The 451 Take
Among all industries, the financial industry is perhaps the furthest along in experimenting with and implementing blockchain and distributed ledger technology. At the end of the day, the first application of the technology was a digital currency. However, we believe that real-world adoption is coming slower than anticipated by some because blockchain technology requires a significant mindset shift and openness – running a successful proof-of-concept project is not enough. One must have sufficient confidence in the technology, governance of blockchain networks must be carefully considered and regulatory concerns need to be sorted out. Many financial institutions rely on decades-old systems that creak and groan when confronted with modern and disruptive technologies. Additionally, the 2017 frenzy around cryptocurrencies and initial coin offerings has been a double-edged sword. Nonetheless, many stakeholders in the industry seem to believe in the disruptive and transformational potential of this technology, and there are live implementations to support that.
The Early Days
In that same year, a consortium of 42 banks came together, led by fintech firm R3 (formerly R3CEV), to explore banking use cases such as securities settlements and payments. This newly formed consortium identified two key limitations of permissionless blockchains in existence at that point, in the context of complex business transactions that take place in the financial sector: privacy and finality of transactions. Consequently, R3 started to develop a financial-grade platform dubbed Corda that would address these limitations. An early version of Corda was launched in 2016.
Multinational investment bank JPMorgan Chase, in particular, has had a bumpy relationship with bitcoin and cryptocurrencies over the years. However, the bank has been experimenting with blockchain technology and developed Quorum, a permissioned blockchain platform built on the Ethereum protocol. JPMorgan is also a founding member of the Enterprise Ethereum Alliance (EEA). At a recent press conference, the bank's CIO made a statement claiming that blockchain technology will replace existing financial systems in the next few years.
There are myriad financial use cases that have been explored in the last five years, including record reconciliation, cross-border micropayments, trade finance, know your customer (KYC) compliance and intra-bank funds transfer, among many others. A 2015 report on fintech 2.0 – released by Santander InnoVentures, in collaboration with Oliver Wyman and Anthemis Group – claimed that distributed ledger technology (DLT) could reduce banks' infrastructure costs (attributable to cross-border payments, securities trading and regulatory compliance) by up to $20bn per year by 2022, and acknowledged that it has the potential to transform modern banking. Blockchain Revolution, a book originally published in 2016 by Don and Alex Tapscott, extensively studies how blockchain technology is changing money, and its potential to transform business and the world as we know it. Blockchain is gathering increasing interest and excitement from stakeholders and observers of all varieties, but that hasn't yet guaranteed its role in financial services.
The Converts and The Skeptics
Payment startups are moving in different directions on the topic of cryptocurrencies and blockchain. Square, for instance, allows consumers in all 50 US states to buy and sell bitcoins using its peer-to-peer payments service, the Cash App, but does not currently enable merchants to accept bitcoin for transactions. Stripe was one of the first payment processors to allow its merchant customers to accept bitcoin payments back in 2014, but officially discontinued acceptance in April, due to declining customer demand and issues with transaction latency. Stripe is, however, a seed investor in decentralized payment network startup Stellar, which offers its own cryptocurrency called Lumens.
Cryptocurrencies and initial coin offerings (ICOs), in particular, have also mustered a group of critics made up of well-known figures from the world of finance and technology. Although cryptocurrencies have become part of our financial system, they continue to be experiments – 2017 was a frenetic year in terms of ICOs and cryptocurrency prices. ICOs are an innovative method of fundraising, but offer investors little protection from losses due to naïve management teams, poorly conceived products and outright fraud. Many of these ICOs seem to meet the criteria to be classified as securities, although they don't typically register as such. The US Securities and Exchange Commission (SEC) has been conducting investigations, and warns that fraud is likely abundant in this market.
Enterprise Adoption Hurdles
Successful proofs of concept and working testing environments are certainly not enough to get the ball rolling – there are still a handful of both technical (e.g., scalability) and business challenges (e.g., mindset shift) that the industry and early adopters need to overcome before blockchain can gain real traction. Financial institutions are inherently risk-averse, with rigid corporate cultures that tend to resist, not embrace, change. Furthermore, many rely on decades-old core banking systems that creak and groan when confronted with modern technologies.
Challenges also stem from the deeply entrenched nature of the infrastructure and processes that enable transactions around the globe. On the topic of card payments, for instance, blockchain is positioned on paper as a conceivable alternative to traditional payment networks like Visa and Mastercard. However, these networks are firmly rooted in retail payments, and have spent more than half a century building out distribution channels, broad merchant and consumer access, widely recognized acceptance marks, and clearly defined operating rules for banks and merchants. Displacing a system of this size and scale will not come without hurdles.
