By eliminating the need for a central intermediary, blockchain technology proposes a new way to store and transfer value within a network. And as central financial intermediary, the banking industry offers a broad range of potential applications for blockchain technology. The purpose of this study is the exploration of the possible applications of blockchain technology in the field of commercial banking, the derivation of potential operational and strategic implications of such applications, as well as the uncovering of hurdles that currently stand in the way of a wider-scale implementation of blockchain technology. The exploratory research design is based on a thorough literature review on the topic of blockchain in banking as well as on expert interviews with dedicated blockchain professionals. The research methodology resulted in the identification of three particularly relevant use cases of blockchain technology in commercial banking: cross-border payments, trade finance, and know-your-customer applications. Applying blockchain technology within these areas can allow commercial banks to reduce both process complexity and cost, as well as increase inherent security and transparency. Furthermore, blockchain will allow banks to unlock additional strategic opportunities within these three application areas. But before blockchain technology can be implemented in the context of these use cases, significant hurdles remain yet to be overcome. Technological issues, the lack of a common standard, regulatory uncertainty and cultural hurdles of organisations so far prevent the application of blockchain technology in commercial banks on a wider scale. But the common assessment of the experts interviewed over the course of this study indicates that these remaining hurdles will be resolved in the near future. Blockchain technology will then offer banks an opportunity to strengthen their positioning within an increasingly competitive environment.
Keywords: Blockchain, blockchain technology, commercial banking, banking, strategic implications, operational implications, hurdles, Ripple, Skuchain, SecureKey
Table of Contents
BaFin………………………Bundesanstalt für Finanzdienstleistungsaufsicht
BBO………………………………………Blockchain Based Obligation
CBA…………………………………Correspondent Banking Agreement
CCICADA..Command, Control & Interoperability Center for Advanced Data Analysis
DIACC……………………….Digital ID & Authentication Council of Canada
DLT……………………………………..Distributed Ledger Technology
DNS………………………………………….Deferred Net Settlement
ECB…………………………………………..European Central Bank
GPSG………………………………….Global Payments Steering Group
KYC…………………………………………….Know your customer
LOC…………………………………………………Letter of Credit
MEP………………………………..Member of the European Parliament
PSD2…………………………………….Payment Services Directive 2
RTGS………………………………………Real-time gross settlement
SWIFT…………..Society for Worldwide Interbank Financial Telecommunication
A new industrial revolution is underway. Just as the discovery of steam power and mechanized production, of electricity and mass production, and the introduction of information technology have each facilitated a fundamental shift in global economic and social conditions, the rapid increase in speed of development and diffusion of new technologies in almost every sector in recent years is carrying an equal promise of transformation for today’s society (Schwab, 2016, p. 6 ff.).
Among these technological megatrends is the blockchain, a distributed ledger that allows for secure processing and immutable recording of transactions in a network without the need for a trusted third-party. By representing a “[…] radically new approach[es] that revolutionize[s] the way in which individuals and institutions engage and collaborate” (Schwab, 2016, p. 19), this technology is at the heart of this fourth industrial revolution.
Even though it was originally introduced in 2008 with the development of the cryptocurrency Bitcoin, blockchain technology has only started to spark the interest of a wider audience in recent years, as is demonstrated by the stark increase in Google search queries depicted in figure 1.
This increasing interest in blockchain technology has furthermore materialised itself in significant investments into blockchain-related start-ups. In 2016 alone, an estimated amount of US $550 million has been invested into the blockchain sphere (CB Insights, 2017).
Financial services, especially the banking industry, is among the sectors on which blockchain technology is expected to have the most profound impact, as it is an industry that is characterised by complex process structures that are largely based on intermediation (Liesenjohann, Matten and Terlau, 2016, p. 54 ff.; Tapscott and Tapscott, 2016a).
“Banking is necessary, banks are not!” – Bill Gates
Bill Gates spoke these famous words in 1994 (Filkorn, 2016). But almost thirty years later, the traditional banking model is still in place. And while the digitalisation has not only transformed a wide range of industries but society as a whole, banks have been surprisingly un-innovative (Filkorn, 2016) – merely adjusting their service offerings and infrastructure in an incremental manner (Doyle and Quigley, 2014, p. 1). Banks simply did not feel the pressure to adjust or to reinvent their businesses, be it because strict regulations made it difficult for disruptors to enter the banking industry, because banking customers have always been notoriously loyal or, most importantly, because, as “keepers of trust” (Batlin et al., 2016, p. 12), banks have always been important facilitators of the flows of value within the global economy (Ruttmann and Mohr, 2016).
But advancements in technology and changes in regulation, such as the introduction of the PSD2 directive in Europe, are increasingly threatening this historical monopoly of traditional banks (Kruta, 2017). As a result, the incumbent players’ margins on their traditional service offerings have been shrinking, while, at the same time, customers are demanding increasingly personalised offerings and value-added services (Brereton et al., 2014; Doyle and Quigley, 2014). The lack of digital innovation in banking is putting incumbents at risk, as industry experts, such as former Barclays CEO Antony Jenkins, are predicting the dawning of the Uber moment of banking – a technology-driven, fundamental disruption across the entire industry (Williams-Grut, 2017).
Among the technologies driving this change is blockchain, a potential paradigm shift that threatens to render irrelevant the traditional function of banks as “keepers of lists” (Brennan and Lunn, 2016, p. 9; Lehman, 2016). As is depicted in figure 2, this large disruption potential is what attracts a large part of the overall development efforts of start-ups within the blockchain sphere: More than 50 per cent of all ventures that base their business models on blockchain technology are currently focusing on the financial services sector.
But while the blockchain somewhat poses a risk to the traditional functions and offerings of banks, it may also be the tool empowering banks to perform the much-needed reformation of their complex, inefficient and expensive structures as well as their endangered business models (Lehman, 2016).
As has been outlined above, the financial services industry is often quoted as one of the most promising areas of application for blockchain technology, with potential use cases being researched in commercial banking, investment banking and capital markets as well as in the insurance industry.
This exploratory study aims to provide a comprehensive overview of the application of blockchain technology in commercial banking. More specifically, the following three research questions shall be addressed over the course of this study:
RQ1: What are the possible applications of blockchain technology in commercial banking?
RQ2: What are the operational and strategic implications that arise from the implementation of blockchain in commercial banking?
RQ3: What are the challenges for the implementation of blockchain technology in commercial banking?
Answers to these research questions will be based on an in-depth review of current literature on blockchain in commercial banking, as well as on the insights gained over the course of several interviews with blockchain experts from various backgrounds. A more comprehensive description of the research methodology shall be given in the fourth chapter of this thesis.
The ability to own and to transfer assets via transactions is at the heart of economic value creation. And to keep track of these business agreements, market participants have always relied on ledgers. But to make sure that these ledgers remain accurate and are not being tampered with by fraudulent market participants, most business networks rely on central, trusted parties, such as banks or other intermediaries, to oversee these business ledgers and to validate each transaction that is taking place within the network (Brakeville and Perepa, 2016).
This need for an intermediary has become even more important in the modern age, as assets have increasingly been digitalised and central third parties are required to make sure that a digital asset is not duplicated and spent more than once by the same party (Thompson, 2016a). But while the use of such a central intermediary brings the major benefit of introducing trust into the system, it also comes with certain limitations, such as the introduction of bottlenecks into the network, leading to a slowdown in transaction processing speed and an overall lack of transparency (Brakeville and Perepa, 2016).
But as will be presented in the following chapters, blockchain technology offers a solution to these issues by introducing a shared, incorruptible ledger whose integrity can be ensured without the need for a central intermediary.
When an unknown scientist under the pseudonym Satoshi Nakamoto published his white paper about Bitcoin – a “purely peer-to-peer version of electronic cash” (Nakamoto, 2008, p. 1) – in 2008, it was not the cryptocurrency itself but its underlying mechanism, known today as the blockchain, that was considered revolutionary (Thompson, 2016a). But overall awareness of the blockchain technology remained rather limited, as Bitcoin itself was not yet widely known.
Starting in the year 2012, increasing activity surrounding Bitcoin could be observed, as the cryptocurrency’s market capitalization grew and start-ups in the field of payments and coin wallets started to emerge. But still, Bitcoin and the underlying blockchain remained subject to a general scepticism, being associated mainly with the financing of rather sketchy online activities and other misconceptions (McKinsey & Company, 2015a, p. 5). Nonetheless, by the year 2014, over 80 uses of blockchains had been reported (Grant, 2016). Slowly, the initial scepticism gave way to the increasing efforts of tech enthusiasts around the world who, under the keyword Blockchain 2.0, explored uses of the blockchain technology outside the domain of cryptocurrencies (Yerdon, 2016). By detaching the enabling technology from its initial exclusive use for cryptocurrencies, blockchain became a possible application for any situation in which “validation of trust, proof of ownership, or a record of an event are required” (NewsBTC, 2016).
Following the rise in interest within the start-up sphere as well as among industry incumbents, the recent years have been characterised by the emergence of blockchain consortia making a joint effort to bring blockchain technology into practice (McKinsey & Company, 2015a, p. 5).
In its essence, a blockchain is a shared – or distributed – database capable of processing and recording all transactions taking place within a network on a peer-to-peer basis, eliminating the traditional need for a third party to record and verify single transactions, and creating an immutable transaction history (Finextra Research, 2016, p. 6; Howard, 2015).
While the blockchain has been first introduced as the technological foundation of the cryptocurrency Bitcoin (Gupta, 2017), significant efforts have since been put into the development of alternative blockchain protocols, such as Ethereum or Ripple. And while certain differences exist between these protocols, all blockchains share certain key characteristics.
First of all, a blockchain is distributed, meaning it is being stored on all devices connected to the network simultaneously. It thus distributes information evenly to all parties, i.e. every network participant has visibility over the entire database (Mainelli, 2017). As such, a blockchain can be described as a system of “collective book keeping” (Burelli et al., 2015, p. 6), capable of establishing a network for value exchange that is, as opposed to the centralized network structures that are currently mainly used within the global economy, not dependent upon the supervision by a trusted intermediary and, thus, allows for direct peer-to-peer communication (Mainelli, 2017; Sproul et al., 2016, p. 7).
Moreover, consensus mechanisms are at the heart of every blockchain, and while many different consensus mechanisms have been developed over time, they always serve the same purpose. In simplified terms, consensus mechanisms comprise a set of rules and procedures that allow the system as a whole to agree on which transactions are valid and will be executed, thus establishing a single version of the truth across the network (Andersen, 2016, p. 4; Brakeville and Perepa, 2016; Brown, 2016; Seibold and Samman, 2016).
A blockchain furthermore assigns a cryptographic identity to each member of the network. Every network participant possesses a public key, which is essentially his or her address that is visible to every other network member, as well as a private key that is used to digitally sign each transaction commissioned by this party. Cryptographic mechanisms make it practically impossible to decrypt the identity of a transacting party based on a public key (Sproul et al., 2016, p. 7). This mechanism allows for pseudonymity of network participants while, at the same time, keeping the transaction history visible to everyone (Mainelli, 2017; Plansky, O’Donnell and Richards, 2016).
The fourth important characteristic of a blockchain is its immutability. Due to the blockchain’s architectural design – linking each new block of transaction data to the existing history of the entire network – the content of any of the previous blocks in the chain cannot be changed without the rest of the network noticing and, thus, rejecting such an attempt to tamper with the transaction history (Brunner et al., 2017, p. 43; Tapscott and Tapscott, 2017).
And lastly, as a digital system, a blockchain is programmable, meaning users may embed a certain computational logic within the network. This allows for the automated execution of transactions or other actions based on the occurrence of predefined trigger events (Iansiti and Lakhani, 2017, p. 70; Mainelli, 2017).
Besides these overarching common features, many differences can exist between blockchain protocols – most prominently regarding which consensus mechanism they employ and regarding the question who is granted access to the blockchain network. The following chapter will first provide a basic description of the block creation process on the Bitcoin blockchain, after which an overview of two of the most prominent examples of consensus mechanisms will be given. Finally, possible differences in terms of accessibility of the respective network will be presented.
The blockchain’s name essentially describes the workings of the underlying technology. A blockchain consists of a chain of data blocks containing the entire history of transactions that have taken place among all members of the network since its initiation. The chain is continuously expanded by new blocks containing the data of recent transactions that have occurred within the network.
A single block can be compared to a page within a ledger, and its creation and connection to the existing chain of blocks always follow the same process, as is depicted in figure 3. First, a transaction is created by a participant of the blockchain network. This transaction, as well as a cryptographically secured digital signature of the sender proving the transaction’s authenticity, is then broadcasted to the entire network of users (nodes). Subsequently, the nodes will verify the authenticity of this transaction by decrypting the digital signature of the sender, after which it is pooled together with other recent transactions into a block of data. This block of recent transactions is then again transmitted to the (validating) nodes in the network, which are now required to validate the block. This process requires the implementation of a specific consensus mechanism in the blockchain protocol, a concept that shall be explained in detail in the following chapter. Once the block has been validated, it is added to the existing chain of blocks. With the chaining of subsequent blocks to this block, all the transactions contained within this block become a permanent part of the distributed ledger. Continuous updating of the entire chain enables each node within the network to validate, at any point in time, the status of the blockchain (Seibold and Samman, 2016; Thompson, 2016a; Burelli et al., 2015; Frøystad and Holm, 2015).
As was indicated above, one of the key aspects of a specific blockchain’s workings is the consensus mechanism it employs to verify transactions within its network. Various approaches to such a consensus mechanism have been developed, and the two most prominent protocols shall be presented in the following: the proof-of-work and the proof-of-stake mechanism.
It is only after a formal approval that a transaction will be executed on a blockchain. But the absence of a traditional middleman to verify and approve transactions within a blockchain network requires the introduction of a new mechanism that allows for a reliable verification within an anonymous environment. As any node within a blockchain network can create a new block of transaction data, the network needs a mechanism that decides which block should eventually become part of the unique existing blockchain.
This role is taken up by a so-called consensus mechanism (Narayanan et al., 2016, p. 56 ff.). In the absence of trust between transaction partners, such a mechanism is defined by certain parameters, as depicted in table 1, allowing it to replace the usually required middleman to clear transactions and ensure a reliable transaction environment.
|Decentralized governance||A single central authority cannot provide transaction finality.|
|Quorum structure||Nodes exchange messages in predefined ways, which may include stages or tiers.|
|Authentication||It provides means to verify the participants’ identities.|
|Integrity||It enforces the validation of the transaction integrity (e.g., mathematically through cryptography).|
|Nonrepudiation||It provides means to verify that the supposed sender has really sent the message.|
|Privacy||It helps ensure that only the intended recipient can read the message.|
|Fault tolerance||The network operates efficiently and quickly, even if some nodes or servers fail or are slow.|
|Performance||It considers throughput, liveness, scalability, and latency.|
Based on these parameters, many different consensus mechanisms have been developed over time. And while all of them work towards the same goal of ensuring a trustless and secure transaction environment by establishing a single version of the truth, each alternative features “varying degrees of speed, cost, scalability, privacy and network security […]” (Blockchain Technologies, 2016). In the following, the focus will be laid on two substantially different consensus protocols: Bitcoin’s proof-of-work protocol and the proof-of-stake protocol.
The proof-of-work protocol, even though already having been developed in its essence in 1999, is one of the most widely used consensus mechanism today (Seibold and Samman, 2016, p. 5). Within the Bitcoin blockchain, this mechanism, also known as mining, serves two main purposes. First of all, it prevents network participants from tampering with the transaction data on the blockchain, thus allowing for trustless consensus among network participants and ensuring security (Bulkin, 2016), while secondly creating new Bitcoins (Blockchain Technologies, 2016).
A proof-of-work protocol requires network nodes, also known as miners, to run complex mathematical computations to validate the pool of recent transactions within the proposed block. This ensures that the validating nodes have invested significant resources in the form of processing power, bandwidth and electricity to verify transactions, a process for which they are compensated in return (Bheemaiah, 2015).
The mathematical computations performed by the nodes transform certain pieces of data into a unique and seemingly random sequence of letters and numbers known as a hash, as is depicted in figure 4. While it is easy to transform data into a hash by applying a certain hashing algorithm, it is practically impossible to backwards-translate a hash into the original data, and any minor change of inputs will furthermore result in an entirely different hash (CoinDesk, 2014).
Within the proof-of-work-mechanism, a block hash is created by applying the SHA-256 algorithm to distinct pieces of data, among which are the hash of the previous block on the chain, a binary hashing of all the transactions pooled in the current block (also known as the Merkle Root), a timestamp of the hashing, and the nonce, a random number that is varied constantly (CryptoCompare, 2016).
Miners put these pieces of data through the hashing algorithm and compare the resulting hash with a certain arbitrary condition set by the network, also known as target. As hashes are one-way functions, it is practically impossible to find an acceptable hash value just by looking at the current target. Random guessing is the only possibility for a miner to hunt for a solution to the target, and thus large computing power is required to be able to compete for the discovery of a solution with other miners in the network (Krawisz, 2013).
Should the computed hash comply with the target, the miner has solved the mathematical problem, proof-of-work has been generated, the block is linked to the local copy of the blockchain, as is depicted in figure 5, and propagated to the entire network. For this, the successful miner is rewarded with Bitcoins, thus incentivizing the provision of computing power for the validation of transactions (CoinDesk, 2014).
Three factors relating to this proof-of-work mechanism add to the security of the Bitcoin blockchain: First of all, it is not possible to predict which miner will find the solution to the target, consequently making it impossible to predict which block will be added to the blockchain at any point in time (The Economist, 2015a). Furthermore, the hash of each block on the blockchain includes the respective hash of its preceding block. As a hash value changes entirely when making even the slightest change to the input data, manipulating a certain transaction within a previous block on the blockchain would require the recalculation of the hash of that respective block and of those of all the consecutive blocks on the chain. Considering the effort needed to find the solution to a single block, such a manipulation becomes practically unfeasible (Acheson, 2016; The Economist, 2015a). And third, potential double-spending by network participants is prohibited by the proof-of-work mechanism. When mining, nodes always built on the longest existing version of the blockchain. Thus, while a miner might be engaged in the manipulation of a historic block of the chain, the chain is continuously expanded by other miners. Thus, to force the network to accept the manipulated version of the blockchain, a miner would have to lengthen the chain quicker than the other nodes in the network were lengthening it originally. This would require the malevolent attacker to control more than 50 per cent of the computing power within the network – which should be practically impossible and/or completely uneconomical (Gervais et al., 2016; The Economist, 2015a). As a consequence, the proof-of-work mechanism enables the network to achieve consensus in the absence of trust by making it prohibitively expensive to try to manipulate the blockchain (Krawisz, 2013).
The question that remains to be answered is how this mechanism leads to a unique chain that is characterised by consensus across the network. As Krawisz (2013) puts it, “the ability to generate blocks is a show of computational strength, which is just what the Bitcoin network needs to help verify all the transactions. But it is also a show of community spirit because by agreeing to enter the contest for the next block, they show themselves to be willing to respect the interests of the community rather than manipulate the block chain for self-interested purposes.”. Put otherwise, as it is assumed that most the network participants are honest, when in doubt, the longest blockchain will always be the ‘correct’ blockchain. This chain enjoys the consent of all nodes, as a manipulated blockchain will never be able to outpace the honest chain (Karame and Androulaki, 2016, p. 66).
The proof-of-work mechanism suffers from certain limitations. Most importantly, as has been described earlier, a proof-of-work protocol requires the input of significant computational effort and, thus, resources to verify transactions. As O’Dwyer and Malone (2014) have shown, the annual power consumption required for the entire Bitcoin mining operations can be compared to Ireland’s average annual electricity consumption. Depending on the availability of respective mining hardware, mining can become an uneconomical venture for nodes, as electricity costs can outweigh the reward for mining (Stieben, 2013) and moreover raises ecological questions (BitFury Group, 2015). Furthermore, the fact that the amount of computing power required to be able to sustain a profitable mining activity is prohibitively expensive for the average person favours the concentration of computing power on singular nodes. This, in turn, yields the danger of a 51 per cent attack and contradicts the blockchain’s idea of decentralisation (Manning, 2016).
Finally, a question that remains to be answered is what happens to a proof-of-work system once all units of its underlying cryptocurrency have been mined. Since miners only perform the work necessary to validate transactions out of the economic incentive of being rewarded for this work with Bitcoins, the finite supply of Bitcoins might lead to transaction validation activity breaking down once this supply runs out. While some authors predict that transaction fees will continue to provide sufficient incentive for mining activities to be upheld, it remains to be seen whether the cost of the validation activity will be sufficiently low in the future to be covered by the small transaction fees received by miners on the Bitcoin blockchain (Faggart, 2015).
