Lead or be disrupted. Blockchain in Banking

Published: 2020-01-27

Technologies disrupting whole industries have become a common phenomenon. Financial Services Industries have so far avoided the fate of Media Industry, where new technology companies have completely taken over. Fintech startups are growing in numbers, but incumbent Banks are not waiting. They are actively pursuing new technologies and business models. This is very evident in the Blockchain space. Banks everywhere in the world are actively researching this promising new technology and are deploying it to improve their existing business processes as well as to create completely new solutions. This article provides a high-level overview of most active and interesting directions that industry players are taking and projects that are being implemented.

Digital Money and Payments

While Bitcoin fans hail the original cryptocurrencies’ value as an alternative payment solution, many critics point to its volatility as the critical obstacle to Bitcoin becoming a globally accepted solution for everyday payments. Stable coins, first designed to disintermediate banks in crypto trading, are quickly becoming a focus of research and implementation projects in Banks across the globe. Many Central Banks are undergoing in-depth studies on this topic. Potentials of Blockchain to create new payment systems in variety of use-cases is not missed by most banks, so let’s review some of the most notable efforts in this area.

JPMorgan Chase, one of the world’s largest banks, is leading the effort to create a JPCoin, a US Dollar pegged stable coin, to facilitate payment solutions. While its top management is famously skeptical on cryptocurrencies, it is heavily investing in new solutions for payments based on one of Ethereum forks called Quantum. The bank has received support for building this solution from many companies, including Microsoft, who has integrated it into Azure.

Another big US bank, Wells Fargo, is also creating its own token, but with smaller ambitions – to address intrabank payments to/between its overseas branches.

IBM is an early adopter of Blockchain, and it comes as no surprise it is building many solutions on it. Among them is the payment platform World Wire, based on which IBM is creating fiat tokens and payment systems for RCBC (Philippines), Banco Bradesco (Brazil), Bank Busan (South Korea) and other banks using Stellar Blockchain.

Union Bank, another big bank in the Philippines, is also building its own stable token and the payment system. Emerging market banks are attracted to Blockchain to address the international money transfers and create affordable solution for this large segment.

Similarly, Brazilian bank Bantotal has created a platform, joined by over 60 Latin American Banks to facilitate remittances via Bitcoin. Ultimate security and public nature of the Bitcoins network are attractive in Latin America, plagued with distrust in government’s economic policies, unstable currencies, inflation and other problems.

SWIFT, the main network for international wire transfers, sees too well the disruption coming from the Blockchain technology. It tries to adopt quickly, and it has already integrated its GPI with Corba enterprise Blockchain.

FNality is a consortium of some of the biggest banks in the world, designing a Blockchain platform for wholesale banking payments. This will bring some fresh solution to payments and settlements in one of the biggest areas of the Financial Solution Industry.

Most of the solutions described above are built on Private Blockchains, but they are all careful to have future interoperability with the Public Blockchains, which is very promising.

Trade Financing

Second most frequently addressed use case we found was in Trade Financing. Banks and big technology solution providers across the globe have understood that Blockchain can take this business segment from analogue and paper operations to a digital era. Effects of this transformation will be enormous, similar to switching from mail to email. Here are just a few selected examples of systems being built.

Marco Polo is the earliest entrant into Blockchain space for trade and working capital finance. Based on the R3 enterprise Corba platform, built out by TradeIX and R3, it has dozens of members from the world’s leading financial institutions and their corporate clients. Its network is live since 2017, it has a number of technology solutions for trade financing products and is gaining usage traction across the globe.

Voltron Trade approaches another section of trade financing – Letter of Credit, used in more than 10% of export contracts globally. Similarly to Marco Polo, it was founded by a number of large international banks, and is built on R3’s Corba. Any exporter will be happy to jump on this digitization effort, since it takes away their main pain point – collecting tons of paper to get paid after a few weeks of waiting in the best case scenario.

Another Letter of Credit disruptor, WeTrade, is a system built on Hyperledger Fabric, and is supported by Deutsche Bank, UBS, HSBC and a number of other big banks from a dozen EU countries. The platform is live since summer of 2018 and is building up its customer base.

