Major global banks back R3 with $100 million

Bank consortium R3 CEV has secured $107 million in the second portion of its series A funding round — one of the largest blockchain funding rounds to date.

R3 said it is using the funds on the deployment of its technology and to develop more strategic partnerships. The company endured some minor PR blows last year when some of its high profile members defected from the consortium, including Goldman Sachs, Santander, Morgan Stanley, National Australia Bank and as of last month, JPMorgan Chase.

Bank of America Merrill Lynch, Bank of Montreal, Bank of New York Mellon, Barclays, BBVA, BNP Paribas, Citi, Credit Suisse, Deutsche Bank, HSBC, ING, Mizuho, Royal Bank of Canada, Societe Generale, TD Bank, The Bank of Tokyo-Mitsubishi, The Northern Trust Company, The Royal Bank of Scotland, U.S. Bank, UBS and Wells Fargo are among the 43 member participants. R3 made the first and second portions of the round open to the consortium’s bank members only; the third and final part will also be open to non-member institutional investors. R3 expects to reach at least $150 million when the third tranche closes.

“Our strength has always been our global reach, helping people do business within and across borders all over the world,” said Kaushalya Somasundaram, head of fintech strategy and partnerships at HSBC. “We’re keen to explore ways to make financial markets, and payment and trade networks more connected, more accessible and more secure,” which HSBC plans to achieve through the collaborative approach at the heart of R3’s model.

The company will focus its technology deployment efforts on Corda, its blockchain-like distributed ledger for exchanging financial agreements among financial instituttions; as well as its infrastructure network for partner built financial applications.

R3 did not disclose its valuation or its investment framework, in which interest initially rose in November members began dropping out of the group. Santander said it would refocus its blockchain efforts on other bank co-led projects — like Utility Settlement Coin and the Global Payments Steering Group — and JPMorgan, which is also involved in other bank blockchain collaborations, wanted to pursue a technology path that’s “at odds” with R3’s strategy. But Goldman reportedly backed out when conditions of the investment framework changed.

R3 initially sought to raise $200 million from its members in a round that would have granted them 90 percent of the firm’s equity with the remaining 10 percent going to R3 itself. That deal was renegotiated in the fall to a $150 million target that would give members a a 60 percent equity stake and R3 the remaining 40 percent. Goldman allegedly sought more leverage in the deal and a board seat.

The funding announcement comes a day after R3’s rival Enterprise Ethereum Alliance, the R3-like group building solutions with the open source ethereum, revealed it has exploded in new members — bringing its total membership to 116 from 30.

Why blockchains won’t revolutionize finance

Blockchains are capable of a lot.

They’re good for tracking pork chops. They can help put a stop to the spread of conflict diamonds. With blockchains, doctors can better track patient data, freeing them up to actually see their patients instead of fiddling with all that paperwork. Refugees who don’t have access to basic health and financial services because they don’t have paper proof of existence may be able to get “official” digital identities, thanks to blockchains.

But financial services doesn’t have any such imperatives forcing it to dedicate millions of dollars in research, talent and venture investments in blockchain technology. For this industry it’s really just advanced database technology. It may help it save money – but it’s not a revolution.

“Really [blockchain companies are] building a feature, and I think this is what people have got to understand,” said Jamie Burke, CEO of Outlier Ventures, a research group for blockchain use cases. “The best outcome is it’s bought by an incumbent and it’s just going to become a feature of that incumbent, and that’s fine. I don’t think you’re going to be building the next SAP – as much as everyone thinks that’s going to happen I just don’t see that happening.”

Incidentally, SAP, the software and IT firm, has just partnered with Everledger, a blockchain company that tracks the provenance of diamonds, to build blockchain capabilities into its business network. It also joined the Hyperledger blockchain community.

Let’s start from the beginning
Broadly speaking, a blockchain is a shared ledger that’s maintained and verified by the participants of its network – two different financial institutions, for example – and doesn’t rely on any one party to manage it. It is updated almost immediately when new information – like details of a financial transaction – is added. It’s different from other database technology in that the ledger is completely immutable; the information on it can’t be tampered with or edited. (For the purposes of this article, “blockchain” is shorthand for “distributed ledger technology.” This is not an argument about semantics.)

