Tag Archive for: blockchain

Blockchain and the Ripple effect: did it ripple?

|24-4-2017 | Carlo de Meijer | treasuryXL

Our expert Carlo de Meijer has published an interesting article about a blockchain initiative that we want to share with you. We have slightly shortened the original article about Ripple.

 

Who is Ripple?

Have you ever thrown a stone in still water of a river or a lake. I did! The effect is rippling the water in a way that can be followed outwards incrementally. It might be this effect that the founders of Ripple, the payments blockchain network had in mind when choosing the name for their project. Did it ripple?

San Francisco based Ripple is seen as one of the most advanced distributed ledger technology (DLT) companies in the industry, which focuses on the using of blockchain-like technology for payments.

In just four years, Ripple has established itself as a key player in the fast-growing distributed ledger technology world. Since 2013, the Ripple Protocol has been adopted by an increasing number of financial institutions to “[offer] an alternative remittance option” to consumers. Especially the years 2015 and 2016 marked the expansion of Ripple, with the opening of an office in Sydney (April 2015) and the opening of European offices in London (March 2016 ) and in Luxembourg (June 2016).
In June last year, Ripple obtained a virtual currency license from the New York State Department of Financial Services, making it the fourth company with a BitLicense. As of 2017, Ripple is the third-largest cryptocurrency by market capitalisation, after Bitcoin and Ether.

What is Ripple?

Ripple is a financial real-time gross settlement solution, currrency exchange and remittance network using distributed ledger technology. Released in 2012, it purports to enable “secure, instant and nearly free global financial transactions of any size with no chargebacks”.
Ripple is built upon a distributed open source Internet protocol, consensus ledger and native currency called XRP (ripples) enabling (cross-border) payments for retail customers, corporations, and other banks.
The Ripple Protocol, described as “basic (settlement) infrastructure technology for interbank transactions”, enables the interoperation of different ledgers and payment networks and brings together three aspects of modern payment solutions: messaging, settlement and FX management. It allows banks and non-bank financial services companies to incorporate the Ripple Protocol into their own systems, and therefore allow their customers to use the service.

The protocol enables the instant and direct transfer of money between two parties. As such the protocol can circumvent the fees and wait times of the traditional correspondent banking system. Any type of currency can be exchanged including USD, euros, RMB, yen, gold, airline miles, and rupees.
“Ripple simplifies the [exchange] process by creating point-to-point and transparent transfers in which banks do not have to pay corresponding bank fees.” Chris Larssen, former CEO Ripple

The Ripple company also created its own form of digital currency dubbed XRP in a manner similar to bitcoin, using the currency to allow financial institutions to transfer money with “negligible fees and wait-time. One of the specific functions of XRP is as a bridge currency, which can be necessary if no direct exchange is available between two currencies at a specific time. For example when transacting between two rarely traded currency pairs. Within the network’s currency exchange, XRP are traded freely against other currencies, and its market price fluctuates against dollars, euros, yen, bitcoin etc.

Did it Ripple?

Growing adoption by banks
Ripple has experienced a growing adoption by banks. Many financial companies have subsequently announced experimenting and integrations with Ripple. The first bank to use Ripple was the online-only Fidor Bank in Munich, which announced the partnership early 2014. Fidor Bank would be using the Ripple protocol to implement a new real-time international money transfer network.
Since then a host of major banks have adopted Ripple to improve their cross-border payments, and many have completed trial blockchain projects. These banking institutions – including Santander, UniCredit, UBS, Royal Bank of Canada, Westpac Banking Corporation, CIBC, and National Bank of Abu Dhabi, among others – view Ripple’s payment protocol and exchange network as a valid mechanism for offering real-time affordable money transfers.

Some recent developments in the Ripple network

The real uptake of Ripple however started to take place in 2016 and continued during the first quarter of 2017.

National Bank of Abu Dhabi (February 2017), Axis Bank (January 2017), SEB (November 2016), Standard Chartered (September 2016), and National Australia Bank (September 2016) are the latest banks to join Ripple’s blockchain-powered network for cross-border payments. And more banks will get on the Ripple bandwagon during 2017. Ripple says its network now includes 12 of the top 50 global banks, ten banks in commercial deal phases, and over 30 bank pilots completed.
“Banks and their customers have been hearing about the promise of blockchain technology to enable real-time cross-border payments. Now, some of the most innovative and successful banks like NBAD are making this a reality by offering Ripple-enabled payments to their entire customer base, and in doing so, paving the way to make 2017 the year we see broad commercialization of blockchain take hold globally.” Brad Garlinghouse, CEO of Ripple

Further Rippling: enlarging the network

Global Payments Steering Group
Last year September Ripple created the “first: interbank group for global payments based on distributed financial technology. Bank of America Merrill Lynch, Santander, UniCredit, Standard Chartered, Westpac, and Royal Bank of Canada have joined as founding members of the network, known as the Global Payments Steering Group (GPSG). CIBC will also join the GPSG as a new member.
“The creation of 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,” Donald Donahue, GPSG chairman.

GPSG aims to use Ripple’s technology to slash the time and cost of settlement while enabling new types of high-volume, low-value global transactions. 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.

R3CEV
Last year October R3 and twelve of its blockchain consortium member banks – including Barclays, NAB, Nordea, Royal Bank of Canada, Santander – have trialled Ripple’s Digital Asset XRP, to tackle the costs and inefficiencies of interbank cross-border payments. Ripple says XRP has the “fastest” settlement speed, settling in about five seconds or less.
“The prototype paves the way for a major overhaul of how banks process and settle cross border payments”. David Rutter, CEO of R3

Banks traditionally provision liquidity for cross-border payments by holding various currencies in local accounts with correspondent banks around the world. But these ‘nostro’ accounts are costly because banks have to fund them, trapping capital. Ripple argues that this can be fixed by instead using a digital asset – such as its XRP – which provides liquidity on demand.
Ripple’s network was trialled in R3’s lab and research centre, making markets for fiat currencies using XRP and then completing authenticated payments without multiple nostro accounts. The trial introduced XRP to test the feasibility of reducing or retiring the use of current nostro accounts for local currency payouts.

Ripple Innovations

In the meantime a number of important innovations were announced in the Ripple offering.

Ripple Validator Node
Global IT company CGI announced it is the first commercial enterprise to implement the Ripple Validator Node. Ripple validators are servers that confirm Ripple’s distributed financial technology transactions on the network. The CGI-hosted Ripple Validator Node provides banking clients with a trusted network partner for Ripple’s distributed financial technology that settles international and domestic transactions in real-time.

