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Blockchain: can it be of help for the agricultural industry?

| 03-11-2016 | Carlo de Meijer |

During my economics study in the seventieth of last century (indeed a long time ago!) one of the courses I followed was agricultural economics. Recently I met a Canadian (with Dutch roots) from the agricultural business and we were talking about the opportunities for using blockchain technology in this area. Up till now there has been very little talk of blockchain applications within core agricultural areas. But he told me that this is changing and that the agriculture industry is now increasingly exploring the potentials of using blockchain for the “agri sector”.

This triggered me to write this blog asking myself the question: how and where is the agriculture industry using blockchain and what is the potential for massive blockchain growth in the agricultural economy.

Agricultural business is a complex industry

The agricultural business nowadays is a huge, important, industrialised but very complex industry. The agricultural supply chain is an inefficient one, characterised by a large-scale non-transparent and non-communicating network consisting of many actors, processes, products and data. A big problem here is the great disconnection between supplier and retailer. The lack of transparency and disconnection makes it very difficult to track issues, tracing the origin of products and give a fair price for producers. And that while regulatory pressure, food crises and scandals (such as the mad cow disease (BSE) and cross contamination)) have increased the need for greater supply chain transparency and thus the need for data integration. These days, the public is increasingly embracing the need for transparency in food products and farming techniques.

Retailers want the best quality agricultural products, while also seeking to the lowest prices. On the other hand a growing number of consumers are demanding sustainable food products. They have less trust in existing agricultural products food, increasingly seeking information on authenticity and production practices. Consumers, especially within these niche markets, are increasingly willing to pay for products that provide this information.

“Consumer demand for “clean” food, including organic, is skyrocketing, but producers and manufacturers are often struggling to verify the accuracy of data from farm to table”.

Blockchain can help …

The agriculture industry is now looking for ways to alleviate the complex issues related to farming and distribution. They have a strong need for supply chain intelligence, especially for technology that supports traceability of critical products data through the supply chain across all of affected businesses. Currently, there’s however no easy, accurate and efficient way to identify the exact origin of an agricultural product.

Blockchain could here play an important role. While many of the existing technologies are inadequate or too costly to help, blockchain technology has all ingredients to become a real problem-solver. This technology records information in a distributed ledger in a way that is both secure and immutable. By being distributed among many users these ledgers are resilient with no single point of failure, and they can be (depending on design), transparent to all users. The blockchain technology thereby removes the need for formally identifying both parties to the transaction thus major cost savings can be achieved.

…. to solve existing problems

According to a report from AgriDigital using blockchain could solve many of the existing shortcomings/problems. The use of this technology could lead to improved product tracking and tracing origin of products, efficient supply chain management, fair pricing and decreased transaction fees, etc.

Efficient Supply Chains in Developed Economies

Possibly the highest potential for blockchain in agriculture is in the developed world, where it can be very helpful in monitoring the supply chain of food products. This technology seems to have the best potential to bring overall provenance and transparency throughout the food supply chain. The blockchain technology offers significant opportunities including increased transparency and data integrity, “with immutable provenance data from farm to table”, allowing a visible assurance of authenticity.

Product tracking

By providing both parties with access to information on similar transactions, as well as on the current stock price of goods, even suppliers in rural areas are able to determine what their harvest is currently worth and sell it to distributors at a price that reflects global market conditions.

Tracing origin

By establishing a blockchain-driven ecosystem for the registration, payment, and transport of crops or other agricultural products, retailers can also verify easily that the product they are receiving is exactly what they paid for (product origins).

“With every step of the transaction process recorded on the blockchain, if a supplier claims that its coffee beans are ethically sourced from Colombia, for example, this can easily be confirmed by tracing the journey from farmer to coffee shop, alleviating concerns about misrepresentation” AgriDigital report.

From a consumer point of view, using transparent distributed ledger could give consumers confidence about where their food comes from and how it was produced. With monitoring the consumer food chain they can have a better idea of the origin of the food, the date on which it was created and the efficiency with which it occurred, instead of relying on the existing systems that can be manipulated easily.

Fair pricing and decreased transaction fees

Blockchain can provide an easy solution for both buyers and suppliers seeking to negotiate a fair price for their product. Using Blockchain, commodity buyers are able to deal with their supplier directly and transfer payment via mobile. This may ensure that farmers receive fair payment for their produce and the retailer pays a fair price as that would save the retailer money in agents. Ultimately, this technology enables farmers, manufacturers, and retailers to justify premiums for certain products.

Minimising Human Error

Blockchain can also be used to minimise physical and financial losses in the agricultural sector caused by human errors. By adopting blockchain technology tasks can be taken from the workforce in many ways and automate them, minimising the amount of resource that is wasted or misused. Also, Blockchain can present information to farmers regarding diseased products throughout their supply chain: what types of crop are they; where were they grown? By drilling down into this data set, the farmer can then minimise future losses.

Use cases

There are nowadays various blockchain use cases that could be adopted by the agriculture industry, ranging from real-time management of supply chain transactions and financing, smart (farm) contracts, data monitoring to reduced human errors.

Management transparent transactions

Blockchain enables both small farm firms and agricultural concerns to be able to keep track of their transactions and contractual obligations with buyers, suppliers and other stakeholders in order to maintain accountability. Thanks to this technology the connection between commodity buyers and farmers can now be monitored more closely, and distribution channels streamlined yet further. This minimises fraud, maximises transparency, and ensures that each link in the supply chain is satisfied.

Efficient financing

But also financial transactions between farmers and buyers, that are nowadays hugely inefficient, could be improved thanks to blockchain technology. As it will enable real-time payment on delivery, this may improve the settlement process for farmers, buyers, and banks. As a result, farmers get paid immediately, industry competition increases and buyers save time and money. Also, adding transparency, trust, and efficiency to settlements can decrease risk and unlock new financing mechanisms for banks.

Smart farm contracts

Another use case is that of smart contracts in the agriculture industry. This especially relates to the provision of agricultural services linked to conditions and rules that could be specified in the blockchain, fulfilment of which is verified via the technology platform, such as pre sales of harvests or trigger compensation for the farmer based on confirmed weather data in real time. Sensors that automatically feed data into the blockchain in real time will provide the basis for smart contracts of this kind. The blockchain will not only be able to verify payments or record ownership properly. Rather it will automatically ensure that contracts are complied with, protecting the rights and obligations of contracting parties.

Data Monitoring

A fourth use case – and one of the most obvious one – is in data monitoring. It allows farmers to capture data in real-time. For instance, wireless sensors can be integrated into fields to monitor crop growth, harvesting, and subsequent yield, with all of the data recorded onto the blockchain. That will help them plan their areal more effectively and maximise the “success rate” of their harvests. Over time, this information would become an invaluable resource to the farmer.

Land registry

Another application of blockchain technology, especially for developing countries is to record land ownership in the country. In many countries in South America, but also Africa and South East Asia, a great majority of land is still unregistered. These countries often struggle with land tittle fraud, leaving the poor, who have most of their wealth in land, vulnerable. There is nowadays a growing number of countries in these regions that are thinking about using a permanent and secure land title record system based on blockchain technology.

Better Finance for the developing countries

Blockchain also has huge potential to create and improve access to finance in the developing world. For many of the farmers in these countries, affordable access to capital remains a huge challenge. Mobile banking creates novel financing opportunities such as micro-financing, but because of a lack of transparency and therefore high risk, the current paradigm is tons of small and costly transactions. Blockchain can — and already is — solving this problem for financiers and farmers. Examples include agri-ledger out of the UK, BitPesa in East Africa, and Rebit in the Philippines.

The concept of Smart Farms

The integration of all these various applications of blockchain technology in agriculture could lead to the concept of so-called smart farms. These are a form of sustainable agriculture that aims to enhance environmental quality, integrate technology with natural biological cycle controls and create economic viability within farm operations. Smart farming thereby involves the collection and distribution of large amounts of data related to different farming methods, weather conditions and animal health. Smart farming employs a lot of digital equipments and remote sensors, to collect the necessary information such as the information in advance so that timely measures can be taken regarding fertilisers, soil mapping, crop yields and machinery used. Smart farming also makes use of sensors for the early detection of animal health and upcoming reproduction events. This kind of livestock data is collected by monitoring the body movements of animals, their body temperature, pulse rate and tissue resistivity. GPS is also used for locating their positions.

Start-ups

Globally, there is a growing number of start-ups exploring the potential for blockchain in agriculture. Some of them already provide practical blockchain based solutions to various food items, to improve the traceability of food throughout supply chains and provide concrete proof of origin such as SkuChain. Other start-ups such as Filament provide blockchain solutions to create concepts like smart farms. Additional start-ups like Provenance and FarmShare are also researching and developing blockchain-based agricultural platforms.