Due to the disadvantages of a proof-of-work mechanism (especially the environmental impact due to the high energy consumption), proof-of-stake was first proposed as an alternative consensus mechanism in 2012 (Seibold and Samman, 2016, p. 7) and offers a completely different approach to the computing power-based proof-of-work mechanism. Within a proof-of-stake consensus mechanism, a node’s ability to add blocks to the blockchain is directly related to its respective ownership stake in the cryptocurrency. Thus, a node that possesses five times more coins than another node would be able to validate five times more blocks than the other (Manning, 2016). In other words, block validation is made easier for those nodes that own a larger stake in the network, the motivation behind this being to give more power to those network participants that have the “strongest incentive to be good stewards of the system” (Narayanan et al., 2016, p. 233). Thus, in a sense, a proof-of-work mechanism seeks to guarantee validity by requiring a high input of work, while a proof-of-stake mechanism seeks to guarantee validity by requiring validators to invest in a stake as collateral.
The general process of block validation under a proof-of-stake mechanism can be described as follows. A certain number of currency holders decides to place their coins within a proof-of-stake mechanism and thus become validators. The algorithm then chooses one of these nodes to become the validator for the next block based on a weighting that is dependent on their respective deposit size. Thus, a node with ten coins will be ten times as likely to be chosen as validator than a node with one coin (Github, 2016; Narayanan et al., 2016, p. 231 ff.).
In addition to the proof-of-work and proof-of-stake protocols, a wide range of other consensus mechanisms has been developed (Seibold and Samman, 2016). But as each consensus mechanism has its unique advantages and shortcomings, it is important to note that the choice of a consensus mechanism is very much dependent on the architecture and purpose of the blockchain in question (Liesenjohann, Matten and Terlau, 2016, p. 15). To illustrate these potential differences in architecture and purpose, a short overview of the different types of blockchains regarding accessibility will be given in the following.
In addition to the respective consensus mechanism that they employ, blockchain networks can also differ in terms of their accessibility for potential users. It has by now become common practice to distinguish between three main types of blockchains: public, private and consortium blockchains (Liesenjohann, Matten and Terlau, 2016, p. 15).
A public, or unpermissioned, blockchain is, as its name suggests, accessible by any willing participant around the world. As soon as a node has accessed the network, it can engage in transactions and take part in the validation and consensus process. In general, public blockchains can be “considered to be fully decentralized” (Buterin, 2015) and are consequently fully transparent and open networks (Winters, 2016). To this day, the Bitcoin blockchain is probably still the most well-known example of a public blockchain, as anyone is free to participate if he or she can run the required software.
On a fully private, or permissioned, blockchain, the participation of nodes requires a central authority’s permission. This gatekeeper enacts control over who is allowed to engage in transactions, to validate transactions and to gain insight into the transaction history within the network (Winters, 2016).
As such, a private blockchain relies on the interposition of a central middleman. Since the core feature of the original Bitcoin blockchain was the abolishment of such a central authority, blockchain enthusiasts are having heated discussions over whether such a setup does or does not defeat the essential purpose of a blockchain (Interview #1, p. XLI) (Winters, 2016). But aside from this discussion, a private blockchain offers the benefit of being able to process transactions more efficiently and, thus, quicker than an unpermissioned blockchain (Thompson, 2016b). Furthermore, as Buterin (2015) points out, the central authority can make quick changes to the blockchain’s parameters, a functionality that may be crucial in certain fields of application, such as national land registries. Moreover, transactions on a private blockchain are cheaper than on a public blockchain, as they needn’t be verified by thousands of nodes, but only a few participating nodes (Brennan and Lunn, 2016, p. 44 f.).
A consortium blockchain differs from a public blockchain in the sense that a certain consortium of network participants decides over which node is allowed to approve which transactions, while the read access may lie anywhere on the spectrum from entirely public to private and will depend on the ultimate goal of the respective blockchain (Winters, 2016). Thus, a consortium blockchain “may be considered ‘partially decentralized’” (Buterin, 2015).
This type of blockchain offers especially interesting possibilities to organisational users as a means of collaboration, as it offers the same benefits of private blockchains – for example transaction efficiency and privacy – while distributing power between multiple network participants (Thompson, 2016b).
After having provided an overview of the conceptual and technological foundations of a blockchain in the previous chapters, a question that remains unanswered is which benefits the implementation of a blockchain architecture offers over traditional, centralised network and database structures.
As has been described earlier, blockchains allow for the disintermediation of transaction processing systems, thus enabling trustless, direct peer-to-peer transactions between parties. As such, a blockchain offers certain key advantages of traditional network structures that rely on intermediation by a trusted third party.
First and foremost, blockchains possess the potential to increase the speed at which transactions are carried out. By establishing direct peer-to-peer connections between network participants, the overall transaction processing time can be significantly cut by not having to transact through central third parties anymore (Underwood, 2016, p. 15).
Furthermore, blockchains bear the promise to reduce the overall cost inherent to a transaction processing system, as disintermediation also eliminates the cost associated with having to work through an intermediary (Plansky, O’Donnell and Richards, 2016). But a blockchain also allows for cost savings via the simplification of business processes and the automation of certain tasks (Nomura Research Institute, 2016, p. 65). Network participants are furthermore able to mutualise the infrastructure cost of a blockchain network (van Steenis et al., 2016, p. 9)., as all nodes “[…] provide the required computing power and data storage capacity.” (Interview #3, p. XLIX f.).
Moreover, the distributed character of a blockchain enables all nodes to gain full insight into the transaction history within the network. In an age where certain actors within business ecosystems have gained a competitive edge by building on information asymmetries, this increase in transparency can boost competition by levelling the playing field regarding the symmetrical distribution of information within industries. It can furthermore increase efficiencies by reducing the need for risk-hedging, thus allowing for more pricing accuracy and making regulatory compliance easier (McWaters et al., 2016, p. 24 ff.). In addition, it is not unreasonable to believe that organisations will be rewarded for such an increase in transparency with higher trust by stakeholders (Tapscott and Tapscott, 2016b, p. 30).
In addition to establishing more transparency, a blockchain can furthermore enhance the overall data quality within a network. Organisations today often still rely on outdated legacy systems and processes “to manage and repair unclear, inaccurate reference data […].” (Parker, 2016). A blockchain can solve this issue by “remov[ing] the need to reconcile multiple copies of data […].” (Parker, 2016). This eliminates potential discrepancies between separate databases and greatly enhances overall data accuracy and quality (Kasolowsky et al., 2016, p. 3 f.).
One of the key selling points of the blockchain technology is furthermore the security it offers due to its distributed nature and its inherent consensus mechanism that make it virtually tamper-proof. As there is no central party with controlling power over the network, a blockchain’s history cannot be changed without overwriting it on all nodes connected to the network simultaneously. This would require an attacker to possess at least 51 per cent of the computing power of the entire network – rendering every hacking attempt uneconomical (The Economist, 2015b). Furthermore, due to the distributed nature of the blockchain, there is no “central point of failure” (Interview #3, p. L), as is the case in centralised networks that rely on an intermediary, thus greatly increasing the resilience of the overall network (Brennan and Lunn, 2016, p. 8; McKinsey & Company, 2015a, p. 6).
Overall, the blockchain offers certain key advantages over traditional, centralised databases and transaction systems. But as two of the interviewees for this study put it, this does not mean that blockchain technology is fit to replace centralised systems in every scenario (Interview #2, p. XLV; Interview #4, p. LVII). In the current blockchain hype, many use cases of blockchain appear to be a “solution searching for a problem” (Brennan and Lunn, 2016, p. 4). As one interviewee noted, to avoid wasting time and resources on the development of irrelevant blockchain use cases, starting by analysing a situation with a decision tree is a good starting point to identify worthwhile blockchain opportunities (Interview #4, p. LVII).
According to such a decision tree, as is presented in figure 6, a blockchain platform makes sense for business applications only under the condition that a database is needed, this database requires shared write access, will be accessed by unknown parties with contrasting interests and shall not rely on an intermediary to ensure system integrity (Brennan and Lunn, 2016, p. 45 f.).
As an “immutable, unhackable distributed database of digital assets” (Kirkland and Tapscott, 2016), blockchain has already been dubbed the “biggest innovation in computer science” (Kirkland and Tapscott, 2016). And while the blockchain was first developed and applied in the context of the cryptocurrency Bitcoin, it offers many more potential areas of application. In essence, “[Blockchain] is to Bitcoin, what the internet is to email. A big electronic system, on top of which you can build applications. Currency is just one.” (Financial Times, 2015).
The quest for applications beyond cryptocurrencies, also dubbed Blockchain 2.0, has led to the development of new blockchain protocols, such as Ethereum or Hyperledger, which allow users to build custom applications based on an underlying blockchain. Blockchain 2.0 now enables not only the transfer of digital currency, but “to register and transfer any digital asset besides bitcoins.” (NewsBTC, 2016). This feature carries profound implications for the applicability of blockchain for a wide range of use cases, as it enables the representation of physical assets on the blockchain, a process also known as tokenization of assets (FINRA, 2017, p. 3; Evans et al., 2016).
Following the comprehensive classification of potential areas of application of blockchain technology by Frøystad and Holm (2015), a short, non-exhaustive overview over current and possible future fields of application of blockchains will be given in the following chapters.
In the following, a cryptocurrency, or digital currency, will be defined as follows:
“A cryptocurrency is a digital representation of value that is neither issued by a central bank or public authority nor necessarily attached to a fiat currency, but is accepted by two or more parties as a means of exchange and can be transferred, stored or traded electronically.” (Frøystad and Holm, 2015, p. 18)
Blockchain has been at the heart of a new wave of cryptocurrencies since the development of the Bitcoin protocol by Satoshi Nakamoto in 2008. And cryptocurrencies are on the rise. As of May 2017, Bitcoin alone boasted a market capitalisation of more than US $31 billion (Coinmarketcap, 2017). But why is it that these new digital currencies seem to be so much more successful than any other concept of digital money before them?
Concepts of digital currencies have been developed as early as the 1980s, but have faced various major issues that have prevented them from being implemented and utilised on a larger scale. One of these issues has always been the so-called double-spend problem: how does one prevent an actor from simply copying a purely digital form of money, and consequently being able to spend it more than once (NewsBTC, 2016)?
This is where the blockchain steps in as one of the main building blocks of a free-floating and secure digital currency. As an immutable digital ledger, it registers the entire transaction history within the network. Trying to spend the identical currency unit twice would contradict the recorded history on the blockchain, and the transaction would be consequently be refused by the other nodes within the network (Narayanan et al., 2016, p. 69).
While cryptocurrencies offer valuable benefits over traditional currencies, significant challenges remain to be addressed: not only are they currently still subject to high fluctuations in value, but also is their risk of inflation or deflation not controllable. Furthermore, due to a lack of a regulating entity, there is no way of implementing monetary policies based on a cryptocurrency (Frøystad and Holm, 2015, p. 18). But regardless of these issues, regulators increasingly concern themselves with providing a legal framework for the use of digital currencies:
“It is too early to assess the possible impact of the forthcoming EU legislation on virtual currencies, but there is little doubt that it will be profound. Whether it will affect the growth of the emerging virtual currency industry, or provide it with a more stable regulatory framework, thus increasing its acceptance as money and eventually allowing it to become mainstream, is an open question.” (Scheinert, 2016, p. 10)
It is essential for an owner of any kind of property to be able to prove his legal claim towards his asset. Nowadays, various kinds of physical and digital ownership records are used to protect property rights, to resolve disputes, to allow for the transfer of ownership and to prevent fraud. But any common method of recording relies on a trusted third party to ensure its integrity (Mizrahi, 2015, p. 1).
While the blockchain technology’s original application as facilitator of the Bitcoin currency solely involved the registry and transaction-processing of a purely digital asset, solutions are now emerging that provide users with a proof of ownership of any kind of digital or physical asset via registry on a blockchain, thus eliminating the need for a trusted intermediary for the management of ownership records.
Such a registry of assets other than cryptocurrencies offers various potential uses. It would provide the creators of intellectual property with a means to ensure that they receive the appropriate remuneration for the value they create. In this domain, the start-up Ascribe offers a potential solution to the issue of piracy within the digital sphere. It allows artists to create an unequivocal, trackable and verifiable proof of ownership for their creations and gives them full control over who gets to experience their works of art. Unique pieces of art can be furthermore be transferred from one owner to another, just as Bitcoins (Tapscott and Tapscott, 2016a).
Another breakthrough application of blockchain that falls within the value-registry sphere is the validation of existence and possession of physical documents. A system securing and proving the authenticity of documents or other types of data, as is currently offered by the blockchain start-up Factom, enables users to eliminate certain risks associated with the handling of large amounts of physical documentation, such as risk of loss, deterioration, information leakage, etc. (Frøystad and Holm, 2015, p. 21).
But the blockchain offers more opportunities than a mere reduction of risks and costs. By providing land-owners with a tool to unmistakably secure their property claim, homeowners can protect themselves against misappropriation by governments in politically unstable regions (Tapscott and Tapscott, 2016b, p. 40 f.). Furthermore, real estate transactions are often tedious and take a long time to complete, thus significantly delaying the actual transfer of ownership. A blockchain can help to speed up such transactions, while eliminating the risks involved in manual registration, such as registering property with incomplete or wrong information (Lantmäteriet, ChromaWay and Kairos Future, 2016, p. 26). Blockchain-based land registry systems are currently being considered by a multitude of countries, including Honduras and Georgia, and a public-private collaboration in Sweden is planning to start testing its registry in March 2017 (Rizzo, 2017).
The ValueWeb (Skinner, 2016), also known as Internet of Value, refers to an evolutionary transformation of the internet by a number of emerging technologies, amongst which blockchain is one of the key drivers (Frøystad and Holm, 2015, p. 26). In its essence, the ValueWeb allows for the creation of markets for any asset there is, allowing individuals to monetize whatever they “own, think or do, or can influence others to do” (Undheim, 2014).
An essential role within such this ValueWeb is played by so-called smart contracts, which allow users to “exchange money, property, shares, or anything of value in a transparent, conflict-free way while avoiding the services of a middleman” (BlockGeeks, 2016). In this sense, they expand the use of the blockchain protocol from being a mere ledger for financial transactions to storing and automatically executing any agreement between multiple parties (IDRBT, 2017, p. 7).
Just as regular contracts, smart contracts encompass all details of a contractual agreement between multiple parties, but in contrast to the traditional paper-based contract do not require a third-party intermediary to ensure the enforcement of the agreement. As such, smart contracts are self-verifying, self-executing and tamper resistant (SmartContract, 2017). Smart contracts thus possess the potential of making the formation of contracts as well as their enforcement “more efficient, cost-effective, and transparent” (Frøystad and Holm, 2015, p. 30) and can be especially of high value “in industries where accurate monitoring and execution of high-value contracts is critical […].” (SmartContract, 2017). A comprehensive comparison between blockchain-based smart contracts and traditional paper-based contracts is given in table 2.
|Parameter||Traditional Contracts||Smart Contracts|
|Settlement time||1-3 Days||Minutes|
|Form||Physical (wet signature)||Virtual (digital signature)|
|Enforcement||Lawyers necessary||Lawyers possibly unnecessary|
The lifecycle of a smart contract always follows four distinct steps. First, smart contracts are coded by translating all desired contractual parameters into the respective programming language, after which the contract is encrypted and sent out to the other nodes within the blockchain network, just as would be the case with a regular transaction on the blockchain. Next, a certain triggering event, which has been precisely defined in the contract parameters, occurs. This event can either be a specific transaction taking place within the network, or the receipt of certain information. Following this triggering event, the contract is executed, and value is transferred as defined in the contract. Finally, settlement takes place in whichever form has been specified within the contract (Frøystad and Holm, 2015, p. 31). Thus, in simplified terms, a smart contract can be compared to a physical vending machine. After the buyer has inserted a coin, the machine automatically enforces the buying agreement between the owner of the machine and the buyer (Narayanan et al., 2016, p. 286 f.)
Due to their very general nature, smart contracts based on blockchains possess the potential to reinvent business processes in various industries (Sproul et al., 2016, p. 6): Smart contracts could be applied by a governing authority to establish a tamper-resistant voting system, and/or induce more people to participate in a vote, as the hassle of having to line up in front of voting offices is alleviated (BlockGeeks, 2016). Smart contracts could furthermore be used to replace intermediary services, such as Airbnb or Uber, by introducing what is known as a decentralised app (dApp) (Tapscott and Tapscott, 2016b, p. 336): a “completely open-source application that operates autonomously, and with no entity controlling the majority of its tokens” (Voshmgir, 2016b, p. 6). Before the introduction of blockchain technology, the bulk of computing power used to lie mainly in the hands of centralised organisations. But now, dApps offer users the opportunity to directly code and upload an application onto a shared computing space, the blockchain, where it will function as it was meant to without any central power controlling it (Tapscott and Tapscott, 2016b, p. 297 ff.).
As has been outlined in the previous chapters, blockchain technology can be applied to a wide range of contexts and for a variety of purposes, from replacing fiat currencies with digital cryptocurrencies, over serving as a digital asset registry, up to enabling the vision of an internet of value – thus not representing “[…] only a replacement of current systems, but […] something that makes possible entirely new things.” (Interview #3, p. LI).
But while use cases for blockchain technology can be found across many economic sectors, financial services have early on been identified as a key area of application. As central financial intermediaries, banks have been fulfilling a wide range of important functions within the global economy for a long time. The following chapter shall provide a brief overview over these functions, before a deep-dive into the possible applications of blockchain in banking as well as into their strategic and operational implications for banks will be given.
As central financial intermediaries, banks serve a critical purpose in the worldwide economy. They are the balancing force between financing needs of individuals, corporations or states on the one hand, and investing needs of these actors on the other hand (Berger, Molyneux and Wilson, 2012).
Blockchain use cases can be found across the entire range of different banking services. As the focus of this thesis will be laid on blockchain applications in commercial banking, the following chapters will provide a simplified conceptual classification of the three main types of banks that are active in most modern economies: commercial banks, investment banks, and central banks.
Commercial banking comprises mainly of those parts of the banking business that the greater public will, in general, associate with the term banking.
A commercial bank’s role is threefold. First, it accepts funds from depositors and, in turn, uses these funds to provide a range of financial services, such as giving out loans to customers. It is this critical function of financial intermediation that enables individuals and corporations to engage in economic activities.
Second, commercial banks provide security and convenience to their clients. In the simplest form, banks can be seen as a “safe haven for the depositor’s funds” (Berger, Molyneux and Wilson, 2012, p. 1) that, by enabling customers to handle transactions via, for example, debit cards, eliminate the safety risk of having to hold large amounts of cash on hand.
This idea is furthermore linked to the third major function of commercial banks, which is the operation of the payment system by issuing checks, debit and credit cards as well as arranging wire transfers, all of the time making sure that the correct accounts are credited and debited in a timely manner (Casu, Girardone and Molyneux, 2008, p. 25 ff.). As such, these banks facilitate commercial transactions between buyers and sellers of goods and services by practically “lending their reputation and credibility to the transaction” (Simpson, 2015).
While commercial banking mainly refers to deposits and lending activities, investment banking focuses on offering specialised services relating to financial markets to corporate clients. The main role of investment banks is helping companies to raise money, i.e. advising them on whether and how to raise equity or debt (Casu, Girardone and Molyneux, 2008, p. 69).
But investment banks also engage in activities on financial markets themselves. Not only do they regularly engage in the trading of financial securities on their own behalf, hoping to make a profit by buying low and selling high, but often they also act as market makers on financial markets, a key facilitating function in which they buy and sell large amounts of securities according to the market’s supply and demand fluctuations, thus keeping financial markets liquid (Investopedia, n.d.).
Further activities encompass the creation of new financial products for specific clients or general investors by combining existing financial instruments, acting as research agents for clients and offering mergers and acquisitions-related services (Pritchard, 2015).
While commercial and investment banks are (mainly) for-profit institutions, central banks don’t operate with the goal of generating a profit. In a simplified sense, a central bank’s most prominent function is to control the money supply by either injecting the market with liquidity, essentially by ‘printing money’, or by reducing the available amount of the respective currency by absorbing funds. Adjusting the overall money supply via these practices, an activity that is also known as the monetary policy of a central bank, directly influences the level of inflation within a market and is thus performed cautiously to attain a certain target inflation level (Heakal, 2015).
This macroeconomic responsibility is complimented by the microeconomic responsibility of acting as the “lender of last resort” (Heakal, 2015; Berger, Molyneux and Wilson, 2012, p. 23): By lending money to commercial banks, a central bank ensures that solvent banks do not become the victims of short-term liquidity crises – a circumstance that could otherwise potentially destabilize an entire economy (Deutsche Bundesbank, n.d.). As such, central banks are essentially the backbone of a nation’s banking system, put in place to prevent it from failing (Heakal, 2015).
As has been outlined earlier, the purpose of this exploratory analysis is to identify the currently most relevant use cases of blockchain technology in commercial banking, to determine the respective operational and strategic implications of these use cases for banks, as well as to give an overview over the current hurdles standing in the way of a wider adoption of blockchain technology.
These research questions are analysed via a two-pronged research methodology well-suited for exploratory studies (Saunders, Lewis and Thornhill, 2009, p. 140): an in-depth literature review on the one hand, and expert interviews on the other hand, both of which shall be further described in the following.
