At first bitcoin was viewed with suspicion by the banking industry. The currency was known more for its association with anarchist hackers, online drug sales, and disasters like Mt. Gox than for the technology underpinning it, blockchain.
Suspicion has turned into a deep embrace. Now blockchain, an innovation in running shared databases, is touted as the technology that will drag financial services into the 21st century. The world’s largest banks are taking a tool whose creator intended it as a weapon against them and adopting in a bid to reduce costs and increase profits.
Few people working outside of finance would guess at the inefficiency of some banking systems. While high-frequency trading conjures thoughts of split-second trades and the breakneck swapping of shares on electronic markets, settlement is measured in days. Instead of complicated algorithms, fax machines are still in common use. The syndicated loan market is held up as emblematic of this slowness; deals can take 20 or more days to complete.
Simply put, there’s a lot of financial machinery that is “very manual and typically very paper-based,” says Simon Taylor, blockchain and distributed ledger lead for Barclays, which is backing start-ups using blockchain to digitise everything from shipping documents to the diamond trade.
In addition to their individual projects, the banks have thrown their weight behind R3, a company that is developing a blockchain network for use by the financial services industry.
More than 20 global banks, including the likes of Bank of America, Goldman Sachs, HSBC, JPMorgan, and UBS, are now backing the company as they look to blockchain as a means of upgrading that manual back-office machinery.
It is not the only game in town. Nasdaq, which owns the technology-heavy US equity index and exchange, has partnered with a San Francisco start-up Chain to develop a private trading platform. Chain counts Nasdaq, Visa and Citi Ventures among its investors.
Blythe Masters, the former JPMorgan banker, is leading her own blockchain start-up, Digital Asset Holdings. She has said the benefit of such systems ultimately lies in reducing the time it takes to trade and move collateral.
“If you can speed up the process via which assets change hands, capital requirements will drop because there is a resulting lower rate of operational risk and counterparty risk,” she said at a recent conference in New York, organised by CoinDesk.
The savings are potentially massive. Santander InnoVentures, Anthemis and Oliver Wyman have estimated a possible $15-20bn cut in costs for cross-border payments, securities trading and regulatory compliance.
Although the technology is underpinned by complex cryptography, it can be thought of as simply a means of running a database that is stored in multiple locations and is controlled by no single party. The term blockchain is sometimes interchanged with the term “distributed ledger technology”.
It is the innovation that has powered bitcoin. Instead of relying on an entity like a bank to manage their money, users of bitcoin can freely access a global database, create their own cryptographically-secure account in that database, and then adjust the entries in their account (receive and send payments).
In the bitcoin network, the currency is an incentive for anonymous actors to maintain the system, but for banks, the focus is on blockchain without bitcoin, or without a monetary token to incentivise users of the system.
“It’s completely unnecessary in the world of banking where you have trusted relationships and a legal regime,” says David Rutter, chief executive of R3.
Instead of an open system accessible to all, the efforts are focused on building closed systems that are maintained by a pre-approved group of institutional users.
The hope is that building a common rail for the movement of assets, instead of each bank managing their own separate systems, own, will reduce friction in the exchange of assets.
“Every bank has an accounting engine that does broadly a same thing, so does it make sense that you could share that burden,” says Simon Taylor of Barclays.
There are still huge challenges to overcome and few are expecting rapid, dramatic change, or “open-heart surgery on the core engines,” as Mr Taylor puts it. Regulators are have only recently got a handle on how to treat bitcoin— the ramifications of widespread adoption of blockchain technology are just now beginning to be considered.
There is also scepticism about the ability of banking to keep up with the pace of innovation bitcoin has sparked, not least from early and continued believers in the currency. Barry Silbert, whose Digital Currency Group is the most prolific investor in bitcoin start-ups, notes banks are the “slowest moving, risk averse, cautious organisations in the world”.
But what’s obvious is the emergence of bitcoin and now the focus on blockchain has kicked bankers into action and has forced them to rethink the infrastructure that underpins finance. As entrepreneur David Galbraith recently pointed out, “blockchains have created the market awareness and incentives to innovate as much as the technological means.”
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