SkuChain (supply chain)

SkuChain Technology is a distributed ledger blockchain-based system in the food industry that relies on its immutable nature to solve the problem of supply chain integrity. They focuses on the creation of direct relations, which simultaneously increases confidence and visibility of flow of goods. SkuChain is nowadays developing a system of improved (next generation) barcodes and RFID tags, with the aim to digitally secure the transfer of goods across the entire global supply chain and protecting end to end supply chains against counterfeiting. They therefor will provide cryptographic proof of each SKU’s origin and supply chain that can be verified all the way from the start to the point of consumption.

Filament (smart farms)

Another start up is Filament, a wireless sensor firm, that is developing sensors to monitor crop health and recording results in a blockchain. With Filament’s platform, users connect physical objects and existing networks into “wider networks and applications” – making smart farm technology into reliable infrastructure. By monitoring the food supply chain, consumers can get a better idea of where the food is coming from, the date it was created, and how it was produced more efficiently.

Provenance (tracking)

Others such as UK start-up Provenance are using blockchain to improve the traceability of food and provide concrete proof of origin. Provenance uses blockchain to keep a track of food supply chains and makes the information public, secure and all-inclusive. The ledger is used to document the supply chain of materials, ingredients, and products to provide consumers with greater transparency about their authenticity and origin. They provide buyers – in the format of a real-time data platform – with a fully transparent record allowing the end user to see each step of the journey the product has taken: where it is, who has it, and for how long.

Farmshare (community-supported agriculture)

FarmShare, another start-up, is developing an agricultural system that runs on the blockchain to evolve community-supported agriculture in developing economies. The project is an evolution of the CSA model, which takes advantage of the blockchain’s potential for creating new forms of community property ownership, collaborative labour relationships, and locally-oriented alternative economies. Farmshare has been networking with its local community and within the technology industry. Farmshare thereby uses blockchain technology to buy, sell and trade a local crypto currency (cryptographic tokens) that can be used/exchanged to purchase weekly deliveries of locally produced food from nearby farms within a natural community. FarmShare enable shares in harvested crops to be electronically distributed to members, creating self-sufficient local economies. This in turn generates greater involvement within the community, and ensures there are incentives for local agriculture to be run more effectively.

Real world examples

Tuna industry
Provenance is now experimenting with proving the supply chain of the tuna industry in Indonesia being delivered to Japanese restaurants. Mobile, blockchain technology and smart tagging were thereby used to track fish caught by Indonesian fishermen with verified social sustainability claims. They used information on sensors or RFID tags and local certification, recorded in the blockchain, to track the fish along its journey from “hook to fork”. Its ambition was to demonstrate a solution to the serious need for data interoperability: “for tracking items and claims securely, end-to-end, in a highly robust, yet accessible format without the need for a centralised data management system”. The pilot was successful in tracking responsibly-caught fish and key social claims down the chain to export. It was found that blockchain technology meet these needs and offer an “exciting paradigm shift” necessary for traceability in such vast complex supply chains as the South East Asia fishing industry.

Local grain industry

Start-up Full Profile is starting with an in-market blockchain pilot for the 2016-2017 grains harvest in Australia. Since the grain industry deregulated in 2008, growers have been increasingly exposed to payment risk — not receiving money for their crop once a shipment legally changes owners. Because blockchain records detailed information for every transaction along the value chain, this technology can take out a number of risks faced by growers and traders selling grain. Thanks to this increased transparency buyers and sellers both have access to the information, as well as information about similar transactions, so both parties have a fuller understanding of fair prices. For grain growers and traders, key features of blockchain, such as real-time payments and settlements, allow growers to get paid for their grain the instant they deliver loads of grain at harvest.

Agribusiness trade

The use of blockchain technology could also dramatically transform agriculture across Africa. WakChain is Africa’s first permissioned blockchain for the farmer and the continent’s agribusiness. Wakchain nowadays uses this technology to scale up the transformation brought about in Nigerian agriculture. Existing structural inefficiencies, poor market and transport linkages mean that the farmer is disincentivized from fully reaping the rewards. Blockchain could create the foundation for more seamless intra-African trade especially in the agribusiness value chain. The idea of Wakchain is that farmers and players in the African agribusiness value chain should be able to trade from anywhere in the continent, using blockchain technology and in a manner that maps the distributed nature of agricultural activities. Blockchain can help African farmers by enabling them transact, verify and enforce the provisions of their contracts better.

Future

Though we haven’t yet seen the large-scale commercial adoption of blockchain, and there are still many bottlenecks to remove, this technology has the ability to fundamentally transform the agriculture industry. Blockchain technology has big potential to solve significant problems in the food and agricultural industry. Farmers in the Western world have always been eager adopters of technologies that make sense and deliver real value. It will be interesting to see how lucrative blockchain can prove to be for the present day farming techniques. The challenge now for blockchain, and agricultural technologies in general, is connecting the technology to viable business models and compelling use cases. All the start-ups mentioned above are working hard to do just this.

Carlo de Meijer

Economist and researcher

Blockchain, near real-world projects and collaboration: viable approaches

| 25-10-2016 | Carlo de Meijer |

In one of my earlier blogs I wrote that we are beyond the hype of blockchain and distributed ledger technology. Support in the financial industry and beyond for this technology is accelerating in a rapid way. A lot of time and money is now invested into blockchain and its applications.

“Distributed ledger technology is set to move out of the test environment and into the wild next year, with nearly two thirds of banks expecting to be in production with full-scale, commercial blockchain projects by 2019”, according to recent research from IBM.

If so, that would mean much earlier than the 2020 to 2025 period that was earlier predicted for mass adoption of blockchain technology.

Collaborative near real-world examples

Financial institutions, technology companies as well as start-ups are increasingly collaborating on projects and pilots (or are planning to do so) to use distributed ledger/blockchain technology in trade finance, payments and securities. Next to existing platforms such as Ripple (payments), there is a growing number of collaborative initiatives including the Distributed Ledger Group (R3CEV) and the Hyper Ledger Project (Linux Foundation) (see earlier blogs). This could really accelerate the whole process towards mass adoption.

The first collaborative near real-world tangible use cases and practical applications of distributed ledgers in the financial industry are now being brought to the open. And more are expected soon. Here follows a number of interesting examples of actual projects, initiatives and trials. Main question is: will they be viable in the long run?

R3CEV

Credit Suisse (syndicated loans)

Led by Credit Suisse and the bank-backed blockchain consortium R3CEV, a group of seven member banks (BBVA, Danske Bank, Royal Bank of Scotland, Scotiabank, Société Générale, State Street, US Bank and Wells Fargo) and a number of buy-side firms have started a new initiative to apply distributed ledger technology to overhaul “antiquated” and costly manual intervention in the global syndicated loans market. Goal is that in the future, syndicated loan data processing can be done exclusively on the distributed ledger, eliminating the cost for each market participant to maintain its own separate lending system. The Swiss bank is working with Synaps Loans (a joint venture created earlier this year through a partnership between smart contract vendor Symbiont and loan settlement platform provider Ipreo), on a proof-of-concept (PoC) which will run through the end of this year. Through Synaps, loan investors have direct access to an authoritative system of records for syndicated loan data. By connecting a network of agent banks through blockchain, faster and more certain settlements in the syndicated loans market can be achieved. This allows immediate savings by reducing manual reviews, data re-entry and systems reconciliation.

R3CEV and eight member banks (treasury bond trading)

Working under the R3CEV flag, a group of eight member banks have successfully tested a distributed ledger prototype for bond transactions. Thereby they used an implementation of Intel’s proprietary distributed ledger platform, Sawtooth Lake, for the trial. The platform featured advanced smart contract functionality, enabling trading, matching and settlement of US treasury bonds on-chain, as well as automated coupon payments and redemption based on network time and third party data sources. The partners used physical, non-cloud-based nodes hosted across the US, Canada, Asia, Australia and Europe to interact and simulate US treasury trading on the ledger. In addition, the technology enabled an on-chain identity registry to facilitate the permissioning of validators and transactors, and the association of those roles to different organisations. Intel is now donating the bond-related transaction families developed for the trial to the Hyperledger Project.

R3CEV and 15 member banks (Letter of Credit)

R3CEV and 15 of its consortium member banks successfully completed a number of prototypes using distributed ledger technology for trade finance purposes. The involved member banks in the trials (including Barclays, BNP Paribas, Commonwealth Bank of Australia, Danske Bank, ING Bank, Intesa Sanpaolo, Natxis, Nordea, Scotiabank, UBS, UniCredit, US Bank and Wells Fargo), designed and used so-called smart contracts on R3CEV’s Corda distributed ledger platform to process accounts receivable (AR) purchase transactions, invoice financing or factoring, and letter of credit (LC) transactions. Estimates suggest that “such technology has the scope to reduce operational and compliance costs of paper-based trade financing by 10 to 15% and provide a platform for banks to grow revenues by as much as 15%”.