As blockchain offers a wide range of possible applications in commercial banking, an in-depth literature review has been conducted to identify those use cases that are currently deemed the most relevant and pressing in practice.
A total of 39 recent studies on blockchain technology in banking have been collected and analysed over the course of this study (see Appendix A). These studies have been analysed as per the following scheme, the results of which are depicted in figure 7: First, all use cases mentioned as relevant within each of the respective studies have been collected. In a next step, these use cases were sorted into four main categories per the following classification: 1) commercial banking, 2) investment banking, 3) central banking, and 4) other. Next, the use cases that have been categorised as belonging to the realm of commercial banking were standardised to eliminate discrepancies in terminology between different authors.
This standardisation resulted in the classification of all commercial banking blockchain applications into eight distinct use cases: 1) Cross-border payments, 2) Automated compliance, 3) Loans, 4) Domestic payments, 5) Know your customer (KYC), 6) Micropayments, 7) Trade finance and 8) Asset management. Following this process of standardisation, the studies could then be collectively screened for the most-mentioned use cases of blockchain technology in commercial banking. This evaluation of recently published literature on blockchain in banking resulted in the selection of three distinct blockchain use cases for further analysis within the scope of this thesis: cross-border payments, trade finance, and KYC.
Each of these use cases was then analysed following the same pattern. First, the current situation within these fields of application was researched to identify the underlying problem that blockchain could help to solve. In a next step, current blockchain-based solutions for these fields of application were identified. From the resulting list of start-ups and technologies, one specific example was selected to demonstrate a possible technological solution incorporating blockchain technology for the specific use case. This selection was based partly on the availability of detailed information regarding the technical workings of the solution, and partly on the density of the recent news flow regarding practical initiatives of this start-up and its partnerships with banks. Following the presentation of the technological solution, each use case was then analysed regarding its specific operational and strategic implications for commercial banks.
In addition to the literature review and analysis, interviews with dedicated blockchain experts have been conducted over the course of this study. The interview methodology followed a semi-structured approach, with an overarching interview template (see Appendix B)forming the basis of each interview, but allowing for deviations to occur naturally as the respective discussions evolved (Saunders, Lewis and Thornhill, 2009, p. 320).
The contact to relevant interviewees was established via personal networking in three cases, and via LinkedIn in another case. To provide a holistic perspective on the topic, these experts were selected to include members of different stakeholder groups and to represent each of the three selected use cases:
- Interview #1: Blockchain consultant specialising in payments; former member of the innovation lab of a global payments provider
- Interview #2: Generalist blockchain consultant at a global consulting firm
- Interview #3: CEO of a global digital identity institution; board member of a European Fintech advisory group
- Interview #4: Blockchain consultant specialising in real economy and trade applications; former managing director of multiple European electronics companies
The interviews served a twofold purpose: on the one hand, they allowed for validation of the results of the literature review, and, on the other hand, served to ensure that the results presented in this thesis are up-to-date and based on practical insights. Three of the interviews were conducted per telephone, and one was conducted via video conferencing.
The research methodology employed in this study does not come without limitations. To ensure the actuality of the insights gathered, but also due to the general lack of coverage of the topic within academic research, the literature review and the establishment of the state of the art was based primarily on grey literature in the form of studies and reports issued by corporations, research institutions, and government institutions. As these primary literature sources are not indexed in any central research database, the search for relevant literature was limited to the utilisation of common web search engines. Thus, it is difficult to estimate whether the sample of 39 studies analysed within the scope of this thesis adequately represents the unknown number of all studies on the topic of blockchain in banking. But as the analysis of 39 reports has yielded a rather unambiguous result regarding relevant use cases, it can be assumed that a larger sample would have likely resulted in similar findings.
Furthermore, a limiting factor in the identification of relevant blockchain use cases is the fact that different authors tend to utilise very different terminologies within their respective publications. To make the sample of studies comparable it was thus necessary to standardise the terminology of the use cases, which may have led to the distortion of the findings in some way. But as the use cases are, most of the times, described in a detailed manner in each study, it was possible to match associated use cases based on the described processes and applications.
And lastly, as this study focuses only on relevant use cases of blockchain technology in commercial banking, it was necessary to classify the overall banking use cases as belonging to the realm of either commercial banking, investment banking, central banking, or other sectors. But as use cases of blockchain technology often involve a wide range of different stakeholders, this distinction cannot always be clearly drawn.
A similar assessment of methodology limitations can be applied to the interviews performed over the course of this study. The lack of standardisation of a semi-structured interview may result in less reliable data than structured interviews, and the results may suffer from an interviewer bias due to the interviewer potentially influencing responses via the use of specific tone of voice or non-verbal behaviour (Saunders, Lewis and Thornhill, 2009, p. 326 ff.). Thus, in an effort to ensure a high level of data quality and unbiased answers, the focus was laid on the use of open questions (Saunders, Lewis and Thornhill, 2009, p. 332).
Next to potential data quality issues within the experts’ responses, the selection of the interviewees themselves can be a limiting factor in terms of research design. As the blockchain technology is currently being explored by a wide range of different stakeholders who may not necessarily have the same opinion on relevant topics, insights may differ depending on the selection of interviewees. Thus, to base the study’s findings on a range of different viewpoints, the interviewees for this study were selected to represent multiple different stakeholder groups. Nevertheless, both a larger sample of interviewees, as well as the inclusion of interviewees from other professional areas, might have yielded different results. But the fact that the overall insights gained from the conducted interviews were in no case contradictory to each other increases confidence in overall data reliability.
As the blockchain technology carries the promise of transforming the way value is stored and transferred, the financial services sector is naturally the first that comes to mind when considering potential applications of this technology. And indeed, use cases for blockchain are currently being explored in the insurance industry, in capital markets and investment banks, as well as in commercial banks. And even central banks, such as the Bank of England, are researching the potential adoption of a blockchain-based cryptocurrency (Liesenjohann, Matten and Terlau, 2016, p. 18).
The focus of this study will be the analysis of potential applications and their strategic and operational implications within the commercial banking industry. The following chapters will therefore be dedicated to the assessment of the importance of blockchain technology given the overall forces driving change in the commercial banking sector, after which a detailed analysis of the three currently most relevant use cases of blockchain in commercial banking will be conducted.
A lot has changed since the beginning of the digital revolution in the middle of the last century. The so-called third industrial revolution, which brought us the introduction of the personal computer, the internet, and information technology, enabled the emergence of a wide range of new business models, disrupting entire industries (Schwab, 2016, p. 7).
When it was acquired for US$ 22 billion by Facebook in 2014 (Frier, 2014), WhatsApp had already amassed a user base of 465 million people in the five years since its founding in 2009 (Statista, 2017). Suddenly, it was possible for a start-up with just 55 employees to compete with and to effectively disrupt the business models of established companies – organisations that employed tens of thousands of people and had been in the business for decades (Perrault, 2016). It is this disruption of established businesses by the likes of WhatsApp, Uber, Airbnb and other digital ventures, by which the process of creative destruction, which essentially describes the ongoing revolution of any economy from within (Schumpeter, 1942, p. 83), manifests itself in the current age (Gans, 2016; Frey and Osborne, 2015).
Banks have been operating in a difficult market environment over the past years. Market conditions such as low interest rates, a reduction of overall debt levels and increased pressure from regulators have shrunken revenues (CGI Group, 2016, p. 2; Doyle and Quigley, 2014), and with overall investments into Fintechs around the world having grown tremendously over the recent years, as is demonstrated in figure 8, the banking industry ranks among the primary candidates of sectors ripe for a fundamental disruption. And while changing customer needs, as well as regulatory influences, are also among the factors that drive the reshaping of the banking industries, technological advancement is at the heart of the disruption process (Brereton et al., 2014, p. 6).
Amongst the uprising technologies that are currently working on reshaping the banking industry as we know it, blockchain technology is probably one of the most talked about. By introducing an immutable and, thus, trustless shared ledger of transactions to all kinds of (business) networks, blockchains could, in theory, “[…] threaten a central provider, such as a bank […].” (Interview #2, p. XLV) by reducing the reliance on banks as financial intermediaries within the traditional “hub and spoke model” (IDRBT, 2017, p. 10), and making room for entirely new business models in the financial services industry (Haycock and Richmond, 2015, p. 62 ff.).
But while the definite impact of the blockchain technology on banking as we know it remains a matter of speculation as of today, practitioners are extending their understanding of potential applications of blockchain technology in banking on a daily basis. A wide range of use cases has so far already been conceptualised, and Fintechs, as well as established banks, are working on the goal of developing blockchain-based banking applications beyond the proof-of-concept (PoC) phase. And the current projections of an annual blockchain-enabled cost savings potential for banks of around US $20 billion per annum by 2022 in back-office processes alone (Belinky, Rennick and Veitch, 2015, p. 15) may serve as an explanation for these increased development efforts.
As has been outlined earlier, blockchain is one of the technologies that are currently discussed to carry a large potential to transform the entire financial services industry. But while blockchain technology might seem applicable in a wide range of use cases, all the interviewees for this study pointed out that many of these potential applications are ‘solutions in search of a problem’, as other currently available technologies could also be used to implement certain use cases (Interview #1, p. XLI; Interview #2, p. XLV; Interview #3, p. LI; Interview #4, p. LVII).
Thus, to assess the impact of blockchain on commercial banks, it is important to lay the focus of the analysis on the pressing and most realistic use cases. Over the course of the literature review and the expert interviews, the three distinct use cases cross-border payments, trade finance and KYC have been identified as the most relevant areas of application of blockchain technology in commercial banks.
When considering the significant technological advancements made in all areas of our modern society within the past 30 years, it is difficult to believe that an integral service to our everyday life, banking, still largely relies on IT structures that date back as far as 40 years. While other sectors, such as the media industry, have radically transformed their organisations as well as their products and services with uprising of digital technology (Ito, Narula and Ali, 2017), commercial banks have not made essential changes to their servicing structure since the 1970s (Haycock and Richmond, 2015; Heidmann, 2010). As one interviewee pointed out, “[…] banks are currently mostly operating on quite the old systems, rely on bloated structures and still often have processes in place that are largely dependent on a lot of manual work” (Interview #1, p. XXXVIII).
This issue of antiquated IT structures in financial services is especially visible within the field of cross-border payments (Interview #1, p. XXXVIII), which are an integral part of a bank’s service portfolio and which total up to US $155 trillion each year (Leising, 2016). These payments are currently directed through a complex network of intermediaries, a system also known as correspondent banking, taking up a lot of time (in most cases three to five days), introducing many risks into the process of sending money from one party to another across country borders, and entailing high costs for banks and their clients (Bauerle, 2017).
As one of the blockchain’s main strengths lies in the disintermediation of networks, and, with it, the establishing of direct peer-to-peer connections for value exchange, cross-border interbank payments appear to be a very promising use case in which blockchain has the potential to benefit both banks and their customers. But before the blockchain solution to correspondent banking is introduced, an overview of the current correspondent banking system and its pain points shall be given in the following.
As is depicted in figure 9, a transfer of funds between two customers of different banks, Alice and Bob, is currently processed by the inclusion of a variety of parties other than the two commercial banks at which Alice and Bob hold their respective client accounts.
Alice, a customer of bank #1, would like to transfer US $10 into Bob’s bank account. But Bob lives in another country and does not own a bank account within the same bank that Alice does. To process such an interbank transaction, Alice’s and Bob’s banks may enter one of the following transaction relationships: the simplest relationship currently possible would be the transfer via a so-called Correspondent Banking Agreement (CBA) (Committee on Payments and Market Infrastructures, 2016, p. 9 f.; Brown, 2013). In the basic scenario, the two banks would be directly connected to each other via such an agreement, allowing for the flow of funds from one entity to the other. In a more complex scenario, the banks could be indirectly connected via CBAs with other banks, thus creating the need to direct the funds through a network of intermediary banks that are unrelated to the transaction.
It is easy to imagine that this system can, depending on the relationship of the two banks, in practice quickly become highly complex (Brown, 2013). In its essence, the SWIFT system is a vehicle enabling banks to engage exactly in such transactions. But it is a common misconception that the SWIFT network is a direct payment transferring vehicle (Brown, 2013). SWIFT in fact only allows banks that are members of its international network to exchange payment orders with each other, which are essentially messages indicating a payment to a specific account. Banks are then obliged to settle these payments through the respective correspondent accounts that they hold with each other (SWIFT, 2017a).
While, in theory, the above-described transaction process, involving banks holding accounts with each other, seems perfectly viable, there is a major liquidity issue inherent to it. If a bank would want to be able to transfer its customers’ funds to any other bank around the world at any given time via such CBAs, it would need to hold large sums of funds tied up in correspondent accounts (also known as nostro and vostro accounts) at all the respective correspondent banks (Summers, 1994, p. 22). Thus, a solution to this system might be for the two banks in our example to gather all the international money transfers that have been demanded by customers to another bank on a given day and to just settle the net balance with the other bank at the end of the day (Brown, 2013).
This is where the so-called Deferred Net Settlement (DNS) systems step into the picture (Summers, 1994, p. 76). In such a system, payment messages are not exchanged via SWIFT, but through a central clearing system (e.g. BACS in the UK) that keeps track of all transactions and calculates the net sums to be settled between banks (Bank of England, n.d.). Thus, banks only need to settle the net balances at the end of a given period with, either directly by credit and debit of the accounts they hold with each other, or by utilising a real-time gross settlement (RTGS) system, as is described below. As credit card schemes, as well as money transfer operators such as PayPal, also operate with such a transaction aggregation and net settlement process, they too can be categorised as DNS systems (Brown, 2013; Bank of England, n.d.).
But while a DNS system does significantly reduce the amounts of cash a bank needs to hold in its nostro accounts at other institutions, again, this system is all but perfect: Since there is a delay between the issuance of a payment by Alice and the settlement between bank #1 and bank #2, bank #2 will not release the money to Bob before the net balance between the two banks has been settled. Thus, a significant delay is introduced into the process of transferring money from Alice to Bob due to counterparty risk in the relationship between banks (Brown, 2013; Summers, 1994, p. 104).
But there is another system put in place that sought to eliminate the issues of cost, liquidity and counterparty risk once and for all. The idea of all banks holding accounts with a Central Bank that is free of counterparty risk led to the development of RTGS systems, such as CHAPS in the UK, FedWire in the United States and TARGET2 in the Eurozone (Brown, 2013). These systems enable real-time money transfer between different banks via accounts that each of them hold with the central bank, thus allowing for immediate settlement of gross amounts instead of batch netting once every defined period (Bank of England, n.d.).
Unfortunately, RTGS systems also have certain practical limitations for banks. They are mainly used for high net worth payments (treasurytoday, 2004), and the processing of payments via these systems is often subject to defined operating hours, for example from 7 a.m. to 6 p.m. for the European TARGET2 (ECB, 2010, p. 14). But most importantly, as they are run by the respective central bank, their use is limited to transferring funds on a national or regional level. Due to the lack of a comparable global entity capable of maintaining accounts on behalf of individual banks, current RTGS systems do not provide a solution for global payments. Thus, to be able to process international payments, up until today banks still need to hold large amounts of funds in nostro accounts at other banks within foreign countries – trapping vast amounts of capital that could be used more productively if a more elegant solution were to be found to process cross-border payments (Seel, 2016).
In summary, Seel (2016) identifies certain key challenges arising out of the current network organisation for international payments: Banks are currently required to maintain multiple international CBAs to be able to process funds transfers from a customer of bank #1 to a customer of bank #2. This, in turn, requires active managing of nostro/vostro account balances, a complex, time-consuming and costly process. As Interviewee #1 put it, “transferring money from, for example, Germany to America still involves a lot of manual work, with bank employees actually filling out forms by hand and faxing them […].” (Interview #1, p. XXXVIII). Moreover, keeping cash tied up in nostro accounts puts banks under increased pressure, especially when thinking about regulatory capital and liquidity requirements. The nostro/vostro account practice furthermore exposes parties to counterparty risk whenever one bank grants credit to another. And besides this exposure to counterparty risk, currency risk poses another major complication to the international payment process: Due to delays in the process, the relevant foreign exchange (FX) rate may change significantly between the moment a payment is issued by bank #1 and the moment it is received by bank #2.
All these issues are the cause of the inherently high cost of cross-border payments via traditional banking structures, which is especially a problem for low-value transactions (Higginson, 2016, p. 53). But a modern, blockchain-based solution may be underway to reform the antiquated mechanisms of cross-border payments.
As has been described above, today’s cross-border payment infrastructure relies on banks holding many CBAs, and with this, numerous nostro/vostro accounts with other institutions around the globe, a process that increases risks, costs, and which introduces time delays for both banks and their customers into cross-border payments.
Ripple, founded in 2012 and based in San Francisco, offers a blockchain-based solution which seeks to innovate this current practice by utilising blockchain technology to allow for a more efficient and more secure transfer of funds in any currency in real time. As such, Ripple may not only be the global RTGS system that has so far been the missing puzzle piece in the international interbank payment system (Rosner and Kang, 2016, p. 661), but also a key enabler for the establishment of the ValueWeb (McKinsey & Company, 2015b, p. 20).
In essence, Ripple is a “settlement infrastructure technology for interbank transactions” (Meijer, 2017a) that allows for the direct transfer of funds between two parties, in any currency the transacting parties wish for. As such, as Ripple’s former CEO Chris Larsen puts it, “Ripple simplifies the [exchange] process by creating point-to-point and transparent transfers […].” (Meijer, 2017a).
Ripple currently offers two technical solutions for interbank cross-border payments, as is depicted in figure 10: Either the sender’s bank can leverage an existing nostro/vostro relationship with other banks to transfer the funds (relevant for high-volume corridors, where banks possess the necessary leverage to source FX at competitive rates), or the bank can rely on market makers within the Ripple network to provide FX liquidity at competitive exchange rates (Ripple, 2017b).
No matter which of the two paths for exchange a bank chooses to utilise for the cross-border fund transfer, Ripple will ensure a real-time fund movement due to coordination across all involved ledgers. This is achieved via the utilisation of Ripple’s Interledger Protocol (ILP), as is depicted in figure 11. From a technical perspective, Ripple’s solution rests on two components (Ripple, 2017a, p. 2 ff.): Ripple Connect is a plug-and-play module that allows banks to easily connect to the Ripple network. By establishing a direct line of messaging, Ripple Connect allows banks to exchange information regarding sender and recipient of a payment, fees involved in the process and an estimated processing time for the initiation of the payment. All this information is bundled by Ripple Connect and, in correspondence with the Ripple network to get the latest information on currency exchange rates, can present a comprehensive overall cost overview of the transaction to the initiating bank. If, following the review of this information, the initiating bank chooses to accept the conditions, the beneficiary bank is in turn notified of the payment request and the respective terms of the transaction. The beneficiary bank can then, upon approval of the quote, also choose to accept the transaction. Following this review and acceptance of the terms of the transaction, the automated settlement of the payment is triggered. Hereby, the funds are transferred from the originating bank’s ledger to the recipient bank’s ledger via the coordination by the ILP.
This is where the second component of the Ripple system, the ILP validator, and with it, the blockchain, comes into play. The ILP validator ensures that the institutions involved in the transaction process possess the funds necessary to process the transaction, thus providing all transacting parties with a single version of the truth regarding success or failure of the transaction (Ripple, 2017a, p. 2). Once the Ripple network has validated the transaction, the ILP validator triggers the transaction settlement (Ripple, 2017b, p. 10). The permissioned Ripple network hereby relies on a distributed ledger, keeping track of the respective banks’ and market makers’ account balances, and a specifically designed consensus mechanism used to validate transactions (ASTRI, 2016, p. 36). This allows it to process transactions within a timeframe of around 3.5 seconds (Anderson, 2017) and removes all settlement risk from the transaction (Ripple, 2017b, p. 10).
This solution currently offered by Ripple easily connects to banks’ existing systems and offers the main benefit of real-time settlement and, if utilising external market makers, more competitive FX rates due to the market-based mechanism (Ripple Labs, 2015, p. 7).
But besides this current offering, in which banks still rely on either on a nostro/vostro account structure to hold foreign currencies or on a third-party liquidity provider facilitating the transaction between two banks across borders, Ripple is furthermore working on its vision of disintermediating the cross-border payments sector entirely (McKinsey & Company, 2015b). Hereby, banks would employ Ripple’s own digital currency, XRP, as a bridge currency for cross-border payments (Rapoport et al., 2014, p. 15). By holding XRP in an account and creating a market to exchange XRP for fiat currencies, payments could be completed on a peer-to-peer basis within the network, without the need to hold foreign currencies in nostro accounts or without having to rely on liquidity providers, thus tremendously reducing liquidity costs (Venegas, 2017; Jarret, 2016). Thus, instead of having to maintain numerous nostro accounts for various currencies around the globe, only a single XRP account would be needed per bank (Ripple, 2016b, p. 9 f.).
