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Blockchain

Blockchain technology: A chain reaction

The technology that underlies bitcoin is going mainstream in financial services. Well, not really – but there is growing engagement across the industry in the so-called blockchain technology space – also known as distributed ledger technology (DLT).

The reality is that while its adoption is still practically zero – there is a flurry of activity across the financial services industry – to understand it, experiment with it and figure out how it might be applied in specific market segments, use cases and problem areas.

Such coordinated change is not that common in financial services, and it might be especially challenging while it remains unclear who the winners and losers will be, where the money will be made, and how the industry will transition from the current to the DLT-enabled future state.

Some say there is nothing that special about what DLT offers that couldn’t otherwise be offered by some tweaks to existing database technology. That’s probably true in some cases, but what we are observing is that DLT is helping the industry galvanize around how they could address some quite pressing challenges.

One thing all seem to agree on is that DLT solves some very long and intractable challenges in the industry – challenges that have created a large overhead for the industry that it is no longer prepared to support – the collective desire to take out cost is the biggest driver for collaboration for the incumbents right now.

As a result it’s still too soon to determine where and how the technology will be deployed “at scale”: The industry is still learning, the technology is still being prepped for prime time and participants are still trying to figure out where the money will be saved, made and lost. Meanwhile, the industry and its supporting technology ecosystem are still experimenting with and building the enabling “fabric.” There remain many technical challenges and unknowns to be overcome in the next few years.

Ripe for change: DLT is a catalyst

The financial services industry is complex and multi- threaded as are the individual banks and asset managers, exchanges, custodians and others that make it up. Many of the inefficiencies in the industry concern how those organizations have come together (through industry consolidation spanning 30+ years) and also how the organizations interact with each other. DLT promises to significantly modernize many back-office processes – previously (and happily) subsidized by healthy profits generated in the front office.

The reality is that the systems and process running the retail and commercial banks, and the capital markets have hardly changed in decades: We still write paper checks (well, quite a few of us still do!); we still get money from cash machines to pay our bar bills; we still largely use plastic cards in leather wallets. Companies still have to go through a lengthy and expensive process to raise capital from investors – and trades still take days and sometimes weeks to settle.

Industry disruption: Is DLT a real threat?

One would think that the emergence of this new “wunder tech” could also enable outsiders to come in and disrupt the industry, causing the kind of mayhem that Craig Newmark (founder of Craigslist) created in the US newsprint industry – or more recently what Uber and Airbnb are doing for local taxi and hospitality industries, respectively. But all these industries are relatively less regulated, less interconnected and less global than the financial industry. Uber can take a market-by-market approach, seeding those markets with cash incentives funded by their near $15 billion in venture capital.

DLT isn’t really about enabling disruption. It’s regular technology evolution, just as javascript was for the Internet. What’s interesting is that while many new technologies offer the opportunity for cost savings (e.g., Internet distribution versus printed publishing), DLT may be the first where competing organizations have to collaborate in order to establish a critical mass that enables them to realize many of the potential rewards. In financial services we’ve seen some of that for equity research, e.g., TheMarkets.com, but never to the extent needed in these cases.

That’s not to say we won’t see new markets and mechanisms enabled by DLT, but it’s hard on balance to see a new entrant come in and take out a slice of the industry.

Why now?

Well, firstly the technology that underlies DLT is very clever, and thanks to bitcoin, quite well-tested in the real world. There is also a growing community of start-ups and developers that are becoming familiar with the underlying technology, as well as the various competing and collaborating DLT fabrics being developed.

Banks are hungry for transformation projects that will take out costs, and there is plenty of additional capital coming into the start-up space to help the banks stand up to the required environments.

Some of the larger technology firms such as Microsoft® and IBM® are pressing forward with blockchain-related initiatives, many of which are aimed at supporting the adoption of distributed ledger technologies across multiple industries.

How will this play out?

It’s hard to say how all of this will play out over the next 5-10 years, but what is clear is that the landscape will change, and there will be net winners and losers as a result. It seems clear that the focus for incumbents will be on leveraging the technology to drive out inefficiencies and lower industry costs. But in the longer term we believe and hope that DLT enables more than just the modernization of the industry.

