Early days yet for distributed ledger technology

     However, Bitcoin’s underlying ‘distributed ledger technology’ (DLT) is not synonymous with digital currencies and offers unique opportunities in financial services. This disruptive technology with its features of immutability, distributed and decentralised processing and transparency has the potential to solve some of the existing inefficiencies in the financial services sector. Swift anticipation and spurt in investments by banks exploring its application also led to hyped up expectations. But while experimentation continues the technology is still far from mainstream application and adoption.

      “The good news is that the hype is over. People are not just focusing on ‘investment in blockchain’ but instead now the technology is being really adopted as enabler to solve a problem and that is a good sign,” remarked Evans Munyuki, Group Chief Digital Officer, Emirates NBD.

     As the hype starts to settle, more use cases to address pragmatic challenges will emerge.

     “Blockchain has gone out of a hype cycle and pragmatism is setting in as initiatives are starting to take shape. There is a change in thinking that blockchain is ‘not an end all of everything’, instead it is a feature of the solution that we provide, and with this thinking lots of opportunities open up” noted Abhijit Singh, Head – Strategic Initiatives, Blockchain at ICICI Bank”

     The current digital technology transformation in the financial industry with rapid adoption and interplay of emerging technologies can open new doors. “Blockchain brings an ecosystem play, results in opportunities for the bank and benefits for the customers especially as it can be integrated with other emerging capabilities like AI, IOT and OCR,” Singh pointed out.

     Overall, the industry’s expectation from the technology resulted in an increase in investments in blockchain and crypto companies by over four times in 2018 according to PitchBook Data. 2019 has also started on a strong note so far.

Emergence of new use cases in financial services

Leading banks realise the potential and continue to experiment with this technology across a variety of applications. The following are some recent use cases:

Cross-border payments: DLT can find unique application in cross-border payments which have traditionally been expensive, complex and time consuming. Several banks explored new proof of concepts. For instance, JP Morgan Chase launched Interbank Information Network that allows member banks to exchange information in real-time to verify payment approvals. Recently, it tested JPM Coin for instantaneous transfer of payments between institutional accounts.

     In Asia, Myanmar’s Shwe Rural and Urban Development Bank partnered with Thailand’s Krungthai Bank to introduce a cross-border money transfer service, ICICI Bank initiated cross-border remittance between India and Canada, while Ripple expanded its reach among financial institutions.

     Among first initiatives by central banks, the Bank of Canada and the Monetary Authority of Singapore (MAS) tested cross-border and cross-currency payments using central bank digital currencies, by linking up their blockchain projects, Jasper and Ubin.

     Blockchain integration could also have scope in improving financial inclusion. For instance, Union Bank of the Philippines recently launched a new initiative called i2i to integrate rural banks in the country. “Our blockchain project i2i is the Philippines’s first banking blockchain-based transaction and payment system that will allow us to connect institutions, like rural banks co-operative banks, remittance agencies and possibly retailers and other consumers on the network. Some of our other use cases are in supply chain, digital identity, KYC, Remittance etc,” said Henry Aguda, CTO Union Bank.

Trade finance: There is compelling use for DLT in trade finance, which is traditionally inefficient marred by lengthy processes, paper heavy, lack of transparency and high costs.

     In October 2018, Hong Kong Monetary Authority (HKMA) launched eTradeConnect, a blockchain-based trade finance platform developed by a consortium of twelve banks in the country to improve trade efficiency, digitised documents and automating processes. HKMA and MAS, Singapore are also now jointly developing a trade finance network.

     Among other examples, China CITIC Bank developed alliance with four banks in trade finance and the letter of credit business. ICICI along with six other banks in India had tested this technology for trade finance in mid 2018.

    “Initially when we did the first pilot transaction on the blockchain in trade finance there were many questions, but now we can see the maturity in the processes. While new, the maturity in processes has enabled the customers to look at this initiative in a more positive light. Our blockchain initiative is integrating nicely into the digital initiative of some of the big companies such as moving towards ‘paperless’” noted Singh.

     Banks are increasingly exploring integration of DLT with other emerging technologies. For instance Westapac implemented POC in trade finance by integrating data analytics, artificial intelligence, Internet of Things and blockchain in a single proof of concept to address issues in demand and price prediction and inventory management.

Other use cases: With smart contracts and immutability of transactions, DLT can find applications in improving security and reducing frauds.

     “Some of the areas that can be digitised using this technology are the bank trust network, trade finance, reconciliation and settlement and other areas where there is manual exchange of information between financial organizations in a business ecosystem. One example is our e-cheque solution as the exchange of documents between authorisation agencies is very important use cases. We have also tested the system in reconciliation and it works very well”, said Munyuki from Emirates NBD

     Banks are also experimenting its application in reconciliation. WeBank-led Financial Blockchain Shenzhen Consortium (FISCO), the financial blockchain alliance connects industrial peers and it developed an underlying platform to promote an ecosystem of open source Blockchain technologies towards reconciliation.