From an operational perspective, the Ripple solution offers banks a more efficient cross-border payment infrastructure over the one that is currently in place and which has been described earlier. In detail, Ripple provides banks with several benefits: First and foremost, Ripple provides a solution for real-time cross-border settlements, cutting down the transaction time from days to seconds (Höltmann and Vasilev, 2016, p. 7). As a consequence of the real-time transaction speed, interparty settlement risk and currency risk exposure due to delays in the transaction process are eliminated (Sculley and Zagone, 2015, p. 3).
Moreover, Ripple allows banks to allocate their liquidity more efficiently onto their nostro accounts. While banks may choose to keep their nostro accounts in place in high volume corridors, Ripple allows them to shift from relying on nostro accounts at other institutions in low-volume corridors to utilizing third-party liquidity providers within the Ripple network to process payments, thus reducing organizational complexity and overall liquidity costs (Ripple, 2017b; Sculley and Zagone, 2015).
Finally, the Ripple system allows banks to reduce operational costs by being able to more efficiently exchange information about the transaction partners, relevant transaction fees and delivery times, as well as by automating the fund processing itself via the Ripple network, thus eliminating the need for manual handling and increasing the visibility and traceability of each transaction (Ripple, 2017b; Ripple, 2016b; Sculley and Zagone, 2015).
All in all, interviewee #1 pointed out that a blockchain-based solution for cross-border payments could enable banks to greatly reduce their costs associated with cross-border payments (Interview #1, p. XXXVIII). As is depicted in figure 12, Ripple estimates that it can unlock total cost savings of up to 42 per cent within the international payment sector of a banking client.
Next to operational improvements and the resulting cost savings, blockchain technology furthermore enables banks to “strengthen their business” (Interview #1, p. XL) from a strategic perspective. Current customers will benefit from an enhanced payment experience, being able to send money across borders in an instant, not having to factor in the current delay of multiple days until an international payment is completed. Moreover, as the costs for these transactions greatly decrease, customers can be expected to benefit from lower charges on international transfers (Trimble, 2016, p. 42). It can be expected that the removal of frictions within the international payment network and, thus, the easy access to a cross-border payment service, will furthermore lead to increased competition on service quality and cost among banks – thus further enhancing customer experience (Ripple Labs, 2015, p. 15).
The Ripple protocol furthermore enables banks to venture into entirely new fields of business. The internet age has brought with it the rise of digital giants, such as Amazon and Uber, whose business models rely on the quick processing of large volumes of low-value payments across a wide range of payment applications and networks (Elison, 2016a; Trimble, 2016, p. 39). As of today, traditional are having a hard time to provide such a service due to the high cost it entails, which is why some businesses even put in place their own payment solution, such as the Chinese internet giant Alibaba did with Alipay. But even these are far away from being able to process payments in real-time. A global RTGS system such as Ripple will allow banks to expand their service offering to include processing of these high volumes of low-value corporate disbursements, enabling them to efficiently serve their customers’ needs in a growing internet economy (Elison, 2016a).
Moreover, Ripple allows banks to offer low-cost international remittance services to retail customers. The World Bank estimates the total volume of international remittances at around US $580 billion (World Bank, 2017). But under current payment network structures, banks are struggling to offer viable international retail remittance services due to the high cost and long timeframe required to process a payment across borders (Edwards, 2016; Let’s Talk Payments, 2016). Thus, consumers are looking mainly to specialised money transfer operators, Transferwise, to process their money transfers (Graham, Manns and Barnes, 2016). A blockchain-based solution for international payments may allow banks to offer an efficient international remittance service at competitive rates, thus complementing their existing service portfolio with a service that is relevant to large expat communities around the globe (Vishwanathan, 2017).
Finally, recent entrants into the international payments sphere, such as Transferwise, have proven to be capable of snatching market shares of established players in international money transfer. Thus, taking the opportunity of the early adoption of a new technology that allows for significant improvement in internal processes and unlocks additional revenue opportunities may be of crucial importance for banks in order to protect their positioning within international payments as one of their core areas of business (Elison, 2016b; Trimble, 2016, p. 42 f.).
In summary, blockchain technology has the potential to revamp the outdated cross-border payment sphere, bringing it up to speed to serve a globally interconnected and fast-paced economy. Having recognised the implications and opportunities that arise within this field of application, stakeholders in the payment sphere are increasingly engaging in initiatives that seek to introduce blockchain technology to international funds transfer.
Ripple has experienced growing interest by banking institutions around the globe since its introduction in 2013 and has, as of April 2017, established itself as one of the key players in the blockchain industry (Meijer, 2017a). In 2016, the company created a global interbank group for global payments based on Ripple technology named Global Payments Steering Group (GPSG), aiming to bundle the efforts for the creation of formalised standards for the use of Ripple. By joining the GPSG, major global banks, such as Santander, UniCredit, Bank of America and Standard Chartered, have expressed their dedication towards the development and implementation of a new global standard for payments (Treacher, 2016). As of April 2017, 75 banks around the world are already part of the Ripple network, with many more predicted to join soon (Meijer, 2017a; Roberts, 2017).
But Ripple and its supporters are not the only ones looking to revamp the antiquated cross-border payment infrastructure via the application of blockchain technology. In October 2016, Visa announced its cross-border B2B payments initiative Visa B2B Connect, built upon Chain Core, a private enterprise blockchain infrastructure (Hadzibegovic and Sohtz, 2016). And also SWIFT, the messaging system currently dominating the international payment network, initiated a PoC in partnership with Hyperledger to evaluate the possibility of applying blockchain technology to improve its current service offering, and to possibly fend off an attack by disruptors such as Ripple (SWIFT, 2017b).
In summary, blockchain technology seems to offer an elegant solution to transcend the currently complex and “absolutely inefficient” (Interview #1, p. XXXVIII) structures within cross-border payment networks. But while banks’ interest in a blockchain-based solution to the antiquated structures in cross-border interbank payments is on the rise, certain hindrances to the implementation of such a system remain. Most importantly, as an entirely new payment system can only be established with the support of a sufficient number of stakeholders (Brady and Mager, 2016, p. 11), collective action to establish common standards will be critical to the implementation of a blockchain-based cross-border payment infrastructure.
But to gain this support, it is necessary to convince relevant actors of the practicality and security it provides. And as security is best proven via the absence of breaches over a long time, the building of trust and the implementation of the Ripple protocol in the international payment sphere may, after all, be a time-consuming task (Rapoport et al., 2014, p. 44).
Trade is essential to the global economy, and banks play an integral part in facilitating the global flow of goods through payment execution, risk mitigation, and financing. And, as the World Trade Organization (2017) estimates that 80 to 90 per cent of world trade relies on some form of trade finance, it is the gearing that keeps international trade running.
Following the definition of the World Economic Forum, “trade finance is the process by which importers and exporters mitigate trade risk through the use of trusted intermediaries. Financial Institutions serve as the trusted intermediary providing assurance to sellers (in the event the buyer doesn’t pay) and contract certainty to buyers (in the event that goods are not received)” (McWaters et al., 2016, p. 75). While banks offer a range of different financial instruments within trade finance, the most commonly used product is the so-called letter of credit (LOC), accounting for around 45 per cent, or US $2.8 trillion, of the total bank-intermediated trade finance (Clark, 2014, p. 8).
Yielding total market revenues of up to US $50 billion for commercial banks around the world (Dab et al., 2016), trade finance is not only attractive from a direct revenue perspective. At default rates ten times below those of regular corporate lending (Everaert, Nolan and Walkowicz, 2015, p. 4), and bringing with it significant cross-selling potential for complementary services, trade finance is an integral part of the offering of a commercial bank (Everaert, Nolan and Walkowicz, 2015, p. 10).
But just as is the case with cross-border payments, trade finance based on LOCs is another key service offered by banks that suffers from high frictions due to complicated and inefficient processes connecting a large number of parties involved.
According to interviewee #1, a typical international trade process and the connected LOC-based trade financing is an inherently labour-intensive, multi-step process involving a variety of actors: “Documents are being sent from one party to another and back, and the bank is always interconnected with each of the parties in order to act as a controlling instance and to process the payments according to plan. This process is so complex, you wouldn’t believe it.” (Interview #1, p. XXXIX).
Figure 13 depicts a simplified trade transaction involving LOC-based trade financing between importer Alice and exporter Bob.
After Alice and Bob have come to an agreement and Alice has placed her goods order with Bob, he provides her with an invoice for her order. This invoice serves as a financial agreement, containing all relevant detail information of the order such as the quantity of goods ordered, the price to be paid and the delivery timeline (McWaters et al., 2016, p. 77). But Alice and Bob do not perfectly trust each other: Alice does not want to risk paying for the order before having received the goods, while Bob does not want to risk shipping the goods before having received some form of insurance that the order will be paid for by Alice.
Thus, Alice appoints her local bank to serve as an intermediary providing certain assurances to both trade parties (Silitschanu, 2017). On the one hand, the bank will provide Alice with the assurance that the goods will only have to be paid for if they perfectly comply with the details specified in the original trade agreement between Alice and Bob. And on the other hand, the bank will assure Bob that payment will be made once it has been established that the goods comply with the original agreement. As such, the service provided by Alice’s bank can be compared to a traditional escrow service, with the bank acting as a “disinterested third party […], releas[ing] funds only after certain conditions are met” (Pritchard, 2016a).
For this reason, Alice’s bank issues an LOC, documenting the financing details for the transactions and guaranteeing payment in case of compliance. As is the case with regular cross-border payments, the relationship between Alice’s and Bob’s banks will hereby often be established via correspondent banks (McWaters et al., 2016, p. 77).
Once Bob has received the LOC, he will initiate the shipment of the goods to Alice. To make sure that the goods shipped comply with the terms initially agreed upon by Alice and Bob, a third-party organisation is appointed with the inspection of the goods, checking them for according to the details stated in the invoice (McWaters et al., 2016, p. 77).
In a next step, the goods must pass the exporting country’s customs, who inspect the shipment based on the respective country’s laws, after which the goods will be shipped to the importing country, where the respective customs office will perform a similar check to ensure conformity with the importing country’s laws (McWaters et al., 2016, p. 77). Once the goods have cleared the customs and have been received by Alice, she will notify her bank and the payment to Bob will be initiated (Silitschanu, 2017; McWaters et al., 2016, p. 77; Pritchard, 2016b).
As has been outlined by this brief example, international trade processes and the attached financing services are quite complex, giving rise to a variety of pain points that have so far not been resolved by the implementation of a more efficient solution.
First of all, the overall trade flow is significantly delayed, as currently all parties involved are required to perform some form of manual work (Interview #1, p. XXXIX). Manual processes are required to, for example, verify customer information, draft the relevant documentation and to check the state of the goods, as well as to uphold multiple lines of communication between the involved parties (Dwyer and Hines, 2016, p. 25 ff.; Belinky, Rennick and Veitch, 2015, p. 8 f.).
This requirement for manual handling is furthermore connected to the second pain point: the overall high cost inherent to the current process (Interview #1, p. XXXIX). This cost is not only related to the time required to perform each of the steps, but also to the duplication of efforts (e.g. duplicative drafting of bills of lading), the “[…] reliance on many different paper documents […]” (Interview #1, p. XXXVIII), and the error-proneness of manual processes. Bain & Company (Williams et al., 2016) estimates that roughly 50 per cent of banks’ costs for an LOC arises from the need for manual document handling and checking. Inflexibility further increases cost: Whenever there is, for example, a slight deviation from the terms stated within the initial LOC (e.g., a shipment delay by one day), the importing bank will require a manual amendment to the LOC be made, or else payment will be withheld (Pritchard, 2016b; Belinky, Rennick and Veitch, 2015, p. 8 f.).
And finally, another major pain point is the inherent lack of transparency of the trade process. One of the main reasons for this opacity is the reliance on a multitude of separate platforms to process relevant information, each related to a separate element of a trade transaction (i.e. one for financing, one for invoicing, one for ownership documentation, etc.) and to the separate parties involved in the trade process (Silitschanu, 2017; Belinky, Rennick and Veitch, 2015, p. 8 f.). Because of this use of different platforms, banks currently suffer from an insufficient integration into the overall trade process (Szmukler, 2016, p. 7).
This lack of transparency and insufficient integration of banks significantly increases the danger of fraud in trade finance (Dwyer and Hines, 2016, p. 25 ff.). In recent years, banks have repeatedly been forced to write off large sums due to fraudulent practices such as double-invoicing: Due to the lack of a shared platform to exchange information regarding trade financing between banks, fraudulent customers may seek financing from multiple institutions using the same invoice. Standard Chartered, for example, was forced to report a loss of US $193 million as the results of such a double-invoicing fraud in 2014 (Chanjaroen and Boey, 2016).
As has been outlined above, the complex nature of the processes currently in place in international trade and trade finance make these slow, expensive, and prone to errors and fraud. But the involvement of many parties, all subject to different legal regimes and cultural norms (Williams et al., 2016), and the requirement for “[…] people from different organisations [to] access the same data” (Interview #3, p. L) makes trade finance a prime candidate for fundamental disruption by blockchain technology – possibly putting an end to the “stacks of paper documents that have long served as the foundation of global trade.” (Johnson, 2016).
Skuchain, a Silicon Valley start-up founded in 2014, seeks to offer an elegant blockchain-based platform solution to simplify the process and document flows within global trade processes, to enhance transparency, to lower costs and to reduce fraud risk for all parties involved.
Skuchain’s current core technology under development is titled Brackets – an acronym for “blockchain-based release of funds that are conditionally key-signed and triggered by signals” (Skuchain, 2017). With their technology, Skuchain pursues the goal of creating collaborative commerce by offering a platform that governs the entire lifecycle of a trade, and that unifies the isolated and heterogeneous applications currently in place at each of the parties involved in the trade process (Plug and Play Tech Center, 2016). As such, the Skuchain Bracket serves to facilitate the flow of information between the parties involved in the trade process, as well as to automate the flow of money based on the respective flow of goods (Skuchain, 2016a).
Based on this fundamental platform, Skuchain is working on the development of digital products that, for example, seek to make the previously outlined current trade finance paradigm of physical LOCs and the manual processing of paper-based documentation obsolete. By leveraging the possibility to implement smart contracts on a blockchain, Skuchain has developed innovative trade finance solutions, most notably a digital LOC, dubbed the Data LC,and the Blockchain Based Obligation (BBO). These smart contracts are designed to automatically execute certain actions based on the occurrence of certain events that have been predefined by the trade parties (Skuchain, 2016b).
The Data LC, a digitalised LOC, is designed to streamline trade finance banks’ operations related to the issuance and processing of LOCs. As they operate on current SWIFT infrastructure already in place in the global trade system, banks do not face the traditional adoption challenge of new technology when utilising Data LCs (Skuchain, 2016a). The BBO seeks to replace Bank Payment Obligations, an alternative trade financing instrument to LOCs, by allowing banks to enter into fully blockchain-based and automated payment obligations (Skuchain, 2016a). These technologies allow for an automated flow of digital documentation as well as simplified financing processes and automated payment based on terms specified in the initial agreement between buyer and seller (Krause et al., 2016, p. 15 ff.).
Figure 14 visualises a simple trade finance relationship based on Skuchain technology. Key documents and agreements to the trade process, such as the sales agreement, the LOC, the bill of lading, and the invoice are digitalised and stored on the blockchain, making them available to all parties at all times. The progress of the trade transaction is continuously tracked on the blockchain, and the occurrence of pre-determined events (for example the acceptance of the shipment by Alice) will automatically trigger the payment to Bob.
But besides this primary goal of transforming the antiquated, paper-based trade finance structures into modern and efficient processes, Skuchain furthermore seeks to give companies that are currently excluded from most sources of trade financing due to a lack of established relationships with banks access to the trade finance market by leveraging the trustless nature of the blockchain (Allison, 2016).
From an operational perspective, the implications of an inclusive blockchain-based solution to the traditional practices in trade finance are quite straightforward. Bain & Company estimates that currently around 50 per cent of costs related to LOC trade finance stem from the need for manual processing and checking of paper-based documentation (Williams et al., 2016). Thus, by eliminating the reliance on the flow of paper-based documentation between the multiple parties, banks as well as the other players involved will benefit from a significant decrease in trade finance operating costs due to the digitalisation and automated sharing of documentation creating less room for errors and eliminating the need for manual reconciliation (Williams et al., 2016).
Furthermore, the automation of processes via the implementation of self-executing smart contracts will result in better and cheaper handling of funds transfers for banks (Dab et al., 2016; Williams et al., 2016). All in all, one of the experts expects the potential blockchain-enabled cost savings in trade and trade finance to lie “[…] north of 50 per cent” as compared to the status quo (Interviewee #4, p. LVII).
In addition to cost savings due to less dependency on manual processing, transitioning to a blockchain-based immutable digital format will also result in a significant increase in transparency of the entire trade and trade finance process (Brunner et al., 2017, p. 45). Real-time access to documentation, and – thinking about the possibility of equipping a trade finance blockchain with a real-time goods tracking application based on the Internet of Things – real-time access to the status of the goods shipped, would allow banks to increase their customer service quality by being able to offer up-to-date status reports on the respective trade (Szmukler, 2016, p. 7).
The increase in transparency regarding customer information flows as well as information on previous trade transactions of this customer stored on the blockchain would furthermore allow banks to better manage their risk (e.g. risk of duplicate invoice financing) and, in turn, offer better credit terms to their customers (Szmukler, 2016, p. 4).
In summary, a blockchain-based trade finance solution possesses the potential to put an end to the trade-off between security and costs that is currently prevalent in the trade finance industry (Krause et al., 2016, p. 14).
But besides offering operational benefits, the blockchain also carries important strategic implications for commercial banks in trade finance (Interview #2, p. XLV). In recent years, the traditional trade finance service provided by banks has increasingly come under pressure. More and more trade relationships are financed on an open accountbasis, a form of inter-firm trade credit, thus cutting out the banker from the financing value chain (Allison, 2016; Everaert, Nolan and Walkowicz, 2015, p. 6). Competition in a shrinking market is increasing, while compliance with international regulations is becoming more and more expensive, all in all resulting in shrinking margins in the traditional LOC business (Dab et al., 2016).
This overall decline in reliance on banks as source of trade finance not only endangers the banks’ direct trade finance revenues, but, also the indirect revenues that the trade finance business brings due to banks being able to develop lasting client relationships and creating lucrative cross-selling opportunities (Everaert, Nolan and Walkowicz, 2015, p. 10).
Thus, in the current market environment, it will be of paramount importance for banks to adapt their current product and service offering to the evolving needs of their trade customers as well as to the overall shift in demand. A blockchain-based solution to trade finance can allow banks to offer new value-added services, such as the above-outlined provision of real-time information, or forecasting and working capital analytics services (Brunner et al., 2017, p. 46; Szmukler, 2016, p. 16). It can furthermore aid banks to conform with heightened customer expectations in terms of digital sophistication of the service offering (Everaert, Nolan and Walkowicz, 2015, p. 6), while at the same time increasing the flexibility of their offering through the reduction of process complexity and cost (Dab et al., 2016).
But besides securing and improving their current trade finance offering, blockchain also offers trade finance banks the valuable opportunity to extend their reach by increasing their scope of potential clients.
As one expert noted, “banking the unbanked” (Interview #4, p. LVIII) offers a wide-reaching strategic potential for banks in trade finance. Under the current system, many customers, especially in developing countries, are denied access to banks’ trade finance offerings – either due to SMEs inability to provide reliable information for credit approval, or plainly due to the currently high cost of provision of, for example, an LOC. Around 50 per cent of SMEs’ trade finance requests are currently being rejected by banks, while only seven per cent of all financing requests by larger corporates will not be served by banks (World Trade Organization, 2016, p. 77). As a consequence, Asia and Africa together currently boast an unmet trade finance demand of over US $820 billion each year, thus offering a large revenue potential for banks that can leverage technology to their advantage (Strukhoff and Brakeville, 2017). By improving data access and risk analysis based on blockchain-generated customer and trade insights, or, in case of full integration of customer data on the blockchain (see Use Case 3: KYC), by being able to access relevant KYC information on an immutable distributed ledger, banks could offer affordable financing to a broader range of customers (Brennan and Lunn, 2016, p. 108; Belinky, Rennick and Veitch, 2015, p. 8).
All in all, banks can leverage the blockchain technology to retain old and win new customers with a service portfolio that makes trade finance “faster, safer and cheaper for everyone.” (Dab et al., 2016).
Looking ahead, with international trade continuing to grow, and associated banking revenues expected to reach US $70 billion by 2020 (Belinky, Rennick and Veitch, 2015, p. 8), trade finance is going to remain an important source of revenue for banks. But the outdated structures in the trade finance sphere also offer significant disruption potential, thus putting slow-moving banks at risk to be pushed out of the market by new entrants or more agile existing players that are open to the implementation of new technology and are not hindered by the dependency on legacy IT systems (Dab et al., 2016).
But as other previous efforts to digitize the trade finance sector, such as the initiatives by SWIFT and Bolero, have shown, change moves slowly in the trade finance sector, and having the support of some major industry players can still be insufficient to achieve widespread adoption of a digital solution in global trade (Williams et al., 2016). As one of the interviewees, who is currently engaged in a blockchain initiative to digitise freight documentation, noted, the success of blockchain in trade finance will strongly depend on the amount of collaboration among banks, Fintech start-ups and all stakeholders along the trade chain (Interview #4, p. LVI), with banks leading the way as the trusted party that ties together all participants within one network (Bermingham, 2017).