Smart Token Chain
Smart Token Chain (STC), a blockchain specialist in the FinTech sector, has completed its first full Smart Token transaction across the Ripple Network. Using Ripple gives STC universal access to a wide range of partners and customers without having to physically craft a digital relationship with each one. STC is leveraging Ripple’s open, neutral platform, called “Interledger Protocol” to move payments globally across different ledgers and networks.
Leveraging the Ripple platform with new Smart Token solutions is accelerating the move toward the launch of a truly useful blockchain and smart contract implementation, which has great potential for making global exchanges of value fast, affordable and highly secure. It also provides a well-documented audit trail that will make dispute resolutions more efficient and less frequent.

Ripple’s new cost model

Ripple created a cost model, designed specifically to help banks understand their cost structure and how Ripple can help them overcome current inefficiencies. With Ripple’s new cost model, banks can easily enter transaction volume and operational metrics to receive a custom cost analysis. The cost analysis breaks down cost to a per-payment level, for both a bank’s current system and if it were to use Ripple. By using this model banks can easily estimate the efficiency gains it could achieve using Ripple for international payments.
XRP Incentive Program

The XRP incentive program is designed to accelerate the use of XRP as a universal bridge currency by creating deep and liquid markets at the outset of being listed on digital exchanges. The program is funded by Ripple and will be operationally managed by exchanges for their liquidity providers.

Global financial institutions are increasingly looking for solutions to consolidate the liquidity tied up with the nostro accounts required to fund their overseas payments. Digital assets such as XRP allow for banks to fund their payments in real-time, and in the process, cut down their dependency on nostro accounts.
As a bridge currency, it can enable liquidity concentration around fewer currency pairs, making cross-border payments more efficient. As evidenced by R3’s trial with XRP for interbank cross-border payments, the use of Ripple and XRP can enable both cost-cutting and revenue opportunities for participating institutions.

BitGo makes XRP more accessible
Ripple’s efforts to build an active ecosystem around its XRP digital asset has been boosted by a deal with virtual currency processor BitGo. Under the programme, BitGo will provide multi-signature security, advanced treasury management and additional enterprise functionality for XRP, which will be integrated into the BitGo platform this year.

The Rippling goes on!

Ripple plans to enlarge the number of exchanges trading XRP. Working with a greater number of exchanges to list XRP is an important step to serve the growing demand for global payments in major and exotic currency corridors. Ripple has previously commented that by using its network and XRP as a bridge asset, banks can save up to 42% on interbank international payments.

“This cost-saving frees up capital to generate revenue opportunities, including new product offerings for high-volume, low-value payments and access to new corridors”, claims Ripple.

The Ripple effect goes on!

 

Carlo de Meijer

Economist and researcher

 

Blockchain: Securities market infrastructure players in the contra-attack

| 7-4-2017 | Carlo de Meijer |

 

Blockchain technology has long been viewed as a threat to CSDs (Central Securities Depositories) and their role as intermediaries for securities transactions. Blockchain and distributed ledger technology may make the role of many intermediaries in the post trade market infrastructure obsolete. In one of my blogs (Blockchain and the securities industry: future eco-system) I was one of those who think that players such as custodians, CCPs, CSDs and others would disappear when blockchain would be used in a massive way.


“It however is not expected that there will be a complete disintermediation of service providers. While the role of custodians would greatly disappear and those of clearinghouses and CSDs will drastically change in a blockchain environment, the rest of the value chain in the securities industry may remain largely intact. The functions associated with tracking, reconciling, and auditing enormous amounts of data are not going to be disintermediated away. They have to continue to exist, but just need to be done more efficiently, at lower cost and with fewer errors”- Carlo R.W. de Meijer

But these players are going in the contra-attack. 15 CSDs from developing and emerging markets, including Strate and NSD, have agreed to form a consortium to explore blockchain and DLT technology in a post-trading environment. The partners say that“financial market infrastructures need to embrace the technology and identify opportunities that will add value to their current clients”.

Let’s look what they are all doing.

CSDs aim to build distributed ledger for mobilising scarce collateral (January 2017)

A coalition of four central securities depositories are collaborating with Deutsche Börse on an initiative to use blockchain technology to ease cross-border mobilisation of security collateral. The members of the so-called “Liquidity Alliance” include The Canadian Depository for Securities Limited (CDS), Clearstream (Luxembourg), Strate (South Africa) and VPS (Norway). Via this initiative they want to overcome existing hurdles when moving collateral across various jurisdictions, making the transfer faster and more efficient. The Alliance’s ‘LA Ledger’ will initially be implemented as a prototype based on the Hyperledger Fabric. Validation by regulatory authorities and market participants will start in the second quarter of 2017.

DTCC taps blockchain to rebuild its platform (January 2017)

The Depository Trust & Clearing Corporation (DTCC), a US post-trade provider, has announced plans to use blockchain technology in 2017 to rebuild its platform. It aims to create a credit derivatives post-trade lifecycle solution built using a distributed ledger platform. Blockchain can simplify the process by automatically maintaining a shared electronic record of the security which is visible to all relevant parties.  This new DTCC’s platform – Trade Information Ware house – will keep track of the security throughout the lifecycle of the associated bond.

IBM, Axoni, and R3 CEV, two technology startups have been selected to work on the project which is set to kick-off in January 2017. DTCC expects the new blockchain-enabled Trade Information Warehouse to go live in early 2018. Furthermore, the project has been developed with input from market participants and infrastructure providers including Barclays, Citigroup, Credit Suisse Group, Deutsche Bank, JPMorgan Chase, UBS Group, Wells Fargo, IHS Markit and Intercontinental Exchange, DTCC said.

SWIFT creates blockchain application to simplify cross-border payments (January 2017)

SWIFT has begun building a blockchain application to simplify cross-border payments. The global platform is integrating open-source blockchain technology with its own products to build a proof-of-concept that might “one day” replace the so-called “nostro” accounts its members keep filled with cash all over the world – just in case they need it. A successful test of distributed ledger technology (DLT) could enable banks to optimize their liquidity globally and SWIFT to reduce the costs of reconciliation between independent databases maintained by the inter-bank platform’s members, reduce operational costs and free up liquidity for other investments.

