A couple of weeks ago, I attended two excellent thought leadership panels ahead of the Global Custodian annual London awards. Blockchain was one of the topics. The speakers ranged from the incremental adopter through to the passionate believer that Blockchain was the long awaited and burgeoning nemesis of the traditional pillars of the financial markets. Those, reader will be pleased to hear, are primarily banks but also several parts of the infrastructure. I also read papers on the subject, with some claiming the concept was overhyped and not for the immediate term. Others called for its applicability to financial services to be kicked into the long grass in the guise of more study needed. I suspect that we are facing a major shift in the technological tectonic plates of our industry. And to paraphrase Bill Gates, we have most likely overestimated its impact in the next two years but risk underestimating it on a ten year horizon.
So what, should I, as a custodian, do about Blockchain? I think, one should first of all get an understanding of its potential scope. And then define the hurdles. And I believe it is better for a business person to lead such an analysis for they will pick up the tabs of any failure. And I am wary of the promises of many technology experts about the scalability, data security and low cost of Blockchain. Such promises have been made before and I bear the scars of multiple memories of failure to meet exaggerated expectations.
What is the potential scope of Blockchain? I believe we need to understand if it is as a single golden copy of a specific piece of static data used in duplicate form by multiple parties. And we need to understand if a golden copy would provide equivalence, and whether that golden copy would be fit for purpose and simpler, using legacy technologies. And how would that differ with a Blockchain solution, especially in the closed user groups we have in many areas of our industry? We also need to understand how Blockchain can be used as the undoubted provider of information on value, whether cash, derivatives or securities, and what precisely that means. In the latter case, for a trader, a security is basically defined by its ISIN and their prime requirement is knowledge on its availability. But, for a custodian, a security is about ownership and has different characteristics if traded or settled and needs to be capable of generating information flow from a company as well as value flow in the form of income and corporate actions.
So what are the hurdles? First, we need to agree that the environment is secure. We can appreciate that the hurdles are high due to the quality of the Blockchain encryption and the design of the application. But we live in a world of state sponsored cyber terrorism and sophisticated cybercrime. Both evolve with the times and one has to question, if amateur hackers can penetrate the fire walls of the Pentagon, whether this new technology can be as inviolate as some proclaim. Second, we need to question scalability. I heard, at the Global Custodian event, that one could envisage creating scale by linking an infinite number of Blockchain servers. I also heard that one should create capacity by offline storage of legacy data. And I heard that there would be real-time gross settlement with Blockchain. I have to admit hearing about creating mass capacity by linking Tandems together in my days as a board member of the UK settlement system, CREST, in the 1990’s. The theory worked but the practise had boundaries. Legacy data storage is logical for a trading venue but historic data has current day applications in a custodial environment with tax lot accounting or entitlements being examples. So any storage of data off Blockchain would need to be robust, with a real time access capability and be cost effective. Third, we need to understand the demand for real time settlement. The challenges experienced in moving the New York market place from T+3 to T+2 needs to be taken into consideration. They pale into insignificance relative to the impact of any move of the global market place onto real time. That has immense challenges for business operations, liquidity management and technology platforms. The concept may be simple but implementation would destroy large segments of the industry, already struggling to keep up with the demands of an ever more extra territorial world regulatory environment. And, finally, perhaps most critically, we need to agree common business and technical standards across the industry and across the world for all the data elements involved that are to survive in the new world. And if we are to undertake the latter exercise by suasion, we will not succeed. For the cost of re-engineering the impacted platforms will be impossible without radical change to historic national centric infrastructures and embedded cultures against automation and rationalisation in much of the financial industry’s operational sector.
There seems to be ambivalence or ambiguity about taking Blockchain forward. Regulators are concerned that new technologies blind-side them. A vested interest, namely legacy operations and technology, contributes to the opaqueness of the Blockchain debate. And infrastructure, perhaps with valid reason, is fighting to be in pole position in any new Blockchain style development.
Today we have a business environment, within firms and across firms, where the same data is captured, purged and reconciled time and again. That is a risk and a cost that the industry cannot sustain. We have a business environment where utilities replicate process time and again. We have a commercial sector that internalises too much, whether in the lack of shared technology, the illusion of a value in self supply or in tolerating divergence in markets where they have immense buying power. That is unsustainable.
Blockchain technologies may be the right way forward. But we need to be able to answer some of the core questions, a few of which I have mentioned in this article. For, if I am right, and the current model is unsustainable, then we should hope we can structure Blockchain and other emergent technologies to ensure the economic future of our businesses.
What do we do about blockchain?
A couple of weeks ago, I attended two excellent thought leadership panels ahead of the Global Custodian annual London awards. Blockchain was one of the topics.
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