed to, say, the 24,000 a second that Visa can. Any solution from the banks will have to be fast and capable of processing heavy loads.
There is also a question over whether the banks will lose almost as much revenue as they save in costs. They make $1.7tn a year, or 40 per cent of total revenue, from global payment services, according to McKinsey. How much of that could be replaced by a blockchain payments solution?
Finally, the proliferation of various blockchain projects among banks, already numbering in their hundreds, raises fears of whether they will coalesce around a single standard or end up using several incompatible technologies.
“Everyone is hoping they can rise up and be the new Microsoft,” says Michael Parsons, a consultant advising big banks on the blockchain. “None of the banks in a consortium has a competitive advantage as they are sharing the information, but if they work separately they haven’t got economies of scale.”
Some sceptics reckon the banks are missing the point. “This is banks talking to each other and the point of blockchain is to establish consensus in the presence of potentially untrusted actors, as with bitcoin, on the internet,” says Dave Birch, of payments consultancy Consult Hyperion.
“It’s a sorry state of affairs, that technology is not going to fix, if the banks don’t trust each other. “
The hoodie-wearing bitcoin pioneers may be despairing to see their creation hijacked by the big banks. But Mr Jaffrey at UBS says many people now working on the blockchain for banks started their careers on bitcoin projects.
“In terms of the debate about hoodies versus the suits, a lot of the so-called hoodies are the ones working with the suits on these solutions,” he says. “We need their expertise.”