Bitcoin has been a financial curiosity since its rise to prominence in 2009. However, it’s become clear that the real technological advance is not the cryptocurrency itself, but the blockchain technology that underpins it. Innovators, entrepreneurs, and academics explored the potential usefulness of blockchain technology, leading to predictions that it would revolutionise entire industries with its increases in efficiency and security. However, almost eight years later, blockchain is still primarily relegated to innovation labs and conceptual models.
What happened to the technology that was hailed as an archival panacea? How has the financial industry started working with it, and what are the plans for the future?
Part of the work of the last few years has been an evolution in the understanding of what blockchain technology is – and what exactly we should call it. Blockchain’s original connection to Bitcoin led to a public perception that it was only for scammers or money launderers. As Bitcoin itself has started to become recognised as a valid, if risky, store of value, so has blockchain’s reputation improved.
Nevertheless, the term blockchain is somewhat limiting, and innovators have adopted the moniker Distributed Ledger Technology (DLT) to better describe the technology. A blockchain is a kind of DLT, but there are other ways to establish a decentralised information network than using blocks and hashes.
Of course, for DLT to be effective, it requires digitised information. “DLT won’t be able to help and can’t be used unless there’s a way to digitise the data you want to open up to decentralised processing” says Ville Sointu, Head Of Distributed Ledger Core Development And Research at Nordea.
Sointu predicts that DLT is the key for industries that have been slow to enter the digital age, such as the paper-heavy real estate market. “The issue in digitising these processes so far has been linked to the complex multi stakeholder value chains that make it practically impossible to work on a centralised solution,” says Sointu. “DLT will be a key to unlocking the digitisation of markets like these and I wouldn’t be surprised if we see significant improvements in customer experience as a result even in the short term.”
For markets that have already become primarily digital, the rush to produce practical DLT applications has been swift. One group in Canada has moved past the use case phase and has a working Proof of Concept that they say could revolutionise identify verification.
SecureKey, a Toronto-based startup, partnered with six of Canada’s largest banks to develop a new “identity network.” Using blockchain technology, the new platform will allow banks to share information about new customers for a smaller cost than using external credit agencies. In addition, the decentralised network avoids the security risk of an information-dense central database.
These kinds of decentralised information-sharing networks have many practical use cases currently being explored within the financial sector. Some of the most promising include simplifying regulatory reporting, transforming paper-heavy trade finance transactions, streamlining reconciliation processes in clearing and settlements, and improving compliance and Know Your Customer (KYC) processes.
The historical challenge with shared digital KYC data has been to find a regulated and trusted entity to provide a secure central storage for all that data. DLT is poised to address those challenges in three key ways:
- Resilience: with DLT there is no central point of failure as each identity-issuing entity runs its own node.
- Immutability: because there is no central database, no single entity can change the data without detection.
- Transparency: DLT makes it easier to comply with GDPR requirements through a decentralised identity solution.
“Last year, Nordea presented KYC pilot outcomes – executed in cooperation with other Nordic peer financial institutions – that aimed to improve customer experience and providing an efficient KYC process for the Nordic financial sector,” said Erik Zingmark, Co-head of Transaction Banking at Nordea. “The hope is that DLT can usher in more efficient digital identity management and a single source for customer data sharing across banks and for reporting to regulators.”
Adoption into banking industry: finding a standard
For DLT to become truly disruptive, it requires cooperation across the financial industry. “It is important to create a common language between this new transactional technology and regulation,” says Sointu. “Being the operating system for the existing financial regulation is what the banks do today and this will be no different as we move to a more efficient and decentralised infrastructure technology. Initiatives like R3 are in a key position to create the necessary integration with law and regulation.”
The R3 group is a consortium of over 70 of the world’s largest financial institutions committed to the research and development of DLT solutions within the financial industry. The consortium has created an open-source DLT platform called Corda, specially designed to handle the complexity and sensitivity of banking transactions. It is the R3 group’s goal to make Corda an industry-wide platform, ensuring compatibility between network participants, while still allowing for innovation with its open-source availability.
Similarly, there have been a number of advancements in the area of trade finance. Seven major European banks have partnered to develop the Digital Trade Chain (DTC), a platform that uses a distributed ledger to manage open account trade transactions. The goal of DTC is to simplify domestic and cross-border commerce, especially for SMEs, by reducing transaction costs.
Practical implications for treasuries
To put DLT to use within your treasury, it is important to remember that it all comes back to the data. “Data standardisation and digitisation remain a key prerequisite for any successful effort in this domain,” says Sointu. “Once information is digital, it can be operationalised and integrated efficiently with DLT.”
And once those DLT solutions are up and running, treasuries are poised to benefit in numerous ways. “Corporate treasuries will benefit from things like real time settlement, asset transparency and transaction immutability,” says Sointu. Treasuries will also benefit from the developing infrastructure that will soon be available to corporates.
The benefits of DLT can also exceed the bounds of the treasury department. “If you’re currently dealing with any type of reconciliation of data with multiple stakeholders and don’t have a proper incentive to build a shared centralised database as a single source of truth, DLT technology can help,” says Sointu. “In all its simplicity we can build a real time reconciliation facility for any data sets without the need to have a centralised database.”
Even more, once the DLT is functional, the integrated data and processes will automatically become interoperable across the enterprise, leading to previously unseen or unrealisable benefits from regulatory reporting, data analytics, etc.
Sointu recommends that treasuries look for ways to capitalise on the investments of the industry into technology development: “As a corporate treasurer I would be well advised to actively pursue solutions that deliver this value to me in a standard way without generating a vendor lock in or even more technology debt.”
Finding the tipping point
DLT applications are still in their infancy, but it is clear that they represent some of the most exciting opportunities for technological advancement, especially within finance. Companies who are not actively pursuing opportunities to engage with DLT will miss out on the first wave of innovation.
“DLT and blockchain need to be on the agenda in any company’s digital transformation journey along with other key technologies like machine learning, big data and cloud computing,” says Sointu. “This means that a top down approach is necessary all the way from CDO/CTO level.”
However, it is still difficult to say exactly when DLT solutions will fully saturate the market. The rate of growth may be exponential, but transformation takes time.
“Predicting this tipping point for any technology is hard and more so when we’re talking about a change not only in technology but the way companies are structured and the way they conduct business with their peers,” says Sointu. “Because of this broad impact we’ve been predicting a time frame of 5 to 10 years.”
Blockchain vs. Distributed Ledger
A blockchain is a digital record organised into blocks and secured using a cryptographic hash. Blockchains are inherently resistant to the modification of data, making them more secure and reliable than other methods currently available to record and store digital transactions. The concept of the blockchain came from Satoshi Nakamoto who used it as a core component of the digital currency Bitcoin.
A distributed ledger is a consensus of replicated, shared, and synchronised digital data geographically spread across multiple sites, countries, or institutions. There is no central administrator or centralised data storage.
A blockchain is an example of a distributed ledger, but distributed ledgers need not use a chain of blocks or a hash to achieve a distributed consensus.
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