R3CEV and 40 member banks (Commercial Paper trading)

R3CEV and 40 member banks have successfully completed a number of cloud-based ledger experiments. The (then!) 40 member banks were connected to five different R3CEV managed private distributed ledger technologies. Objective was to test, compare and evaluate the strengths and weakness of different blockchain offerings on the market today. The banks thereby modelled a series of smart contracts that were programmed to manage Commercial Paper transactions including facilitate issuance, secondary trading and redemption of Commercial Paper. Each of the distributed ledgers thereby ran a smart contract based on identical business logic to enable the banks to accurately compare the difference in performance between them. These experiments followed a test in January to unite eleven global financial institutions on a private distributed ledger provided by Ethereum.

Barclays and R3CEV (smart contracts repository)

The R3CEV blockchain consortium is working with Barclays Bank, ISDA and legal and academic bodies to explore the development of a repository of master templates for smart contracts when trading and managing securities on distributed and shared ledgers. The new group, has been set up to address the challenges of developing master templates for smart contracts, with an initial focus on how they could be implemented within existing legal and regulatory frameworks. Earlier this year, Barclays Bank demonstrated a Smart Contract Templates prototype creating an ISDA agreement and an interest rate swap trade that then executed as a smart contract on R3CEV’s Corda platform.

Credit Suisse and others (reference data management)

Coordinated by Credit Suisse and working with R3CEV and capital markets tech startup Axoni, seven buy-side and sell-side firms (including Citi and HSBC) have completed a multi-months proof-of-concept (PoC) exercise, which aimed to simplify reference data processes through a distributed ledger prototype. The prototype was created using proprietary distributed ledger software of Axoni (a distributed fintech solutions company) to simulate the collaborative management of reference data, as well as the use of that data for corporate bond issuance. Participants could interact with reference data after issuance, with any proposed changes requiring validation by the underwriter to ensure the ledger provided a single, immutable record of all data related to the bond. The results show how blockchain technology could be used to allow regulators and network participants to view in real time which parties on the ledger have created, issued and proposed amendments to the data record. “This may remove the need to reconcile multiple copies of data and help reduce duplicate reference data costs and improve data latency which will ultimately lower costs and reduce operational risks”, according to Credit Suisse.

Hyperledger Project

UBS and IBM (trade finance)

Swiss bank UBS and IBM have designed a project that replicates the entire lifecycle of an international trade transaction on Hyperledger`s Fabric blockchain. The trade finance project that is still in its earliest stages and focuses on just a single aspect of the process, combines payment transactions, foreign exchange payments and more, into one single, elaborate smart contract. By programming that process into a smart contract on Hyperledger, UBS “expects to be able to cut the processing time down from seven days to one hour”. Besides the letter of credit process, the project also aims to incorporate the account opening process, to build a user-friendly interface “capable to operate on the go, from a transportation vehicle for example”. It remains unclear how long it will take to complete the international trade project, according to UBS.

CLS (payments netting service)

CLS, the multi-bank foreign exchange counterparty, is to build a payments netting service for trades settled outside the core membership thereby using distributed ledger technology based on the Hyperledger Fabric. CLS wants to use its position to standardise and expand bilateral payment netting capabilities for the entire FX market, eliminating intra-day liquidity demands caused by inefficient “bespoke” approaches to netting throughout the market. The company has signed up 14 banks as early adopters of the proposed service, which will accept FX instructions for six products, including non-deliverable forwards (NDFs), and 24 currencies over existing SWIFT-based channels. Participants will also have the option of connecting directly to the platform via a permissioned distributed ledger, administered by CLS using Hyperledger Fabric. CLS will be working with IBM to build new infrastructure. The new service will be delivered in a phased approach – subject to regulatory approval – beginning with a payment netting service for FX spot, forwards, NDFs, swaps, tomorrow/next day and same-day trades across the 18 currencies CLS currently settles, as well as the Chinese renminbi (offshore), Russian rouble, Polish zloty, Turkish lira, Thai baht and Czech koruna.

Bank of America Merrill Lynch/HSBC (Letter of Credit)

A bank consortium consisting of Bank of America Merrill Lynch, HSBC and the Infocomm Development Authority (IDA) of Singapore successfully applied distributed ledger technology to replace paper-based letters of credit (LCs) in trade finance transactions and streamline global trade. They thereby used the open source Hyperledger Project software for the prototype app, supported by IBM Research and IBM Global Business Services. By sharing information between exporters, importers and their respective banks on a private distributed ledger, this enabled them to execute a trade deal automatically through a series of digital smart contracts. The partners now plan to conduct further testing on the concept’s commercial application with selected partners such as corporates and shippers. Their challenge is to take this from concept to commercial use “making it quicker and easier for businesses to connect with new suppliers and customers at home and abroad.”

BTMU and IBM (contract management and trade finance)

The Bank of Tokyo-Mitsubishi UFJ (BTMU) and IBM are collaborating to use blockchain technologies for the design, management and execution of contracts among business partners. They thereby make use of the Hyperledger Project’s open-source platform to automate business transactions with each other on the IBM Cloud. Both partners have built a prototype of smart contracts on a blockchain that should improve the efficiency and accountability of service level agreements in multi-party business interactions. To help improve efficiency, the two will monitor delivery and usage of equipment with a sensor that embeds information into the blockchain. This will then automate invoicing and payment processes between the two companies. BTMU plans to begin using it to manage contracts within their business in fiscal year 2017.

JPX and IBM (post-trade settlement and proxy voting)

Officials of the Japan Exchange Group (JPX) and IBM Japan recently announced advanced plans to test the use of blockchain technology for post-trade settlement and proxy voting. The exchange will investigate how blockchain technology could be used to create new systems for the trading of low-liquidity assets. They thereby will use the framework provided by the Hyper Ledger Project. JPX is also working with Nomura Research Institute (NRI) and several major financial institutions (including SBI Securities, Mitsubishi UFJ Financial Group and blockchain specialist Currency Port) to test the use of blockchain technology for future applications across the securities industry. Until the end of June, the partners have examined various business scenarios and validation items involving distributed ledger technology and prepare prototype systems based on those scenarios.

Credit Mutuel Arkea (verify customer IDs)

Credit Mutuel Arkea has completed a pilot of an operational permissioned blockchain network to verify customer “bona fides” in compliance with Know Your Customer (KYC) requirements. Using the open-source Hyperledger Project fabric, the software “tapped into all valid existing evidence” already stored in the bank’s multiple systems of record such as from mortgage applications or life insurance enrolment and bank accounts opening. Following the success of the initial pilot, Credit Mutual Arkea plans to work with IBM to integrate the different silos of customer data across the bank to create a single ID data chain that can be used across all business processes.

Ripple

The Ripple network recently announced that seven banks including Santander, CIBC, UniCredit, UBS, ReiseBank, National Bank of Abu Dhabi and ATB Financial of Edmonton “had made a breakthrough by being among the first financial institutions in the world to move real money across borders using blockchain-based distributed ledger technology provided by Ripple”. Focus is thereby on international, low-value, high-volume and velocity payments (as these can often be expensive and not profitable for banks). The seven banks are all planning to deploy Ripple commercially, while most having already moved real money via the network.

In the meantime Ripple has signed up several major banks to a steering group on the use of distributed financial technology for global payments (including names like: Bank of America Merrill Lynch, Santander, UniCredit, Standard Chartered, Westpac, and Royal Bank of Canada). The creation of the Global Payments Steering Group (GPSG), is significant because this represents the first time that major banks have formulated policies to govern the transfer of money across borders using blockchain. The group will oversee the creation and maintenance of Ripple payment transaction rules, formalised standards for activity using Ripple, and other actions to support the implementation of Ripple payment capabilities. This Group might become a great competitor for SWIFT.

Standard Chartered (trade finance)

The first bank-developed blockchain platform for trade finance was the product of a partnership between Standard Chartered, the Development Bank of Singapore (DBS) and the Infocomm Development Authority of Singapore (IDA), the government’s IT and communications arm. They developed a blockchain-based invoice trading platform (code-named TradeSafe) that uses the distributed ledger technology developed by Ripple. Invoices and bills of ladings are allocated unique identifiers and stored on this distributed ledger. The use of unique identifiers enables users to view the status of a particular invoice/bill, but also reduces the risk of duplicate financing of the same invoice/bill. Further, to maintain confidentiality, users are allocated encrypted identities.

ATB Financial and Reisebank (international interbank payment)

SAP (the world’s third largest independent software manufacturer), partnered with Ripple and two banks, ATB Financial (Canada) and Reisebank (Germany), to demonstrate how banks can improve the efficiency of cross-border payments by using blockchain technology. For that SAP and Ripple designed and built a proof-of-concept (PoC) prototype based on this technology (thereby connecting SAP HANA Cloud, the open platform as a service (SaaS), and the SAP Payment Engine application, which centralizes payment processing in one solution with Ripple’s network of enterprise blockchain solutions).