We think the asset managers will join the party and potentially look to see enablement of peer- to-peer trading, eliminating the cost of trading through intermediaries, or to create markets in asset classes where liquidity is not provided by existing intermediaries. In this way DLT could be a source of market expansion, which could then lead to further challenges to the banks’ trading businesses.

Corporates might see some benefits – leveraging blockchain to manage their share registry, potentially even to allow new issuance or buybacks of shares. Smaller firms already leveraging crowdfunding platforms will want to use DLT to enable secondary trading – Nasdaq Linq has already launched a service that allows firms to issue shares in this way.

The FinTech space has been the most immediate beneficiary of the DLT movement, but even there it’s too early to declare any winners. Flush with money and lots of ideas, it’s not clear what the “revenue model” looks like from a technology largely built on open source, and that the banks and other incumbents will quickly close ranks to protect the status quo. Even DLT tech start-ups run by financial industry veterans will be challenged to overcome the regulatory challenges, hurdles and costs implied by such a move. Instead, start-ups are partnering with incumbents and picking off specific opportunities, low-hanging fruit, and helping to act as catalysts to change.

Big tech firms will focus on the provision of the infrastructure that will allow the various specialized DLT fabrics (the specialized implementations of DLT) to be hosted and to interoperate.

Firms that run the vast electronic funds transfer and settlements infrastructure could eventually be compromised …

But as with all industry transformation over time there will be relative winners and losers, and many of the losers still operate key elements of the value chains that crisscross the industry: Custodians and share registries that could see their functions rendered irrelevant; exchanges that could see what they do to lower the cost of fully electronic peer-to- peer networks. Firms that run the vast electronic funds transfer and settlements infrastructure could eventually be compromised – or find a new role in this brave new world.

What are we missing?

Making predictions so early in the cycle is a dangerous thing, and we must also always expect and plan for the unexpected.

This could take the form of a preemptive and enabling move by a large and influential outside party, not caught up in the complexities of being a player, but influential enough to change the game – some kind of government-backed initiative (look at the Singapore government’s Smart Nation initiative, or the adoption of a national identity scheme in Estonia). Or perhaps it’s a move by one of the big consumer technology firms (some already dabbling in consumer finance) to issue crypto shares as a loyalty bonus when a customer buys the latest version of their respective smartphone. The smartphone would obviously include a trading app that would allow users to cash in or trade these tokens. Now that would be interesting.

Thomson Reuters approach

Our approach is simple: To engage with our customers and support them in their efforts as they experiment and ultimately implement the technology. Our primary focus will be to do what we do well: the provision of market data to support the ongoing activities of our customers. This is shaping up in the following specific areas:

  1. Provision of a Market Data “Smart Oracle”4 for the purpose of experimentation and ultimately market data provision in blockchain-enabled markets.
  2. Launch of our proprietary blockchain identification and rights management wallet capability to aid organizations looking to experiment with Ethereum™ – Thomson Reuters BlockOne ID™. This is our first contribution towards supporting the broader blockchain community and intended to support experimentation and form the basis of Thomson Reuters proprietary blockchain technology.
  3. Engagement directly with customers, and through industry consortiums and bodies such as R3 and Hyperledger.
  4. Engagement with the broader community through partnerships and events such as hackathons to help to accelerate the development and adoption of the technology.

DApps

Developers creating decentralized applications (DApps) will quickly realize that, once published to the chain, smart contracts are accessible to all participants on that blockchain. While this may be acceptable for public services or developers promoting anonymity
as a feature, in the majority of business situations, owners need a mechanism to control third-party access. Situations would include where the developer wishes to offer feature differentiation, handle contract payments off-chain or where s/he is required to conform with licenses from suppliers such as Oracle. To assist the development community, Thomson Reuters created BlockOne ID, a free user entitlement layer – currently only available for Ethereum – that enables developers to control which visitors can access their smart contracts. When a DApp uses BlockOne ID, only logged-in users can use the DApp to make changes to the blockchain, preventing totally anonymous users from (ab)using the DApp.


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