Blockchain: The good, the bad and the ugly

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What is the value and importance of Blockchain technology for financial markets? If you have been reading in the global media over the last few years, all the Blockchain stories, I think you can be forgiven for thinking that this is a major new technology, bringing a revolution in business and processes. But is that true? What is the actual importance of Blockchain and why is it capturing so much attention from Fintech firms and investing entrepreneurs?

Far from being a new technology, Blockchain technology underpins Bitcoin and as such has already achieved proven status. Whatever your personal feeling about Bitcoin and this does divide opinion, the fact is that Blockchain successfully enabled a new digital currency force to enter the world of commerce. Up to then, most people would have thought that this would have been impossible. Bitcoin succeeded and may be with us for some considerable time, but future versions of Blockchain hold even more potential for the longer term.

Dr Hermann Rapp, Senior Lecturer and Head of Technology and Research at Block Asset Technologies states “From a technical point of view, Blockchain technologies are based on decades of long research and development, in several disciplines; in particular encryption, distributed databases and networking. “ So not really such a new technology after all!

The financial markets are in the process of major reform. Partly as a result of the financial crisis starting in 2007/08 and partly through the demands of society via political agendas to introduce a more secure and protective financial system that does not detrimentally impact the tax payer when crisis events hit.

Over the hundreds of years that the financial markets been in existence, an array of events have broken people’s confidence in the financial system causing the reaction of, increased regulations and in some cases, new market structures. The historical record is there for all to read. The current feverish drafting of new rules and laws and attempts to introduce new systems are a normal reaction to these events, whether localised or international, no matter what size the crisis might be. The difference today is that there is technology available, which can offer dramatic changes in processes and market structures. Blockchain is one such technology.

Today, Blockchain is seen as a disruptive technology, but I think it would still be put in the potential tray. Rapp further comments “The financial crisis and the FinTech revolution since 2007 have led to readiness for new thinking. Distributed technologies are now looked at as a critical factor, which could help to achieve significant operational benefits in terms of speed, security, and cost savings”.

Blockchain is a decentralised electronic ledger that offers many possible and different introductions into the transaction processes within financial services firms, but also as part of the market infrastructure. However, it is its potential application in the market infrastructure arena that is causing a few furrowed brows, by both financial services firms and their infrastructure providers: Why?

Blockchain’s decentralising design could replace infrastructure providers that are constructed both technically and commercially around central control and central transaction processing. Anything that effectively replaces this role, can be deemed a threat. However, threats can become opportunities, hence we see some considerable investment in technology and some early attempts to incorporate Blockchain – NASDAQ proxy voting services, comes to mind.

“Expectations are high and venture capital backed initiatives are exploring the Blockchain space.  Comments Dr Rapp “However, it is still early days. After a first phase of learning and education it is now a time of experimenting and feasibility studies. There remain unresolved issues regarding the integration of central and distributed technologies. The Blockchain protocol is evolving, and there are several benchmarking exercises ongoing to find the best performing platforms and infrastructure. There is no ‘one size fits all’ and different design options with regards to public/private blockchains, adaptation to specific business cases and security architectures.”

Blockchain also threatens the agency roles of firms and suppliers, as the technology can be introduced on a peer to peer basis. It looks as though finally this might result in the realisation of Sir Tim Berners-Lee’s original internet concept. Peer to Peer cuts out the middle man!

Blockchain could feasibly reshape legacy systems and processes built around the historical construction of the markets. There are an almost never ending supply of use cases, where Blockchain could be introduced, but less regarding the business case and implementation to attract transaction volume.

It is a realistic view that markets don’t change because of technology but because demand is created and users are willing to introduce volume. It is important that trust of the customer is paramount for any new change to be adopted. by the customer in the supplier to the customer of the change. So introducing new technology like Blockchain, no matter how great it might be it, can flounder on the rocks, through lack of uptake.   

So apart from the need for business cases and user attraction, Blockchain requires that data quality is as high as possible, and uses standard definitions which are recognisable globally throughout the industry. Unfortunately, the quality of data in today’s financial markets is variable, suffering still from many silo infrastructures.

Whatever the type of data and wherever it is gained from, financial services firms have struggled for decades to introduce the required solutions to improve quality. Data vendors could be called both part of the solution, but equally part of the problem.

What is required in today’s markets is a more streamlined and manageable data capability, which increases the depth and breadth of data, as well as the quality. There are numerous international industry groups that have been working on these problems, but without much speed or urgency, based on the lack of changes in the data industry. ISO15022 might be the last successful change that positively impacted the international markets, with ISO2022 still to gain the same level of use and impact.

The development and implementation of Ontologies could provide the tool to allow data to be managed more efficiently, with only dreamt of dexterity, by operational people in financial markets. The ability to identify and extract the requisite data, from a large pool consisting of seemingly the same data, is what will open up opportunities to build better customer services and also reduce the costs and risks. The outcome would also provide better reporting capabilities for regulatory compliance and increased control by senior managers.

Blockchain provides the technology that could not only deliver data, but also introduce greater levels of security and transparency, which would reduce the dependency of Banks and other financial services firms to buy data many times over.

In this scenario Blockchain can be seen as an enabler of change, although implementation may be a major problem, as the in situ data vendors will look to protect their business and the banks will need to invest in changing their legacy system infrastructures and review their commercial contracts with the data vendors. This will be an expensive, difficult and a thorny issue and demands that senior management understand their existing data problems, (most would run a mile once data is in the conversation). They must realise the opportunity, then invest in change, on something they think works well. This is where Blockchain has significant value and potential, but where at the moment change and implementation, significant usage and volume, looks less feasible in the short term under the current structure.

Issuers too could use Blockchain to deliver data directly to their shareholders and bypass the existing market data supply chain.

Blockchain offers a technology conundrum, as the technology works and is available but how do you enable interoperability with legacy systems, other Blockchains and current market practise. Remember “Just because you can, does not mean you will!”