This prototype was used to send the first international interbank blockchain payment of CAD $ 1,000 from ATB Financial to Reisebank. With parties representing different continents, this cross border payment transfer using blockchain technology was completed successfully. The payment which would normally have taken between two to six business days to process “was now completed in around 20 seconds, so nearly instantaneous”. In addition for being far quicker, this blockchain payment transaction cost a fraction of current transaction rates.

Japanese bank consortium (real-time settlement and domestic fund transfers)

A consortium of 15 Japanese banks are to work with blockchain joint venture SBI Ripple Asia, to build a new payments platform for 24 hours real-time settlement and domestic fund transfers, thereby using Ripple’s blockchain technology. This should firmly reduce the fees currently paid by banks for performing cross-border transactions and pave the way for the arrival of real-time domestic and cross-border payments. Initial participants include Bank of Yokohama and SBI Sumishin Net Bank (SBI Holdings owns part of it). It is expected that the size of the consortium will increase to 30 banks, and that the new service will go live in Spring 2017.

Santander (cross border payments)

Santander has become the first major UK bank (and the first bank in the world) to use Ripple for cross border payments. Starting in May Santander has begun piloting a Ripple-powered payments app built on the blockchain technology, that facilitates international payments. The app, currently being tested by bank staffers, connects to Apple Pay, and allows cross-border payments to be made between GBP 10 and GBP 10.000, around the clock and at any time of the day, using Touch ID. Funds appear in the recipient’s account the next working day. These transfers can be made from sterling to euros and US dollars (currently payments made in euros can be sent to 21 countries and US dollar payments to America only). The results of this trial will be used to assess whether to bring this technology to its customer base at a later date.

Foundational challenges

When it comes to blockchain, we may say that we are beyond the hype. The many experiments, proof of concepts and other real-world trials with blockchain technology are all evidence of that. And we will see many more of them this year and beyond. But quoting Terry Roche of Tabb Group in a recent blog the technology now needs to deliver real-world benefits.

“While blockchain’s promises remain bright, however, there are (still) numerous foundational challenges (process, technical, community, etc.) that the financial services industry needs to overcome to get a beneficial blockchain world.”

While all these projects ask a lot of investments, not all of them may prove to be viable in the end. The financial industry however has no endless funds available to explore endless options. In today’s constrained technology marketplace, there needs to be a defined and realizable gain associated with any project for firms to fund it. That is why the industry should prevent dead-end options and only focus on viable applications that have a long-term future and suits best in their business model!

Carlo de Meijer

Economist and researcher

Blockchain and Hyperledger Hackfest: from another planet

| 17-10-2016 | Carlo de Meijer |

Last week I was invited to attend a Hyperledger Hackfest at ABN AMRO in Amsterdam. This event organized by the Hyperledger Fab led by IBM took place in the rooms of the bank’s new Innovation Lab, an ultra-modern environment. Certainly the right place for such a happening. Technical specialists and architects from companies and organisations all over the world from China to Japan and the US as well as Europe were participating.

From another planet

For me as a ‘normal’ economist who thought to know a lot about blockchain and distributed ledger technology, trying to bridge the gap between this technology and the financial world, this was sometimes different (and difficult) stuff. Just as if I was on another planet. But for many of them the other way around may also be true. The present financial world is often a complex one for these technical people. To realise that this technology should fit in this financial world they also need to understand what is happening there in other to bridge their gap. That means we should learn from each other in order to get the best of both worlds.

Blockchain platform Iroha

I have learned a lot at this event. But for this blog I like to restrict myself to an interesting offering that is a real example of such a cross-disciplinary research approach: the Japanese blockchain platform Iroha. One of the speakers from the Japanese fintech Soramitsu, was just returning from the Geneva SIBOS event where he had announced the open sourcing and proposal of a blockchain network called Iroha to the Hyperledger Project (see my earlier blog about Hyperledger Project). Once the proposal is accepted by the Hyperledger Project and its members, Soramitsu will be able to collaborate with a wider range of partners and corporations in testing the network and finding easier methods in deploying blockchain networks to private companies.

What is Iroha?

Iroha, jointly sponsored by leading Japanese technology firms, including NTT DATA Corporation, is a distributed ledger technology and smart contract platform using Java-based smart contracts and a Byzantine Fault Tolerant consensus algorithm, called Sumeragi. This network is adapted from the Hyperledger Fabric architecture, with plans for greater interoperability in the future

Soramitsu intends to increase the availability of smart contract enabled networks to open opportunities for companies in using the blockchain technology. Iroha is expected to provide private businesses, financial institutions and organization with a simple blockchain architecture that is easy to understand, develop, and integrate. That will enable businesses of any size to implement its network with substantially lower costs, as well as run smart contract-based applications with improved security measures.

All of Soremitsu’s partnering institutions and research firms will support the development of Iroha, by running experiments on Iroha’s local currencies and the network’s overall efficiency.

Expected use cases for the Iroha blockchain network include: Payment and Settlement, Contract management, Securities clearing, Development of financial products such as Insurance, Supply Chain Management, Smart Grid, Trade finance, and Internet of Things (IoT), and efficient compliance with Know Your Customers (KYC) regulations.

Soramitsu collaborative approach

Soramitsu, started in February 2016, and a member of the Hyperledger Project, currently oversees various research projects and developments with Japan’s leading research institutions, technology and financial firms.

Weather derivatives

The company’s Iroha project can be implemented outside the realm of finance. Recently, Soramitsu began the development of derivative insurance contracts using blockchain technology, such as weather derivatives, together with the Japanese insurance company Sompo Japan Nipponkoa Holdings.

KYC

In addition, the company is working with Rakuten Securities to develop a Know Your Customer (KYC) using blockchain technology. They are now looking for global KYC partners.

Smart currencies

Soramitsu has also created a new joint research project with The University of Tokyo, The University of Aizu, and the Center for Global Communications (GLOCOM) of the International University of Japan to study the creation of local currencies running on blockchain and distributed ledger technology (Iroha network), so-called ‘smart currency”, and their effects on regional development. This project will focus on the area around Aizu, in Fukushima Prefecture, Japan.

Thereby the University of Tokyo and its Interfaculty Initiative in Information Studies, Professor Hideyuki Tanaka researched the effects of network economics and information technology (IT). The University of Aizu OpenAppLab and regional technology center looked into the relationships of local smart currencies to solve regional problems. Lastly, GLOCOM, who founded the Blockchain Economics Research Lab back in March 2016, focused its efforts on socio-economic systems and the impact of distributed ledger technology.

Blockchain and cross-disciplinary approach

What may we learn from this? Intensive collaboration between the financial and the technology world is a must. This in order to meet the needs of both worlds. The Hyperledger Project is already a platform where all these disciplines come together. Given its open-source approach this gives the best guarantee to make further progress. It is no up to the regulators to make that a reality!

Should SWIFT be afraid of blockchain technology?

Blockchain and the Hyperledger project: beyond the hype

| 27-09-2016 | Carlo de Meijer |

Who is not yet convinced of the potential of blockchain? Here is another example that shows blockchain is beyond the hype. Early September, the Hyperledger Project, a collaborative cross-industry effort to advance blockchain technology, announced that 17 new companies and organisations have joined, bringing the total number of members to more than 80. And expectations are that this number will see a further growth, to beyond 100 at the end of 2016.

Let’s have a look how this collaboration platform performed! But first, what is the Hyperledger Project, and what is their goal?

What is the Hyperledger Project?

As they describe themselves on their website:

“The Hyperledger project is an open source collaborative effort created to advance blockchain technology by addressing important features for a cross-industry open standard for distributed ledgers. It is a global collaboration including leaders in finance, banking, Internet of Things, supply chains, manufacturing and Technology. The Linux Foundation hosts Hyperledger Project as a Collaborative Project under the foundation”.

Goal
Main goal is to build an enterprise grade, open source distributed ledger framework and code base to drive blockchain innovation. This should enable organisations to build and run robust industry-specific applications, platforms and hardware systems to support their individual business transactions. All of these innovations will work with an open-source code and distributed ledger architecture.

Through the creation of a framework that integrates different components for different use cases, the consortium is seeking to bring cohesion to a number of independent blockchain efforts that are in the process of developing protocols and standards. The collaboration should help identify and address important features and currently missing requirements for a cross-industry open standard for distributed ledgers.

Codebases
The Hyperledger Project is made up of different codebases donated to the Linux Foundation, contributed by several of its members including IBM, Digital Asset Holdings, Blockstream, Ripple and others to further the Project goals. IBM alone donated 44.000 lines of codes. In total, there are now 160 code contributors (including individuals that may not be working on behalf of any company). It provides a vehicle for companies to collaborate on features.

Members
The Hyperledger Project has gained a lot of industry support in advancing blockchain technology. Since its formal launch in February this year, with original 30 founding members, this number jumped to 80 in a half year time.

New Hyperledger members thereby come from all over the world, including Europe, the US and Asia. They have joined a rapidly growing and diverse group across various industries, including finance, banking, trade finance, supply chain management, manufacturing, technology etc.

