The hype around the blockchain is becoming deafening.
Just this week, both Westpac and the Commonwealth Bank have run sessions on the blockchain during the Sydney leg of an international series of conferences on the technology’s potential.
Bitcoin was the genesis of the blockchain. The cryptocurrency uses the technology essentially as a distributed ledger for transactions.
However, around two years ago, there started to appear a number of companies that were working on blockchain-based applications separate from Bitcoin.
Friend or food?
As a virtual, decentralised currency, Bitcoin represents a challenge for governments and regulators.
Banks have a vested interest in the status quo; the system they operate within is highly regulated and it has taken a significant investment to get them to this point of operation.
But now there has developed a clear separation between Bitcoin, which uses the blockchain, and the blockchain, which can be used without Bitcoin.
The blockchain is used to store information about transactions. When you consider this at 10,000 feet, this is essentially what a bank’s core systems have been built to provide.
In essence, the blockchain is both a threat and opportunity for the banks.
Blockchain is digital banking
In some respects the blockchain is employing concepts and technologies that already exist, so what’s really new?
Shared ledger: Systems of record existed before the blockchain.
Cryptography: The basis of current commerce.
Smart contracts: We had this with Workflow technology
Consensus (of the nodes that validate transactions): This is new!
Fundamentally this is taking money and banks into a true digital era. What I mean by this is that most large banks have been innovating on the edges with new interfaces, UX etc.
Blockchain is using all of these technologies together and that is a key difference.The blockchain is all about technologies that are all massively compute-technology-intensive with compliance and auditing built in from scratch.
There is significant jargon in this space: Sidechains, coloured coins, smart contracts and more. I’m not going to attempt tackle them in this article.
What should be understood, however, is that there are public and private blockchains. The private ones are permissioned with known participants, while the public ones are what are called permission-less and involve untrusted third parties.
You can store just about any information on a blockchain: Names, addresses, ID, passport, photos. In fact you could store your whole life on this medium and then employ it to validate yourself when you need to fill in forms or identify yourself.
It is expected that employing private blockchain technology to provide point solutions will be the starting point for most of the banks that are interested in the technology.
There will be a natural resistance to tackle public blockchains as this requires much greater coordination and regulatory approval.
Regulators should be friends
Regulators have yet to endorse blockchain, but neither have they condemned it as inappropriate.
There has been a strong belief that this lack of being a declared safe playground held back the technology, with the uncertainty slowing uptake.
However, this no longer the case: There is an explosion of blockchain use cases with more than 50 ways to apply this technology in innovative fashions. Over the last few weeks I’ve heard three to four pitches from new startups that are in this space.
Regulators are naturally conservative, but the power of the blockchain has great potential. Just imagine a bank having a private blockchain system used adjacent to their core banking or payments applications.
Right out of the box a blockchain has a built-in audit trail. You can trace or interrogate the data, and theoretically this would allow a regulator to perform their own searches of the data set.
That is, frankly, a scary thought for many banks but the transparency it could bring would be welcomed by regulators.
A win-win for regulators and banks?
There is a significant cost for every bank to be compliant with growing regulatory requirements – AML, FATCA, APRA and so on. Compliance costs have been a major component of strategic project spend at banks.
It is not a surprise to hear that a major bank spends $100 million to $200 million on regulatory compliance for just one small requirement.
This is clearly required to keep things running effectively, but each new layer of regulatory compliance adds an incredible burden and the required investment doesn’t add a single dollar of profit.
Embracing the blockchain for private in-bank use to replace existing legacy can yield immediate benefits for a bank — and immediate benefits for regulators.
It was my ‘ah ha’ moment that this is a win-win.
We have to be careful when making these kinds of changes — the implications are significant — but it is almost undeniable that the benefits will outweigh the costs both in the short and longer term.
What’s blocking the blockchain?
It is a question of ‘what’ not ‘who’ is blocking the blockchain. The ‘what’ is that adoption will take time; the systems are complex and perhaps a tad fragile. But there are benefits in to be realised when it comes to cost savings and efficiency.
Moreover the banks are embracing this threat. They realise that if they don’t, they will go the way of Kodak.
I’ve heard it said that the blockchain will be as big as the web. If that is the case then we will are witnessing a massive and significant event.