Since this article was first published, Chinese entities have announced dozens of projects in Blockchain usage for their banking and payment systems. Most advanced among them is the platform BCTrade2.0 by China Construction Bank, one of the largest Chinese commercial banks. It offers factoring and forfeiting services with cross-chain and inter-bank transactions. Since launch its trading volume surpassed $53 billion (as of October 2019). This platform is only a tip of the iceberg – all top banks in China have dozens of Blockchain projects in production or in development, and level of activity there is astonishing.

Other use cases

While payments and Trade Financing are the use cases with most activity, there is a number of other use cases where Financial Services Industry participants use Blockchain or address a newly developed market.

DTCC, US markets central depositary and clearing house handles trillions of dollars in transactions. It has seen the Blockchain as a powerful disruptor of its core business and has decided to own that disruption by building Blockchain based platform for clearance of the derivatives. It was among the early enthusiasts in the Blockchain space, and it’s projects are still in development, but given the responsibility it carries that’s to be expected. Once DTCC starts running live systems for clearance and settlement of securities, it is reasonable to believe the whole banking system will quickly move into that direction.

Custodian services for digital assets is a unique new business opportunity. Many players, old and new, are entering the space and are racing to become a custodian of choice for Financial Services Institutions and to create wallets that meet the needs of such customers. Fidelity Investments, Bank of America as well as KB Kookmin (the largest bank in South Korea) are among the known brands working in this direction, while BitGo and many other Blockchain startups are aiming to build up their brand with this lucrative market niche.

Most banks in the world avoid serving customers from the crypto space for variety of reasons: KYC/AML issues, regulatory risks, etc. However, a number of crypto businesses are creating significant cash flows – exchanges, for example. Serving this customer base requires specialized knowledge for the banks and some small players are seeing this as a great growth opportunity. Samples are pretty unknown names, like Quontic Bank, Signature or Silvergate. You might have never heard of them before, but if the segment sees some more of exponential growth like in 2017, some of them may yet become household names.

Central Banks

In dozens of countries including world’s biggest economies, Central Banks have actively researched Blockchain technology and its potential impact. While most have attempted to slow down the disruption of new financial instruments created by the Crypto world with regulatory limitations, they still understand the need for change and are working to create new financial markets. That work has so far been mostly academic both in scope and speed, it is very interesting as it gives some foresight into what awaits us.

First and most obvious use case Central Banks are interested in is issuance of a national cryptocurrency, either for everyday use by its citizens or for the wholesale banking market. Most of studies in this area have found that this use case can bring many benefits – new payment systems can be cheaper, faster and more secure then systems currently in place. They can help with attracting unbanked population and increase velocity of the economy. Interesting potential option is that with national cryptocurrency Central Banks can take direct deposits, which can be interesting approach to countries where trust in banks is low. Another motivator in creating a new payment network is political. Current global payment

systems are heavily reliant on US Dollars, and many countries would prefer an alternative that does not expose them to the US government. However, many risks will arise from national cryptocurrency adoption. Most research points to financial stability risks, as a very generic term that can describe many scenarios, but most importantly points to the novelty of such direction. Current financial system has been created through centuries of experience, and that experience has shown that a working system needs many institutions and a strong structure to insure consistent and stable growth of economy. Creating a new financial system quickly would be grounds for new bubbles and crises that would follow, so regulators prefer a very cautious approach. Regardless, promises of frictionless finance are many and Central Banks worldwide will continue to explore options to change the markets.

There is a number of other use cases that are researched and piloted by Central Banks. Clearing and settlement, bond issuance and management and trade financing are very promising and would create great value if implemented and are supported by efforts of the private sector, as discussed earlier. Less obvious, but very interesting use cases include:

1. KYC/AML systems, along with identity – many see cryptocurrencies as a tool for anonymous monetary transactions, but in reality they make it easier, faster and cheaper to control financial flows and prevent crime. Some Central banks have realized this and are working to take advantage and create better controls of the financial system they oversee.

2. Reports managed by Central banks are huge – they need to monitor health of all banks within their jurisdiction and Blockchain can make this process cheaper, faster and more secure, and help Central banks to manage risks much better.

3. One of the functions of the Central banks is to manage cash in the economy. Some Central banks have an idea to use Blockchain to improve that process and make it more secure.

Besides Central banks worldwide, global financial institutions like IMF or SWIFT have done in depth research on all these topics and more and continue to do so. Overall, even if the speed at which any of them bring ideas to use is slow, it certainly looks like both regulators and banks are aware of the disruptive nature of the Blockchain technology and prefer to lead the change rather than be disrupted.