The Hyperledger Project has backing from many big corporates. Amongst its members there are a large number of established names from technology giants like IBM, Intel, Cisco, Accenture; to financials with names as JP Morgan, BNY Mellon, ANZ Bank, HSC, Wells Fargo; exchanges such as London Stock Exchange, Deutsche Borse, organisations like SWIFT, CLS, DTCC, Digital Asset Holdings, as well as the bank-backed blockchain consortium R3CEV.

Incentives
Why are they all joining the Hyperledger Project?
There are various motivations and reasons why companies are joining this Project. But in general, Hyperledger is seen by many as being “at the cutting edge of blockchain”. Major institutions are increasingly viewing the Hyperledger Project as a venue for further engagement. International collaboration cross-industry, organised effort plus local experience are thereby looked at as key to ensuring the scalability and the adoption of distributed ledger technology.

For them the Hyperledger Project is uniquely positioned to foster the collaborative approach needed in order to advancing the blockchain ecosystem and promoting blockchain’s extensive application to serve as the future credible infrastructure. They hope, by working with this growing community, to further Hyperledger’s vision and open blockchain development efforts. This by sharing ideas, experiences, expertise and knowledge in an effort to bring blockchain’s emerging technology to market

“A key factor of the project’s success will be member expertise and guidance” – Brian Behlendorf

Recent developments

The Hyperledger project has been rapidly moving forward since the start. Next to the announcement of a growing number of organisations joining their collaborative platform, we have seen a number of interesting developments surrounding the Hyperledger Project.

Election Technical Steering Committee
The governance structure has been further strengthened. The Hyperledger Project recently elected a new Technical Steering Committee (TSC) consisting of 11 members. The members include representatives from names like R3CEV (the other blockchain consortium), Digital Asset Holdings, IBM, London Stock Exchange, and DTTC. The composition of this TSC reflects the importance of these players in the Hyperledger Project, from both a technology as well as a business point of view.

Hyperledger Project and SIBOS Innotribe
Hyperledger Project announced it will sponsor the Innotribe Networking event at Sibos 2016, on Wednesday, September 28. The conference will be held on September 26-29 at PALEXPO in Geneva. As the world’s premier event for financial services, Hyperledger Project is looking forward to discussing open source distributed ledger technology and its potential to transform the industry with leading companies and experts.

Trade Finance Proof of Concept
The Hyperledger Project as well as the bank-backed blockchain consortium R3CEV announced initiatives to develop blockchain prototypes for trade finance innovation on the same day. Both initiatives were exploring how distributed ledger technology could streamline the existing old-fashioned, paper-based and expensive world of trade finance, using letters of credit. They thereby tried to tackle trade financing challenges via this technology.

Hyperledger Project trade finance proof of concept
The Hyperledger Project trade finance proof of concept comprised HSBC, Bank of America Merrill Lynch and IDA (Singapore). Aim of the various parties was to use a blockchain prototype to streamline global trade. The application mirrors a paper-intensive letter of credit (LC), whereby participants could execute a trade deal automatically through a series of digital smart contracts. They thereby used the open source Hyperledger Project blockchain fabric, thereby supported by IBM Research and IBM Global Business Services.

R3CEV blockchain trade finance initiative
R3CEV and 15 of its blockchain consortium members have “successfully” completed two prototypes using distributed ledger technology for smart contracts. The banks designed and used so-called smart contracts on R3’s Corda distributed ledger platform to process accounts receivable (AR) purchase transactions, invoice financing or factoring, and Letter of Credit (LC) transactions.

The involved member banks in the trials include: Barclays, BNP Paribas, Commonwealth Bank of Australia, Danske Bank, ING Bank, Intesa Sanpaolo, Natxis, Nordea, Scotiabank, UBS, UniCredit, US Bank and Wells Fargo.

Competition or collaboration?
HSBC, involved in the Hyperledger Project trade finance PoC, but also member of the bank consortium R3CEV, asked if there was no duplication, and if so, expressed the view that “we will all have to come together, because this has to be industry-led”.

According to HSBC “… now we need to get the technical teams together to understand the pros and cons, because part of what we have learned is also the technical limitations of distributed ledgers, in terms of the number of nodes you can have or the quantity of data you can have on it. So now may be the time to share those and see how we can put our heads together to take this to next level.”

“R3 is a member of the Hyperledger initiative and as such we will continue to explore ways to utilise the code being developed by its open source community in the real-world products we are developing with our consortium members”, said HSBC.

Hyperledger hackaton Amsterdam
ABN Amro, IBM, Holland FinTech and Linux Foundation are to run the first-ever Hyperledger hackaton, inviting coders to develop new financial applications capable of running on distributed ledgers. This one-and-a-half day hackaton will take place on 11-12 October in Amsterdam and is open to developers, tech students and fintech companies that are experimenting with blockchain technologies.

Hyperledger Project to address academic lecture ISITC
Leading members of the Hyperledger blockchain Project will address the European branch of ISITC, the International Securities Association for Institutional Trade Communication. The academic lecture to be held at the London Metropolitan University is intended to give the members an idea of what differentiates the Hyperledger Project from other blockchain projects.

This event that will be held in London is the latest effort by ISITC’s newly formed Blockchain DLT Working Group to lay the foundation for a global effort to standardize distributed ledger technology. The DLT Working Group that emerged earlier this year was invited to create a list of 10 blockchain standards for future development. It has changed its task slightly to focus on a cross-industry framework from which a modified list of benchmarks might eventually emerge. The Working Group prioritised working with other standards bodies and consortia like the Hyperledger Project to minimise overlap.

Hyperledger Project “ Blockchain Explorer “
As more companies like Bank of America and HSBC begin to unveil proofs-of-concept (PoC) using the Hyperledger protocol, a more standardised way to search its data is just part of what it will take to scale. Even beyond building out standards, creating common codes may allow organisations to focus on creating industry-specific blockchain applications.

The Hyperledger Project is now building an open-source tool that will let anyone explore the distributed ledger projects being created by its members. Instead of overlapping efforts and of launching competing open source services, unified effort emerged the blockchain explorers being developed by the likes as IBM, Intel and DTCC. The joint project has been named the “Hyperledger Explorer”. Creating common code will allow organizations to focus on creating industry-specific applications that enhance the value of this technology.

This tool would make it easier to learn about Hyperledger from the inside, while still protecting the privacy. When completed, the Hyperledger Explorer is expected to give Hyperledger developers and non-technical users access to block information, transaction data, network information (such as a list of nodes) and chain codes or transaction families. The Board and the recently newly formed Technical Steering Group will be working on these code proposals in the coming period.

Standardisation

The Hyperledger Project thinks it is still too early to strive for a technical standard for a general purpose inter-chain communication protocol (or even data format). Instead, they would like to encourage the different ongoing proposals to converge towards common architectures and or/even common tech stacks or set of reusable modules. This could serve as the starting point for the development of standard APIs, enabling the inter-chain communication and thus start the discussion around the technical realisation of such a protocol. Parts of this common code could also be reused by other projects, thus contributing to a standardisation of the blockchain technology overtime.

Carlo de Meijer

Economist and researcher

Blockchain, financial regulatory reporting and challenges

| 20-09-2016 | Carlo de Meijer |

It is always challenging to look for new topics worth mentioning related to blockchain or distributed ledger technology. One issue that needs special attention is financial regulation reporting under blockchain. In June, the European Securities and Markets Authority (ESMA) published a consultation (or discussion) paper “The Distributed Ledger Technology Applied to Securities Markets”, about the relevance of using distributed ledger technology (DLT) for the securities markets (see my blog “ESMA and Blockchain: Governance, how to deal with ,…”, June 27).

They thereby raised various questions regarding regulatory reporting activities using this technology. ESMA asked how blockchain would fit within EMIR and reporting. In the meantime, Deloitte, one of the “Big Four” professional networks in the world, developed a pilot solution for the management of regulatory reporting in a blockchain environment. This looks very promising.

The reporting challenge

One of the main challenges of financial institutions is complying with existing reporting regulations: EMIR in the EU and Dodd Frank in the US. This puts a heavy load on the industry and consumes substantial resources. The reporting infrastructure currently in place is rather complex due to the myriad of regulatory obligations on securities market participants. These requirements are process intensive and are increasingly needing additional innovative technology infrastructures.

EMIR

Under the European Markets Infrastructure Regulation (EMIR), all counterparties involved in trade transactions must ensure that the details of any derivative contract – OTC or exchange traded – are reported to a trade repository no later than the working day following the contract. And that is rather complicated. The main challenges faced by financial institutions reporting their transactions are related to data quality, cost of reporting, timing issues and more importantly, data reconciliation. Regulators are pushing trade repositories to improve the EMIR report data that they collect from reporting firms.

