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.”

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.

Banks push the envelope of innovation, but not alone

Financial institutions are more and more aware that they need to lead in innovation. Rather than shutting startups out to secure their position, banks are opening up and inviting startups in.

Santander Group announced this week that it had raised another $100 million for Santander InnoVentures, its London based fintech venture capital fund.

Since inception in 2014, the fund has already invested globally in startups in digital identity, wealth management, blockchain, online lending and payments.

Santander isn’t the only bank with a corporate venture capital arm meant to foster startups and technologies that can provide banks with a competitive advantage. Barclays operates a network of fintech-focused accelerators in the U.S., Europe and Africa. Citi runs Citi Ventures and BBVA operates Propel Venture Partners, formerly BBVA Ventures.

What’s is next for the banking industry?

What will the banking industry look like in 5 or 10 years? What trends do banks foresee?

To identify which trends banks think will shape the future of finance, we analyzed over 100 startups backed by VC arms of big banks by sampling data from the investors’ own websites.

Looking at bank CVCs only provides part of the picture on future trends, as banks can swallow and incorporate innovative private companies through private equity arms or through mergers and acquisitions.

Lending related startups are the biggest group of companies (12%) backed by banks’ venture funds. Not surprisingly, cybersecurity and IT infrastructure are the next largest cohort (11%). In an industry powered by trust, banks can’t afford to be a single step behind the hackers.

Analytics and big data solutions that enable banks to better serve their clients with products and services were next (10%). Other notable categories include payments (10%), blockchain technology (8%), and authentication, identity management and fraud prevention (8%)

Wealth management and personal finance platforms, marketing tech and user experience also received investment from the financial industry’s corporate venture capital arms.

This data set isn’t perfect. It does, however, offer a glimpse into the collective psyche of banks in regards to the changing landscape.

Investing in millennials

Ph.Ds will be written about millennials and generations to come: Their mobility — geographic, in the job market, in the way they communicate, purchase and do business — is already established as one of their pivotal traits.

Banks are capitalizing on this mobility and reacting to it. By exploring new ways of financing, enhancing the hardware and software the global economy relies on and leveraging the vast and profound data sets this mobility produces, banks are making sure they will stay ahead.

On the big data side, many banks use IBM’s cognitive computing platform, Watson Analytics, to better analyze customer data. This allows a bank to better understand the value of its customers and build tailored offers, credit lines and marketing campaigns. Clients include BBVA, Citi, Standard Bank and ANZ bank.

Japan’s Mizuho Bank has deployed robots supercharged by IBM’s Watson in several of its branches, bringing AI out from the shadows.

On the UX side, banks are expanding their mobile offerings, continually adding more services to their online and mobile platforms. Santander, for example, also operates Openbank, a branchless bank in Spain.

Collaboration, not disruption

Banks can’t innovate alone. Saddled with legacy systems, heavy regulations and cumbersome workflows, banks just can’t move as fast as startups. But startups, in turn, need the banks…The future is about partnerships.

BBVA, for example, launched Innova Challenge, an initiative that promotes open and collaborative culture between the bank and developers, with the aim of including a larger community in creative and technological development. BBVA opened its platform to the developer community through an API. Citi also opened up its APIs to developers through its Citi Mobile Challenge.

“Many fintechs have succeeded but today they are still operating only at the edges of banking,” explains the Santander Group in a recently published white paper about the future of fintech, titled Fintech 2.0. “To help engineer more fundamental improvements to the banking industry, they must now be invited inside, to contribute to reinventing our industry’s core infrastructure and processes. That can succeed only as a collaborative endeavour, with banks and fintechs working together as partners.”

Santander explores a few problems in the financial industry that startups and banks will need to work together to solve. Among them are streamlining processes by leveraging data gathered by connected devices, embedding distributed ledger technology (blockchain) and creating frictionless processes for the consumer.

Funny enough, Deutsche Bank also recently published a white paper under the same title and a similar theme, though focused on payments.

“The time has come for one further change,” writes the German bank, “a shift in mindset from one of competition to collaboration. By exploring strategic partnerships, traditional banking providers and new innovators can together create long-term success and revolutionize the payments market and wider financial sector for the benefit of all.”

The banks are calling for more collaboration. Will startups follow?

Photo credit: Román__PG via VisualHunt.com / CC BY-NC-SA