When using the R word it’s important to remember that it is incredibly difficult to “disrupt” industries as highly scrutinized as financial services. New technology needs to integrate with old systems and interfaces – those don’t get replaced overnight. It’s also the kind of technology that’s most effective when there’s a network effect and currently, most organizations are still exploring why they actually “need” blockchains and which iteration of the technology is going to work best for them.

Outlier, which serves as a startup incubator and accelerator, has met 1,220 blockchain startups in the last four years (that’s almost one per day). AngelList alone lists 543 blockchain startups and 739 blockchain investors. Venture Scanner is tracking 882 bitcoin and blockchain companies across 73 countries. Digital Currency Group is invested in at least 80 blockchain companies.

According to Burke, 99 percent of them are overhyped.

“If 90 percent of everyday startups fail in their first three years, 99 percent in blockchain may very well be close to actuality,” he wrote this week. “If you apply the math to the 1,220 startups in our tracker that’s 12 that will ‘succeed’ in line with my definition of sustainable.”

How did we get here?
Industry participants like to point to the evolution of blockchain from the tech underpinning bitcoin to something that would revolutionize finance.

In 2014 bitcoin dominated the headlines with its various associations with hackers and money laundering. Banks scoffed at it. In 2015 they learned about the technology, in 2016 they all ran proofs of concept using blockchain technology for various financial applications. Their minds changed so quickly and momentum has been strong. This year is often touted as the year banks will begin actually using blockchain technology, which IBM’s predicted in September (IBM actually launched its commercial blockchain Fabric last Monday).

IBM has been working with Hyperledger building a general purpose blockchain, where all details of a trade are shared with all members of the network. It has one of the largest networks of major bank partners but has many more outside of the banking industry.

R3 CEV, Hyperledger’s competitor, is using the technology to build something completely different: a platform called Corda mean specifically to record and manage financial agreements between regulated financial institutions.

“We identified that the technology is highly relevant to a huge bunch of problems in finance,” Richard Gendal Brown, R3’s head of technology and a former IBM veteran of more than 20 years, said of Corda. “It doesn’t follow that the technology that created this wave of hype can be used directly and unchanged – that the technology which was designed to solve problems not in finance is the solution to these problems we’ve identified in finance.”

What’s truly revolutionary about the technology is kind of mundane, Brown said. For the first time, parties who don’t fully trust each other can share information on a system that allows each of them to know they’re in consensus with each other. However, it doesn’t matter for financial services if people don’t have appropriate ways to apply it there.

“They’re the two problems you have to address – what, if anything is new here, and can we define its relevance to financial institutions?” he said. “That stands in contrast to an approach that would say, ‘blockchains are cool, let’s go find opportunities to apply them.’ In that way lies madness.”

Technology is maturing, but has not reached maturity
Late last year R3 suffered one of its minor PR blows when two of its founding member, Goldman Sachs and Santander, dropped out of the consortium. Goldman has not commented on that decision although rumors say it opposed R3’s investment framework, which initially would have allowed it to retain a 10 percent stake with the investors splitting the remaining 90 percent. When R3 said it would cut that to 60 percent for bank members, Goldman pulled. Santander said it decided to take its blockchain focus in a different direction, one more geared at cross border payments and smart contracts, instead of trade processing.

Julio Faura, head of R&D for innovation initiatives at Santander, still maintains that blockchain technology has the potential to revolutionize payments but admits it’s not clear when or how.

“The past year has been a great improvement but [blockchain] still needs to mature even more before we can really think about doing real-production ready applications with blockchain,” he said. “I do think it has the potential to have a revolution. It will take time, we have to be quite pragmatic and driven here.”

Santander is involved in Utility Settlement Coin, a blockchain project co-launched with three other banks to create a blockchain-based clearing and settlement system; the Global Payments Steering Group, a standards-setting group formed with five other banks for the use Ripple’s technology (in which Santander is also an investor).