New regulations like MiFIR (Markets in Financial Instruments Regulation) and SFTR (Securities Financing Transactions Regulation), are planned to be enforced in the coming years. These will dramatically increase the scope and the volume of transactions to be reported by financial institutions to the competent authorities on a daily basis. This is the challenge Deloitte is trying to address through its DLT solution, which aims to support current and future regulatory challenges when it comes to OTC transaction reporting.

Dodd Frank

But also on the other side of the Ocean, the derivatives industry is still grappling with the post-trade requirements imposed by the Dodd-Frank Act including swap data reporting. Major banks are struggling to get ongoing regulatory feedback if they are reporting correctly. The Dodd-Frank Act requires all swaps (whether cleared or un-cleared) to be reported to swap data repositories (SDRs). However each of the four registered SDRs, has different system architecture and regulating technology.

Non-consistent regulation

Financial institutions have to report enormous “quantities” of data to different regulators. This creates a lot of headache, as reporting is not necessarily consistent between US and EU regulators. Often times, these reports may have a similar purpose (i.e. identifying customers and counterparties, risk exposures, details of trades) but could have different methodologies behind the calculations. Some of the reports may have different formats or definitions, which can occasionally lead to regulatory arbitrage, fragmentation, and often to confusion.

Distributed ledgers and regulatory reporting: the benefits

Distributed ledger technology has the ability to take away a number of pain points for both financial institutions and regulators. This technology offers various new opportunities when it comes to trade, post trade and related regulatory reporting.

– The distributed ledger would represent a golden source or “single source of truth” on all financial institutions’ reporting.

– With a distributed ledger, the transaction data will be readily available to the trade repositories and regulators in a unified form and there will no longer be any need for time-consuming reconciliation.

– And thanks to smart contracts the quality and transparency of reported transaction data may further increase and the reporting costs substantially reduced.

Financial institutions

Meeting regulatory reporting requirements would be less of a problem for financial institutions. As the distributed ledger would act as both execution platform and as place to store the record of transactions, it would certainly improve, simplify and add efficiency to regulatory reporting.

As all the information would be on the distributed ledger, organisations could make their regulatory reporting obligations in a more efficient way:

– facilitating the collection, consolidation and sharing of data for reporting, risk management and supervisory purposes,

– while enlarging the scope of information available from a single source

As a result, regulatory reporting could be done automatically and in near real-time.

Regulators

Distributed ledgers could also make access for regulators to this information easier and faster. As all such transactions data and information are directly and electronically available on the distributed ledger, regulators can easily access detailed movements of assets. They could keep track of transactions and positions directly on the ledger. As a result less time-consuming regulatory reporting will be needed

Improvements in regulatory reporting

Blockchain technology could contribute to many improvements in regulatory reporting. This especially is true for reporting reconciliation and validation, while it could lead to unified protocols (in the longer term!)..

Reporting reconciliation

Through blockchain more shared data of reports may be used. As a result so-called unique trade identifiers used by counterparties to a transaction, that don’t have a matching counterpart can be more easily identified and fixed. This would replace the current costly and time-consuming system where each independent trade repository sends submitted reports to each other for reconciliation.

Validation

One of the most basic efficiencies to be gained by using distributed ledgers could be in the area of reporting swap transactions. Validating reports is currently a big issue especially in the US under Dodd-Frank’s derivative reporting. Blockchain could create “a window of transparency” into selected classes of swap positions and exposure. By building a blockchain where participants share validation information that they use to analyse reports, it would be able to more properly identify faulty reports across submitting firms.

Unified protocols

Nowadays many individual trade repositories are used, with multiple variations of message type names. As such, even though the EMIR framework requires certain data fields per trade report, the names and explanations of them can be different based on the trade repository collecting the information. By creating a shared report submission platform using blockchain technology, to be used by participants to input market data and benchmark information, that could force participants to adopt industry-wide definitions for naming and definitions of trade fields.

Multi-jurisdiction

Existing laws protecting data privacy of individuals or corporates restrict data storage beyond national borders. Adopting unified trade protocols, would enable to enlarge an EMIR transaction reporting platform based on blockchain to other regulations. Reports that for instance require ‘mark to market’ valuation, could then use the pricing data information to create their reports across multiple regulation types. Also, trades that are cross-border and need to be reported to multiple regulations could be submitted once and sent for each regulation.

Deloitte Proof of Concept

Deloitte Luxembourg has developed a proof of concept for regulatory transaction reporting in a distributed ledger technology environment. This delivers a far more efficient and lean processing of regulatory reporting using proofs of process and tokenized transaction reports, compared to the present situation.

In this innovative process of transaction reporting, counterparties of the transaction will seal and report their deal using a smart contract, whose terms include all the aspects needed for the transaction reporting. Through smart contracts, transaction reporting becomes even more transparent, reliable, fast and immutable. The regulators will be able to control and monitor the transaction data and their daily updates, which are stored in the distributed ledger. This Deloitte proof of concept will certainly be of great help in assessing the various issues on regulatory reporting raised by ESMA.

The way forward

Notwithstanding the various opportunities’ to be gained from distributed ledger technology for financial regulatory reporting, there are still a number of hurdles and bottlenecks to overcome. Given that this technology is being developed without much (non-consistent) regulatory oversight, it is still unclear how adoption of the distributed ledgers will handle international transactions and data flows.

Some regulatory bodies (such as FCA in the UK) have tacitly encouraged and embraced blockchain technology to help facilitate regulatory reporting. However, issues around a lack of standardisation and the ability of(a number of) legacy technology systems to handle blockchain will need to be solved before distributed ledger technologies can be properly adopted en masse.

Also setting up a distributed ledger for reporting purposes under Dodd-Frank may prove to be problematic. One of the key mandates of Dodd-Frank is the creation of and reporting of all swap transactions to central databases. Any development of a ledger for reporting purposes must comply with this key statutory fact. Distributed ledgers however are decentralised!

Carlo de Meijer

Economist and researcher

Blockchain: Playing in the sandbox

| 13-09-2016 | Carlo de Meijer |

A new – but important – chapter can be added to the blockchain story. The World Federation of Exchanges , the WFE, recently urgently called for the creation of regulatory sandboxes for distributed ledger technology. This should help industry efforts “to explore and understand the impact of blockchain-based services in the capital markets”. The Federation added that regulatory bodies should collaborate with the industry on new developments to minimise unintended consequences.

Regulators enter the stage

This is a very important signal to the regulators that they should take this technology serious and needed to enter the blockchain stage in order the give regulatory clarity. Innovations like blockchain should be primaly industry driven, and “not be unnecessarily impeded by regulatory intervention”, said the WFE. (see also my Blog: “Blockchain and regulation: do not stifle ….”, published 4 April).
Collaboration with the industry will allow regulators to understand the technology, how the future infrastructure will look like and what the impact will be on the financial markets. But above all how they could most effectively perform their regulatory tasks. With the insight and knowledge obtained, regulators will be better placed on the changes necessary to evolve the regulatory environment to not only better regulate these businesses, but also continue to ensure that the legislation does not frustrate this innovation.

Regulatory sandboxes

Regulatory sandboxes have proven to be a useful tool for the wider fintech industry in various jurisdictions. “Promising innovations may be stifled and opportunities missed as firms may be unclear on whether a new product or service complies with legal and regulatory requirements, and consequently may choose not to pursue their new product or service further”.

That is where the ‘regulatory sandbox’ comes in. They have been formed to provide a safe environment for businesses to test their innovative products. These sandbox allow firms to experiment with fintech while providing the appropriate safeguards to contain the consequences of failure for the customers.

New entrants to the financial services market, can use the sandbox to test products, services, business models and delivery without first needing to meet all of the normal regulatory requirements and incurring the considerable costs of putting in place the complex structures and processes to successfully apply for regulatory authorisation.

This should allow appropriate collaboration and exchange of information between industry and regulators.

Regulatory sandboxes: an overview

Since this year these regulatory sandboxes have been extended to distributed ledger technology in a number of countries including UK, Hong Kong, Singapore, Australia and Abu Dhabi. And now also other regulators are thinking about introducing such a testing environment.

Regulatory Sandbox Open for Play in the UK

The UK regulator FCA launched a regulatory sandbox early May this year. This is a next step for the FCA, the Financial Conduct Authority as part of Project Innovate, which aims to boost competition and growth in financial services. Goal is to help banks and other financial service providers reduce the time it takes to bring innovative ideas to the market.

The FCA’s sandbox will allow business to test disruptive technologies including distributed ledgers in a live environment “without immediately incurring all of the normal regulatory consequences”. The FCA however said that consumer protection will be a significant focus, and will be considering appropriate consumer safeguards.

Application

Fin-techs could apply to the UK’s regulatory sandbox from 9 May till 8 July. The second ‘cohort’ will have an application deadline of mid-January 2017.this year

The FCA uses an inclusive approach to defining potential users. That means anyone from a start-up to a multinational can benefit from the sandbox. For authorised users and suppliers, the FCA has identified three key tools to businesses on a case-by-case basis (individual guidance; waivers; and, no enforcement letters). Unauthorised business will use the sandbox predominantly to facilitate testing without the need for full authorisation from the FCA.

