Transferring the technology that underpins bitcoin from a power point presentation to a prototype is challenging the world’s largest investment banks.
According to its adherents, blockchain promises billions of savings as banks automate their payment systems. Freeing even a portion of the funds waiting to be settled could be significant. Vast quantities of collateral and margin are tendered as insurance to back daily trading on financial markets, estimated at between $65bn and $80bn a year, according to Oliver Wyman.
The idea that one of Wall Street’s basic functions — moving money through a trusted system — can benefit from the Silicon Valley ethos of sharing information on peer-to-peer networks is one that appeals to some bankers.
Goldman Sachs, Citigroup, Barclays, UBS and Deutsche Bank are experimenting with their own technologies and have filed patents. But despite the buzz, there are few working models and a lack of joint adoption across the industry.
“Blockchain is a bit like gluten,” says Tim Swanson, head of research at R3CEV, a New York start-up backed by 30 banks. “Everyone is talking about it but no one knows what it is in great detail.”
Like all fads it could fade unless backed up, he adds. “People have to deliver something within the next 12 to 18 months or they will go back to their existing technology vendors.”
Few ideas have caught the industry’s attention in recent years as much as blockchain, a digital ledger distributed by a network of computers. Each participant must approve a transaction before it is recorded, in a “chain” of computer code. Cryptography is used to secure the transactions and the details are public.
As the ledger is shared by many parties, it becomes close to impossible to tamper with. Ownership of an asset is immediately transferred to a new owner after authentication and verification, guaranteeing nearly instantaneous execution and settlement.
While the industry has been debating security and other issues — including the use of digital tokens, access to the network and the ability to scale — serious practical challenges remain.
It is not clear how committed banks are to this brave new world and the back-office overhaul it entails.
Aite, a consultancy, has suggested that capital-market spending on blockchain research and development could reach $400m by 2019, from $30m last year.
“In terms of total R&D at banks, it’s a drop in the ocean,” says Virginie O’Shea, an analyst at Aite. “They don’t see it as going to revolutionise their business. It’s more speculative than anything. Blockchain is this year’s ‘big data’.”
Lee Braine, of Barclays’s investment bank CTO Office, says the sector is pursuing two avenues: testing technology by experiment, and looking at how it could be made to work across financial services. “This is a great opportunity to set up standards early,” he says. “This means common interfaces among common systems.”
Multiple chains run internally by banks would need to be linked to “interoperate”. Increasingly many accept that independent third parties need to set and co-ordinate standards, the way the GSM standard allowed mobile phone networks to interoperate.
Goldman’s patent includes the admission that its technology may need a central party, to which both sides of a trade agree, to act as a co-ordinator.
With an internal blockchain “all you’ve done is set up an interbank liability”, says Peter Randall, chief operating officer of Setl, a UK blockchain start-up, and the former head of the Chi-X Europe share trading venue. “True settlement is where you never have to see the other party again. Settlement can only take place in central bank money.”
Companies such as R3, Setl and Digital Asset Holdings, headed by former JPMorgan banker Blythe Masters, are aiming to become that utility-style operator.
Any such system would have to be grafted on to banks’ existing IT and payment systems, some of which have been in place for decades, and meet the requirements of market watchdogs. Regulatory issues include anti-money laundering and trade reporting laws.
“In theory it could bring benefits,” says Mr Swanson. “But if we’re not rigorous in issues like switching costs and all the ‘boring stuff’, it won’t go anywhere.”
Many in the industry say expectations are too high and favour a long-term, phased approach to putting asset classes on the blockchain. It could start with central bank transfers in the payments system and then move on to settlement of various types of security.
UBS has engaged the UK’s Clearmatics to develop a “proof-of-concept” bitcoin settlement token, which settles in central bank money. It is a far cry from bitcoin’s founding principle to be a cryptocurrency beyond central bank reach.
“The underlying foundation of financial institutions is to achieve settlement finality in central bank funds,” says Mr Randall.
Get alerts on Clearing and settlement when a new story is published