Euroclear pencils in 2017 for bullion on blockchain roll out (December 2016)

Euroclear, the securities market depository, is set for a 2017 go-live for the application of blockchain technology in the London bullion market after completing its first pilot trades. Over 600 OTC test bullion trades were settled on the Euroclear Bankchain platform over the course of a two-week pilot. A number of leading market participants in the London bullion market – all part of the Euroclear Market Advisory Group – were involved in the test run, including Scotiabank, Société Générale, Citi, MKS PAMP Group and INTL FCStone. The Euroclear Bankchain Market Advisory Group set up in June this year now includes 17 participants working with Euroclear and blockchain platform provider Paxos in the roll-out of the new service. Another market simulation will run early this year in preparation for a production launch later in 2017.

Euroclear report: “CSDs matter in blockchain settlement system” (December 2016)

A new report by Euroclear has looked at the regulatory and legal aspects of the use of blockchain technology in post-trade settlement in a European context. The report, Blockchain Settlement: Regulation, Innovation, and Application, with support from Slaughter and May, found that central securities depositories (CSDs) would play an important role in a blockchain-based settlement system. It added that as ‘custodians of the code,’ CSDs could exercise oversight of, and take responsibility for, the operation of the relevant blockchain protocol and any associated smart contracts. CSDs will continue to perform an important role as trusted, centralised FMIs, providing gatekeeping services and oversight of the relevant blockchain. While the Euroclear report states that CSDs are trusted central entities that facilitate the settlement process, it is believed that the distributed ledger technology system would be a natural evolution of this facilitation role.

SWIFT deploys PoC for bond trading based on blockchain (November 2016)

SWIFT has unveiled a proof-of-concept for managing the entire lifecycle of a bond trade based on blockchain technology. SWIFT, that has been targeted in the press as “a legacy incumbent that will be doomed by DLT”, is determined not to be left behind “in the wake of the revolution that is unfolding in the finance world” with the adoption of blockchain or Distributed Ledger Technology (DLT). SWIFT believes “it can leverage its unique set of capabilities to deliver a distinctive DLT platform offer for the community.”

At the beginning of 2016 SWIFT and Accenture released a paper investigating how blockchain technology could be used in financial services. As a technology assessment, SWIFT and Accenture identified gaps between existing DLT solutions and industry requirements.

SA Strate to launch block chain based e-proxy voting in 2017 (October 2016)

Strate, South Africa’s central securities depository (CSD), plans to launch an e-proxy voting system based on blockchain technology in 2017. The body, responsible for clearing and settling all transactions that take place on the Johannesburg Stock Exchange (JSE), has partnered with Russia’s National Settlement Depository (NSD) to develop and test systems aimed at simplifying shareholder voting. Both CSDs plan to launch the e-proxy voting system in 2017, as such they are looking to partner with an international service provider whose product is around 70% to 80% complete. In South Africa, the planned e-proxy voting system will be rolled out on a client-by-client basis, with an eventual goal to have the entire market take up the system.

The decision to partner with NSD, taken at the Sibos Conference in Geneva last year, is rooted in the fact that both CSDs have conducted independent proof of concept studies and are at a similar stage in understanding and developing an appropriate voting solution. The NSD was also one of the first financial organisations in the world to announce the development of a blockchain-based prototype for e-proxy voting. Strate and NSD will share information regarding standards, regulations and DLT technologies; explore mutually beneficial ideas; and look to make savings through the sharing of technology and development costs. They are claiming that several other CSDs have expressed interest in joining them.

Innovation in CSD space session at SIBOS: “ a slow burn for CSDs” (September2016)

During the “Innovation in CSD space: What about distributed ledger technology?” session at SIBOS, some panellists argued that the technology would “hail the end of CSDs” while others said there would be no revolution, just a “natural evolution” of what exists.

The message from the CSDs was that they are “open to innovation with blockchain, but will test it out in safe places first”.   

WFE Survey “Financial market infrastructures piling into blockchain” (August 2016)

More than 84% of trading venues and clearing counterparties (CCPs) surveyed by the World Federation of Exchanges (WFE) are either investigating or actively pursuing the applicability of distributed ledger technologies in financial markets.

WFE says that the poll of 24 members indicates that firms are at different stages of evolution in their DLT initiatives, with one having already deployed a DLT-based application, some at proof-of-concept, and others on the spectrum of evaluation, design, and proof-of-technology. Clearing and settlement provided the most obvious use case for respondents, but with regulatory, legal and technical risks an issue there was little consensus on a viable time frame for live production.

Strate, global CSDs to collaborate on blockchain use (August 2016)

Strate, the South African body responsible for settling transactions concluded on the Johannesburg Stock Exchange, met with 20 other central securities depositories (CSDs) in Switzerland in September to discuss how blockchain technology can be used across global financial markets. Aim is to form a group of CSDs to share information and knowledge. The group of CSDs would try to determine an ideal model for putting clearing settlements and the transaction of shares on to a blockchain.   And as opposed to each going and developing their own technology, the group could potentially get a vendor to develop something for all of them or develop something their selves and share it and share in the costs.

Euroclear explores use of blockchain in London gold markets (June 2016)

Euroclear is exploring the potential of using blockchain technology to create a next generation settlement service for the London gold market. The clearing is working with blockchain infrastructure firm itBit and market participants to evaluate the use of distributed ledgers to remove the risks and reduce the capital charges related to the settlement of unallocated gold. Euroclear will thereby use ItBits’ Bankchain product, a private network of trusted participants that clears, tracks and settles trades in close to real-time, opening the prospects of providing true delivery-versus-payment in the bullion market.

Rise testing post-trade blockchain tech with banks, custodians and CSDs (May 2016)

RISE Financial Technologies (RISE), a provider of distributed ledger technology for both post-trade settlement and securities safekeeping, has become the first technology firm to launch the second generation of blockchain for the post-trade sector. RISE is testing its solutions with a number of leading financial institutions including banks, custodians, and CSDs.

The core attributes of RISE’s technology are de-centralised ledger qualities and permissioned transparency, which gives access to different types of information depending on who you are. These qualities are applied to ensure any ‘single point of failure’ inherent in many technology systems is removed and guarantees data integrity. So investors have sight and control over their assets but not those of other participants; issuers have a view but no control into final beneficiaries; financial institutions (ledger operators/validators) have access to client information; and regulators have a complete view of the information in their jurisdiction in real-time but no direct control over the assets.


