Blockchain Boom

Blockchain Boom

Blockchain Boom: How Banks and Payments Companies can Realize Big Savings by Employing the Technology

Charles Keenan

Charles Keenan

Charles Keenan has written about payments since joining the American Banker as a staff reporter in 1997, a time when automated teller machines were appearing just about everywhere but people's living rooms thanks to the relaxation of surcharging rules.

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With blockchain technology, banks are motivated by potential disruption, but the projected cost savings have been enough of a justification to spawn big investments recently.

It's hard to quantify the spending by financial services companies on the blockchain. Investment is accelerating though, and many banks have already taken the lead with finding ways to use distributed ledger architecture to improve business processes. More than 80 banks have funded R3, a consortium that has developed the protocol 'Corda,' with the latest round of $107 million announced in May.

In part, this is due to the growing feeling that the blockchain could revolutionize the financial industry. It might sound like hyperbole in the payments world, especially given the slow pace of industry initiatives such as real-time settlement of ACH in the United States, EMV ubiquity with merchants and the use of contactless as a way to pay.

Yet when considering disruption elsewhere — such as what Uber has done to taxis, how Airbnb has changed how people travel and how Amazon has upended discount retailing — the idea of the blockchain bringing disruption to banking and payments isn't so far fetched. It’s essentially using existing IT tools: encryption keys and databases — but it's the way these elements are put together that is different. Blockchain technology allows for a database to be decentralized and distributed over many computers, making records more secure and harder to alter — offering immutability. It also provides for potentially faster processing and settlement of any transaction, whether it's Bitcoins, contracts or mortgage documents.

"The disruption may come not just by changing the existing business patterns, but also through discovery of newer ways of doing business and newer products," says Vipin Bharathan, a blockchain strategist for BNP Paribas North America. "There will be new businesses unlocked with this technology that we have not even dreamt about."

In payments alone, this should be a cause for concern. Consumers have relied on banks to hold the record of their transactions and store of value and to authorize their identity in order to conduct the exchange. Yet with the blockchain, consumers can maintain their own identity with a private key and can confirm who they are without need of a bank to validate it. A password proves the consumer owns the assets and provides a record of the transactions.

Pair this reality of blockchain architecture with the cautious approach of banks and it could mean significant pain down the road for many companies unless they start to experiment. "The business has a skepticism about the adoption of this technology, as they are focused on tangible returns, usually in the short term, Bharathan says. "You have to expand your horizons to see value in the blockchain."

Banks also face restrictions by regulators, who tend to see events through a backward-looking lens, Bharathan adds. Yet along with banks, they are beginning to see the advantages of the transparency and immediacy of blockchain technology.

Investing in R3's Corda is just one of many avenues banks are taking simultaneously to hedge their bets. Ethereum, a blockchain launched in 2015 by Vitalik Buterin, has become a leading candidate as an enterprise solution for distributed ledger in just two years. Meanwhile, cloud providers are adding support to other blockchains. Microsoft Azure, for example, announced in May the addition of support for Hyperledger Fabric, R3 Corda, Quorum, Chain Core and BlockApps. Azure had already supported Ethereum.

"We haven't picked out the one chain to rule them all, frankly, because we think there won't be one chain to rule them all," says Christopher Swanson, vice president, research and development at U.S. Bank. "You'll end up seeing a dozen or two platforms that have carved out a niche within specific asset classes."

BNP Paribas, a member of the R3 consortium, has also tested a cross-border payments system for its corporate institutional clients in Europe based on the protocol Nxt, with an aim to start testing it in the United States next year. U.S. Bank has done the bulk of its work with R3’s Corda, including working with Credit Suisse on using the blockchain to track leveraged loan transactions, and building out solutions in the trade finance space. Yet the Minneapolis-based bank is also collaborating with Canadian banks in the identity space using Hyperledger Fabric, and is dabbling with Ethereum and Quorum, Swanson says.

"A good way to find yourself on a dead end of a branch is to isolate yourself and pick a winner, when I don't think there will be a clear winner in the relatively near future," Swanson says.

Savings to Come Before Disruption?

As banks experiment, they will likely use the blockchain to first reduce costs. Eight investment banks said that the technology could reduce operational costs by 30 percent by 2025, which will roughly equate to $8 billion a year, according to a 2017 report by Accenture Consulting in conjunction with McLagan, a compensation consulting firm.

Industry estimates of cost reductions could be conservative according to Caitlin Long, chairman and president of Symbiont, a New York-based vendor that helps digitize and automate processes using the blockchain. Long, who worked at Morgan Stanley, saw firsthand the inefficiencies of loan record keeping. "If the banks can see the forest through the trees, they'll realize there are a lot more cost savings possible from deploying this technology than it might at first seem," Long says. "It reduces not just their costs but their capital requirements, which makes their ROE go up, and that is golden."

Symbiont is one of the vendors behind Credit Suisse's project to simulate leveraged loan trades, with the aim of conducting a real one next year. This past spring, Credit Suisse announced a successful simulation of an end-to-end processing of a transaction. These loans, which have multiple bank partners and institutional investors, require extensive documentation. They still use faxes, manual reviews and data entry to complete agreements.

It's an onerous undertaking for banks to keep track of the data. "They are all keeping their own copies and reconciling them with each other," Long says. "That is where the technology has the opportunity to change and the cost savings are significant."

The statements and opinions of the writer do not necessarily reflect those of TSYS.

Other Articles by Charles

Charles Keenan

Charles Keenan has written about payments since joining the American Banker as a staff reporter in 1997, a time when automated teller machines were appearing just about everywhere but people’s living rooms thanks to the relaxation of surcharging rules.

His work at the American Banker included writing about credit and debit cards, merchant processing, and bank stocks. He later freelanced for the Banker and industry publications such as Banking Strategies, Bank Director, Community Banker, and U.S. Banker. He also writes about investing, insurance and health care, and is based in Los Angeles.

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