From what can be seen today, while some banks seem have chosen a wait-and-see strategy, others are picking up the opportunity of leading the way in the trade finance evolution (Krause et al., 2016, p. 17). And, realising the importance of collaboration, they do so in a joint effort with start-ups and established tech players. Current examples of banks’ involvement are plentiful: In early 2017, Deutsche Bank, HSBC and five other major global banks joined forces for the development of a new blockchain-based trade finance solution based on technology offered by Skuchain contender Wave (Andreasyan, 2017). And in 2016, CBA, Wells Fargo, and Brighann Cotton completed a blockchain-facilitated trade transaction between a cotton buyer and seller with the help of Skuchain technology (Higgins, 2016a).
The list of trade finance institutions involved in blockchain experiments is growing longer every month, and it seems as if the transition from the PoC phase to the actual implementation of blockchain technology in trade finance is only a matter of time as “[…] the market […] is strongly going to move towards the implementation of blockchain solutions.” (Interview #4, p. LVI). Brian Behlendorf, executive director of the blockchain consortium Hyperledger, even expects first products to go live as early as late 2017 or 2018 (Bermingham, 2017).
But before any solution can be implemented on a large scale, there are major challenges to be overcome. First of all, prerequisites for a blockchain-based trade finance platform are a common standard and regulatory guidelines regarding the digitalisation of documentation, all of which are currently not in place and the lack of which has also been a major reason for the underwhelming response to BPOs and other efforts to digitise trade finance (Brunner et al., 2017, p. 47; Dwyer and Hines, 2016, p. 27).
What’s more, unifying trade finance processes on a common platform between all involved actors would require some form of interoperability between new systems and legacy IT in place (Meijer, 2017b). And finally, the question of whether blockchain will be the technology that revolutionises trade finance also comes down to the issue of required investments. While global banks and other large players in trade may possess the financial capabilities to invest in an entirely new technology, smaller players certainly do not have this financial freedom (Dab et al., 2016).
All in all, while blockchain does offer a solution to reforming the antiquated trade finance structures, it must be acknowledged that it is not the only kid on the block trying to do so. But the momentum that distributed ledger technology carries at the moment might be the decisive factor tipping the scale in favour of a reformation of trade finance based on blockchain (Dab et al., 2016). What’s certain is that it should be of paramount importance to banks in the trade finance sector to become involved in the digitalisation of trade finance to retain their competitive edge and, most importantly, their customers (Dab et al., 2016).
The digitalisation, secure storage, and transmission of documents via the application of blockchain technology not only produces a very promising use case for commercial banks involved in trade finance. Much more, it carries even larger implications when applied on a more fundamental level: the digitalisation of a customer’s identity (Mainelli, 2017).
The provision of identity is a fundamental requirement for most transaction services in our modern business society (Bruno et al., 2016, p. 32). Especially banks are required to perform thorough KYC checks to ensure compliance with anti-money laundering (AML) regulations, such as defined in Basel III (Interview #3, omitted). But doing so has become increasingly difficult for financial institutions around the globe. Not only do global financial institutions have to comply with a wide range of different regulatory requirements depending on their geographic reach, but all of these regulations are ever-changing, thus requiring constant adaption (Dwyer and Hines, 2016, p. 34; Pulley, 2016; Matsangou, 2015).
With the external market environment putting banks under pressure to decrease cost (Stumbles et al., 2016), a stark increase in KYC-related costs puts further strain on financial institutions’ bottom lines. In a recent survey on the state of KYC processes in the financial sector, Thomson Reuters estimated the average annual cost related to KYC processes and client onboarding per institution in 2016 at around US $60 million, with individual banks’ expenses reaching as high as US $500 million per year. This translates into a cost increase of 19 per cent as compared to 2015, and costs are expected to rise equally in 2017 (Pulley, 2016).
But as is depicted in figure 15, the increasing regulatory complexity does not only result in increasing operational expenses for KYC processes but also in an increasing number of cases of firms having to pay large fines for non-compliance with standing regulation. J.P. Morgan, for example, incurred over US $16 billion in legal penalties for KYC and AML violations in 2015 (Imafidon, 2016).
But as shall be outlined in the following chapters, blockchain technology may provide an elegant and cost-effective solution to put an end to upwards-spiralling KYC costs, benefitting both banks and their customers.
The processes currently in place at commercial banks to ensure compliance with KYC regulation in customer onboarding can be, at best, described as cumbersome for both banks and their clients. Whenever a new client wishes to open an account with the institution, the bank is obliged to conduct an in-depth ‘background check’ to verify the customer’s identity and to cross-check the customer with certain blacklists (Schneider et al., 2016, p. 71 f.).
For banks, this authentication of their customers’ identities involves large amounts of manual checking of paper-based documentation. Not only does this task take up a lot of time to carry out, with customer onboarding processes being dragged out to 24 days on average, thus delaying business activity (Thomson Reuters, 2016, p. 10), but it is often a duplicative effort for both banks and their clients: Customers not only have to endure separate KYC checks for each financial institution they work with (Interview #3, p. LI), but even within the relationship to a single institution a customer may be required to hand in the same information twice, be it due to a lack of coordination across different banking subsidiaries, or due to a change in the customer-bank relationship (McKinsey & Company, 2017, p. 9; Murphy, 2017, p. 3; Dwyer and Hines, 2016, p. 34 ff.; Sproul et al., 2016, p. 16).
Considering Goldman Sachs’s estimation of an average KYC due diligence cost of US $15 thousand to US $50 thousand per customer, it becomes clear that this duplication of efforts is a serious cost driver in the current system (Schneider et al., 2016, p. 72). As an expert on digital identity points out, the removal of such duplicate efforts would entail a tremendous cost-savings potential (Interview #3, p. L). But the high cost arising from cumbersome manual KYC checking is only one of the issues arising out of the current onboarding processes: Proneness to errors due to the required manual effort, and, to make matters worse, deliberately fraudulent customer behaviour impede banks’ compliance with regulations even further (Mainelli, 2017; Lowell, 2016; UBS AG, 2016, p. 9).
Overall, current customer identity management solutions seem “antiquated” (Yurcan, 2016), especially considering the significant technological advancements that have been made since the dawn of the information age. But as the following chapter will illustrate, blockchain technology may offer a solution to provide efficient and secure digital identity services that satisfy the needs of individuals, of businesses, and of regulating entities.
As has been outlined above, the customer due diligence required to comply with KYC and AML regulation within the onboarding process of new customers is a complex and inefficient process involving significant duplication of efforts across the financial services sector. As one expert puts it, “for this use case, DLT is really perfect.” (Interview #3, p. L). SecureKey, founded in 2008 in Toronto, is a leading player in digital identity solutions and is one of the recent examples of companies seeking to innovate this cumbersome process via the application of blockchain technology.
SecureKey has partnered with technology giant IBM, ten leading Canadian banks, as well as the Canadian government initiatives DIACC and CCICADA in an effort to create a blockchain-based digital identity management solution that will not only greatly reduce the effort required by both banks and clients to open up new bank accounts, but will also allow clients to make use of their digital identity when using government services and when engaging in all sorts of economic activities (Kirk-Douglas and Haswell, 2017; Schenker, 2016).
The planned service would entail the customer initially registering and authenticating his identity with a bank of his choosing. The bank then digitises the customer’s identity information and stores it on a permissioned blockchain. Upon request of the customer, the banks will then share the verified digital identity with any company or institution that requires the customer to prove his identity in the future (Kirk-Douglas and Haswell, 2017).
A digital identity solution as currently under development in Canada would carry significant operational implications for banks by streamlining and optimising customer onboarding and internal processes (Bruno et al., 2016, p. 91).
As has been outlined earlier, current processes result in a significant and increasing cost burden for banks. A digital identity stored on a blockchain, which, after it has been established once, can be easily shared, would result in the elimination of the duplicative efforts in client onboarding across different institutions. The share of automated processes in client onboarding could be greatly increased, allowing organisations to reduce the headcount of staff dedicated to KYC activities, while at the same time reducing the number of errors caused by manual handling and cross-checking of documentation (Contri and Galaski, 2016, p. 11; Schneider et al., 2016, p. 74 f.).
Moreover, once a digital identity has been established on a blockchain, updates can be easily received in real-time by all parties utilising the digital identity (Dwyer and Hines, 2016, p. 35). And lastly, the access to the digital client identity will be restricted to explicitly authorised parties. This secured and restricted method of storage translates into a significant reduction of the danger of fraudulent misuse of client information by third parties (Bruno et al., 2016, p. 91; Sproul et al., 2016, p. 16 f.; Yurcan, 2016). Overall, these operational improvements are expected to translate into significant cost reductions for banks offering and utilising blockchain-based digital identity solutions.
In addition to enabling operational cost reductions, a blockchain-based digital identity solution would make it easier for banks to prove their compliance with standing regulation. By, for example, connecting an individual’s transaction history to his respective digital client identity, immutable audit trails could be established, making it much easier and cheaper for institutions to ensure and to prove their regulatory compliance (Bruno et al., 2016, p. 92; Dwyer and Hines, 2016, p. 35; Schneider et al., 2016).
All in all, Goldman Sachs (Schneider et al., 2016, p. 77) expects a blockchain-based digital client identity solution for banks to allow for overall industry cost savings between US $3 billion to US $5 billion as compared to the status quo. As is demonstrated in figure 16, these cost savings will stem from the operational efficiency gains outlined above, as well as from the expected reduction in fines due to fewer breaches of standing KYC/AML regulation.
But besides enabling banks to save money due to operational efficiency gains and process improvements, a blockchain-based digital identity solution also carries important strategic implications for banks.
First, by establishing and maintaining a digital ledger for client identities, banks will gain much deeper insights into client characteristics and behaviour. This would allow them to improve their service offering by tailoring it to each client’s specific circumstances (Bruno et al., 2016, p. 91).
Moreover, owning and operating a digital identity management system would free banks from the reliance on third-party providers for such services, such as Thomson Reuters or SWIFT (Dwyer and Hines, 2016, p. 35; Schneider et al., 2016, p. 77). Banks would be able to position themselves as the trusted intermediary required to validate, store, and manage a consumer’s or a company’s digital identity. As such, they could benefit from significant positive brand recognition and increased trust by clients (Bruno et al., 2016, p. 92). And as digital identities will become increasingly important within the society and economy, this effect will only increase with time, as the identity-providing banks will be able to position themselves as vital facilitators of the digital economy (Bruno et al., 2016; Contri and Galaski, 2016).
But most importantly, these banks could make use of this positioning and monetise their access to and control over digital identities within the context of an Identity-as-a-Service (IaaS) offering. Under this scenario, the bank could be imagined as not only creating and managing the digital identities of its individual and business clients but would also offer the creation and storage of digital identities as a stand-alone service. And keeping in mind the quick progress towards a global Internet of Things, these services could quickly expand to entailing not only the digital identities of humans and companies but also that of smart devices (Schenker, 2016). Access to the permissioned blockchain and the specific digital identity information required by, for example, other businesses, such as utilities, would then be allowed by the bank after payment of a specified fee (Sarnitz and Maier, 2017; Batlin et al., 2016, p. 28; Bruno et al., 2016, p. 91; Contri and Galaski, 2016, p. 11).
And finally, the establishment of a digital KYC registry will benefit other blockchain use cases in banks (McWaters et al., 2016, p. 51 f.). Thinking about the previously presented trade finance use case, a KYC registry could allow for an even more efficient setup and execution of trade finance transactions, as, for example, LOC requests could automatically be approved or declined based on existing client and trade partner information stored on the digital identity blockchain.
With the rise of the digital economy, the traditional physical identity system is becoming more and more of a hindrance to the modern transaction environment. In response to this issue, digital identity systems are on the rise around the globe (Bruno et al., 2016, p. 35).
In recent years, more and more service providers have ventured into digital client identity management, two of the most prominent examples being Thomson Reuter’s Org ID and SWIFT’s KYC Registry (Dwyer and Hines, 2016, p. 34). While the idea of a “KYC shared utility” (Lowell, 2016) already constitutes a significant improvement over the previous need for each bank or other business to conduct individual KYC checks, the introduction of blockchain technology now presents the chance for an advancement towards a secure and efficient digital identity solution for everyone (Lowell, 2016).
Consequently, a wide range of start-ups has started working on the development of a blockchain-based KYC, or, in some cases, a much broader digital identity service. Examples are plentiful, with KYC-Chain, Cambridge Blockchain, ShoCard, and Tradle being only some of the most talked about companies. But the wide range of different approaches chosen by each of the companies and institutions working on KYC and digital identity solutions visualise the immense uncertainty surrounding the question of which path will be the path to widespread adoption. Are we going to see the rise of digital identity solutions managed by singular, trusted institutions, as has been outlined as a strategic opportunity for banks in the previous chapter, or will we see, for example, multiple actors cooperating to offer a consortium solution, as can be currently observed in Finland (Bruno et al., 2016, p. 59)? And how comprehensive is the information content of such digital identities going to be (Binu, 2017; Yurcan, 2016)?
Whether we are going to see the implementation of a comprehensive digital identity system, or that of only very specialized KYC registries, it can be said that banks are well positioned to become the trusted parties required to establish and maintain such systems, as they are already the holder of vast amounts of client data and have established trusted relationships with their clients (Atkins, 2017; Bruno et al., 2016, p. 89; Buitenhek, 2016, p. 118; Schenker, 2016; Yurcan, 2016). As such, banks could transition from being the ‘storage for money’ to becoming a ‘storage for data’, a vision that may become more and more relevant as traditional banking revenues are declining further (Batlin et al., 2016; Schenker, 2016; Yurcan, 2016).
This outlook is currently manifesting itself in the increased activity of banks in the development of blockchain-based KYC/digital identity solutions. End of March 2017, BBVA, Alfa Bank, and the start-up BlockNotary announced the development of a PoC for a blockchain-based KYC system to facilitate customer onboarding (EconoTimes, 2017). And also Crédit Mutuel Arkéa and the industry consortium R3 have announced to be working on a blockchain solution for KYC management (Haswell and Eckenschwiller, 2016; Higgins, 2016b).
But before such a solution can be up and running, significant challenges need to be overcome. The development of a suited blockchain infrastructure that efficiently integrates numerous actors and connects to legacy systems is only a minor issue when compared to the more significant hurdles: the need to gather a critical mass of client information, as well as the need for the development and adoption of new standards and entirely new set of regulations. As is the case with all blockchain use cases, collaboration between banks, start-ups and regulators will be of crucial importance on the way to developing a solution that is ready to be widely adopted (Bruno et al., 2016, p. 101 ff.; Dwyer and Hines, 2016, p. 35 f.; Schneider et al., 2016, p. 77; Yurcan, 2016). But the apparent willingness of governments to make progress in this area, as is depicted by the recent efforts in Canada outlined earlier, or the recently proclaimed vision of the German government to establish a digital identity service based on online banking credentials and blockchain technology, definitely allows for a positive outlook regarding governmental support in this area (Seibel, 2017).
All in all, even though there are those that do not see it as a necessary technological foundation (Cooper, 2016), blockchain could be the key to the digital identity revolution – and banks seem well positioned to position themselves at the heart of it (Interview #3, p. LIV)(Schenker, 2016).
The use cases that have been outlined in the previous chapters have illustrated the wide-ranging operational and strategic implications that the blockchain technology may carry for commercial banks. But before blockchain technology can create value in practice, be it in financial services or any other field of application, there are certain key hurdles that need to be overcome.
First and foremost, there are certain purely technological issues that are yet to be addressed by developers before blockchain technology can be put to use on a grand scale in financial services. According to three interviewees (Interview #1, p. XXXVII; Interview #2, p. XLIII; Interview #4, p. LVII), scalability of blockchains is still being questioned by many, as an increase in the number of nodes and the amount of transactions to be validated comes with an increase in required computing power and storage capacity and, thus, cost (Seffinga, Lyons and Bachmann, 2017, p. 29). The larger a blockchain network, the longer it furthermore takes for a transaction to be processed.
This scalability issue is best expressed in numbers: The Bitcoin blockchain is currently capable of handling three to five transactions per second, while the Ethereum blockchain handles 15 to 25. But as of today, the Visa system is capable of handling around 2,500 transactions per second (Evans et al., 2016). While solutions to the scalability issues of blockchains, such as the proof-of-stake consensus algorithm or the Bitcoin Lightning Network, have already been developed, they have yet to prove themselves under market conditions (Interview #1, p. XXXVIII; Interview #4, p. LVII)(Ben-Ari, 2017; Le Borne et al., 2016, p. 13).
Furthermore, it was noted several times in the interviews that in order to be able to efficiently transfer value via the blockchain, an efficient mechanism must be found that allows for the easy, safe and quick conversion of fiat currencies into cryptocurrencies – an issue that many PoCs currently “[…] cheat their way out of […].” (Interview #1, p. XLI). Such a mechanism would help to address the current instability of cryptocurrencies and the need for liquidity between blockchain assets and fiat currencies (Interview #1, p. XLI; Interview #2, p. XLIII) (McWaters et al., 2016, p. 22; van de Velde et al., 2016, p. 15).
A more radical approach would be a central bank-led initiative to “move ‘real money’ onto the chain” (Lehman, 2016), allowing for real peer-to-peer financial transactions. The recent uptake in blockchain involvement by central banks around the globe, as is demonstrated by the recent efforts made, for example, by the Bank of England (Burton, 2017), might be an early indication of a development towards blockchain-based fiat currencies. But whether blockchain-based fiat currency will become a reality or not, an efficient mechanism for the transfer of value will be necessary “[…] to make use of the blockchain’s full capacity regarding functionality […].” (Interview #2, p. XLIII).
In addition to scalability and efficiency of exchange of value, security remains a key issue in the development of blockchain platforms. While the original proof-of-work mechanism was designed to discourage attacks on the system by design (rendering it uneconomical to do so), blockchains based on other consensus mechanisms require different security mechanisms. Due to the nature of the business, banks will most likely choose a permissioned blockchain architecture for most of their relevant use cases (Guo and Liang, 2016; Liesenjohann, Matten and Terlau, 2016, p. 23; Schneider et al., 2016, p. 3). But this means they will have to deal with a trade-off between security and cost. Moving from large, unpermissioned ledgers, such as Bitcoin, to smaller, private ledgers with selected participants decreases the overall cost of the system, but potentially also decreases inherent security (Brennan and Lunn, 2016, p. 44 f.): As, for example, hijacking an unpermissioned ledger would require the attacker to take control of at least 51 per cent of all validating nodes, hijacking a permissioned network could be possible by taking control of only very few, or possibly even only one node (European Union Agency For Network And Information Security, 2016, p. 16).
Furthermore, as was noted by two interviewees, the blockchain protocol and its cryptographic components are virtually perfectly safe. But deviations in terms of the introduction of insecure consensus mechanisms or individual incidents, such as the theft of a private key, can introduce significant security risks into the system (Interview #3, p. LI; Interview #4, p. LVII). The key questions that need to be answered are thus who gets to decide who is granted access to a permissioned blockchain, how secure are alternate consensus algorithms and how can private keys be securely stored and managed (Berke, 2017; ASTRI, 2016, p. 47; Brennan and Lunn, 2016, p. 44 ff.; Ernst & Young, 2016a, p. 64; Le Borne et al., 2016, p. 11).
Connected to these technological issues of blockchain technology is the evolving problem of mass fragmentation, as “there are too many different platforms […]” available (Interview #2, p. XLII). As more and more actors become involved in the definition of use cases and the development of blockchain-based technological solutions to these use cases, more and more different blockchain platforms and, with these, more and more possible technological standards become available (Interview #1, p. XXXVIII; Interview #2, p. XLII; Interview #3, p. LI).
As one interviewee pointed out, this leads to the typical “chicken-egg-problem” (Interview #1, p. XXXVIII): Reaping the benefits of blockchain technology across financial services will be largely dependent on network effects (Batlin et al., 2016, p. 34; Meszaros et al., 2016, p. 6). A critical mass of users must either be unified on a single platform, or interoperability between different blockchain protocols and legacy IT systems must be guaranteed for blockchain-based solutions to make sense. Thus, agreement on a specified set of standards is required by all stakeholders before a blockchain can be implemented on a wider scale (McKinsey & Company, 2017, p. 16; European Union Agency For Network And Information Security, 2016, p. 24; Le Borne et al., 2016, p. 9). And while Ripple’s ILP already demonstrates how interoperability between different token-based ledgers can be established, a solution for blockchains without a native token remains yet to be developed (Ben-Ari, 2017).
