We have entered a period of what Google’s chief economist, Hal Varian, likes to call “combinatorial innovation”; a term for when many factors combine to drive the creation of new inventions. Today, the key factors sparking innovation are transparency of information, speed and connectivity, open source software and APIs which enable the development of layered ecosystems of applications. One such innovation that was created by the coming together of these factors is the blockchain.
What is blockchain and how can it benefit why should finance professionals care?
The blockchain serves as an append-only data store of transactions that has two components: a replicated ledger and a distributed database. The database is stored and synchronized by all parties (referred to as nodes) to a shared ledger within the blockchain network. Bitcoin, a digital currency that uses blockchain technology, is used to track money transactions but it can also track the exchange of other assets including financial securities or data related to an individual’s identity such as IDs or proofs of address, for example.
Blockchain is far from being a passing fad and finance professionals need to become familiar with the concept because, in time, it is likely to fundamentally overhaul the way financial transactions are made. Indeed, once it begins to be adopted more widely, it will revolutionize the structure of the financial services industry as the technology eliminates the need for trusted intermediaries such as clearing houses. Financial institutions that are not exploring the opportunities that blockchain creates will lag behind in terms of knowledge and strategic options, particularly in relation to efficiency and cost saving opportunities. Further, front office systems automation, as well as the simplification and standardization of back office systems, are areas that are likely to take place as a result of blockchain technology implementation. Financial institutions, therefore, have duty to look to innovative technology solutions the adoption of which may be more imminent than is currently understood.
Where do you see blockchain making an impact within finance? When?
GreySpark is currently exploring seven capital markets’ use cases for the blockchain:
- Payments and remittance
- know-your-client or anti-money laundering
- digitized financial instruments
- regulatory reporting
- clearing and settlement
- smart contracts applications for servicing of financial instruments
The most pertinent use cases, in GreySpark’s opinion, are in clearing and settlement, reconciliation and the use of smart contracts.
Smart contracts are event-driven computer programs that allow the automatic verification of the transactional governance (terms and conditions) between two counterparties, eliminating the need for a central arbitrator. Smart contracts can be added to blockchain-based transactions to deal with the legal aspects of a commercial agreement.
The use of blockchain technology will mean that the execution, clearing and settlement of a trade can occur quasi-instantly, lowering post-trade latency and reducing counterparty exposures. Blockchain transactions are quicker, less expensive and involve fewer intermediaries such as brokers and central securities depositary that the traditional approach.
Blockchain technology can also be used to simplify the reconciliation of trades as this approach does not require the comparison and rectification of ledgers held by different institutions. In the case of a private blockchain, where participants gain permissioned access to the database, institutions are able to meet their reconciliatory obligations without actually having to reconcile with other institutions, thanks to the replicated and synchronized nature of the blockchain ledger.
It will, however, take some time for the scale of blockchain applications to reach a critical size. As it is at an early stage of development, the excitement it is generating in the industry is a normal thing, but the first step into this new world, such as investing in blockchain start-ups for example, must be taken with great care: lucidity and a comprehension of the implications will be a key success factor in this area.
Can you give an example of a block chain initiative that you’re currently working on that demonstrates where this market is headed?
While the applications for Distributed Ledger Technologies for each use case are equally valid, some of the use cases have already proven to be stronger than others. These offerings are capable of either disrupting or replacing existing trade-lifecycle technology systems and processes in banks and financial markets infrastructure providers such as clearinghouses and exchanges.
GreySpark believes a starting point for the industry should be to focus on developing ways of employing blockchain technology to improve the process of transferring securities by enabling market participants to connect on a peer-to-peer (P2P) basis without the intermediation of brokers. This would remove friction and allow the execution, clearing and settlement to occur at a trade-entry level, quasi-instantaneously.
When trying to turn the transfer of securities into a real P2P blockchain-based system, the challenge lies in taking the whole trade lifecycle into consideration to ensure the process is seamless. For instance, from the technology perspective, this includes being able to digitize securities and map share registers on the blockchain. Another challenge is to ensure the blockchain technology is scalable enough to deal with tomorrow’s transaction volumes. To address this, companies such as SETL are developing solutions to extend bandwidths and increase block capacities.
What does 2016 have in store for blockchain?
In 2016, people will begin to focus on, not only defining proof of concepts, but on the development of operational and productive applications. A carefully investigated proof of concept will enable firms to identify vendors that are right contenders for executing their blockchain program.
Also, increasing numbers of financial institutions will reach out to consultancies like GreySpark to help them to adapt to innovative technologies, assess emergent players and understand the risks associated with the new technology. Clients will be equipped with strategic plans to help them both understand and gain competitive advantage of the evolving technology environment. To address emerging trends and face innovation challenges in the Capital Markets industry, major financial institutions need help in deciding whether they should build in-house systems, collaborate with existing key players or invest in or directly acquire them. Ignoring the new concepts and innovations is an option financial institutions can no longer afford.
William Benattar is a member of GreySpark’s fintech advisory team. By maintaining a comprehensive view of the fintech arena, William assists GreySpark in helping start-up firms enter the marketplace; advises private equity houses on financial technology due diligence; and advises buyside and sellside clients on the development of strategic and innovative projects . Prior to joining GreySpark, William worked for Kantox in the business and product development team, focusing on strategy developments of FX systems. While being student ambassador for Google, William has spearheaded initiatives aimed at helping SMEs develop and implement their digital strategies. William is an existing mentor at the London-based accelerator program — Startupbootcamp Fintech — advising start-ups on product development, roadmapping and fundraising avenues.
GreySpark is a business and technology consultancy that specialises in mission-critical areas of the Financial Markets industry with offices in London, New York, Hong Kong, Sydney and Edinburgh. GreySpark has expertise in Electronic Trading, Risk and Trade Management, Operations and Data Management and provides Business and Financial Technology Consulting services to buyside and sellside businesses as well as exchanges, market data providers, Independent Software Vendors and technology makers.
GreySpark recently published a report entitled The Blockchain: Capital Markets Use Cases.