Blockchain: Now is not the time to bury your head in the sand

State Street's EMEA CEO, Jeff Conway, outlines the challenges that Blockchain represents.

Blockchain’s distributed ledger-transaction protocol represents the biggest threat and opportunity to our business today.

Currently a typical industry transaction often includes as many as five entities: two principals (buyer and seller), each with their own agents (broker-dealers), who trade through a neutral exchange or clearing house. Increasingly, the agent role is being absorbed into the exchange role, such as in tri-party collateral or direct market access models. 

In some parts of the industry, the exchange role is being reduced and shifted to become more technology-centric.  The ongoing shift from voice to electronic trading, peer-to-peer lending and crowdfunding are examples of where this is already occurring. 

New technologies have the potential to take the agent-free model even further into the industry. For the financial services sector, such technological advances present the opportunity to overhaul existing models, speed up processes, and streamline costs.

Blockchain is one of the more compelling vehicles of technological disruption, and its appeal is obvious. In a nutshell: it could create a single source of truth for transactions – with far-reaching consequences. Because of its distributed-ledger model and use of cryptography it has the potential to create a reporting system that is not only more efficient than existing options, but also more transparent and secure.

It will have a significant impact starting with inefficient areas, that are (a) manual, (b) require a lot of stakeholders to engage, align and sign-off, and (c) have intermediaries that create a single point of failure and add cost to the system. The areas likely to be impacted first will be things like bank loans, liquidity management (collateral management, securities borrowing), derivatives, and broader settlement area.

One report recently estimated that it could save capital markets USD 2bn in the US and USD 6bn globally annually1.

Blockchain could ultimately become a standard for financial transactions and real-time settlements, increasing transparency and efficiency in a highly fragmented industry; a fantastic prospect for the industry and one that represents exciting, new opportunities. However, as some commentators have suggested, one that also has the potential to drastically reduce demand for many custodians – one of our core businesses representing $27 trillion in assets.

No one doubts the usefulness of blockchain, because it is working now in the Bitcoin world. Whilst this is a very simple example of its potential, it does showcase that such technology does not have to become; it’s here. Ignoring it is not an option.

At State Street, we have started to experiment with blockchain in three ways: internally as part of core software development; selectively partnering with vendors and other partners in this space to conduct private trials; and as part of a handful of consortia of the world’s biggest banks and technology companies. For example, we are one of 42 banks working with the consortium, R3 which is targeting a goal of standardised and shared ledger technologies; and in Europe we are also a member of the Post Trade Distributed Ledger Group (PTDLG), which aims to research and identify opportunities and associated benefits of blockchain technologies.

More of the industry will likely move towards blockchain models in the coming years. However early implementations are likely to be on a limited scale or in “greenfield” areas where legacy issues and standardisation requirements are less of a factor.

If we can make blockchain the internet of financial services, we all benefit particularly if it allows for real-time settlement across different geographies and currencies.

As mentioned, some analysts have suggested blockchain might disintermediate custodians. However, there will still need to be on and off ramps to the blockchain meaning a ‘digital custodian’ will be needed to enable this ‘tokenisation’, and ‘creation and maintenance of smart contracts’. Also, for a system-based on encryption, there may be a need for secure maintenance of personal encrypted keys. All these are new components in the value chain. A trusted advisor, such as State Street could play such roles. However, we recognise the need to evolve from our current state, hence our focus on emerging technology.

The industry is still far from realising the full impact of blockchain and other emerging technologies within financial services. However, it can’t count on business as usual with such disruptive technologies on the horizon. One recent report went as far to say that blockchain could become part of the mainstream and in use within the next five to 10 years2.

Those that do not embrace such change and bury their head in the sand risk being left behind.

1 Goldman Sachs Investment Research, May 2016

2 Goldman Sachs Investment Research, May 2016