Carlo de Meijer 

Economist en Researcher

 

 

 

 

More articles about blockchain from Carlo de Meijer:

[separator type=”” size=”” icon=””]

 

Blockchain regulation in the securities industry: Still many unanswered questions!

| 24-3-2017 | Carlo de Meijer |

One of the obstacles for massive adoption of blockchain technology is the lack of clarity from regulators. Regulators world-wide have long time taken a wait-and-see attitude towards blockchain and distributed ledger technology (DLT) (see my Blog “Blockchain and Regulation: do no stiffle …. April 4, 2016). But that is changing. Regulators across the globe have turned their attention and are now considering how existing regulations may (or may not!) accommodate the development of new distributed ledger technologies. This growing interest shows that it is becoming all the more serious for regulators in the securities industry that blockchain is coming to reality and that this asks for a more closer look a this technology.

Since the start of 2017 a number of regulatory organisations including ESMA (EU), FINRA (US) and IOSCO (Global) have launched reports asking for answers to meet the various challenges of blockchain or distributed ledger technology in the securities industry.

“Regulators prepare to address perceived weaknesses or potential risks relating to blockchains in their regulatory frameworks, and be ready to voice any concerns to, or discuss potential DLT benefits with the relevant authorities”.   

What have regulators been doing up till now

To keep pace with the developments in the DLT space some regulators have already established dedicated Fintech offices, contact points and hubs. Others launched regulatory sandbox frameworks that enable innovators to experiment with Fintech solutions for financial services (see my Blog, “Blockchain: playing in the Sandbox September 7, 2016”). And there are regulators that have set up labs and accelerator programs to explore how new technologies including DLT can help them better achieve their regulatory objectives.

To give some examples:

  • Regulators, such as the US Commodity Futures Trading Commission (CFTC) and the US Securities Exchange Commission (SEC), have attempted to incorporate DLT innovations into existing legal and regulatory frameworks. Also, the French Parliament last June approved a law that lets some securities vouchers be issued and exchanged on a DLT.
  • Others, such as the UK Financial Conduct Authority (FCA), the Swiss Financial Market Supervisory Authority (FINMA), and the Monetary Authority of Singapore (MAS), have created regulatory sandboxes for companies utilizing innovative technologies.

But, as FINRA, ESMA and IOSCO all note in their recent reports, integrating novel DLT products into existing regulatory regimes may prove challenging as DLT continues to develop.

FINRA Report

Early January this year, the US Financial Industry Regulatory Authority (FINRA) published a report titled “Distributed Ledger Technology Implications for the Securities Industry. The FINRA report provides, while structured as only a “request for comments”, an overview of DLT, highlights applications and gives a detailed review of how blockchain technology may impact existing securities regulations affecting dealers and marketplaces.

The report thereby gives a clear picture of the many regulatory considerations for broker dealers that (it says) “market participants may want to consider and regulators will want to have worked out before such infant technologies can be allowed to leave their sandboxes.
US regulatory considerations include issues such as governance, operational structure, network security and regulatory considerations, customer data privacy, trade and order reporting requirements, supervision and surveillance, fees and commissions, customer confirmations and account statements and business continuity planning.

This report is intended to be an “initial contribution to an ongoing dialogue with market participants” about the use of DLT in the securities industry. Accordingly, FINRA is requesting comments from all interested parties regarding all of the areas covered by this paper.

“FINRA welcomes an open dialogue with market participants to help proactively identify and address any potential risks or hurdles in order to tap into the full potential of DLT, while maintaining the core principles of investor protection and market integrity”. FINRA Report

  • More questions than answers!

The FINRA report doesn’t provide specific guidance for many questions, but it does represent something of a practical checklist of issues that will need to be addressed by regulated securities businesses considering implementing DLT networks more broadly.

To give an idea of the many questions raised:
How would the governance structure be determined? Who would be responsible for the business continuity plan, addressing conflicts of interest? How would errors or omissions on the blockchain be rectified? What type of access will be provided to regulators? In the event of fraud, who covers the cost? How will regulated entities deal with DLT transactions? Who is the custodian? Does the DLT network itself affect the market risk or liquidity of the digital asset? How is access to the data controlled? Which entities are playing what roles. Would dealers become clearing agencies? How is customer information updated for changes? How is the process supervised and tested? And many, many more!!

  • Possible implications for existing US regulation

Many FINRA rules, as well as some rules implemented by other regulators, such as the Securities and Exchange Commission (SEC), that FINRA is responsible for examining or enforcing with respect to broker-dealers, are potentially implicated by various DLT applications.
For example, a DLT application that seeks to alter clearing arrangements or serve as a source of recordkeeping by broker-dealers may implicate FINRA’s rules related to carrying agreements and books and records requirements. The use of DLT may also have implications for trade and order reporting requirements to the extent it seeks to alter the equity or debt trading process.

Other FINRA rules such as those related to financial condition, verification of assets, anti-money laundering, know-your-customer, supervision and surveillance, fees and commissions, payment to unregistered persons, customer confirmations, materiality impact on business operations, and business continuity plans, also may to be impacted depending on the nature of the DLT application.
The head of the US Commodity Futures Trading Commission Christopher (CFTC) Giancarlo recently said that US fintech policy should take a “do no harm” approach. He added that US regulators should coordinate to “avoid stifling innovation”.

ESMA Report

Early February 2017, the European Securities and Markets Authority (ESMA) published a report regarding distributed ledger technology (DLT). In this report named ”The Distributed Ledger Technology Applied to Securities Markets” ESMA summarizes its position on DLT, with a note that it will continue to monitor this “dynamic” technology and consider whether a regulatory response may become a necessity. It sets out ESMA’s views on DLT, its potential applications, benefits, risks and how it maps to existing EU regulation.
ESMA concluded that regulatory action is premature at this stage, but may not be in the longer term. The report anticipates that early applications of DLT will focus on optimising processes under the current market structure, particularly less automated processes in low volume market segments.

ESMA “has not identified any major impediments in the current European Union regulatory framework that would need to be addressed in the short term to allow for the first applications of DLT to securities markets to emerge in a scenario where DLT would be used to optimise processes within the current market structure”.

Longer term, and based on industry responses to the discussion paper, ESMA in its report notes the potential of the technology to support clearing and settlement activities. Potential risks outlined in the report include cyber-attacks, fraudulent activity, operational risk if errors are disseminated, fair competition issues, and market volatility.

Also ESMA “appreciates that broader legal issues, such as securities ownership, company law, insolvency law or competition/antitrust law may have an impact on the deployment of DLT”.

IOSCO Report

The “IOSCO Research Report on Financial Technology”, also published in February this year by the International Organization of Securities Commissions (IOSCO), highlights the increasingly important intersection between financial technology (Fintech) and securities market regulation. It describes a variety of innovative business models and emerging technologies that are transforming the securities industry including the application of the blockchain technology and shared ledgers.