Accessing the FCA sandbox is however not straightforward. A firm must meet a number of key eligibility criteria including: be in an in-scope business; demonstrate a genuine innovation; deliver a consumer benefit; demonstrate a need for the sandbox; and, be ready for testing. It should also be noted that the sandbox will not be available for activities which fall outside of the Financial Services and Markets Act 2000. For example, payment service providers and e-money issuers already potentially benefit from the lighter touch regimes in the PSRs and the Electronic Money Regulations.

Hong Kong Monetary Authority (HKMA) plans to create a regulatory sandbox

HKMA last week announced plans to create a regulatory sandbox, where start-ups and banks can test solutions and express their ideas before applying for authorisation. The sandbox allows banks to conduct tastings and trials of newly developed technology such as blockchain on a pilot basis. Within the sandbox, banks can try out their new fintech products without the need to achieve full compliance with the HKMA’s usual supervisory requirements.
In a related initiative, the HKMA has set up a ‘fintech facilitation office’ with its own dedicated e-mail account to act as a platform for the exchange of ideas between the regulatory body and banks and tech firms. Industry players, such as banks, payment service providers, fintech start-ups, the HKMA, etc. can get together at this facility to brainstorm innovative ideas, try out and evaluate new fintech solutions, conduct proof-of-concept trials, and gain an early understanding of the general applicability of creative solutions for banking and payment services.

ASIC released consultation paper on regulatory sandbox

Also Australia plans a regulatory sandbox for fin-techs technology innovations including blockchain. The Australian Securities and Investments Commission (ASIC) released a consultation paper on this issue, detailing proposals for a testing ground for innovative robo-advice providers and other similar services. It also highlighted ASIC’s views about some regulatory options already open to fin-techs under the current law.

The sandbox will allow new entrants to test a service for up to 100 retail clients for up to 6 months without holding an AFSL. The service can only relate to advice and “arranging” for dealing, catering primarily to robo-advisers. Product issuers such as payment facility providers and marketplace lenders are excluded, as is advice about general and life insurance. Start-ups will not need to apply to ASIC to be admitted to the sandbox (unlike comparable sandbox arrangements in other jurisdictions), but may need to be vetted by a “sponsor”, such as a hub, co-working space or venture capital firm.

A final regulatory position is expected by December.

MAS proposes regulatory sandbox for fintech

Early June, the Monetary Authority of Singapore (MAS) released a consultation paper detailing guidelines for a ‘regulatory sandbox’. With this sandbox approach the MAS hopes to encourage and help firms experiment with innovative solutions to support their development, and bring fintech solutions to the mainstream.

Any interested firm can adopt a sandbox to experiment within a well-defined space and duration; the MAS will provide the appropriate regulatory support and will relax certain legal and regulatory requirements. This sandbox will however have to meet certain evaluation criteria (technologically innovative; benefit consumers and address a significant problem or issue; intention and ability to deploy the solution in Singapore on a larger scale; report to the MAS on the test progress; major foreseeable risks have to be assessed and mitigated; etc.).

In April, the country expressed its desire to become the leading hub in Asia for blockchain-technology and fin-tech start-ups. MAS aims to provide a responsive and forward-looking regulatory approach that will enable promising fin-tech solutions to develop and flourish. The sandbox will help reduce regulatory friction and provide a safer environment for fin-tech experiments.

Abu Dhabi FSRA seek blockchain start-ups for fintech sandbox

The Financial Services Regulatory Authority (FSRA), the independent regulatory authority of Abu Dhabi’s newest financial free zone, has released a consultation paper in which it detailed its plans to create a sandbox environment for fin-tech under which start-ups would be allowed to work under a flexible regulatory framework for up to two years. The FSRA is seeking to promote the development of blockchain start-ups as part of a drive to create new efficiencies in the regional financial sector.

The FSRA’s proposal would seek to limit start-ups accepted into the program to those that “promote significant growth, efficiency or competition in the financial sector”. To give some clarity where they are focusing on the paper goes on to cite examples of technologies that fit this description.

“The advent of robo-advisers that offer lower costs, simplicity and real-time portfolio analytics and monitoring; or leveraging on the application of blockchain technology and distributed databases to facilitate price discovery, smart contracts, settlement of financial transactions, etc that may lead to safer [and] better products, and higher productivity and growth.”

Benefits for startups

The benefits of these regulatory sandbox are manifold. Both start-ups, the whole industry and regulators may profit.

There ought to be clear benefits :

First of all from a time and cost point of view.

Most immediately, the ability of businesses to safely test their products and also be engaged in direct dialogue with the regulator without first having to expend time and money on a speculative application for regulatory authorisation should relieve start-ups of high costs they often cannot afford.

From a compliance point if view

At the same time, the businesses can adapt their offerings to better ensure regulatory compliance.

From an investor point of view

Once through the process, and assuming the road-testing has produced a successful outcome for the business, the task of attracting investors should be simpler as a major unknown will have been removed.

From a financial industry point of view

The regulatory sandbox may help to foster innovation in financial services and that is good for the whole industry and their customers.

From a regulatory point of view

With the insight and knowledge obtained from that role, the regulator will be better placed to assess the changes necessary to evolve the regulatory environment to not only better regulate these businesses, but also continue to ensure that the legislation does not frustrate the competition that the FCA wishes to promote.

Global regulatory collaboration

Given its global reach, the level of complexity and the interconnectedness of financial markets, and the level of complexity and the interconnectedness of financial markets, regulatory bodies worldwide should collaborate to ensure that no different regulatory environments are created and regulatory arbitrage is excluded. National and foreign regulators must coordinate to create a common principles-based approach for blockchain oversight A special role should be given to bodies like the IOSCO and the G-20 Financial Stability Board.

Carlo de Meijer

Economist and researcher

Blockchain: Some remarkable announcements part II

| 05-09-2016 | Carlo de Meijer |

While Blockchain is seen by many as a network phenomenon that needs large market participation, collaboration and interoperability to succeed, both R3CEV and a group of four large global banks came with announcements that are at least a bit remarkable. The bank-backed consortium had filed for a patent of Corda (which is contradictory to the need for open standards and protocols), and at the same time a small group of R3 consortium members have expressed their wish to create their own digital currency (while large collaboration is needed).

Utility Settlement Coin

A second remarkable announcement was that of a number of large global banks to create their own digital currency. This plan could be seen as another example of going alone, or at least with just a limited number of players, while large scale collaboration is required for more massive adoption of this technology.

Separately, a group of four R3 consortium members, including BNY Mellon, Deutsche Bank, Icap and Santander have joined with UBS and Clearmatics to a blockchain based transaction settlement project called the Utility Settlement Coin (USC), and plan tests in a real-world environment.

What is USC?

USC is an asset backed digital cash instrument implemented on distributed ledger technology. The USC is focused on facilitating a new model for digital central bank cash. (By the way, there are several digital cash models being explored). USC is aimed at facilitating payments and settlement for use within global institutional financial markets. Using this technology could contribute to more efficient transactions in terms of speed and lower costs.

USC is aimed as a service of cash assets, with a version for each of the major currencies and USC is convertible at par with a bank deposit in the correspondent currency. USC is fulltime backed by current assets held at a central bank. Sending a USC will be sending its paired real world currency.

Going forward

The group will collectively build of on earlier experiments by UBS and blockchain software company Clearmatics. They launched the concept in September 2015 to validate the potential benefits of USC for capital efficiency, settlement and systemic risk reduction and as a forerunner for central bank backed digital cash issuance. The virtual coin will act as a proxy for physical currency assets held in deposit at the central bank.

“The focus of the work will consist of financial structuring of the USC and wider market structure implications, as well as market integration points for a fully operational utility settlement coin for future use by institutions” according to the group.

The USC concept will be developed through a series of short repetitive phases and platform developments. At each stage the aim is to increase the number of market participants, broadening engagement, connectivity and network effects. That virtual currency, USC, should go live in 2018.

Active dialogue

Active dialogue with central banks and regulators will continue to ensure a regulation compliant, robust and efficient structure within which the USC can be deployed. Recent discussion of digital currencies by central banks and regulators has confirmed their potential significance.

Read more remarkable Blockchain announcements in the first part of this article.

Carlo de Meijer

Economist and researcher

Blockchain: Some remarkable announcements part I

| 29-08-2016 | Carlo de Meijer |

R3 and Corda patent

R3CEV, the bank-backed consortium this week announced that it had filed for a patent of Corda, the distributed ledger software that underlies its new project ‘Concord’.

Some critics have argued that blockchain-based solutions should not have patents attached. That could not only hinder innovation in the field of distributed ledgers technology over the coming years. But it could also stand in the way of a more massive adoption of this technology.

R3, however sees it different and says that “although Concord will resemble other platforms working on blockchain technology the underlying software Corda has/offers enough unique features to justify a patent”. “Corda is just one element of the wider Condor platform”.