Everything comes back to data, and maybe AI
For Faura, the proliferation of mobile devices presented an opportunity to change payments based on new sources of data. Overhauling old technology systems is just as much, if not more, about organization and personnel management as it is about the actual technology, he said.

“There’s an opportunity for us and for any other company to use that data widely to get to know our customers better and give them better services at competitive prices,” Faura said. “[Blockchain] is a technological breakthrough but… you need people to embrace the use of data analytics to complement their knowledge and experience, so they make better and more informed decisions.”

Burke called blockchain the “trojan horse” that’s incentivizing financial services to standardize its data in such a way that it might be able to apply artificial intelligence to it to make the market more effective and efficient.

“You’ll see more truly innovative stuff happening with blockchain technologies in emerging or developing markets because there is no infrastructure there,” Burke said. “This stuff will become that infrastructure much in the same way mobile banking leapfrogged conventional banking in Africa or India, where they didn’t even bother building websites, they just started building things with mobile technology. The reality is that where the technology is, people can’t build it at scale or build it securely.”

Inside blockchain’s simmering war of semantics

Blockchain has a branding problem, and a recent skirmish involving R3 has shed new light on it.

The company, perhaps the most high profile and well funded of blockchain technology companies, had to put out a small fire last week after a presentation in which it said it doesn’t need to use a blockchain.

In the Tuesday afternoon presentation about Corda, its recently released open source technology for financial agreements, it specified that one of Corda’s “pertinent features” does not involve a blockchain ‘because they don’t need one.” An audience member tweeted the slide, social media users reacted and today, headlines about the company ditching a multi-million dollar research effort circulated.

This is not as big of a deal as it’s made out to be, Charley Cooper, managing director at R3 said Friday in a statement. “We’ve said from the beginning that while Corda is a distributed ledger platform, it is not a traditional blockchain platform and was never designed to be one,” he said.

Blockchains are decentralized, shared ledgers that are updated in near real time, maintained and verifiable by the participants of the network with access to the ledger, and whose information can’t be changed or edited. Blockchains and their positive features, however, came to light through the notoriety of the digital currency bitcoin, which is an open, public network. They’re different from distributed ledgers, which are better suited to major financial institutions like the ones working with R3.

On one hand, the semantics of this don’t matter very much. Until now, industry participants and observers alike have been comfortable throwing around the word blockchain in the broad sense; it’s generally understood people are discussing blockchain the technology, not bitcoin the digital currency. On the other hand, R3 has been particular about keeping “blockchain” out of its official language because the difference between what its building and a first-generation blockchain is so distinct.

While R3 has never objected to being described as a “blockchain” company it has also almost never self-identified using the terminology. The three-year-old company usually just describes itself as a technology company that builds distributed ledger fabric for financial institutions and incorporates all the specifications of the finance industry, which prioritizes data privacy and confidentiality.

“Blockchain is more of a construct or architecture and is equalitarian. DLT is more selective in terms of who gets distributed what,” said Javier Paz, a a senior analyst at consulting firm Aite. “When we think of blockchains we think of bitcoin, ethereum and public, open networks. Distributed ledgers are something more for banks and entities that have to preserve confidentiality.”

When R3 and its technology vendor peers emerged with visions of cherry-picking the best of blockchain technology for financial services, bitcoin puritans flailed and wailed that it couldn’t be done — or if it could, it wouldn’t truly be blockchain technology. That’s a stance the industry seems to have accepted and moved away from now.

In financial services, there’s been an indifference around using the term “blockchain.” People often understand that the blockchain-inspired technology being built for financial services is different from that used to power bitcoin, but have deferred to the term for the sake of simplicity – something R3 admitted to doing itself in a Friday afternoon blog post responding to the frenzy.

“Humans are creatures of habit. As time went on, the term blockchain came to be associated with any type of distributed ledger, even as the technology matured and evolved to meet the needs of different groups of users,” said David Rutter, R3’s founder and managing partner. “This isn’t an issue unique to our space. The marketing team at Canon must have spent countless hours working out how to stop people referring to all copy machines as Xeroxs.”