Technology Vendors and Startups at the Forefront
We have also come across startups that reportedly have paying customers using their blockchain-powered offerings. California-based ShoCard's digital identity technology, for example, is reportedly being used by banks and credit card companies to verify the identity of customers in compliance with know-your-customer obligations, and share credentials with other financial institutions. It is also used by Creditinfo to allow consumers to share credit reports with banks. BlockApps, the first company incubated out of ConsenSys in 2015 and a founding member of the EEA, is also commercializing blockchain technology, targeting businesses in finance and insurance. UK-based Gospel Technology's enterprise-grade data platform can be used in multiple industries, including the financial industry, to reduce data breaches and secure the sharing of sensitive data.
Live Blockchain Networks in the Financial Sector
One example of a live implementation is the we.trade platform, which is currently operating across 11 European countries. It was established by a group of European banks, including Deutsche Bank, HSBC, KBC, Natixis, Nordea, Rabobank, Santander, Société Générale and UniCredit, which teamed with IBM to build a fully automated platform that leverages Hyperledger Fabric for tracking and managing trade transactions between SMBs. The platform essentially brings together the parties involved in trade (i.e., buyer, buyer's bank, seller, seller's bank and transportation companies) and records the entire trade process, from order to payment, while guaranteeing automatic payment when all contractual conditions are met.
Finastra's Fusion LenderComm – a marketplace for syndicated lending and loan trading – is built on Corda and has been live since April. It enables financial institutions to publish loan data to the ledger, which lenders can see, eliminating the need for doing queries by phone, fax or email. It essentially digitizes communication between banks and lenders. It was developed in close collaboration with banks including BNP Paribas, BNY Mellon, NSBC, ING and State Street.
Nasdaq, the world's second-largest stock exchange by market cap, has been early in experimenting with blockchain for trading private securities. Starting earlier this year, private company security investors on Nasdaq's Linq platform can use Citi's cross-border, multi-currency payment service, CitiConnect for Blockchain, to buy, sell and settle transactions.
Tradewind's VaultChain Gold is a gold-trading platform built upon Corda. The Royal Canadian Mint stores the gold for Tradewind, while VaultChain is used for recording the titles for ownership. Also, the Mint contractually guarantees that the gold can be physically delivered to authorized liquidity providers and dealers.
Current regulations and regulatory initiatives are mostly limited to cryptocurrencies and ICOs, and governments around the world are taking different stances – from outright banning cryptocurrencies and ICOs to being 'crypto-friendly' and even issuing their own cryptocurrency. The SEC, in particular, has been very active in conducting investigations into ICOs and cryptocurrencies. It has even launched a fake ICO to help investors identify fraudulent initial coin offerings.
China, for example, has banned ICOs, prohibited crypto operations for banks and crypto-to-fiat operations for exchanges, and blocked access to offshore crypto exchanges and ICO websites. However, despite the strict regulation of cryptocurrencies, blockchain technology is part of the government's 13th Five-Year Plan (2016-2020), and China's president, Xi Jinping, has been increasingly endorsing blockchain technology at formal appearances. (China's Five-Year Plans are roadmaps for economic and social development.)
Most governments around the world seem to recognize the value of blockchain technology overall for public services, as well as the corporate sector. The main purpose of regulation here is to protect the public while letting innovation flourish, and innovators and early adopters will need to work with regulators so regulation can evolve in the right direction.
The EU, in particular, is not rushing into regulating the blockchain space to avoid curbing innovation and falling behind in technological advancement. Regulatory forces such as PSD2 (EU) and Open Banking (UK) could create market opportunities for blockchain. We see specific use cases pertaining to API access and management and implementing Strong Customer Authentication (SCA) stemming from these regulations. These regulations may guide the hands of European financial institutions to modernize their core banking systems to better support third-party collaboration and data access, which could create an entry point for blockchain to work its way into banks' back-office infrastructures.
Csilla is a senior analyst for 451 Research’s Data, AI & Analytics channel. She currently focuses on decoding the blockchain market to help replace confusion and complexity with an examination of the technology, the competitive landscape and available solutions that are driving the market, as well as real-world use cases and deployments.
Jordan McKee is a Research Director for Customer Experience & Commerce, and also leads 451 Research’s coverage of the payments ecosystem. He focuses on digital transformation across the commerce value chain, with an emphasis on the major trends impacting payment networks, issuing and acquiring banks, payment processors and point-of-sale providers.
Keith Dawson is a principal analyst in 451 Research's Customer Experience & Commerce practice, primarily covering marketing technology. Keith has been covering the intersection of communications and enterprise software for 25 years, mainly looking at how to influence and optimize the customer experience.