     In another example Smart Dubai along with Network International and Emirates NBD implemented a reconciliation and settlement platform that enabled faster reconciliation of payments of two government entities.

     Among government driven initiatives, MAS is implementing Ubin, a collaborative project with the industry to explore the use for clearing and settlement of payments and securities. MAS and Singapore Exchange (SGX) recently announced that they developed ‘Delivery versus Payment’ capabilities for the settlement of tokenised assets which is expected to simplify post-trade processes and shorten settlement cycles.

     Some proof of concepts also emerged in syndicated lending, KYC and anti money laundering.

     “I think the other emerging blockchain use cases in the industry could also be in regulatory compliance infrastructure. A lot of financial institutions submit thousands of reports to the regulators that need to be on time, so this could be a perfect use case for distributed ledger if we can get all the banks and the regulators in one chain”, opines Aguda.

But hurdles remain

Despite overall promise, DLT still remains in early stages with multiple technical and operational hurdles.

     “Challenges remain on getting other banks on-board as they are at different stages of approvals and integration of back-end systems and processes”, said Singh

     The readiness of banks also varies, which delays the process of on-boarding them into networks.

     “One challenge we faced two years back was basically the lack of familiarity and knowledge of blockchain in the market but we have overcome that now. Other challenge is that there are lots of financial institutions with legacy infrastructure and hence it is difficult for them to change systems to join blockchain networks. We no longer invest in legacy technology so we are ahead on the curve, but the challenges that we faced two years back will be same as what some others in the Philippines will be facing once they start adopting blockchain”, pointed Aguda.

     Building consortiums needs technology that can go easily into production, is flexible and readily scalable across institutions.

     Aguda explained that their i2i blockchain design is lightweight so that it can support rural banks or small non-banking financial institutions that may not have core banking functionality and can be integrated easily.

Technology is only part of the problem

“Technology is only 20% of the problem, 80% of the challenge is the driving the business and getting all the parties aligned towards a common goal. With regards to technology, the standards are still evolving and we do not have a defined interoperability protocol. The biggest challenge however is to create an ecosystem and align all the parties and unless the regulator or government rides this, it is not going to happen, pointed Munyuki”

     The regulatory acceptance of the legitimacy of the transactions remains another grey area, for instance in case of a dispute, can the transactions done on blockchain stand as a proof in the court of law?

     Legal acceptance across countries however may mean lengthy process of legislation changes.

     “Real adoption will need regulations and legal framework to be in place” pointed Munyuki.

      He explained that in most current use cases of trade finance there are only two to three parties working together but we need to get all the relevant parties in the ecosystem in order for it to be really beneficial. To be impactful the consortium needs to be cross-border and this will happen only if there is a governing or monitoring entity as part of the ecosystem that can define rules and govern it.

Regulators could play a crucial role

Most countries have multiple regulators and to bring them all on the same page is not easy. In a heavily regulated industry like financial services, it appears that the decentralised technology would probably require a central agency to truly facilitate its use.

     “It will happen sooner or later, something should happen in next three year’s time. Entities like MAS from Singapore, HKMA from Hong Kong and other central banks, supported by government, are pushing for paperless strategy are the key drivers. This is evolving to acceptance of digital signatures and should evolve into use of data in blockchain as an evidence for an audit trail and the legality of around that will be established” opines Munyuki.

     Some regulators lead in experimentation and promoting innovation, these include collaborative projects, facilitating consortiums and regulatory sandbox to promote its use.

Still a long road ahead

“There is no stopping the era of virtual economies and distributed platforms and these are going to be most important technology in the future but we still have to work out the regulations and legal framework around it. This is when the mainstream adoption will start”, opines Munyuki.

     Though the industry recognises the potential but applications are still in early stages with mainstream adoption at least three to five years away.

     Many banks have invested in experiments but now the businesses increasingly want to reap returns on their investments.

     “There is a shift in paradigm. There was a time, we were doing experiments with one or two transactions on blockchain and if successful we were happy. But now the expectations are different. Businesses are increasingly expecting this to be the mainstream channel fairly quickly”, commented Singh.

     “The internet of the world could not grow in initial private ecosystems. It achieved mass adoption only after telecom providers made it public and that is how I expect the blockchain adoption to happen. I envision that you will be able to apply for a blockchain address from a telecom authority and thereafter you can have multiple use cases, replicate blockchain addresses, the address can become the identity and you will be able to transact with it. I expect to see this scenario in seven to ten years,” said Munyuki.

     There is still a long road ahead that requires continual experimentation, evolution of technology towards interoperability and scalability. Regulatory frameworks must also develop and mature before the financial industry can generate real value from this technology.