The true potential of blockchain technology is beginning to emerge and there could be some interesting applications in the post-trade space. Javier Paz, senior analyst at Aite Group and author of a recent report on chaintech, discusses the difference between blockchain and chaintech, current industry initiatives to scale up its usage, as well as how it might be deployed in the back office.
Q: What are the definitions of blockchain and ‘chaintech’?
A: ‘Chaintech’ is the more comprehensive term. It includes the concepts of distributed ledger technologies and blockchain. Bitcoin, of course, is an important manifestation of blockchain. So what is the difference? The concept of blockchain has been evolving, especially since 2016. When most of us first heard of blockchain, we saw some type of diagram with many dots in a network sending packages. These dots are nodes in the network, sending packages to update the network, and / or to validate the information being sent around.
At that stage, all, or a lot of the ledger data was distributed to the wider network, with most of the founding blockchain concepts being public chains, like Bitcoin and Ethereum. Then banks entered the picture, drawn by the buzz of Bitcoin, and changes in ledger structure started to take place.
Bank-friendly ledgers had to accommodate for greater security and confidentiality concerns, as well as faster transaction speeds. R3 Corda, launched in April 2016, was an architecture that was multiform, supporting distributed multi-node structures, alongside a bilateral type of construct, that was outside of the original blockchain purview.
This new structure, later replicated by other chain platforms, gave rise to the distinction between distributed ledger technology, where some information is distributed, and ‘chaintech,’ where you mix distributed and non-distributed elements within the same network.
Q: As you pointed out in your research paper, many of the larger sized financial institutions are investing heavily in chaintech proof of concepts or select vendors in this space, while the smaller firms, such as mid-tier banks or brokers, for instance, are not investing as heavily. Why the difference in interest levels? Do larger banks see more potential in this area compared to smaller firms?
A: The difference is in economies of scale. Transacting a few thousand trades, or a few million trades a year, determines the value of blockchain-led efficiencies in the post-trade space.
It makes little sense for smaller financial institutions to lead the charge to usher a new way to settle trades if the larger firms providing them important settlement services or ancillary work are themselves still figuring out how they will use blockchain technology.
The larger firms are definitely busy doing something with blockchain in the settlement space. But what is less clear is whether they are close to common standards or common chaintech protocols. The R3 Consortium has under its banner the largest number of banks—something like 80+ members, of which 65 or more are banks. But there are other chaintech platforms that banks are seriously evaluating, such as Hyperledger Fabric, a Digital Asset platform, Axoni’s AxCore, and JP Morgan’s Quorum, which is an Ethereum-inspired open source code.
Q: How do you see blockchain or chaintech impacting the post-trade space?
A: One of the hottest areas right now seems to be e-proxy voting. Nasdaq was the first to the line with a project they launched in Estonia late last year. This was followed by Broadridge and TMX Group this year, also coming forth with their own advanced versions and plans of providing this service and using blockchain technology.
Blockchain seems to be causing greater initial impact on securities that are not traded very frequently, and this is evidenced by the DTCC’s plans to roll out the technology in credit derivatives and in the repo market.
A big test of the technology on a major scale is coming up in Australia later this year, as the ASX Group—which is in the process of using the technology to replace its clearing and settlement system for all cash equity trades—will decide whether this platform they’ve been working on for two years, alongside Digital Asset, will effectively replace what they have during 2018.
This test could boost the credibility of the technology being used outside of the United States. However, Australia’s daily volume of stocks is much different than that of the US, which is the biggest cash equities market. The real question is, whether chaintech throughput is ready for prime time in the US.
All of these developments in the US outside of cash equities, and outside of the US in cash equities, are really exciting and important to watch, and provide time for the technology to grow to eventually provide more throughput and flexibility to meet the demands of real, high-volume securities trading.
Q: Are there operational benefits that blockchain or chaintech can potentially deliver to financial institutions, that are driving the interest behind investment in this technology?
A: There are some $2 billion dollars or more in inefficient middle and back-office operations across the cash equities industry, that blockchain could help eliminate, according to Goldman Sachs. That is serious money, supporting operational redundancy and manual reconciliation in some 10% of all trades. Something like 800 million trades had to go to manual reconciliation in 2015 —that is a lot of inefficiency.
The price tag for this inefficiency impacts all firms, on the sell side, the buy side, and those providing services in between.
Q: Focusing on the C-level executives, what are the main questions they should be asking themselves when evaluating the applicability and the value of blockchain to the post-trade space? What kind of information or data do they require to make decisions?
A: The C-suite should mine blockchain impact from a defense and offence perspective. From a defensive perspective, they should ask themselves, what are manual-heavy and error-prone parts of their businesses that could become obsolete through blockchain? What are duplicated processes within the firm, or across the supply chain, in which they operate?
From an offensive perspective, they should try to quantify these inefficiencies, and see if the potential blockchain use could give them, as a potential pioneer in its application, a competitive edge.
They need to educate themselves so that they are able to assess this highly technical information. In that regard, blockchain is different than, say, big data or moving operations to the cloud. Management needs to understand the key concepts of blockchain architecture, which will allow them to better seize opportunities, and deal with extensibility issues. This means allowing blockchain adoption to grow with them into the future, and open up new opportunities to interact with clients and with partners, rather than just have it built to specifications based on phase needs.
Q: Finally, looking ahead, how do you see investment in blockchain for post-trade developing in 2017 and beyond?
A: Investment in blockchain platforms is becoming larger and more selective, going to firms that are generating serious traction from large corporate end users. But plenty of investment will also be directed to smaller, utility-like firms, operating in specialized areas touching capital markets, with interest coming from established vendors like IBM, Broadridge, FIS, FiServ, and firms building a portfolio of blockchain technologies applied to particular verticals.