The third major hurdle to adoption is the regulatory uncertainty surrounding the entire blockchain sphere, as there is currently no set of rules or regulations that govern blockchain protocols (McKinsey & Company, 2017, p. 16; Murphy, 2017, p. 7; Ernst & Young, 2016a, p. 64). Due to the distributed and borderless nature of a blockchain, even fundamental questions such as who is to be regulated, and by whom, remain yet to be answered (ASTRI, 2016, p. 45 f.; Le Borne et al., 2016, p. 8). And also more detailed legal questions, for example to what extent smart contracts will be considered legally binding contracts, will have to be answered in order to pave the way for blockchain in commercial banking and other sectors (Batlin et al., 2016, p. 34 f.; Meszaros et al., 2016, p. 9).
One interviewee noted that while regulators such as the German BaFin and the ECB are currently very open towards discussions surrounding the utilisation of blockchains for the storage and transfer of information, the use of cryptocurrencies for the transfer of value is not something they are willing to consider (Interview #2, p. XLVI). And while another interviewee states that regulators have indeed started directing resources towards exploring the regulatory implications of blockchain technology, a common opinion across different regulating remains yet to be formed (Interview #3, p. LIII).
When the European Parliament discussed the regulation of blockchain technology in May 2017, MEP Jakob von Weizsäcker expressed the overall uncertainty surrounding the required regulatory action: “It’s probably too early to intervene at this stage, because we as legislators don’t yet see sufficiently clearly to know what the main issues are going to be […].” (Acheson, 2017). Thus, regulatory uncertainty remains an issue that incumbents and new start-ups in the blockchain economy will have to deal with.
Somewhat connected to the issue of a lack of rules is the open question of how to ensure data privacy and confidentiality in business relationships. As a blockchain is designed as an entirely transparent system, all users have a full overview over all transactions that have taken place within the network. While the respective parties to a transaction are, in theory, granted anonymity due to the usage of public keys, this anonymity would be endangered in permissioned blockchain networks with a limited number of participants (Peck, 2017; European Union Agency For Network And Information Security, 2016, p. 21; Le Borne et al., 2016, p. 8). A potential solution to this issue is currently being explored within the Hyperledger project: By signing each transaction with a different transaction key, anonymity could be granted even within small private networks (Ben-Ari, 2017).
And lastly, banks will need to overcome significant ‘soft’ hurdles on their way to blockchain adoption. Most importantly, organisational inertia may prove to be a significant roadblock to the implementation of blockchain in banking. The general “lack of trust” (Interview #2, p. XLIII) in new technology, which is even exacerbated in the case of blockchain due to the radical change the technology implies, puts banks at risk of missing the window of opportunity to secure themselves a position in a blockchain future (Interview #3, p. L; Interview #4, p. LVIII).
Furthermore, banks are having serious issues in attracting and retaining capable young talent that is needed to promote a change in an organisation’s fundamental mindset regarding IT systems and processes, as “junior employees in the IT sector are currently not very inclined to go work for a bank.” (Interview #2, p. XLVI). As of today, the open-source nature of blockchain technology rather elicits scepticism among internal IT experts, indicating the requirement for “a generation of rethinking” (Interview #2, p. XLIII). And what’s more, the potential of blockchain to reduce headcount and cannibalise existing product offerings may even lead to active internal resistance towards the adoption of blockchain (Meszaros et al., 2016, p. 8; McKinsey & Company, 2015a, p. 14).
In summary, before blockchain-based applications are ready to be implemented in practice on a larger scale, significant hurdles remain to be overcome. But the majority of experts interviewed for this study expects these current issues to be resolved within the coming years, thus paving the way for the implementation of blockchain use cases on a wider scale. As one expert put it, “the technology itself is […] unstoppable […].” (Interview #3, p. XLIX).
A fundamental paradigm shift is underway in banking. Not only are ever tightening regulations and changing consumer expectations putting a strain on banks’ traditional business model, but technological advancements, and with it, the wake of Fintech 2.0, are forcing banks to question and rethink their basic purpose and value proposition (Belinky, Rennick and Veitch, 2015; Brereton et al., 2014).
While in the past large brick-and-mortar operations fostered the building of customers’ trust in the institution and allowed banks to benefit from scale economies, these factors are becoming more and more of a hindrance for banks (Batlin et al., 2016, p. 39). New entrants into the banking industry, such as Fidor Bank and N26, who offer a radically digital customer experience and are not deadlocked by clumsy legacy IT systems, complex processes, and heavy cost structures, are currently threatening to displace the traditional players (Haycock and Richmond, 2015, p. 62 ff.). To avoid a “death by a thousand cuts” (Ernst & Young, 2016b, p. 8) by Fintechs gradually unbundling the traditional banking services, incumbent banks will need to transform themselves to become more efficient and agile (Interview #2, p. XLIV)(Haycock and Richmond, 2015).
But incumbent banks are not only threatened to be displaced by new entrants that offer a radically digital customer experience. Blockchain technology, which is at the heart of the technological revolution in banking (Forest and Rose, 2015, p. 10), carries the promise of making possible a secure exchange of value without the need for verification by a trusted third party. But while this characteristic, which essentially questions one of the key roles currently played by banks in the global economy (Haycock and Richmond, 2015, p. 53 f.), initially may have provoked existential fears among bankers (Interview #3, p. XLIX), the common mindset across the industry has shifted towards embracing blockchain as a potential key to salvation (Interview #2, p. XLVI)(Nebuloni and Zink, 2017; Kharpal and Chatterley, 2016).
As has been demonstrated by this analysis, the blockchain presents commercial banks with the unique opportunity to reform both their organisation and their service offering to fit the requirements of a digital and fast-moving modern society. While the research and development on potential use cases of blockchain technology is an ongoing process, this study has identified three key areas of application for blockchain in commercial banking: cross-border payments, trade finance, and KYC processes. The high dependency on the manual handling of largely paper-based processes, the involvement of a multitude of different parties and the duplication of efforts are among the main reasons that make these lines of business prime candidates for the reformation via blockchain technology.
The application of blockchain within these areas of commercial banking carries broad operational and strategic implications. First and foremost, as has been illustrated for the cases of cross-border payments, trade finance, and KYC processes, the blockchain allows banks to streamline their service structures and get rid of frictions in their systems that are the cause for errors, delays and overall high operational costs. A blockchain-based solution thus carries the promise of reducing operational costs and complexity that result from legacy process and IT structures. This may allow commercial banks to lay the groundwork for survival in a business environment that is characterised by the increasing commoditisation of basic financial services (Jain and Shanker, 2015).
But besides increasing operational efficiency, blockchain also presents banks with the unique opportunity to embrace new revenue opportunities and, most importantly, a new strategic positioning that is fit for the future (Meszaros et al., 2016; Plansky, O’Donnell and Richards, 2016). In cross-border payments, banks will be able to better serve the increasing customer expectations in terms of speed of service, while, at the same time, being able to offer an extended portfolio of services via the possibility to perform cheap international remittance services as well as corporate disbursement processing that is fit to suit the needs of the internet economy. In trade finance, banks will be able to maintain important customer relationships by being able to offer value-added services, such as real-time information provision, in addition to the mere provision of financing. Furthermore, the blockchain will allow banks to expand their trade finance customer base to include SMEs that are currently being denied access to trade financing due to banks’ inability to determine the risk involved in SME trade financing. And lastly, blockchain-based KYC processes will not only serve as an enabler of other blockchain use cases in banking but will allow banks to pursue an entirely new strategic positioning as ‘keepers of identity’.
But this necessary change, of course, does not come by itself. Banks are required to act on their future and disrupt themselves from within, in order not to “fall victim to the innovator’s dilemma” (Shin, 2016) and be rendered irrelevant. To be able to make use of this opportunity, collaboration between banks, Fintechs and other stakeholders in the industry will be of major importance (Interview #4, p. LVI). As one of the interviewees noted, “the bank […] has the advantage that it already possesses the relevant connections to involved parties as well as systems in place. So if […] a start-up comes up with a great technology in this area, it still lacks the users […].” (Interview #1, p. XXXIX).Thus, combining the Fintechs’ technical expertise with banks’ large networks and their long-standing positioning as trusted entities can be crucial in paving the way for the future of banking (Murphy, 2017, p. 7; Buitenhek, 2016, p. 112; Krause et al., 2016, p. 17; Lehman, 2016). But more and more banks are becoming aware of this need for collaboration: while internal IT departments do play a role in accompanying blockchain projects, these pilot projects are mostly very much a joint effort between banks, start-ups, universities and larger tech companies (Interview #2, p. XLVI). More and more players are joining forces in collaborative efforts to explore use cases and to further the development of blockchain technology. Examples of such initiatives are plentiful: Industry consortia such as R3, Fintech-led initiatives such as Ripple’s GPSG, and bank-led initiatives such as the Digital Trade Chain, are all seeking to enable near-future adoption of blockchain technology on a wider scale (Infosys, 2017; Dwyer and Hines, 2016; Meszaros et al., 2016).
But before this can become a reality, significant hurdles remain yet to be overcome. Technological barriers, such as the current lack of an easily scalable platform and of an efficient mechanism to transfer value, must be addressed in practice. Furthermore, concerns over the security of variations of the original, entirely public blockchain, come to mind within the conceptualization of enterprise private blockchains. In addition to these technological barriers, the lack of a common platform or standard could lead to the issue of mass fragmentation. As the success of blockchain technology is largely dependent on network effects, it will be necessary to either find a way to unite all users on a single platform or to ensure interoperability of different technological standards to reap the benefits of blockchain-based systems. As a third major hurdle, regulatory uncertainty currently stands in the way of blockchain adoption. National and supranational regulators may need to establish a framework of rules surrounding blockchain applications, allowing banks and other stakeholders to invest in these new solutions more effectively. Lastly, banks will need to direct their attention to overcoming ‘soft’ hurdles, such as their own organizational inertia, by actively countering the current knowledge gap among their employees, as well as by increasing their attractiveness as an employer to attract key talent that will support a shift in the general organisational mindset towards a more agile future setup.
The blockchain’s potential impact on the economy and the society is often compared to that of the internet. But sticking to this comparison, we are currently in the mid-90s (Liesenjohann, Matten and Terlau, 2016, p. 62) – the full range of possibilities for applications and their respective implications are yet to be discovered (Interview #1, p. XL; Interview #2, p. XLII). As two experts put it, while the search for the ‘Killer-App’ continues, we may nonetheless see blockchain applied on a wider scale very soon (Interview #3, p. LI; Interview #4, p. LVIII). While the “blockchain hype” (Interview #3, p. XLVIII) is slowly coming to an end, stakeholders are now moving towards the “plateau of productivity” (Interview #2, p. XLVII). The initial fear among banks confronted with the sudden rise of cryptocurrencies and blockchain technology has given way to the willingness to seize the chances that the technology offers. And while there are currently still not many blockchain projects that have surpassed the PoC phase and “[…] delivered a real product or solution […]” (Interview #3, p. XLIX), the coming three years are going to be characterised by intense experimentations and further investments into blockchain technology, as banks “[…] get to know the technology” (Interview #2, p. XLII). But as was noted by one of the experts, regional differences may exist regarding blockchain involvement of banks: “[…] in Asia, a lot of our customers are already quite advanced in terms of their experimentation with blockchain technology. In Europe and America, reactions are still quite a lot more restrained.” (Interview #2, p. XLII).
When Bill Gates spoke his famous words „banking is necessary, banks are not” (Filkorn, 2016) in 1994, the Fintech hype was still far away. And little did he know back then, that with the introduction of Bitcoin in 2008, a technology would be introduced with the potential to fundamentally reform the banking industry. From today’s perspective, it seems that the blockchain technology will not mean the end of banking (Batlin et al., 2016, p. 39) – but maybe “the end of banking as we know it” (Tapscott and Tapscott, 2017). As one expert noted, banks will always remain relevant as a trusted service provider to customers (Interview #2, p. XLIV). But as “[…] part of an answer to the question of digitalisation” (Interview #2, p. XLIII), blockchain could reshape the banking industry just as the Internet reshaped media companies, and those that embrace it will be empowered to use it their advantage in the creation of new business models, while others “[…] are going to miss out on this opportunity.” (Interview #3, p. L), and may fall victims to their reluctance in adapting to their changing customer and market environments (Ito, Narula and Ali, 2017; Olsen et al., 2017, p. 5; Treat et al., 2017, p. 8; Shin, 2016).
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|Author(s)||Study title||Year||Use cases|
|Barclays Bank PLC||Trading up: applying blockchain to trade finance||2016||Trade Finance|
|Belinky, Mariano; Rennick, Emmet; Veitch, Andrew||The Fintech 2.0 Paper: rebooting financial services||2015||Trade Finance, Securities Settlement, Mortgages|
|Brennan, Charles; Lunn, William||The Trust Disruptor||2016||FX settlement, Trade reconciliation, Transparent valuations, Cross-border payments, Credit efficiency, Loan settlement, Derivatives clearing, Collateral management, Compliance reporting, Risk visualization, Basel III compliance, Client fund transparency, KYC/AML, Trade reporting, Client onboarding, Intracompany settlement, Normalize reference data, Timestamping, Account portability, Broker fraud identification, Securities as smart contracts, Crowdfunding, Virtual identity, Credit scoring, Remittance, Escrow services, Customer deposit cost, P2P lending|
|Bruno, Giancarlo; McWaters, R. Jesse; Galaski, Rob; Robson, Christine||A Blueprint for Digital Identity||2016||KYC|
|Buitenhek, Mark||Understanding and applying Blockchain technology in banking: Evolution or revolution?||2016||Cross-border payments, Trade finance, Syndicated Loans, Securities Trading, KYC, Accounting|
|Burelli, Francesco; John, Megan; Cenci, Edoardo; Otten, Janne; Courtneidge, Robert; Clarence-Smith, Charlie||Blockchain and Financial Services||2015||Currency, Nanopayments, Remittance, Financial Inclusion, Clearing, Betting, Crowd-funding, Digital assets, KYC, Voting, Audit, Cloud storage|
|Dhar, Suparna; Bose, Indranil||Smarter Banking||2016||Currency, International payments, Payment settlement, Smart contracts, Digital identity, Collateral ledger, Information sharing, Smart property|
|Dwyer, John P.R.; Hines, Patricia||Beyond the Buzz||2016||Cross-border payments, Trade finance, Supply Chain Finance, KYC, Post-trade processing, Credit default swaps, Cash equities clearing, Repurchase agreements, Syndicated loans, Private company securities|
|Everaert, Edle; Nolan, Diane; Walkowicz, Tomasz||Trade finance: The landscape is changing – are you?||2015||Trade Finance|
|Finextra Research||Banking on Blockchain||2016||Trade Finance, Cross-border payments, Capital Markets, KYC, AML|
|Froystad, Peter; Holm, Jarle;||Blockchain: Powering the Internet of Value||2015||Smart Contracts, Domestic Payments, Cross-border payments, Trade Finance, Capital Markets, Currency|
|Guo, Ye; Liang, Chen||Blockchain application and outlook in the banking industry||2016||Trade Finance, KYC, Cross-border payments|
|Höltmann, Alexander; Vasilev, Ogynan||Wenn der Blockchain-Nebel sich lichtet||2016||Clearing, Settlement, KYC, Cross-border payments, Trade Finance, Regulatory automation, Smart Contracts, Smart Leasing, Digital identity|
|IBM Institute for Business Value||Leading the pack in blockchain banking||2016||Reference Data, Retail Payments, Consumer Lending, Cash Management, Trade Finance, Corporate Lending, Mortgages, Deposits, Cross-border payments|
|IDRBT||Applications of blockchain technology to banking and financial sector in India||2017||Digital Currency, Trade Finance, Cross-border payments, FX Trading, KYC/AML, Supply Chain Financing, Securities trading, Custody & Securities Servicing, Pre-IPO Share Allotment, Loan Syndication, Bond Trading, Monitoring of Consortium Accounts|
|Infosys||Blockchain Technology: From Hype To Reality||2017||Cross-border payments, Digital Identity Management, Clearing & Settlement, Invoice Financing, Letter of Credit, Secure Documents, Smart Contracts, Collateral management, P2P payments, Syndicated loans, OTC derivatives, Repurchase Agreements|
|Krause, Eric G.; Velamuri, Vivek K.; Burghardt, Tobias; Nack, Denny; Schmidt, Moritz; Treder; Tobias-Micha||Blockchain technology and the financial services market||2016||Cross-border payments, Domestic Payments, OTC market, Trade Finance|
|Liesenjohann, Marco; Matten, Benjamin; Terlau, Matthias||Blockchain #Banking||2016||Currency, Cross-border payments, Smart contracts|
|McKinsey||Beyond the Hype: Blockchain in Capital Markets||2015||Capital Markets|
|McKinsey & Company||Blockchain Technology in the Insurance Sector||2017||Trade Finance, Cross-border payments, Repurchase Agreements, Derivatives, KYC, AML, Identity Fraud|
|McWaters, R. Jesse; Bruno, Giancarlo; Galaski, Rob; Chatterjee, Soumak||The future of financial infrastructure||2016||Cross-border payments, Insurance, Syndicated Loans, Trade Finance, Bonds, Automated Compliance, Voting, Asset Rehypothecation, Post-Trade|
|Meszaros, Richard; Adachi, Diana; Dharamsi, Hanif; Yetiskin, Burak; Thomas, Paul||Blockchain Technology: how banks are building a real-time global payment network||2016||Cross-border payments, Cash pooling, P2P payments|
|Murphy, Dean||Four Blockchain Use Cases for Banks||2017||KYC, Trade finance, Cross-border payments, Reduction of fraud|
|Nomura Research Institute||Survey on Blockchain Technologies and Related Services||2015||Currency, Cross-border payments, Securities transactions, Loyalty points services, Electronic coupons, Land registration, Patent information, Electronic health records, Document management, Various notifications, Voting, Supply Chain Tracking, Merchandise trades, Management of precious metals and jewels, Authenticity certification, Sharing economy, C2C Auctions, Electronic libraries, Smart locks, Digital contents, Ticket services, Smart contracts, Derivatives, Escrow services, Energy control, Testaments, Company liquidation|
|Olsen, Thomas; Ford, Frank; Ott, John; Zeng, Jennifer||Blockchain in Financial Markets: How to Gain an Edge||2017||KYC/AML, Syndicated loan (asset tokenization), Asset servicing, Reference data, Ownership & transaction ledger, Cash ledger|
|Perrin, Olivier; Ricomini, Jean-Charles;||Blockchain: Financial transactions’ new DNA?||2016||Cross-border payments, Trade finance, KYC, Domestic payments, Internet of things|
|PricewaterhouseCoopers||Blockchain in retail and consumer banking||2016||Mortgages, Loyalty, KYC|
|Schneider, James; Blostein, Alexander; Lee, Brian; Kent, Steven; Groer, Ingrid; Beardsley, Eric||Blockchain: Putting Theory into Practice||2016||Sharing Economy, Smart grid, Title insurance, Securities Trading, KYC|
|Seibold, Sigrid; Samman, Georg||Consensus: Immutable Agreement for the Internet of Value||2016||Trade Finance, Cross-border payments, KYC, Securities Trading, Document digitization, Accounting & Assurance, Currency, Smart Contracts, Swaps, Record Keeping, Trade Settlement|
|Sproul, David; Grewall-Carr, Vimi; Marshall, Stephen; Lewis, Harvey; Shelkovnikov, Alexander; Welmans, Tyler||Blockchain: Enigma. Paradox. Opportunity||2016||KYC, Insurance Claims Handling, Asset Registry, Royalty Payments, Energy Trading|
|Szmukler, Daniel||Applying cryptotechnologies to trade finance||2016||Trade Finance|
|Tandulwadikar, Akhil||Blockchain in Banking: A Measured Approach||2016||Capital Markets, Trade Finance, Document signing and management, Digital Identity, Cross-border payments, P2P Transfers, Gaming, Ride Sharing, Data storage|
|Underwood, Sarah||Blockchain Beyond Bitcoin||2016||KYC, Capital Markets, Land registry, Supply Chain, Smart grid, Insurance|
|van de Velde, Frank; Scott, Angus; Sartorius, Katrina; Dalton, Ian||Blockchain in Capital Markets||2016||Remittances, Currency, Cross-border payments, FX Trading, Securities settlement, Asset documentation, Supply Chain Financing, Trade Financing, KYC|
|van Steenis, Huw; Graseck, Betsy L.; Simpson, Fiona; Faucette, James E.||Global Insight: Blockchain in Banking: Disruptive Threat or Tool?||2016||Post-trade settlement, Trade finance, Cross-border payments, Reference data for securities, Regulatory data|
|Voshmgir, Shermin||Blockchain, Smart Contracts und das Dezentrale Web||2016||Cross-border payments, Nanopayments, Supply Chain, Accounting, Auditing, Smart Grid|
|Walport, Mark||Distributed Ledger Technology: beyond block chain||2016||Diamond Trade, Corporate actions, Capital Markets, Governmental application|
|Whitechapel Think Tank;||DLT: Clearing Away the Debris?||2016||KYC, Cross-border payments, Market settlement|
|Williams, Glenn; Gunn, David; Roma, Eduardo; Bansal, Bharat||Distributed Ledgers in Payments: Beyond the Bitcoin Hype||2016||Cross-border payments, Trade Finance, Domestic Payments, Cash Remittance, Nanopayments, Cards|
(Barclays Bank PLC, 2016; Dhar and Bose, 2016; IBM Institute for Business Value, 2016; Perrin and Ricomini, 2016; PricewaterhouseCoopers, 2016; Tandulwadikar, 2016; Voshmgir, 2016a; Walport, 2016; Whitechapel Think Tank, 2016)
|Author||Study title||Year||Use cases|
|Barclays Bank PLC||Trading up: applying blockchain to trade finance||2016||Trade Finance|
|Belinky, Mariano; Rennick, Emmet; Veitch, Andrew||The Fintech 2.0 Paper: rebooting financial services||2015||Trade Finance, Capital markets, Loans|
|Brennan, Charles; Lunn, William||The Trust Disruptor||2016||Capital markets, Other, Capital markets, Cross-border payments, Loans, KYC, Automated compliance, Asset management|
|Bruno, Giancarlo; McWaters, R. Jesse; Galaski, Rob; Robson, Christine||A Blueprint for Digital Identity||2016||KYC|
|Buitenhek, Mark||Understanding and applying Blockchain technology in banking: Evolution or revolution?||2016||Cross-border payments, Trade finance, Capital markets, KYC, Other, Loans|
|Burelli, Francesco; John, Megan; Cenci, Edoardo; Otten, Janne; Courtneidge, Robert; Clarence-Smith, Charlie||Blockchain and Financial Services||2015||Currency, Micropayments, Cross-border payments, KYC, Capital markets, Other, Automated compliance|
|Dhar, Suparna; Bose, Indranil||Smarter Banking||2016||Currency, Cross-border payments, Domestic payments, KYC, Other|
|Dwyer, John P.R.; Hines, Patricia||Beyond the Buzz||2016||Cross-border payments, Trade finance, Other, KYC, Capital markets, Loans|