Many people haven’t fully realized yet that “blockchains” no longer suit everyone or everything, Paz said. Its initial construct no longer suits the ideas that many financial services users of DLT demand – privacy and confidentiality – but essentially R3’s platform can be configured to behave like a blockchain, that’s just not part of the company’s business proposition.

So while a change of terminology might have been met with indifference previously, perhaps the technology and the subset of financial services that are invested in it might be at an evolutionary point that warrants it.

“I prefer the word ‘chaintech,’ which captures the evolution of chain architecture we’ve seen over the last half year,” Paz said. “We started with the first-generation concept of blockchain — where there are nodes and information that gets distributed — but this is where a change of terminology is helpful and necessary to help the evolution.”

November Blockchain Hype Meter: Fleeing R3

blockchain hype meter

The biggest story regarding blockchain this month were incumbents leaving the R3 blockchain consortium. Sure, there were some other interesting happenings, but when three big financial institutions leave a consortium, it overshadows other happenings.

Goldman, Santander, and Morgan Stanley leaving R3 is bad for blockchain hype, but when looking at the details of why these companies left, it wasn’t because of loosing faith in blockchain or trying to go another route. It was, to the shock of no one, about money.

R3 had asked members to invest in a $200 million series A round to be a part of the consortium. A few institutions balked at the idea of forking up a large investment for a product that wouldn’t be their own, and left R3. In response, R3 lowered its funding goal to $150 million and changed the terms of the round. Reports have emerged that member banks are interested in investing a total of $59 million, a third of the lowered funding goal.

Though three incumbents leaving R3 is a big deal and hurts hype, what does it mean for the future of mainstream blockchain use?

On paper, the consortium model sounds like a good idea for blockchain. A bank that moves to a distributed ledger for transactions between its own accounts isn’t changing much from the current system we have today. Just like banks agreeing to move to SWIFT, getting the most out of blockchain will only happen when a majority of institutions or retailers are connected via blockchain(s). So building blockchains as a group effort may be the best way to set up financial networks for the long run, and a consortium is smart way to accomplish that goal.

On the other hand, companies may not want to put the cart before the horse. We’re still at the early stage of blockchain, and institutions may want to dip their toes slowly in the water of blockchain. Experimenting with blockchain inside a company and then figuring out a way to build it out may be the more realistic strategy. Once institutions get secure with blockchain, they can start to slowly bridge gaps between private blockchains, linking institutions when they want to, and working out how to bridge the gaps with APIs and other technology.

Though the consortium model may be the better long term solution, just because companies are leaving R3 doesn’t spell the end for blockchain. Money was a big factor, and companies that left the consortium haven’t abandoned blockchain. It just may take a little more time for banks and institutions be linked together via a blockchain.

November Blockchain Hype Meter

(In case you missed the October HYPE meter, click here)

It was a pretty quiet month for blockchain hype, with only 33 articles on the subject appearing in the publications we track. Though there was a lot of negative HYPE this month, there were still a few more positive articles than negative ones.

Sweden’s central bank is considering adopting a digital currency. Walmart wants to use blockchain to track food safety. And the UK’s Royal Mint is working on creating a blockchain powered marketplace to trade gold.

Most of the negative articles had to do with the exodus out of R3. Along with that, Ripple CEO Chris Larsen stepped down this month. Finally, the IRS started getting involved with tracing Bitcoin users, which is good for making Bitcoin more mainstream but bad for HYPE.

Notable HYPE articles (19 total)

  • How blockchain will change your life (WSJ)
  • Blockchain technology branches out from finance sector with EY deal. (CNBC)
  • Ones to watch: The rise of online-only money (FT)
  • Opportunities for blockchain in Asia (Bloomberg)

Notable Not HYPE articles (13 total)

  • Bitcoin was supposed to change the world, what happened? (CNBC)
  • IRS is seeking tax evaders who use bitcoin (NYT)
  • Has the blockchain hype finally peaked? (FT)
  • Hong Kong central bank flags blockchain money laundering risk (Bloomberg)

November HYPE meter score: 24 (d3fc0n 2: Is there a DAO to invest in?)