  • Risk assessment

The IOSCO report analyses both the opportunities and risks that these new technologies present to investors, securities markets and their regulators. Though the risks differ depending on the technology, certain risks are recurring across the Fintech sector, such as those arising from unlicensed cross-border activity, programing errors in the algorithms that underlie automation, breaches in cyber security, and the failure of investors to understand financial products and services. Another risk is the failure of financial firms to “know-the-client” for reasons of anti-money laundering and fraud control.

“Financial technology regulators may need to develop “highly automated” surveillance and hire technology experts if they want to closely monitor risks posed by blockchain and other distributed ledger technologies” IOSCO Report

  • Cross border challenge

And there is the cross-border challenge. While tech firms operate globally, regulation is conducted largely within national or sub-national borders. The local nature of regulation may create challenges regarding cross-border supervision and enforcement, whereas regulatory inconsistency across jurisdictions increases the potential for regulatory arbitrage.

“The global nature of Fintech therefore creates challenges that regulators should address through international cooperation and the exchange of information”,according to the report.

DLT and blockchain Regulation: not today!

Regulation of blockchain and distributed ledger technology in the securities industry is not to be expected short term. There are still more questions than answers. Before regulators will be able to address the various issues raised, they must better understand their impact. And that takes time. It is in the securities industry’s interest that they remain in an ongoing dialogue with regulators to get the best of both worlds.

 

Carlo de Meijer

Economist and researcher

 

 

 

More articles about blockchain from Carlo de Meijer:

 

Blockchain and derivatives: Re-imagining the industry

| 10-3-2017 | Carlo de Meijer |

Since the first meetings organised by the Technology Advisory Committee of the US Commodity Futures Trading Commission (CFTC) on January 26 and February 23, 2016, on “Blockchain and the Potential Application of Distributed Ledger Technology to the Derivatives Market”, we have seen a lot of activity in this area.

The Depository Trust and Clearing Corporation (DTCC) last month – so a year later – launched its plans to develop a blockchain-based post-trade framework for derivatives processing with tech firms R3, IBM and Axoni starting in January. The US-based clearing institute aims to replace the technology underpinning its Trade Information Warehouse database with a distributed ledger. The announcement by DTCC of its plan to transition its Trade Information Warehouse (TIW), into a blockchain platform  is described as a “watershed moment” for the industry in deploying distributed ledger technology (DLT) in production at this scale and a “reimagining” of credit derivatives processing.

DTCC and TIW

But for an idea of the scale of this operation, first something about DTCC and TIW. The Depository and Clearing Corporation focuses on post-trade financial services, providing clearing and settlement services to the financial markets. It provides central custody of securities and ways for buyers and sellers to make their exchanges in a safe and efficient way.
The Trade Information Warehouse (TIW) , a central part of its financial infrastructure, and a  a major component in the credit derivatives market, currently automates recordkeeping and other workflow functions, such as lifecycle events and payment management for more than $11 trillion of cleared and bilateral credit derivatives annually, among 2,500 buy-side firms located in more than 70 countries. This is roughly 98% of all transactions in that asset class.

DTCC involvement with blockchain

DTCC has been in the forefront of early-stage experimentation, notwithstanding this technology could disrupt this industry and might make obsolete or reduce the role of a number of clearing and other business parties in the post trade market infrastructure. Already end 2015 DTCC expressed its interest in blockchain technology and became a founding member of the Hyperledger Project, an open-source blockchain development project managed by The Linux Foundation and aimed at driving the adoption and standardization of distributed ledger technology in the financial services sector. Last year DTCC also invested in and partnered with Digital Asset Holdings (DAH).

The decision to go ahead with a blockchain-powered “revamp” of the DTCC’s Trade Information Warehouse follows a successful trial of this technology by the company last year. In April 2016, DTCC announced the successful completion of a proof of concept of blockchain technology and smart contracts to manage post-trade lifecycle events for standard North American single-name credit default swaps (CDS) in partnership with Axoni, Markit, Bank of America Merrill Lynch, Citi, Credit Suisse and JPMorgan.

Soon after their partnership, DTCC and DAH started a collaboration to develop and test blockchain-based solutions for the $2.6 trillion US repurchase agreement (repo) market. DTCC and DAH said “they wanted to streamline U.S. Treasury, Agency and Agency Mortgage-Backed repo transactions and thereby lower costs and risks”.

The DTCC TIW blockchain project

In their plans the DTCC’s Trade Information Warehouse is to be “re-platformed” through a distributed ledger framework based on blockchain technology to drive further improvements in derivatives post-trade lifecycle events. The project has been developed with input and guidance from a number of market participants including Barclays, Citi, Credit Suisse, Deutsche Bank, JP Morgan, UBS and Wells Fargo, and infrastructure providers IHS Markit and Intercontinental Exchange. These parties helped develop the technology by providing workflow guidance. The final goal of the project is to develop a permissioned distributed ledger network for derivatives, governed by DTCC, with peer nodes at participating firms.

  • Cooperative effort

The whole project is a cooperative effort of a number of partners. By mid-2016, the DTCC submitted a request for proposal (RFP) for interested parties to “re-platform” the warehouse and cut back on reconciliation costs. DTCC has selected a series of firms including IBM, startup Axoni and bank-backed R3CEV to help integrate distributed ledger technology into its first large-scale, real-world application.

Under the DTCC agreement, IBM is the primary contract holder for the DTCC implementation and will lead the initiative, provide program management, contribute DLT expertise and integration services as well serving as the solution-as-a-service (SaaS) provider. Axoni is to provide distributed ledger infrastructure and smart contract applications, while the blockchain bank-backed  consortium R3CEV  is acting as a “solution advisor” from both a technological perspective and from a banking workflow perspective. R3 is thereby charged with “really helping validate that the architecture is sound, but also making sure that the feedback from this big R3 global network is heard”.

“The combined expertise of IBM and our partners enables us to provide DTCC with a resilient, open and innovative new technology platform to support this groundbreaking opportunity.”  Bridget van Kralingen, SVP IBM Industry Platforms.

  • Phased approach

Development on the technology started in January and is expected to go live in early 2018. Over the course of 2017, the partners will work collaboratively to “re-platform” the existing Trade Information Warehouse (TIW) to a permissioned distributed ledger network custom-built for cleared and bilateral credit derivatives – governed by industry-owned DTCC with peer nodes at participating firms.

