As the financial services world continues to adapt to the possibilities of blockchain and Distributed Ledger Technologies (DLT), we are now at a critical juncture, as to where the industry goes from here in utilising these technologies.
Now that various organisations have more experience of implementing DLT from initial proof-of-concept to actual production, the picture is becoming ever clearer. However, it is crucial to understand what the banks need and want from the technologies and what their key priorities are moving forward. I believe there are six vital factors that the financial services industry needs to consider in the months ahead.
Factor one – interoperability
The CEOs of leading DLT and blockchain solution providers, including Digital Asset (Blythe Masters) and R3 (David Rutter) have a huge amount of financial services experience behind them. More interestingly though, they both truly understand the opportunity that exists for DLT to transform the market. The shrinking return on investment (ROE) of sellside firms is not going to be swept under the rug any longer, with the cycle of increasing revenues following a downturn probably being broken for good. Only the ‘mutualisation of infrastructure’ coming from DLT, which could deliver 40-50% cost savings has the possibility of turning that around. And most importantly, doing nothing gives you an existential threat.
Discussions on complex topics, for example around interoperability between blockchains remain progressive, despite the remaining challenges. However, I do believe that due to the alignment of all parties’ interests, that this problem will eventually be solved in good time.
Factor two – experienced resources are key
Whilst the rest of the world has been distracted with cryptocurrencies and ICOs, some companies have been ploughing the less glamorous furrow of DLTs. CEOs from the DTCC, CLS and the Australian Stock Exchange (ASX) have all expressed how working with DLT over the last few years has enabled them to emerge in a great position to now go live. As the technology is still very young, these were far from ‘normal’ IT projects. Vendors worked hand-in-glove with their clients and often their product was strongly shaped by this first client engagement. The upside of this was that with first mover advantage, firms get the ability to select the best resources from the available pool. This is a significant advantage, as one of the few things we can be sure about future of DLT is that there will most likely not be enough people to deliver it. The downside is that firms have had to invent or learn everything from scratch. An example of this, the need for genuine consortium engagement, cannot be overestimated since it ensures you are able to on-board people at different speeds rather than in one big bang.
Factor three – technology that works
The next key factor that needs to be realised, is that the technology works. The Australian Stock Exchange (ASX) has put the Digital Assets Platform through a series of strenuous tests and deadlines which they were able to meet and even exceed. With confidence, they are now able to replace their post-trade CHESS system with the new DLT platform and now also have a deep understanding of how the technology works. CLS is using blockchain for a component of their service, CLSNet. This is a bilateral payment netting solution, built on a DLT platform. The direction of travel is clear, in the appropriate situation it works.
Factor four – the need for a wider community
As I mentioned earlier, there remains discussion about resources and this leads onto abstraction layers. Gartner* have mentioned that junior crypto-developers can command salaries of EUR150k, with senior architects north of EUR350k. With eye-watering numbers like these, the race is on to open up these concepts to a wider, general purpose community. Digital Asset has recently announced their Digital Asset Modelling Language (DAML) SDK programme, which seeks to address this. DAML abstracts away the distributed and complex parts of a DLT solution, allowing developers to either focus on codifying their process in DAML, or writing Bots and front-ends that interact with the ledger using standards-based interfaces. This now looks like something more and more people will be able to use.
Factor five – smart contracts and trust
The debate over smart contracts also remains equally thought-provoking. Several industry experts see them from the point of view of trust minimisation, whereas some liken them to stages on a workflow: the workflow just happens to be across parties who may not trust each other. Either way, there is agreement on the criteria required to put physical assets onto a distributed ledger, namely:
- There must be a way of linking the physical asset to its ‘digital twin’
- There must be a mechanism for the physical asset to be ‘controlled’ by the DLT
So, for example, locking a driver out of their car if they have not kept up with their car loan repayments works. Checking on the provenance of cartons of medicinal drugs may not, as there is no way of linking the drugs to their digital twin, unless tamper-proof packaging is used. This highlights the fact that any future solution will not only include DLT, but is likely to also involve a collection of other technologies that provide different parts of the overall solution e.g. identity management etc.
Factor six – don’t forget the business case
My final key area to discuss is the business cases for DLT based solutions. Currently, we are at the stage of ‘DLT 1.0’. This means most people are focussing on the cost reduction power of DLT. Streamlining existing business flows and getting intermediaries to focus on the ‘value adding’ parts of their service, rather than those they have to do due to legacy or monopoly positions. There are some very big prizes here (EUR1bn+) and whilst we can see a path towards them, there is much more work to realise these benefits.
More interestingly though is ‘DLT 2.0’ which is about new services and revenue streams. Here we have hardly scratched the surface of what is possible. One widely believed view is that to avoid missing out you needed to get involved with 1.0 before you can understand what 2.0 really means for your industry. Again to quote Gartner*: “We tend to overestimate a new technology’s impact in the short term and underestimate it in the long term.”
So to summarise where I believe we are with Distributed Ledger Technologies:
- The technology works
- Now is the time
- The future is bright for those who embrace the technology and get involved