Blockchain has continued to grab column inches in technology publications, financial services industry press and more recently in the mainstream media.
In this article, we look at some of the most promising potential uses in the financial services sector. We highlight the parallels between some of those uses, to help you assess which of these applications could bring significant improvements to the processes your business may be wrestling with.
If you are still new to the concept of blockchain,or if you have read numerous articles but still have no idea what blockchain actually is (you are not alone), see here for our short introduction to blockchain technology and here for our more detailed blockchain for business report.
Finance infrastructure use cases
Payments and settlement
Payments and the settlement of transactions is the original use case for blockchain technology. Love or hate Bitcoin as a concept, it has clearly demonstrated a means to store value and to transfer that value anywhere in the world, with very little cost and without the need for a central authority or clearing house. Many major banks and other financial services providers are investing in developing blockchain-based payments infrastructure.
There are currently a number of different projects seeking to implement a blockchain payments solution, often with only nuanced technical differences between them. Among the most interesting of the current initiatives for banks is Utility Settlement Coin (USC), which is being developed by a consortium of 12 major banks led by UBS. USC is a digital representation of a fiat currency. It is asset backed 1:1 with fiat currency held at the relevant central bank. The promise of USC is to facilitate instantaneous transfer of funds, including cross-border, without the exchange risk associated with Bitcoin or other crypto-currencies, which remain very volatile. It is anticipated USC will first be used by Banks to settle balances in the interbank markets, but ultimately, if proven to work, the model could be extended as a completely new payment rail.
Currently, even where underlying transactions can take place and are recorded on the blockchain, payment still takes place ‘off-chain’ via traditional payments rails (see below: finance transaction use cases).
Another of the early blockchain uses cases is managing identity. The promise of blockchain for identity verification is that corporate and personal identity can be stored and maintained on a blockchain. This would be a single ‘golden source’ of identity information, which could be trusted by anyone searching it (due to immutability and consensus mechanisms inherent in blockchain). Banks could therefore all refer to this single definitive source for satisfying their KYC and AML requirements, rather than numerous different banks all satisfying themselves individually, at significant duplicative cost.
There are a number of Banks looking closely at blockchain solutions for AML. However, whether or not identity on blockchain can live up to that promise is still to be seen. See here for further detail on blockchain and Identity.
Finance transactions use cases
A consortium of 19 Banks led by Credit Suisse have partnered with a blockchain development company called Synaps to develop a platform for processing and trading syndicated loans.
Currently, the process for transferring participations in loans takes on average 20 days. It involves a written transfer request to the facility agent appointed for that loan, waiting for the facility agent to determine the trade is permitted by the credit agreement, raising and executing transfer documents and then relying on the agent to settle the trade and reconcile the participant bank’s hold levels, interest payments and accruals.
This causes headaches for bankers and in particular their treasury teams, as not being able to buy and sell loans with clear settlement dates can give rise to a drag on the balance sheet. For example, if I want to sell £50m of my participation in Loan A and buy a £50m participation in Loan B and the sale of Loan A takes 19 days to settle and the purchase of Loan B takes 15 days to settle, for four days both loans are still on my balance sheet.
The blockchain solution promises to reduce loan trades to a certain T+3 days settlement period by using a central platform to process loans and administer trades. To facilitate this, key aspects of the credit agreement relating to loan transferability are coded into a smart contract on the blockchain: For example:
- whether consent or consultation is required to transfer the loan;
- details of a ‘white list’ or ‘black list’ of potential transferees;
- any minimum hold requirements to be adhered to; and
- any minimum permitted transfer amounts.
When a loan trade is proposed, the smart contract instantly determines whether the proposed trade is permitted by reference to the parameters already set (instead of sending a request to the Agent to do that manually, saving days on that one step). The instigating bank proposes a trade to another bank. If the buying bank accepts the proposed trade, the loan transfer documents and any borrower notices are generated, signed and recorded on the blockchain ledger. The blockchain ledger then automatically reconciles the transactions and updates the lender’s hold levels and interest payments, and calculates interest accruals.
The consortium has successful completed a number of “live” loan trades, proving the technology works, and will continue its proof of concept stage until the end of this year.