|Everaert, Edle; Nolan, Diane; Walkowicz, Tomasz||Trade finance: The landscape is changing – are you?||2015||Trade Finance|
|Finextra Research||Banking on Blockchain||2016||Trade Finance, Cross-border payments, Capital markets, KYC|
|Froystad, Holm||Blockchain: Powering the Internet of Value||2015||Other, Domestic payments, Cross-border payments, Trade finance, Capital Markets, Currency|
|Guo, Ye; Liang, Chen||Blockchain application and outlook in the banking industry||2016||Trade Finance, KYC, Cross-border payments|
|Höltmann, Alexander; Vasilev, Ogynan||Wenn der Blockchain-Nebel sich lichtet||2016||Capital markets, KYC, Cross-border payments, Trade Finance, Other, Automated compliance|
|IBM Institute for Business Value||Leading the pack in blockchain banking||2016||KYC, Domestic payments, Loans, Other, Trade finance, Loans, Cross-border payments|
|IDRBT||Applications of blockchain technology to banking and financial sector in India||2017||Currency, Trade finance, Cross-border payments, Capital markets, KYC, Other, Loans|
|Infosys||Blockchain Technology: From Hype To Reality||2017||Cross-border payments, KYC, Capital markets, Trade finance, Other, Loans|
|Krause, Eric G.; Velamuri, Vivek K.; Burghardt, Tobias; Nack, Denny; Schmidt, Moritz; Treder; Tobias-Micha||Blockchain technology and the financial services market||2016||Cross-border payments, Domestic payments, Capital markets, Trade finance|
|Liesenjohann, Marco; Matten, Benjamin; Terlau, Matthias||Blockchain #Banking||2016||Currency, Cross-border payments, Other|
|McKinsey & Company||Beyond the Hype: Blockchain in Capital Markets||2015||Capital markets|
|McKinsey & Company||Blockchain Technology in the Insurance Sector||2017||Trade Finance, Cross-border payments, Capital markets, KYC|
|McWaters, R. Jesse; Bruno, Giancarlo; Galaski, Rob; Chatterjee, Soumak||The future of financial infrastructure||2016||Cross-border payments, Insurance, Loans, Trade finance, Capital markets, Automated compliance, Other, Asset management|
|Meszaros, Richard; Adachi, Diana; Dharamsi, Hanif; Yetiskin, Burak; Thomas, Paul||Blockchain Technology: how banks are building a real-time global payment network||2016||Cross-border payments, Other, Domestic payments|
|Murphy, Dean||Four Blockchain Use Cases for Banks||2017||KYC, Trade finance, Cross-border payments, Capital markets|
|Nomura Research Institute||Survey on Blockchain Technologies and Related Services||2015||Currency, Cross-border payments, Capital markets, Other|
|Olsen, Thomas; Ford, Frank; Ott, John; Zeng, Jennifer||Blockchain in Financial Markets: How to Gain an Edge||2017||KYC, Capital markets, Asset management, Other, Loans|
|Perrin, Olivier; Ricomini, Jean-Charles;||Blockchain: Financial transactions’ new DNA?||2016||Cross-border payments, Trade finance, KYC, Domestic payments, Other|
|PricewaterhouseCoopers||Blockchain in retail and consumer banking||2016||Loans, Other, KYC|
|Schneider, James; Blostein, Alexander; Lee, Brian; Kent, Steven; Groer, Ingrid; Beardsley, Eric||Blockchain: Putting Theory into Practice||2016||Other, Other, Insurance, Capital markets, KYC|
|Seibold, Sigrid; Samman, Georg||Consensus: Immutable Agreement for the Internet of Value||2016||Trade finance, Cross-border payments, KYC, Capital markets, Currency, Other|
|Sproul, David; Grewall-Carr, Vimi; Marshall, Stephen; Lewis, Harvey; Shelkovnikov, Alexander; Welmans, Tyler||Blockchain: Enigma. Paradox. Opportunity||2016||KYC, Insurance, Other|
|Szmukler, Daniel||Applying cryptotechnologies to trade finance||2016||Trade Finance|
|Tandulwadikar, Akhil||Blockchain in Banking: A Measured Approach||2016||Capital markets, Trade Finance, KYC, Other, Cross-border payments|
|Underwood, Sarah||Blockchain Beyond Bitcoin||2016||KYC, Capital markets, Other, Trade finance, Insurance|
|van de Velde, Frank; Scott, Angus; Sartorius, Katrina; Dalton, Ian||Blockchain in Capital Markets||2016||KYC, Currency, Cross-border payments, Capital markets, Other, Trade finance|
|van Steenis, Huw; Graseck, Betsy L.; Simpson, Fiona; Faucette, James E.||Global Insight: Blockchain in Banking: Disruptive Threat or Tool?||2016||Capital markets, Trade finance, Cross-border payments, KYC|
|Voshmgir, Shermin||Blockchain, Smart Contracts und das Dezentrale Web||2016||Cross-border payments, Micropayments, Trade finance, Other, KYC, Automated compliance|
|Walport, Mark||Distributed Ledger Technology: beyond block chain||2016||Capital Markets|
|Whitechapel Think Tank;||DLT: Clearing Away the Debris?||2016||KYC, Cross-border payments, Capital markets|
|Williams, Glenn; Gunn, David; Roma, Eduardo; Bansal, Bharat||Distributed Ledgers in Payments: Beyond the Bitcoin Hype||2016||Cross-border payments, Trade finance, Domestic payments, Other, Micropayments|
- Could you tell me a bit about your company and your role?
- Can you give me a short description of your or your team’s role and responsibilities within the organisation?
- How important is blockchain for you/your team/your organisation right now?
- How important of a topic is blockchain currently to banks?
- Is blockchain more of a threat or a chance for the industry?
Focus: Use Cases
- Which are the use cases that you find the most relevant within commercial banking?
- What is going to be the impact of implementation of such use cases?
- How is the strategic direction of a bank affected by this?
- What does this mean for internal operations?
- What are the main challenges on making the blockchain vision come true?
- How do you evaluate the developments of blockchain applications in banking in the near- and mid-term future?
- Do you think the topic is pursued with the relevant level of attention?
- Are there practical examples of initiatives you find especially relevant?
- Do you think we will see applications moving beyond the proof of concept phase soon?
- What is your company’s next steps/your roadmap concerning blockchain?
|Time and Place: Telephone Interview|
I: Before we conduct a deep dive, would you mind telling me a bit about your professional role and engagement with blockchain overall?
R: Sure. I was recently tasked with exploring blockchain opportunities for a global payment network. I focused especially on micropayments and on mechanisms for the efficient conversion of fiat currencies and cryptocurrencies. This is something that is still not easily possible today, as it still requires quite a lot of effort, such as wire transfers and similar processes. And in connection with credit card usage, the danger of fraud is quite high.
I: Talking about fraud, does the blockchain technology offer a possibility to reduce the overall danger of fraud and connected issues, such as money laundering?
R: Blockchain as a technology, which allows a network to reach a distributed consensus, offers the great advantage of immutability. Furthermore, network participants enjoy anonymity, as their real identities are hidden behind cryptographic addresses. The interesting thing about this is the implications that this carries. A bank would, for example, immediately know if someone possesses the funds necessary to hold up to a liability, or not. And in trade, trade partners could at all times inform themselves about whether the other party really possesses the relevant resources, or not.
I: So this means blockchain technology creates security via transparency for its users?
R: Yes, by preventing the double-spending issue. But there are still quite some issues that need to be overcome first before this becomes reality. Most importantly, it still takes up too much time to perform a transaction, depending on how many network participants there are.
I: Are there any solutions to this issue of scalability under development or already available?
R: Yes, there are many variations of the original Bitcoin blockchain available and under development. But this brings us directly to the next issue. Due to the continuously expanding range of available technologies and platforms, we encounter the typical chicken-egg-problem. A network needs enough participants in order to be able to establish itself as a standard. There are also a lot of different cryptocurrencies, and most of them vary widely in their potential use cases. Monero is, for example, a cryptocurrency that is currently widely used within the Darknet as it solves the anonymity issue of Bitcoin, meaning the lack of absolute 100 per cent anonymity of Bitcoin. Furthermore, there are quite a lot of solutions under development for micropayments, which are especially relevant when thinking about the Internet of Things. The Bitcoin blockchain, for example, would never be able to allow for such models with its current transaction capacity of seven transactions per second.
I: So let’s take a look at commercial banks now. In your opinion, what implications does blockchain technology carry for the banking industry?
R: As a P2P protocol, blockchain technology allows for the elimination of intermediaries. In order to transfer money from one account to another, blockchain technology abates the need for a central intermediary to check whether the money was actually sent and received by the parties. Besides this fundamental disintermediation, banks are currently mostly operating on quite the old systems, rely on bloated structures and still often have processes in place that are largely dependent on a lot of manual work. Looking at, for example, cross-border payments, we see that transferring money from, for example, Germany to America still involves a lot of manual work, with bank employees actually filling out forms by hand and faxing them to and fro. This, of course, is absolutely inefficient and costs could be greatly reduced if you used blockchain to simplify this. Trade finance is another case that suffers from a lot of such inefficiencies. Here, we have a lot of reliance on many different paper documents, such as these letters of credit and bills of lading. The whole process largely relies on details such as who is in possession of the goods at what point in time, where is the money at which point in time, etc. These processes are pure manual work. Documents are being sent from one party to another an back, and the bank is always interconnected with each of the parties in order to act as a controlling instance and to process the payments according to plan. This process is so complex, you wouldn’t believe it. With blockchain and smart contracts, you could largely automate and simplify this process. So this is generally also a prime example for blockchain technology in banking. The money would be transferred automatically and all the required documents could be easily distributed and made available for all the parties. This reduction of manual processing would, obviously, result in tremendous cost reductions. Furthermore, securities trading is also a really promising use case for banks. The German stock exchange is, for example, one of the actors researching this use case. Because even though clearing and settlement of securities trade have already arrived in the age of technology, but there is still a lot of room for additional efficiencies.
I: So what would you say are the real core use cases for commercial banks?
R: Trade Finance and international payments as well as securities trading are definitely among the most promising. These are things that appear really important to me. Internet of Things is furthermore a really important topic in the field of payments. Banks are, so far, not really deep into this topic. Mainly, they are complaining that this will lead to them losing a lot of their cards business. But blockchain is, in my opinion, also a large opportunity for banks to enter into new fields of business.
I: So blockchain technology does not only help to reduce costs, but is also of large strategic importance for banks?
R: Well, you see, the advantage is that there is no set standard yet. So if we look at, for example, trade finance, we don’t see any established standard yet that is based on blockchain. So the bank, obviously, has the advantage that it already possesses the relevant connections to involved parties as well as systems in place. So if, for example, a start-up comes up with a great technology in this area, it still lacks the users and this, of course, is a major problem for them. In order to reach a critical mass, a bank is obviously much better positioned. But of course the outdated systems are a problem and quite error-prone. Blockchain technology can really help make improvements here. But, of course, we are still at the absolute beginning here. There is still so much to be explored, especially in terms of potential use cases. The technology to allow for a consensus without a middleman will enable a lot.
I: So do banks overall view blockchain as a chance?
R: Banks do see the chances that blockchain offers, but also the potential dangers. There are always those banks that demonize it. But at some point they do realize that they will not be able to get around it, and then they panic. But especially in the area of payment services and trade finance, in which existing systems are really inefficient, the blockchain technology is positively received and banks see the strategic potential to strengthen their business.
I: So would you say that banks are already doing enough in order to make use of the blockchain technology?
R: The momentum is definitely picking up, and more and more banks are approaching the topic. But for me, personally, it cannot move quick enough. I embrace every technological advancement. But sometimes, it is also helpful to take a step back and look at how the environment reacts. But if we take a look at, for example, card payments in Germany, we see that contactless payments, or also payment via mobile phone, are already five or seven years old. But still, I am rarely able to use these systems. But, well, these things take time. And blockchain is not going to be something that you actively use, but something that runs in the background. Banks will be able to really increase efficiencies by automatization, but users will not notice this. So blockchain can kind of be compared to the internet in this case – it works, but nobody really knows or cares about how it works. So banks do not feel any pressure by customers to implement it.
In general, the potential to achieve great changes in the banking sector is really big. But the fact, that the topic is not being researched with steady interest is also visible. Take the exit of the big players from the blockchain consortium R3 as an example. But on the other hand, many big tech companies, such as IBM, experiment a lot. And also consulting firms, such as KPMG, are getting really strong in this area. But of course, often times the hurdles pop up again. Take anonymity as an example. The advantage of blockchain is, that everybody can see the transactions that are being conducted. Now, if I want to keep this secret, then I need a private blockchain. And this, in essence, is nothing else than a database on which only a limited number of people are allowed access. So I don’t necessarily need a blockchain for this.
I: Looking at the current developments, what would you say are the most promising partnerships or initiatives between start-ups and banks?
R: There is quite a lot going on. Some banks are still in the process of finding their place, others have already joined forces and are actively trying to find solutions. Start-ups often times deliver the technology for this. But even though this may look very promising and all, there is this major hurdle of having an efficient mechanism that allows for the efficient conversion of fiat currency and cryptocurrency. Quite a lot of the initiatives use Bitcoin for this, which, in turn, causes other technological issues again. A lot of the PoCs also cheat their way out of this problem, by just not answering the question of how value is transferred on and off the blockchain. So this whole currency conversion and value transfer question is really still an issue. PoCs also often operate under the assumption, that the users already possess relevant cryptocurrencies. But money needs to be transferred into this cryptocurrency first. And I don’t see Bitcoin ATMs standing on the street corner. So there is definitely need for a solution here.
I: Thank you very much for the interview. Take care!
R: You’re welcome. Bye.
|Time and Place: Telephone Interview|
I: Thank you very much for giving me the opportunity to interview you today!
R: Of course, you’re very welcome!
I: For a start, I would like to introduce myself to you. I am currently a master’s student at HEC Paris and I am in the process of writing my thesis on the topic of blockchain in banking. The goal of the thesis is the development of a state of the art analysis, presenting the most relevant blockchain technology use cases for commercial banks. Would you mind giving me a short overview of your role and blockchain engagement?
R: Of course. At our company, we have a global service offering and competence center focused on blockchain technology. Within this area, we help customers to identify use cases as well as to pilot and to implement these use cases. Within this service, audit security and consulting on regulatory topics also play key roles. A certain part of the topics are, thus, quite similar to classical consulting activity in the field of financial services. From America to Singapore, we cover pretty much every continent and region with our service offering. Especially in Asia, a lot of our customers are already quite advanced in terms of their experimentation with blockchain technology. In Europe and America, reactions are still quite a lot more restrained.
I: Why do you think these differences exist?
R: Well, if you look at the Gartner research, the timeframe from 2017 to 2020 can be seen as the experimental phase of blockchain technology. We also see this quite clearly with our clients, who are mostly still in the orientation phase regarding blockchain. The important and interesting part within this is the development of a fundamental understanding for the technology. Many companies use the current phase mainly to get to know the technology. But the challenge of blockchain technology is twofold. On the one hand, the technology is not ready yet. There are too many different platforms, and the current IT infrastructure does not go well with blockchain technology. There is really a generation of rethinking required here. In banks, there is currently definitely still a lack of trust in open source solutions. In summary, immature technology, especially the question of scalability, is still a large issue. The second big issue is the question of transfer of value. The two large blockchains Bitcoin and Ethereum have already developed some solutions here, but there is no regulation and common understanding regarding how to transfer, for example, one Euro from left to right via a blockchain. Banks have started working on something like a Euro-Blockchain, which other companies then could use. But the question hereby is, whether every bank will have their own version of such a blockchain, and will there be a lot of currency exchanges, or will, for example, the large tech players such as Google and Microsoft become involved as key players.
I: So if I understood correctly, the question of how to represent and transfer value effectively on the blockchain remains a key issue?
R: I believe that the abstract problem is the question of how to make use of the blockchain’s full capacity in terms of functionality to digitally transfer any kind of value. Now, if this will be done via a certain cryptocurrency, which then needs to be established in a regulated context – a Bitcoin 2.0 so to say – or whether a fiat currency will be transposed onto a blockchain, is not important. The question of how to transfer digital value in a context that is accepted by society and state is a big hurdle. If I only use the blockchain to transfer information, then, in my opinion, the most important feature of that technology is lost. So this is the status quo, and many companies are waiting for solutions in this area.
I: Now that we’ve already spoken about banks – in the current environment, banks have to cope with a lot of difficulties. What would you say how important blockchain technology is seen by banks in such an environment?
R: Blockchain technology can be part of an answer to the question of digitalisation. Banks currently suffer from a lot of system interruptions, caused by the combination of many different incompatible systems. This is where the blockchain can help to digitalise. Customers will obviously not see the blockchain actively, but they will feel the efficiency gains of it. Inefficiencies due to the need for coordination and the loss of performance can definitely be reduced via the application of blockchain technology. Everything else is a bit more difficult in my opinion, as customers already use a lot of advanced apps today and already communicate with bots and so on. So, from a front end perspective, the customers really don’t care, whether their application or service is based on blockchain technology. From my point of view, it is rather the cost side of things, looking at quality and efficiency, that the customers will notice – and be it only if due to less errors etc. In this step of digitalisation, this will be especially relevant for incumbent banks. Younger banks, and especially the start-up banks, don’t even have these problems to start with. So they are much less reliant on blockchain technology than those incumbents. So this would be the one aspect. The other aspect is related to the actual usage of blockchain technology. I, for my part, am a huge fan of Bitcoin, I have a Bitcoin wallet and I like to use it to pay online. So this probably makes me one of 10,000 active users in Germany, who has the courage to make a larger investment in Bitcoin and who dares to carry his key around. For other users, the topic of key management will be much more difficult. Is it the pure blockchain, that will come out on top against banks? Will I, as a private user, carry around all my assets with me? Is there going to be a national or global central bank-driven blockchain, on which all assets are registered, and can I, for example, then allow different banks access to my assets without entering into long lasting contractual relationships? This I currently don’t see as realistic. I think that most of the customers will continue to want to enjoy the service of a bank as, for example, a partner that always helps them in problematic situations, for example when they have once again lost their login credentials etc. I think that the understanding and the mechanics of, for example, key management would be too difficult for end users. So there would need to be a huge learning process in a new generation, but this I don’t believe will happen. So companies could, for example, offers this service of identity management, in order to store keys. So trust overall will continue to play a large role.
I: Speaking about digital identity, which advantages could the blockchain technology offer for banks in terms of strategic perspective, next to cost reductions and efficiency gains?
R: Now, a bank could, of course, expand their product portfolio based on blockchain technology – which carries huge strategic implications for a bank. Better processes and less costs are rather of operational importance. Strategic moves, entering new markets with new products, is definitely possible with blockchain. If there is the opportunity to build an entire ecosystem of blockchain developers and applications, then this is, of course, a topic in which a bank can position itself so innovatively, that they can steal customers from their competitors. An example for this would be blockchain applications in trade and supply chain. The question is, whether this is really a new product, but entering into such new markets is definitely possible. An entirely new product would, for example, be the connection of loans with blockchain-based surveillance of, for example, the usage, for example in the context of a car loan. But one has to be careful here, as this smart contract logic is also possible with technologies other than blockchain. In a central system, this is also possible, for example with Microsoft’s Cryptlets. With our clients, we regularly ask these questions, whether your actually really need a blockchain-based solution, or whether we can not actually also use current technologies in a better way. So fundamentally, I am rather sceptic, whether the blockchain is always the best technological solution to these issues, as there is a lot than one can also do with current technology, and that even better. So if I now raise the question, whether there are specific use cases that can only be implemented via blockchain technology, we definitely have those. But they are rather a small amount of the use cases that are currently being explored. In that case I am very often in the realm of decentralized business models, which propagate a rather anarchic model. An example for this would be a crowdfunding model which completely abolishes a central intermediary. These disruptive business models can then, in fact, threaten a central provider, such as a bank or insurance company. But a bank can, of course, use such thought experiments in order to prepare itself for a potential attack by such models.