Change from October: -49.

Wall Street’s top 6 bitcoin projects

bitcoin projects on wall street

Less than 1% of internet users are currently using bitcoin as an active currency, but incumbent financial institutions around the world are busy testing the blockchain technology that supports the digital currency. Many of today’s top blockchain projects are being run via financial industry consortia, comprised of top financial firms, technology providers, and consultants.

Here are a handful of the most meaningful bitcoin projects to date:

Credit Default Swaps
Participants: JP Morgan, Citigroup, Bank of America Merrill Lynch, Credit Suisse
Technology/service provider: Axoni

A handful of major banks, including JP Morgan and Citigroup, are testing blockchain technology to help with record-keeping for credit default swaps (CDSs). As an over-the-counter product, it can be a challenge to keep track of CDS transactions. This new test, administered by Wall Street’s unofficial librarian, the Depository Trust Clearing Corporation, successfully showed that payments, amendments, novations and compressions for CDS can be run on blockchain.

Hyperledger Project
Participants: JP Morgan, Deutsche Borse Group, more
Technology/service providers: IBM, Intel, Digital Asset, more

The Linux Foundation helped promote the development and uptake of opensource software. Now, it’s doing the same for bitcoin and blockchain technology. Originally launched as the Open Ledger Project and recently rebranded as the Hyperledger Project, the foundation intends to evangelize the future of finance and to create industry-wide standards. The project is a collaborative, cross-industry open standard for distributed ledgers supported by major financial institutions including JP Morgan, Deutsche Borse Group, BNY Mellon, and ANZ. The organization wants to spur discussion and imagination around the future of supply chains, payments, contracts, and ownership of digital assets.

Commercial paper trading
Participants: R3CEV
Technology/service provider: Chain, IBM, Intel, and Eris

R3CEV is a blockchain startup that’s structured as a consortium of numerous financial institutions, including dozens of banks. In addition to a test using the Ethereum network, R3 recently ran a pilot focused on commercial paper trading. 40 banks participated in the test case. Participants needed to model a financial asset (in this case, commercial paper) and structure a variety of smart contracts for trading that asset — all using blockchain. According to The Wall Street Journal, the goal of the test was to give the banks an opportunity to compare and contrast 5 different blockchain offerings on the market today, including Eris Industries, Ethereum, IBM, Intel and Chain.

Private company capitalization tables
Participants: Nasdaq

In a market with few IPOs, Nasdaq has found other ways to court entrepreneurs and venture capital investors. By building tools and offering in-house and via acquisition of other providers, the stock market seems intent on finding other ways to do business with private companies via Nasdaq Private Market. The same division is experimenting with blockchain technologies. Its blockchain product, Linq, is the first public trial of blockchain technology by a major global stock exchange. One of the first applications of the technology set will help entrepreneurs and private companies manage their cap tables. Eventually, firms using Linq could use it to create, buy, and sell new shares in their companies.

Repurchase agreements
Participants: DTCC
Technology/service provider: Digital Asset

Repurchase agreements, better known as repos, are contracts that enable financial institutions to borrow from one another on a short-term basis by selling securities and buying them back at a set date. DTCC takes in around $2 trillion worth of these agreements daily in the form of thousands of transactions. Participants don’t see a marked difference in their businesses by switching over to blockchain technology, as trades generally settle daily anyway. What it should do, though, is allow financial institutions that are involved in multiple repos to net them out against each other on a given day.

Darrell Duffie, a professor at Stanford’s Graduate School of Business told Fast Company, “I think it’s a smart move,” he says. “It will allow intraday settlement and better netting efficiencies, so it’s a win-win for liquidity in the repo market.”

Japanese Stock Exchange
Participants: Tokyo Stock Exchange, Nomura Research Institute

The operator of the Tokyo Stock Exchange intends to “assess the usability as well as the challenges of blockchain technology when applied to securities markets”. The Japan Exchange group is conducting this project with IBM Japan. JPX plans to conduct proof-of-concept tests to evaluate blockchain technology in markets that have low transaction data volume.