Trade finance is a use case almost tailor made for the application blockchain technology. The end-to-end process for documentary trade finance involves multiple participants (seller, buyer, port authorities, carriers, quality checkers and banks) spread across the globe. It also requires physical documents to travel between the various participants in the supply chain to be approved, stamped and/or signed before a Bank will pay out on a letter of credit and a supplier can be paid.
It is not surprising then that trade finance was one of the very first operational use cases of blockchain in finance. Barclays Bank partnered with blockchain company, Wave, to issue the first letter of credit on the blockchain and since then a consortium of trade finance Banks have partnered with IBM under the umbrella of “Digital Trade Chain” to develop an end-to-end trade finance platform.
Trade finance on a blockchain platform, allows all participants in the supply chain to view the same ledger recording of the progress of goods and documents through the various stages of the supply chain. This increases the speed of the end-to-end documentary trade process and brings greater accuracy and certainty to the process; which also reduces risk to a financing bank.
There are recently also more sophisticated features are being developed for trade finance platforms including:
- smart contracts which automatically release payment under a letter of credit upon verification of goods arriving in port; and
- integration with internet of things (IOT) devices, which can monitor the conditions in which goods are transported and ensure they meet contractual requirements. For example, if the temperature of my bananas exceeds the contracted transportation temperature whilst on the boat, the IOT device speaks to the blockchain smart contract and the contract is void and payment is not made.
Often considered a close relative of trade finance, invoice finance, is also a well suited use case for the application of blockchain technology. The trust between parties created by consensus mechanisms on the blockchain, together with the possibility of immutable records relating to delivery of goods and issue of invoices, could make receivables a much more tangible asset for financing purposes. This makes financing invoices more secure for financiers and reduces costs for companies selling their receivables. See here for our more detailed article relating to blockchain and invoice financing.
What are the emerging trends for blockchain finance use cases?
It is clear that most banks and other financial services providers are now paying close attention to the potential of Blockchain. Many banks now have innovation labs or blockchain labs specifically looking at how Blockchain can be applied in their business. One major bank we have spoken with has reported to have analysed some 200-plus blockchain uses cases over the last 18-24 months. It has whittled that list down to just three use cases which it sees as having the most potential impact on its business (including two of those mentioned above). So, what are the common themes between high potential Blockchain uses cases in the finance sector? Looking at the uses discussed above, which have all now graduated from the initial proof of concept stage, we have identified the following commonalities:
- The involvement of one or more intermediaries: each of the uses cases mentioned above currently involves and relies on an intermediary to pass on information or bring trust to the transaction. The blockchain solution effectively dis-intermediates those intermediaries;
- The requirement for (or potential benefit from) a shared repository of information: blockchain being used as a ‘golden source’ of information, which all parties to a transaction or process can access and view in real time, is a key aspect of each of the use cases mentioned;
- The requirement for (or potential benefit from) having multiple parties able to initiate or contribute to the same transaction: for example, a payments system needs to facilitate millions of people transacting with their banks. In trade finance, the ability for each actor in the supply chain to update the blockchain as to the status of goods and documents (within their own limited position) is game-changing.
- Finally, the existence of a lack of trust between participants in a transaction: in scenarios where transacting parties are not well known to each other they often impose layers of verification (often via an intermediary) or collateral requirements to protect against non-performance. Where such lack of trust is a factor, blockchain can replicate trust cyptographically and in doing so streamline processes and reduce costs.
A year is a long time in the world of blockchain – demonstrated most pointedly perhaps by the fact in December 2016 the price of a single Bitcoin was under $1,000 and at the time of writing has just spiked over $8,000. 2016 was seen by many involved with blockchain as the year of the “proof of concept”, banks in particular analysed lots of different potential applications for the still emerging technology.
2017, it seems, will be characterised by a tightening of focus on specific and plausible use cases, which will include those mentioned in this article. 2017 has also seen many banks hedge their options by joining multiple blockchain consortia each focused on delivering a specific blockchain breakthrough, with many such projects having moved beyond proof of concept to controlled “live” testing during the year.
Will 2018 be the year that many blockchain finance projects move out of the test environment and into the real world? It is certainly looking that way.