Corda White Paper

In the meantime R3 also released its first Whitepaper on Corda. It gives an introductory, non-technical overview that explain its vision, some design choices and outlines the key concepts underpinning the Condor platform.

The Corda project that was announced in April this year, aims to create the software that would be central to its wider blockchain-inspired shared ledger development project, called Condor.

In this Whitepaper it is explained how R3 set themselves the challenge of starting with the various pain points in the financial industry’s: duplicated, inconsistent data and business logic and redundant business processes – and asked themselves “if they could apply breakthroughs in distributed ledger and blockchain technology to solve them”.

Corda is in fact the outcome of the analysis R3 and the participating banks made on how to achieve as many of the benefits of distributed ledger and blockchain technology as possible “but in a way that is sympathic to and addresses the needs of regulated financial institutions”.

What is Concord?

Concord is aimed to become a distributed ledger platform that has been in development for over a year now. Thereby various challenges are assessed such as governance, internal record keeping and regulatory reporting across the financial services marketplace.

R3 describes Concord as a ‘shared-services model’ that still maintains privacy for banks. Concord aims to become a universal software platform connecting bank operations, allowing companies to run high-scale financial applications on permissioned networks across organisations and internally.

This platform that will be designed to record and manage important, financial agreements (read: smart contracts) between regulated financial institutions, aims to digitalise so-called back and mid-office functions, including trade clearing and settling securities trades, asset registry, reconciliation, and even the recording of cash balances.

By moving these middle and back office functions to a secure cloud-based ledger, R3 en its members hope that Concord will significantly streamline present cumbersome operations, and lower the costs of maintain them. By doing that huge cost savings could be realised (billions of dollars).

Traject

A version of Concord is expected to be launched in the next several months. A small number of member banks will begin testing the system early 2017, with an so-called “alpha” version planned to appear by the middle of next year. “We need to make this real to business users in 2017”, according to R3.

It however will be up to consortium members to decide whether to use it or not. Current bank members of the consortium haven’t (yet) committed to using the new Concord platform and aren’t bound to use it. Nevertheless they have invested money and resources helping build it and also have input into Concord’s specifications.

Concord versus Ethereum

Concord resembles Ethereum, another distributed ledger platform, in a number of ways. Just like Ethereum Concord is viewed as a platform that will allow developers to build any variety of applications. But Concord is tailored expressly for financial institutions, and so has different features and functions.

Perhaps the most important difference between Concord and Ethereum is the way transactions will be recorded. With Ethereum every transactions is recorded, verified and disclosed immediately in their respective public, distributed ledgers.

With Concord, while the transaction is verified via a distributed ledger, it is not publicly disclosed, maintaining the confidentiality that was a key concern of R3’s member banks. The details are shared only by the parties involved, or parties to whom they give access.

Carlo de Meijer

Economist and researcher

The Corporate Treasurer and Blockchain

| 17-08-2016 | Carlo de Meijer |

While it has been widely reported that – despite its disruptive character – the majority of banks think that innovations such as blockchain technology will positively impact their business and are exploring how they can use blockchain to their advantage, it is still largely a grey area for many corporate treasurers. But given the various challenges that corporate treasures are facing today, they also need to pay attention to this ‘cutting-edge’ blockchain technology.

Complex environment

Today’s business environment for corporates that are internationally active can be highly complex from a treasury point of view. The treasury includes basic tasks like cash management, bank relationship management, payments, and corporate investing.

The corporate treasurer strives to achieve optimal working capital utilization to ensure that the financial supply chain efficiently and effectively supports the physical one. It does this by monitoring global cash positions and managing credit facilities across all bank accounts of the group companies to move cash to where and when it is needed.

“Cash management and forecasting are more challenging because of increasing business complexity. The level of complexity is likely to get worse over the next two years”

In the digital era, real-time insight into a company’s global cash positions and cash requirements and the ability to move monies intraday is increasingly needed to support this changing business environment.

Today’s model of international correspondent banking however does not easily facilitate the ability to manage cash in a real-time environment.

Challenges

Corporate treasurers thereby face various challenges.

A first one is to obtain in a timely manner consolidated information of group-wide multi-currency positions across a fragmented banking network. This is needed to optimize the financing mix and duration of funding against expected and actual enterprise cash flows.

A second key challenge is optimizing the automation of “order-to-cash” and “purchase-to-pay” cycles with an optimal rate of straight-through-reconciliation (STR) of cash to accounting.

Need for …..

Cash management and forecasting are more important than ever for a company’s financial success, but they have also become more difficult to execute. And the pressure to provide insightful and proactive cash reporting and forecasting is only likely to grow. Management outside of treasury needs a better understanding of a company’s cash positioning and forecasts.

To execute in this environment, treasury functions will need to find ways to provide management with information on cash positions and cash forecasts faster and with deeper insight.

So where should treasury start, in order to improve forecast quality despite increasing internal and external forces that adverse impact reporting?

Blockchain enters the stage

But there is a technology available to take the pressure off the modern cash management professional: Blockchain. This technology could fundamentally affect the various areas of corporate treasury as it could transform how financial transactions are recorded, reconciled and reported.

The potential applications of blockchain technology for the treasury are vast. They may range from cash management and correspondent banking, to trade finance and documentation, supply chain management, commodity financing and account opening.

Especially for treasury relevant payments, when applying blockchain, these could be executed instantly between the various participants. As the ownership and provenance of transactions can actually be embedded in the blockchain data, blockchain has the potential to be used for mainstream payments, thereby providing a robust and secure framework for verifying transactions.

Benefits

Blockchain could have a number of positive impacts on the transparency, efficiency, cost and risk issues currently associated with corporate treasury. This may bring them various benefits.

It will allow for improved liquidity management. Blockchain has the potential to enable real-time/instant insight in a corporate’s liquidity position and how quickly they can provide liquidity to their corporate.
The transparency brought about by blockchain technology between the various players could bring benefits especially for those activities that need multiple controls such as transfer of payments. Such transfers can be done much quicker and in some instances even instantly.
It will also allow for improved risk management. As the credibility of debtors and creditors is supposed to be known at all participants blockchain will also contribute to more security.
Treasurers are nowadays under pressure to reduce costs. Blockchain may allow much lower trading costs for banks because much less parties are involved for reconciliation purposes. Some even say it could save banks billions of euros. And if banks could provide their services to corporates at lower costs that might be of great help for treasurers.
And what about the use of smart contracts, in which lawyers and accountants essentially act as coders. When two parties enter into a transaction together, the accountant/lawyer/coder inputs into the blockchain what the event they have all agreed on. This event will occur automatically. That might contribute to much greater efficiency.
But also from a financial and business strategy issue, blockchain could bring great benefits. Having a clear picture of assets and cash flows, finance has the ability to make strategic investments in shorter period of time, helping to capitalize on potential investment opportunities and evaluate important future transactions.

Take a longer view

Blockchain has the potential to fundamentally change the treasury function at corporates. For some blockchain is even going to be a game-changer for treasury. The change might not be here yet, but it is coming, and treasurers need to take the long view on it.

Carlo de Meijer

Economist and researcher

Agricultural business is a complex industry

Blockchain can help …

…. to solve existing problems

Use cases

The concept of Smart Farms

Start-ups

Real world examples

Future

Collaborative near real-world examples

R3CEV

Credit Suisse (syndicated loans)

R3CEV and eight member banks (treasury bond trading)

R3CEV and 15 member banks (Letter of Credit)

R3CEV and 40 member banks (Commercial Paper trading)

Barclays and R3CEV (smart contracts repository)

Credit Suisse and others (reference data management)

Hyperledger Project

UBS and IBM (trade finance)

CLS (payments netting service)

Bank of America Merrill Lynch/HSBC (Letter of Credit)

BTMU and IBM (contract management and trade finance)

JPX and IBM (post-trade settlement and proxy voting)

Credit Mutuel Arkea (verify customer IDs)

Ripple

Standard Chartered (trade finance)

ATB Financial and Reisebank (international interbank payment)

Japanese bank consortium (real-time settlement and domestic fund transfers)

Santander (cross border payments)

Foundational challenges

From another planet

Blockchain platform Iroha

Soramitsu collaborative approach

Blockchain and cross-disciplinary approach

What is the Hyperledger Project?

Recent developments

Standardisation

The reporting challenge

Distributed ledgers and regulatory reporting: the benefits

Improvements in regulatory reporting

Deloitte Proof of Concept

The way forward

Regulators enter the stage

Regulatory sandboxes

Regulatory sandboxes: an overview

Application

Benefits for startups

Global regulatory collaboration

Utility Settlement Coin

What is USC?

Going forward

Active dialogue

R3 and Corda patent

Corda White Paper

What is Concord?

Traject

Concord versus Ethereum

Complex environment

Challenges

Need for …..

Blockchain enters the stage

Benefits

Take a longer view

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