“It enables a distributed network to be built on this where, ultimately, participants could have nodes in-house,” Schvey, Axoni.

The distributed ledger technology being used for the DTCC TIW project is the AxCore protocol, created by New York-based Axoni. Deployment of the AxCore protocol will be done in phases, and even after it goes live next year, may only be adopted slowly. When the AxCore protocol goes live in early 2018, Axoni intends to submit the software to Hyperledger Project.

Rollout of the new blockchain-powered platform won’t be immediate. Initially, the distributed ledger will run in parallel with the existing settlement infrastructure. The latter can take as long as a week to close compared to the nearly instant settlement times expected from the blockchain solution. Upon launch, the DTCC will run a node that updates the TIW ledger, and other participants will also be able to run a node to support the network or to just get a feed of the information. “Not all of our clients will be moving into the world of distributed ledger at the same pace”. Large participating firms are expected to run their own individual “peer nodes” on the private ledger, with smaller DTCC clients being given the option to tap into DTCC’s own node.

By the time the Axoni technology is fully implemented, the entire life-cycle of a credit derivative will be captured as a smart contract or a “suite of smart contracts”.

Main goals ….

The new-to-create blockchain-powered platform is intended to enable DTCC and its clients to further streamline, automate and reduce the cost of derivatives processing across the industry by removing the need for “disjointed, redundant processing capabilities and the associated reconciliation costs”.

The present processes are arduous with current paper contracts in the form of computer documents still being issued. Blockchain and smart contract technology that will allow buyers, sellers and central clearing houses of derivative trades to share information, such as KYC (Know Your Customer), in real time across various distributed ledger platforms, may unleash great efficiencies. At scale, peer-to-peer networks that secure digital assets would allow parties to identify, transact, and settle with each other in expedited workflows.

  • Streamline derivatives processing
    “Distributed ledger technology is a natural fit for derivatives processing. By recording and automatically managing shared records of financial agreements in the cloud without error, it can minimize the steps required for post-trade processing and free up middle- and back-office staff from the onerous task of reconciliation.” Rutter R3CEV
  • Improvement to settlement times
    With regard to the settlement of derivative transactions, presently the system entails a three to five day process involving many third parties. This represents a significant opportunity cost that parties can recapture with a blockchain-based system that enables even real-time settlement.
    “In a future where they move their infrastructure from what I imagine is a complex environment of interconnected software with a ton of proprietary adapters and middleware to a blockchain, the cost savings and improvement to settlement time – currently as long as a week for some of DTCC’s trades -will be pretty monumental to their business.”
  • Cost saving
    Blockchains are “uniquely suited” to reduce costs associated with reconciliations, settlement, and security. According to industry executives cost savings can come from eliminating redundant IT systems and trading and risk management overhead. The finance industry currently spends roughly $150 billion annually on IT and operations expenditures in addition to $100 billion on post-trade and securities servicing fees. A 2015 report by Santander estimated the global savings to banks more generally speaking could be as high as $20bn a year.
    To provide an example, parties that own identical records in a single, shared ledger would reap explicit cost savings around reconciliations. Similarly, parties that transact obligations in a wholly digital, peer-to-peer network underpinned by such a ledger would reap explicit cost savings around settlement activities as well. Furthermore, parties would be able to manage implicit costs in different ways, like exceptions management, regulatory reporting, know-your-customer (KYC) and anti-money laundering (AML) that stand to be streamlined in ways that provide maximum value in a peer-to-peer workflow.

… and other possible opportunities

Other possible benefits of the use of blockchain in the derivative space include increased transparency, lower counterparty risk, and easier accounting. This may ultimately lead to lower collateral needs and improved liquidity.

  • Improved transparency
    In addition to providing streamlined processing by supporting self-executing code, or smart contracts, it is “widely heralded as a bastion of transparency”. This is especially relevant for regulatory bodies. Since the distributed ledger’s record is immutable, a regulatory node has the potential to give government observers access to real-time data about transactions, instead of having to wait for reports from market participants.
  • Improved risk management
    The use of blockchain technology for derivatives could also improve risk management. It could provide market participants a degree of control over risk and versatility over the balance sheet that is unachievable with today’s paper assets. As an example, parties might consider cash flow exchanges every 30 seconds instead of every 30 days, reducing counterparty and credit risk commensurately, as well as changing how these risks are measured.
  • Improved collateral management
    Under blockchain, dealers will post collateral to the clearing house in the form of initial and variation margin by escrowing cash on a distributed cash ledger or by allocating assets held on other asset ledgers to a distributed collateral ledger. Smart derivative contracts that bind both seller and buyer will be stored on a distributed derivative ledger along with information from the cash and asset ledgers. This will lead to efficiencies for calculating derivative positions and obligations, leading to lower collateral needs.
  • “The smart contract can automatically compute exposures by referencing agreed external data sources (e.g. S&P 500, NASDAQ) that recalculate variation margin. Interoperable derivative and collateral ledgers would automatically allow the contract to call additional collateral units on asset ledgers to support these needs. At maturity, a final net obligation is computed by the smart contract, and a payment instruction automatically generated in the cash ledger, closing out the deal”
  • Improved liquidity
    Transparency, alongside reduced transaction and trade maintenance costs, could, in turn, enhance trading liquidity. In present situation in order to maintain liquidity levels firms nowadays have to overcompensate where the money has to be tied up for some time before the next transaction. The improvement in funds settlement and counterparty risk assessment in a blockchain environment may shorten the liquidity cycle for various derivative positions, allowing banks to inject liquidity into the system for other transactions much more quickly.

Remaining challenges

Despite all the positives around blockchain and smart contract technology, still many challenges exist. These are mostly the same as for other financial transactions, including lack of scalability, no common standards, no legal and regulatory certainty and the arrival of multiple distributed ledgers. But also smart contracts are at an early stage of development. Defining exactly what they are and how they would work is still a challenge. Regulators and standards bodies across many different industries will need to come together to define what they mean for each transaction and sector.

“The industry assumption is that there should not be one ledger to rule them all, there will be different ledgers and we need to work together to make sure they interoperate, not just from banks.” Braine Barclays

Are there opportunities for derivatives CCPs?

An interesting question is: why is DTCC so active in the blockchain arena: for defensive or offensive reasons? Blockchain technology is seen by many as a disruptive factor for a number of market infrastructure players such as CSDs, repositories and CCPs.

