12 Jan3 Blockchain Thoughts for 2016

The year is off and running. Blockchain and the potential for massive back-office savings is at the front of both mind and mouth. I offer the thoughts here with no desire “to be right”. Rather, I am suggesting that these are the areas  in the FS industry which need  focus and understanding. Without this, progress will be slow and investment time and money mis-spent.

Banks have to cooperate. My sense is that to make a big difference across the financial services industry, we need global, industry-wide initiatives. Each year, banks spend $65 to $8o billion in operational on all post-trade activities. The wise and thoughtful COO at SETL, Peter Randall, has suggested that there is the potential to save a significant share of this expense. I agree with him.

#1: Nobody gains big until we all cooperate

Banks are as a rule inefficient. They can and do save costs by centralising & streamlining. In fact, sometimes they are quite successful. The Jan 11th Bloomberg article offers some encouragement. See : “Wall Street’s Big Ax Seen Reaping Best Year-End Profit Since ’06“. But, there are limits to what any one bank can do on its own. This is because, the industry has to work together every day to settle transactions. In simple terms, the banks can only be as efficient as the market mechanisms allow.

Let’s imagine we would like to have a lower cost, faster settlement in securities. We’d like this to span the whole life cycle of a trade. All the way from order entry, through execution, to affirmation, confirmation, allocation, settlement instructing and actual settlement. Well, as long there are CSD, Central Securities Depositories in each country, ICSD’s, the International CSD’s and CCP’s, the Central Counterparties, then any one Operations department has to manage them all. Many countries, many bank accounts, many relationships. Entropy, or “Heinz 57 Varieties” kills.

Two initiatives are worth keeping an eye on in this space:

SETL; this has some hedge fund backing, as well as a working model of a Blockchain platform. This team is now looking for funding. The aim is to have direct Tier 1 Investment Bank financing and participation. So, potential product, not enough backers yet.

R3Cev; this industry consortium of 40+ banks has wide and deep backing . A platform, most likely with product specific variations, is in the pipeline. Just maybe there are too many cooks there. So, backers galore, but no product yet.

#2: It’s money that matters

Nasdaq has announced its first transaction on a Blockchain platform. This needs to be taken with a big pinch of salt. This new platform will no doubt service many aspects of the actual trade and the settlement lifecycle. I would also expect that the this real-life example bodes well for big improvements and cost savings in the post-trade world. To the best of my knowledge though, one thing was not part of the new Blockchain based process: payment.

Cash is an essential ingredient for settlement in financial services. The “secret sauce” is central bank money. Great things will be possible, if the central banks take part in the evolution. They need to be willing to act as agents to move balances from fiat currency to digital currency.

In the successful mobile payments system in Kenya, M-Pesa, the mobile providers act as conversion agents between two worlds. They are overseen by the local Central Bank. This model has worked so far because M-Pesa is not yet systemically relevant. The individual amounts moved or held are relatively small. Delivering a step change in wholesale banking would involve much larger value payments. This would need a more regulated environment.

#3 We might just see an experiment in 2016

Coexistence of the status quo and a new Blockchain world is essential. The old world is unlikely to disappear overnight in another Big Bang. Trust in any new system is a must. This will need some exhaustive rule setting, consensus and testing.

The birth of CLS offers some guidance on what to expect. New global platforms involve a long struggle. They take longer to start, need more testing and consume more investment than envisaged.

If one or more Central Banks are willing to support a trial in 2016, that alone would be a huge step. An alternative is to trial the technology in a different market place. One of my newer industry contacts made a creative suggestion over coffee.  Apply Blockchain to a large loyalty scheme that has several corporate sponsors. This would offer some exciting prospects. Several corporates could offer the same points scheme, following the example of the airlines. The points would be like money and you would be able to use them at the point of sale. Beyond that there are enticing possibilities. For example, there might be a market for swapping one type of point for another. I am intrigued by the prospects. For example, perhaps being able to swap my “Lufthansa Miles & More” balance for much more useful “British Airways Avios”.

Lessons Learned:  There is huge potential in the Blockchain. The head of steam built up around this will lead us somewhere useful. But, it will be hard work to get there and it will be a long road.

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