In early August, the World Economic Forum (WEF) published two excellent reports: A Blueprint for Digital Identity, - which I wrote about a few weeks ago, - and The future of financial infrastructure: An ambitious look at how blockchain can reshape financial services, - which I’d now like to discuss.
“Distributed ledger technology (DLT), more commonly called blockchain, has captured the imaginations, and wallets, of the financial services ecosystem,” notes the report, citing a few statistics as evidence: over 90 central banks are engaged in DLT discussions around the world; more than 24 countries have already launched blockchain-based initiatives; 80% of banks predict that they’ll launch blockchain projects by 2017; over 90 financial and technology companies have already joined blockchain consortia; over the past 3 years; more than 2,500 patents have been filed; and $1.4 billion has been invested in blockchain-based startups over the same time span.
In addition, a panel of global experts convened by the WEF selected blockchain as one of the Top Ten Emerging Technologies for 2016 because of its potential to fundamentally change the way markets and governments work, - further evidence that blockchain is reaching a tipping point of market acceptance.
But, significant hurdles must be overcome before the advent of large-scale blockchain infrastructures. The WEF correctly warns that this will take time. Not only are there major technology and standards issues to be worked out, but the industry will have to collaborate with governments around the world to develop the appropriate legal frameworks and regulatory environments.
- DLT has great potential to drive simplicity and efficiency through the establishment of new financial services infrastructure and processes;
- DLT is not a panacea; instead it should be viewed as one of many technologies that will form the foundation of next- generation financial services infrastructure;
- Applications of DLT will differ by use case, each leveraging the technology in different ways for a diverse range of benefits;
- Digital Identity is a critical enabler to broaden applications to new verticals;
- The most impactful DLT applications will require deep collaboration between incumbents, innovators and regulators, adding complexity and delaying implementation;
- New financial services infrastructure built on DLT will redraw processes and call into question orthodoxies that are foundational to today’s business models.
Let me discuss a few of these findings.
DLT is not a panacea
A recent Gartner report noted that blockchain technologies are hitting the peak of the hype cycle, when the excitement and publicity about a potentially disruptive innovation often leads to a peak of inflated expectations, before falling into the trough of disillusionment when the fledgling technology fails to deliver.
“Distributed ledger technology is not a panacea; instead it should be viewed as one of many technologies that will form the foundation of next-generation financial services infrastructure.,” wrote the WEF in a very timely message. “Over the last 50 years, technology innovation has been fundamental to financial services industry transformation. Today, multiple technologies poised to drive the next wave of financial services innovation are converging in maturity.” DLT is one such technology. Others include biometrics, cloud computing, cognitive computing, machine learning and predictive analytics.
A FinTech report published earlier this year by Citigroup noted that investments in financial technologies have increased by a factor of 10 over the past 5 years. The majority of these investments have been focused on mobile-based applications, - e.g., creating new consumer services, improving the user experience at the point of sale, - while continuing to rely on the existing, back-end financial infrastructures. Not surprisingly given their complexity, change comes much slower to global financial infrastructures.
Sometimes, the emergence of an innovative disruptive technology can help propel change forward. The Internet proved to be such a catalyst in the transformation of global supply chain ecosystems. Over time, blockchain could well become the needed catalyst for the evolution of global financial infrastructures.
Applications of DLT will differ by use case
The majority of the 130-page report consists of a deep-dive analysis of how DLT might apply to several different use cases. These include global payments, insurance claims processing, syndicated loans, capital raising, and investment management compliance.
DLT brings a diverse range of benefits to these various applications, such as operational simplification based on real-time multi-party tracking; faster and more accurate regulatory compliance; near real-time settlement between financial institutions; and liquidity and capital improvements.
While each use case is different, the deep-dives revealed a number of characteristics that might help identify other high-potential applications of DLT to financial services:
- A shared repository of information is used by multiple internal and external parties;
- Multiple entities generate transactions requiring modifications to the shared repository;
- The entities involved in a transaction do not necessarily trust each other;
- An intermediary (often more than one) or a central gatekeeper is required to enforce trust;
- Different entities create dependencies between transactions.
DLT applications will require deep collaborations between incumbents, innovators and regulators
The report suggests that the evolution towards a DLT-based financial infrastructure will take significant time and investment, requiring changes to existing regulations and standards and the creation of new legal and liability frameworks.
Transforming this highly complex global ecosystem is very difficult. It requires the close collaboration of its various stakeholders, including existing financial institutions, FinTech startups, merchants of all sizes, government regulators in just about every country, and huge numbers of individuals around the world. All these stakeholders must somehow be incented to collaborate in developing and embracing new infrastructure innovations. Getting them to work together and pull in the same direction is a major undertaking, given their diverging, competing interests. Overcoming these challenges will add complexity and delay large-scale, multi-party DLT implementations.
Despite these major challenges, the WEF remains optimistic. “Our findings suggest this technology has the potential to live-up to the hype and reshape financial services, but requires careful collaboration with other emerging technologies, regulators, incumbents and additional stakeholders to be successful.”
“Blockchain will become [the] beating heart of the global financial system…” it added in a related media statement. “Blockchain could thus redraw the structure of financial institutions and the back-end of services as we know them today…” allowing consumers “to pay less for all kinds of financial activity, from international payments to the trading of stocks and bonds. It could also give regulators new capabilities, allowing them to stop regulatory violations before they start and to watch more effectively for warning signs of financial crises…”
“Similar to any technological innovation, blockchain comes with a set of risks that must be considered,… These include errors in the design, malicious autonomous behaviour as a consequence of human decisions, and potential gaps in security across all inputs and outputs. Challenges such as these must be overcome if the economic and social benefits of blockchain are to be realized.”