One of the original goals of blockchain technology is to remove the need for central governing bodies.  Traditionally, financial exchanges have required clearing houses to provide a guarantee to the winning party of the derivative contract in case the loser does not pay. The clearing house is able to provide this guarantee by requiring both parties to make cash deposits during the pre-trade phase.

The ledger will replace today’s process by which multiple parties reconcile proprietary books and records to accurately represent the custody and value of a financial instrument at any given point in time. With respect to the derivatives markets, blockchains would ultimately come to be used as digital asset registries, as a record residing in a single, shared ledger. So the mechanisms by which parties maintain custody of their obligations and the smart contracts that enshrine those obligations.

….. Yes there are!

A number of industry analysts however reason traders will continue to novate derivative trades via a Counterparty Clearing House (CCP) in order for dealers to net their exposures and monitor the financial well-being of counterparties (ensuring problems like double-spending are eliminated).

Also Nasdaq thinks there are opportunities for derivatives CCPs.

“The concepts of DLT – in its fundamental form with decentralised recording of asset ownership – and derivatives CCP clearing are inherently different. At first, it appears counterintuitive for a derivatives CCP to pursue a technology aimed at decentralising the processing of transactions and removing the need for a CCP. However, derivatives clearing consists of several processes such as position keeping, reconciliation, collateral management, risk and default management, and settlement. While margining and default management do not benefit from a decentralised process, position keeping and settlement could do – and here DLT can increase efficiency.” Fredrik Ekström, Nasdaq’s Clearing President in “Blockchain Tech for Derivatives CCPs — Friend or Foe?”

Final remarks

If this first large-scale implementation of a distributed ledger proves successful, there’s plenty of room to expand. In my mind one should be optimistic of further developments in this space, especially in consideration of the rising cost of reconciliations, post-trade operations, and security issues that market participants confront today.

It seems very likely that the DTCC initiative, once it becomes operational, will have a significant impact on the derivatives world and may open doors to massive adoption of distributed ledger technology for financial services including derivatives.

“This will be one of the first [instances] globally where we are using distributed ledger technology to become a piece of the infrastructure in a very critical market, in the credit default swaps market, and use it across the entirety of multiple players” “By recording transactions in a distributed ledger, everyone uses that same piece of information, that same trade batch, in the same exact way.” DTCC CEO Bodson.

The entire global credit derivatives market in 2016 was $544tn, according to the Bank for International Settlements (BIS), much of which is processed by the DTCC.

 

Carlo de Meijer

Economist and researcher

 

Blockchain: Accelerated activity in trade finance

| 24-2-2017 | Carlo de Meijer |


Last year August I wrote a LinkedIn blog on blockchain and trade finance. There I described the various pilots and plans for using this technology in the trade space. In that month, the bank-backed R3CEV blockchain consortium revealed that 15 of its member banks had participated in a trial involving trade finance. Since then activity in this area has accelerated. It signals that enterprise banks are increasingly interested in the application of the blockchain to trade finance. The idea is that a distributed database like a blockchain can form the basis for a wholly digitized supply chain.

“Blockchain lends itself easily to the trade finance industry, which heavily rely on the settlement of sensitive information. This technology could be used to digitise sales and other legal contracts (smart contracts), allow the location of goods to be monitored and facilitate payments in close to real time. Potentially, business transactions can be executed directly on the platform itself through the use of “smart contracts” embedded in the platform and the platform could be further connected to payment systems and distribution networks for smoother flow of payments, goods and services.” – I wrote in Blockchain and trade finance: projects and pilots

Moving from the proof-of-concept stage into production

It is also becoming all the more clear that blockchain technology is moving from the proof-of-concept stage into production, especially for cross-border payments and trade finance. Last week seven European banks announced their plans to develop a trade finance platform based on blockchain technology. Let’s have a look – there are more examples.

European banking consortium: cross-border trade platform

Seven of Europe’s biggest banks (Deutsche Bank, HSBC, KBC, Natixis, Rabobank, Société Générale and UniCredit) signed a Memorandum of Understanding in Brussels under which they intend to collaborate on the development and commercialisation of a new product called Digital Trade Chain (DTC). A shared cross-border trade finance platform for small and medium-sized using blockchain technology.

The product is based on a prototype trade finance and supply chain solution originated by KBC and tested to ‘Proof of Concept’ stage. The aim of the project is to simplify trade finance processes for SMEs by addressing the challenge of managing, tracking and securing domestic and international trade transactions by connecting all of the parties involved (i.e. buyer, buyer’s bank, seller, seller’s bank and transporter), online and via mobile devices. They thereby hope to accelerate the order-to-settlement process and decrease administrative paperwork significantly. The group plans to initially focus on building critical mass in seven European markets.

S7 Airlines and Alfa-Bank pilot the first Russian blockchain LoC transaction

Two Russian companies, S7 Airlines, and Alfa-Bank, have successfully closed a deal using a smart contract to settle and record a Letter of Credit (LoC) on a blockchain. Deloitte in Russia provided legal support to the project. Only the people with information about the original parameters of the deal can view the status of the letter of credit in the blockchain record. In this transaction, in addition to Alfa-Bank and S7 Airlines, the information is available to a service company that receives money under the letter of credit. Legally, this transaction meets all the requirements for a letter of credit as a form of bank settlement, and demonstrates the potential of smart contract application in the framework of Russian legislation.
“The transaction enabled us to test the capabilities of smart contracts and understand how the technology helps to improve business processes and document flow efficiency. We are planning to continue cooperating with Alfa-Bank in this area.” – Dmitry Kudelkin, Deputy General Director, S7 Group

Barclays enabled first global trade transaction trial

Barclays announced that it had successfully completed the first global trade finance transaction trial using blockchain technology. The test enabled two partners, Ornua, an Irish agriculture co-operative (formerly the Irish Dairy Board), and Seychelles Trading Company, a food product distributor, to successfully transfer trade documentation via a blockchain platform created by its accelerator program graduate, Wave. A blockchain-based letter of credit closed a transaction between Ornua and the Seychelles Trading Company, guaranteeing the export of almost US$100,000 worth of cheese and butter from Ireland to the Seychelles, facilitated by Barclays. Meanwhile, the funds for the transaction were transferred via Swift.
Wave has worked with Barclays in developing new solutions for trade finance. The start-up’s blockchain-based technology connects all members of a supply chain to a decentralised network, allowing them direct exchange of documents. Wave’s blockchain-based system allows all parties to see, transfer titles, and transmit shipping and other trade documentation through their decentralized network. The new platform helps optimise internal processes for banks and reduces the risk of documentary fraud, while speeding up the time it takes to complete a trade transaction – from as many as 20 days, to just a few hours.
“Blockchain is a very good solution to eliminate the pain in international trade, because you have an industry that combines all industries, because all industries are either importers or exporters at some level. You have the carrier, the bank and the customer and it’s hard to find one centralized entity everyone can work with.” – Wave founder Ruschin