I: So then what would you defined as the currently relevant use cases of blockchain technology for banks?
R: We are currently having discussions with a number of banks. And the most of these discussions center around the issues that arise due to complex processes. In payment services, there is actually surprisingly little activity for us, even though this is something I would expect to be first in line. In principle, there are two approaches: one is to focus on processes with little volume but high complexity, in order to realize efficiency gains. The other direction would be to try to build a market leadership in a certain field via the application of blockchain technology.
I: So do banks try to do this rather by themselves?
R: There is a lot of activity in cooperation with start-ups, banks, universities and tech companies. So there a lot of possible constellations that can be seen. But one thing is certain: inhouse IT may always be part of a project in an accompanying role, but there is never a reliance on purely internal capabilities.
I: Does this cooperation lead to internal difficulties?
R: Ich don’t think that there is a formation of active internal resistance, but rather an issue of knowledge gap. A bank’s IT is, most of the times, quite antiquated. Junior employees in the IT sector are currently not very inclined to go work for a bank.
I: You already spoke about internal and external hurdles for the implementation of blockchain. Is this topic also pursued by regulators?
R: In general, we do see regulators’ openness towards new ideas. Especially in the field of information transfer, there is definitely room for an open and positive discussion with regulating entities. But in the field of cryptocurrencies, there is currently no discussion the be held with either the BaFin or the ECB. That’s something where you don’t stand a chance.
I: So, in summary, would you say banks take blockchain as a chance, or do they see it as a threat?
R: Currently definitively as a chance. All of the banks are involved somehow, and the fear has disappeared. Since the perspective has shifted from cryptocurrencies towards a more technological side, it is being understood as a chance. But some actors do, as I said earlier, still lack a fundamental understanding of the technology. Now, THE blockchain use case that results in a major gain in value creation is yet to be identified. But the three years of experimenting that we are now going to experience is going to uncover a lot in this area.
I: So does the interest in blockchain technology still increase?
R: The momentum is definitely picking up speed. The hype may be over, and players are moving towards the plateau of productivity. I mean, currently there is no money to be made with blockchain, but investments are being made.
I: Thank you very much for this interesting discussion!
R: Thank you!
|Time and Place: Telephone Interview|
I: Hello and thank you very much for giving me the opportunity to interview you today!
R: Hello Mr. Herrlich! Of course, you’re very welcome.
I: Just to get started, could tell me a bit about your engagement with the topic of blockchain technology?
R: Of course. I guess it would be best to get started with definitions. Fundamentally, one can distinguish between three different layers. The top layer is the application, which can, for example, be a cryptocurrency such as Bitcoin or Ether. The middle layer is the blockchain that supports this respective cryptocurrency. And the bottom layer is what we call distributed ledger technology, or DLT, which has emerged based on the original Bitcoin blockchain.
I: So one needs to distinguish between “the blockchain” and “DLT”?
R: DLT is first and foremost a synonym for a wide range of technologies. It includes a wide range of initiatives that are currently being researched around the world, such as Hyperledger, Ethererum etc. Now if we take a look at, for example, permissioned ledgers, then there is no need to utilize a proof of work mechanism. Personally, I engage in topics related to such DLT topics, not the “classical” Bitcoin blockchain. Now, DLT is relevant for me in two ways. On the one side, I am very engaged in the topic of digital identity management in the context of my position, and on the other side I am responsible for consulting Fintechs as part of my role within another global organization, and within this role, obviously, DLT is a topic of major importance.
I: So blockchain technology is a topic that banks, Fintechs and other organisations currently pursue with high importance?
R: What is definitely noticeable is a large interest in regards of DLT. There are a lot of symposia, workshops and pilot projects taking place. The press coverage is also increasing, which is why many speak of the “blockchain hype”. But there are actually not that many projects that have already delivered a real product or solution. Bitcoin is kind of an exemption in this case, because it was built on purpose in a way in which it keeps itself hidden from broad public attention. It was designed so that nobody could control or influence how much money I have in my pocket. In this sense, Bitcoin for me is a classic application that has by now already been up and running for a couple of years and which continues to build general acceptance. Looking at other projects, we don’t see that much progress yet. There are, for example, projects led by central banks, that are very far from potential implementation. There is also a lot of experimentation at exchanges, who try to simplify securities trading via blockchain technology. I’ve seen a couple of pilots in this area. And then there is a whole range of distributed data management projects. But these don’t do anything else other than distributed data storage, but call themselves DLT or blockchain, just because it is currently a trending term. So you really need to look at each project in detail, in order to find out what it actually is that these people do.
I: So would you say that many of the current projects are rather overhyped?
R: Well, they are working towards implementation. The technology itself is definitely unstoppable in my opinion. Whenever Bitcoin, for example, is mentioned as the end of all currency, then this, obviously, scares regulators and central banks and they start getting involved with the topic. Or when someone says that Fintechs are revolutionizing the banking sectors and making banks obsolete, then banks will engage thoroughly in the topic in order to gauge what the consequence for their business models may be. So this was what was visible very clearly about a year ago. But by now, it has kind of calmed down, nobody really believes in a quick revolution anymore. But by now there are quite a lot of projects out there, and my organization is also becoming more and more involved.
I: Could you provide me with some insights regarding your organisation’s projects?
R: First of all, I would like to present you the argumentation why I believe that DLT will prevail. And this is primarily because the costs for computing centers will disappear. You have to image that the DLT offers the potential of zero marginal cost. As soon as you distribute your data on a blockchain, you as an operator do not have to carry any costs for a central computing center anymore. Instead, market participants provide the required computing power and data storage capacity. This will lead to the emergence of other business models and to the fact that I, as a user, will not be required to operate my own database anymore. What’s nice about this is the fact that it is a free operation. DLT, in this sense, functions a bit like a DNS server. These are also distributed worldwide and update themselves via a proxy protocol. DLT takes this concept and applies it to the content itself. Insofar I believe it will prevail due to its cost-benefit ratio. And then, it obviously is suited especially for applications in which people from different organizations have to access the same data.
[OMISSION DUE TO CONFIDENTIALITY]
So the blockchain eliminates this central point of failure, which would, in case of a system crash, paralyze the entire offering.
I: So this means, that your organization would not necessarily be rendered irrelevant by DLT?
R: Well, that is the exciting question: who is the intermediary that will be kicked out of the equation?
[OMISSION DUE TO CONFIDENTIALITY]
So there will always be need for some form of governing entity. Banks are currently looking into exactly such topics. They are especially looking at customer identity management, as in, for example, how to simplify client onboarding. For this use case, DLT is really perfect. My organization is deeply involved in such discussions, because we believe that this is something that should happen under supervision.
I: The simplification of client onboarding definitely is an interesting use case.
R: Absolutely, the cost savings potential for banks is tremendous in this area.
I: So banks see DLT as an opportunity to save costs and to expand their business model?
R: I think one needs to differentiate here. While some definitively see blockchain as a chance, others are going to miss out on this opportunity. But, from my point of view, one aspect is always the same when it comes to technology revolutions. You’re looking for the Killer-Application. But this search is really difficult. In my opinion, DLT is relevant because it completely changes the way costs are distributed, because it allows automation and because it can be managed by a rather small team of people for the benefit of millions and millions of users. So, thinking about this radical simplification, it is really something else compared to what we have today. In this sense, DLT cannot really be seen as only a replacement of current systems, but as something that makes possible entirely new things. So let’s look at an example. If today I want to open a bank account with, say, the Commerzbank. Now, Commerzbank will have to perform a background check on me to make sure that I really am who I say I am. This is actually quite the complex process. Now let’s say that tomorrow I open another bank account, but this time with the Sparkasse. This means that, again, the Sparkasse will have to perform this complex background check on me. Now think about what would be possible if my identity was recorded on a blockchain. Then the Sparkasse could, under the condition that regulators would allow this, confirm my identity with just a few clicks. This would be something entirely new, we don’t have a system like this so far. This makes DLT to another form of operating structure between private individuals and organizations, not just an application. But there are also a lot of initiatives that try to do things with DLT that could also be done otherwise. There are, for example, a lot of other distributed data storage concepts besides DLT, and we mustn’t forget, that DLT still has a couple of issues that prevent implementation.
I: This leads us to the next question. Where do you see the big hurdles to implementation of blockchain technology?
R: I see a couple of hurdles. One hurdle would definitely be the lack of a common standard. At the moment, everyone is involved in different projects, there are competing projects. What I mean to say is there are a lot of pilot projects, but there has not yet been agreement on a standard. For mass market applications you need a standard. A standard would, for example, be the agreement over a certain cryptography mechanism and which keys should be used. How is identity actually managed? These are topics, in which organizations such as the ISO are also engaged in. So this would be one thing. A second issue is the question of trust in security. A distributed system requires trust in the security of this distributed system. Usually, IT departments lock away their systems, and nobody is allowed to enter the computing center in order to make sure that nobody can access the data. But now we suddenly place the data in the cloud. Obviously, this promotes resentment regarding the security of the data etc. There were a couple of cases of fraud within the Bitcoin sphere, which in fact were not related to the Bitcoin blockchain, but to Bitcoin exchanges. But in the broader public, everyone suddenly speaks about Bitcoin having a security issue. And the third issue is of conceptional nature, something that I am actually quite interested in. Most people say that blockchain is a distributed ledger system and, consequently, a distributed data storage. This is what you often hear and read. But I, personally, do not believe that it is a distributed database. First of all, it does not fulfill the function of a database. An example would be the classical function of “show me all the data, for which holds …”. On a DLT, I need to specifically add this functionality. So how this is done today is that, first of all, the entire data on the blockchain is readout off the blockchain, transferred to a classical databank and then a query is performed on this databank, because the relevant blockchain standard just doesn’t exist. So essentially, I have the immutable states meaning transactions cannot be changed. But whenever I want to perform analyses, queries or establish references, then I have to program all of this by hand. So there is a lot of need for technological advancements in this area. And as you realize, the way these data analyses are performed contradicts the fundamental distributed approach, as they are performed centralized again in the end. And then there is the issue of referential identity. This means that when I put data on the blockchain, then, even though the transactional data that this data has created can be verified, the data itself can be contradictive. That means I have to manage referential identity, pointer identity, on top, as the blockchains don’t do this. In its essence, blockchain is a system in which I can write anything I want into a block. There are no restrictions whatsoever. And then many migrated to not even put the data itself on the blockchain, because the amounts of data would just explode, but to just put the hash sums onto the blockchain. Now I end up with an entirely fantastic (in the sense of nonsensical) system. I have an entirely centralized data storage, but the checking of the validity of this data is performed via the blockchain by checking the transaction data. Now this doesn’t really seem like an ideal solution to me. But there will be a lot of developments in this area. But then again, these are the classic questions that always come up when new technology is introduced, which is why I believe that these issues will be resolved in the coming years. Personally, I am a friend of this technology and I do believe it will be implemented on a wider scale.
I: How would you describe the regulatory situation? Is there need for a lot of regulatory involvement in order to implement blockchain solutions?
R: Well, regulators have started thinking about it. There are a lot of Regtechs that are working on this. But regulators are yet to form a common opinion on how to deal with this. Japan and Switzerland have, for example, started to accept Bitcoin as a means of payment for certain things. This has more of an experimental character. But for a blockchain application it is fundamentally questionable whether you actually even need that much new regulation, because all the standing regulation is, of course, also relevant for Fintechs and new technologies. Data has to be secure, no unauthorized person is allowed access, etc. The question is rather whether regulators would accept such a technology as an implementation of their policies. In this area, we basically need to wait and see how the applications will develop. Pilots are being performed everywhere.
I: So regulators will rather intervene reactively than proactively?
R: Well, the regulator makes laws, and this process takes time. The relevant matter has to be perfectly understood in order to be able to do so. So you will never really see proactive regulation. But in some countries, for example, regulators have introduced special zones in which certain Fintechs are freed of the need to comply with certain standing regulation, in order for the regulators to follow a wait and see approach on how the Fintechs will develop. But the result of this has been the realization that it can become quite difficult to “catch” these Fintechs once they’ve reached a larger size. Now the general trend goes towards requiring Fintechs to comply to the same laws and regulations as everyone else. So these are the discussions that are currently being held.
I: How would you evaluate the near-future development? Are we soon going to see blockchain technology in action on a larger scale?
R: The question is, of course, are we interested in ANY DLT application, or are we waiting for the Killer-App which will be relevant to us all, the new Facebook or Uber so to say. When we will see this Killer-App, I wouldn’t be able to tell. But the technology will soon be used widely, I am certain of that. I personally expect a lot from the Hyperledger project, which runs under the Linux foundation as an open source project. I do think that we will see standards evolving from this.
I: And especially in digital identity?
R: Digital identity is, as such, already regulatory reality. There is the eIDAS regulation by the European Commission, which has to be transposed to national law by 2018. This means, that you will be able to digitally identify yourself vis-à-vis government agencies, etc. This is called “Signaturgesetz” in Germany. The problem in this area is, of course, that different countries around the globe fare entirely different in regards of this topic. There are no widespread standards. Out goal is, of course, to integrate [OMMISSION DUE TO CONFIDENTIALITY] in such a standard. Then, we can truly imagine a blockchain that manages these certificates. And a bank could be well positioned to run such a blockchain. Now all of that would, as a closing, be our global vision.
I: Thank you very much for this detailed interview!
R: Of course. Thank you and bye bye.
|Time and Place: Skype Interview|
I: Hello, thank you very much for joining me for this interview today.
R: Hello Mr. Herrlich! Of course, I am glad to help.
I: Could you, as a start, give me a short overview of your involvement with blockchain technology?
R: Sure. I have been active within the topic of blockchain technology since 2014. I position myself as someone who analyzes blockchain from the perspective of a senior manager. For this reason, I have taken course at Princeton University, the MIT and the University of Nicosia. This way, I was able to build up expert knowledge, which, among other things, led to me having been invited to present the topic of blockchain technology in front of the Bundeswirtschaftsministerium as one of seven experts last year. Now I have founded a company with some colleagues, where we focus on executive education, consulting services and implementation of blockchain solutions. We do believe, and already partly see, that a wide range of sectors and companies want to become active in the field of blockchain applications.
I: So, companies are becoming more and more active in terms of blockchain involvement? How high is blockchain ranked on the agenda of companies?
R: It is definitely one of the “items to watch” on the digitalisation agenda. Companies want to understand what blockchain is all about and what it means for them. It is very rare that you talk to business people that have already entirely understood what blockchain is, and who want to take the next step in the sense of starting to work on a concrete blockchain project. There are, of course, certain divisions, especially in large enterprises, that are really involved already, especially in banks and energy companies. But in a European comparison, Germany is really behind on this topic. The Nordics as well as Great Britain are already much more advanced on this. In Germany, we have this typical initial skepticism, as always when it comes to new topics. But when we then look at concrete implementation, I do believe that Germany will quickly catch up. Punctually, there a already some great developments to be seen today, but we only expect the really big push in the next year.
I: My perception is, that the financial services sector is quite ahead of other industries in terms of involvement. Are there sectors within the real economy that are much more involved in the blockchain topic than others?
R: There is especially a lot going on in the energy sector as well as in the Supply Chain Management or rather trade sector. We do see some PoCs in these fields and the development is visibly being pushed forwards. The topic of supply chain is especially relevant to us, as this is one of the key areas within which we want to position ourselves. Next to this, there are of course topics such as Internet of Things, Machine-to-Machine communication and Industry 4.0 that are being discussed related to blockchain.
I: A lot oft he use cases are connected to each other in a certain sense. Looking at supply chains, trade finance plays a key role
R: Definitely. This is actually a topic in which we are closely engaged. We have the expectation, that the market in this area is strongly going to move towards the implementation of blockchain solutions. Especially the large players in trade, such as Maersk, are going to actively push this topic. We currently have a research project running within this area. We, essentially, formed a consortium with local logistics companies in order to explore the possibility of a digital bill of lading from the perspective of SMEs. That way, we aim to connect the “Mittelstand” to the topics that are being driven by large players. We believe, that cooperation is of key importance in this. Initiatives such as ours are visible in a number of regions by now. And, as you already noted, the combination with the finance sector is essential for this.
I: So does blockchain technology offer such great benefits over existing systems, such as SWIFT’s BPO or Bolero, in this area?
R: The large advantage is the programmable trust of the blockchain. I do not require an intermediary anymore. This is especially relevant in cases where you have a lot of different actors as part of a process, all of whom do not trust each other. Ich believe that within the logistics sector, the cost pressure will lead to blockchain implementation. The savings potential within this area are north of 50%. The second advantage is, of course, security. Automation reduces not only cost, but also sources of errors.
I: So is the blockchain always a better solution over existing systems?
R: Jamie Burke, an English blockchain investor, once told me that he thinks that 90% of all blockchain initiatives are nonsense. Well, I don’t necessarily think that it’s really 90%, but it is definitively true that blockchain is currently often used because of the hype. The desire to surf the wave is clearly visible. You have to watch out, that you invest your energy only in projects that actually make sense. So it definitely makes sense to, first of all, look at these issue trees that determine whether a blockchain makes sense for a project, or not.
I: So let’s say I’ve identified a use case, such as trade finance, for which blockchain makes sense, and now I want to implement it. Where do you currently see hurdles to such an implementation?
R: That’s kind of more of a mental issue than a strategic one. If you’re really strict, blockchain is only blockchain where there is a permissionless system. But this means you would be building an infrastructure without the ability to develop a business model based on this. If I build eBay without eBay, then I don’t have the transactions. So this is definitely an issue that hinders the development of new offerings. Without a profit potential it is very difficult to find investments. The economic potentials are thus not really visible yet within these open blockchain concepts. But in the field of enterprise blockchain, they are clearly visible. This is why we see all these consortia of banks. The sector is joining forces in order to develop and finance a solution. Now this is not going to make anyone really rich, but it makes it easier. Now the second issue is really related to the technology. Scalability is still quite limited, even though some projects do offer a solution to this. But all of them have a long way to go until they can be applied on a wide scale. Security issues, such as the Mt.Gox incident, are also a problem. Of course, this is based on entirely wrong communication in the public, but hits like a bomb. So there is in general still a large need for learning and developing a general understanding as to what blockchain is and how it can be applied. In parallel, the governance of the technology needs to be dramatically improved. It has to offer an entirely different usability for users as well as developers. But all of this is developing really fast, especially when compared to other technological developments in the past years. Insofar, I believe that these current issues are going to be resolved quite soon. I am certain that it won’t take longer than two years, until the number of blockchain projects and use cases becomes too large to keep track of.
I: So what can companies expect from blockchain technology, besides the cost savings?
R: I definitely see large strategic opportunities. For banks, the whole topic of “unbanked” is really a big opportunity. And also in the fields of security and ownership, e.g. the control over own data, will definitely serve to create new business models. And thinking about the Internet of Things, this will enable entirely new service offerings. You could also think about the revolution of the sharing economy, even though I don’t believe that Uber and Airbnb will disappear because of blockchain. Overall, a lot of start-ups are thinking about such things. Step by step, we will see advancements in these areas, until we suddenly see a new Facebook in a couple of years and have the same reaction as always: why didn’t anyone think of this earlier?
I: So is the blockchain more of a chance or a threat?
R: I think it is a chance. On the one hand, policy makers and the economy don’t really have an incentive to fundamentally disrupt everything. Even though there are some initiatives currently regarding cryptocurrencies and similar stuff by central banks, I don’t believe that blockchain will now lead to the entire economy being fundamentally overthrown. But the underlying processe, such as interbank payments, and the topics such as “unbanked” will definitely profit from blockchain as a chance. And especially legacy banks will need to get involved in such topics, when thinking about all the new start-ups joining the market.
I: Thank you very much for this interview!
R: You’re very welcome!
I hereby declare that the thesis submitted is my own unaided work. All direct or indirect sources used are acknowledged as references.
This paper was not previously presented to another examination board and has not been published.
Paris, May 2017,
 In line with the definition chosen by many authors, including the World Economic Forum, the terms ‘blockchain’ and ‘blockchain technology’ will be used synonymously with ‘distributed ledger technology (DLT)’ within this study.
 The process description is based on the Bitcoin blockchain.
 Open account trade refers to trade transactions in which goods are shipped in advance of payments. The opposite would be a cash-in-advance transaction, which is another form of inter-firm trade credit. (Clark, 2014)
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