IBM promotes Blockchain Trade Finance In India

In India, IBM is hoping to promote mainstream adoption of blockchain by collaborating with multinational company Mahindra, which operates Mahindra Finance. IBM and Mahindra are developing a blockchain-based trade finance solution to offer banks in the country. The cloud-based tool will look to facilitate trade finance transactions between buyers and suppliers, and could overhaul trade finance for SMEs in particular.
The companies have already completed a proof of concept that “represents a significant step forward in blockchain, a more compelling and efficient supply chain solution for Mahindra Finance’s small and mid-sized enterprise loan business”. IBM and Mahindra will explore other use cases for blockchain including applications for Mahindra’s car and tractor manufacturing operations.

Microsoft and BAML to Test Blockchain for Trade Finance

Microsoft and Bank of America Merrill Lynch (BOML) announced a collaboration on blockchain technology to fuel transformation of trade finance transacting. The companies have teamed up to implement blockchain technology in trade finance to facilitate faster, safer, cheaper and more transparent transactions. The main objective of the collaboration is to develop and test blockchain technology and establish best practices for blockchain-powered exchanges between businesses and their customers and banks, before commercializing it. Microsoft’s own cloud-based platform Azure will be utilized to test the project. Microsoft Treasury experts will serve as advisors and initial test clients. Development and testing of the initial application, built to optimize the standby letter of credit process, is currently in progress.

CBA, Wells Fargo and Brighann Cotton pioneered blockchain trade finance transaction

The Commonwealth Bank of Australia (CBA), Wells Fargo and trading firm Brighann Cotton have successfully completed the “first” global trade finance transaction experiment in October between two banks using blockchain, smart contracts and the Internet of Things (IoT).
“The interplay between blockchain, smart contracts and the Internet of Things is a significant development towards revolutionising trade transactions that could deliver considerable benefits throughout the global supply chain.” Michael Eidel, CBA. The trade involved the shipment of 88 bales of cotton worth approximately $35,000 from Texas US to Qingdao, China. The transaction mirrors a letter of credit, executed through a collaborative workflow on a private distributed ledger – Skuchain’s Brackets system – between the seller (Brighann Cotton in the US); the buyer (Brighann Cotton Marketing Australia); as well as their respective banks (Wells Fargo and CBA).
By connecting Brighann Cotton’s container to the internet of things (IoT), both CBA and Wells Fargo have been able to “track a shipment in real time”. It was the geographical location which triggered the smart contract to release the payment for the cotton (which happened via the traditional Swift system, allowing the banks to avoid having to win the approval of prudential regulators for the deal).

Major banks from India and Dubai complete blockchain trade finance transaction.

ICICI, India’s largest private bank, and Emirates NBD,  recently announced successful international transactions for both trade finance and remittance purposes using blockchain technology.
This pilot transaction was executed to showcase confirmation of import of “shredded steel melting scrap” by a Mumbai-based export/import firm from a Dubai-based supplier, and to exchange and authenticate original international trade documents. The blockchain trade application co-created by ICICI Bank “replicates the paper-intensive international trade finance process as an electronic decentralised ledger”.
The information contained in the blockchain transaction included a purchase order, an invoice, shipping and insurance papers. Each participant was able to access and view a single dataset, to authenticate ownership of goods digitally, transmit their trade documents, check the status of their applications, and transfer their titles, while maintaining confidentiality. Further, it allowed each participant to check online the status of the application, transfer of title and transmission of original trade documents through a secure network, while preserving client and commercial confidentiality. The application is designed to work with existing banking systems and processes, allowing banks to “plug in their systems and process.”
“I envision that the emerging technology of blockchain will play a significant role in banking in the coming years by making complex bilateral and multi-lateral banking transactions seamless, quick and more secure.” – Chanda Kochhar, ICICI MD & CEO

CGI rolls out blockchain lab for trade finance

CGI, a leading IT and business service provider, has launched a lab, a digital sandbox dedicated to helping its trade finance and supply chain clients harness the efficiencies of blockchain for new and existing products. The formal launch took place at Sibos, Geneva, and is part of the company’s rapidly increasing use of Ripple’s distributed ledger solutions. But, the lab itself will soon explore the benefits to trade finance more broadly.The Trade Innovation Lab is a three-tiered “sandbox” that begins with platforms that could include Ethereum, BigchainDB, Ripple, Corda and Eris Industries, then works with CGI’s blockchain developers to build messaging workflows via the Intelligent Gateway that can be integrated via APIs to new blockchain applications. As part of the digital sandbox offering, the company will let its clients experiment with how various blockchains interact with its new Digital Intelligent Gateway, which allows for the sending of a wide range of supply chain messages.

UBS and IBM test blockchain for trade finance

Swiss UBS and IBM have collaboratively designed a project that replicates the entire lifecycle of an international trade transaction on Hyperledger`s Fabric blockchain. Aim is to simulate a complete international trade transaction incorporating stages such as trade finance, cargo inspections, bills of lading, customs inspections, release and payment. The trade finance project is in its earliest stages and focuses on just a single aspect of the process, combining payment transactions, foreign exchange payments and more, into one single, elaborate smart contract.
By programming that process into a smart contract on Hyperledger, both parties expect 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.

Consortium rolls out blockchain trade finance app in Singapore

Bank of America Merrill Lynch, HSBC and the Infocomm Development Authority of Singapore (IDA) have jointly developed a prototype solution built on blockchain technology that could change the way businesses around the world trade with each other. The consortium used the Linux Foundation open source Hyperledger Project blockchain fabric, which development was supported by IBM Research and IBM Global Business Services.
The application mirrors a paper-intensive letter of credit (LC) transaction by sharing information between exporters, importers and their respective banks on a private distributed ledger. This then enables them to execute a trade deal automatically through a series of digital smart contracts. Each action in the workflow is captured in a permissioned distributed ledger, giving transparency to authorised participants whilst encrypting confidential data. With this concept, each of the four parties involved in an LC transaction – the exporter, importer and both of their banks – can visualise data in real time on a tablet and see the next action to be performed.
“A letter of credit conducted on blockchain enables greater efficiencies and visibility in trade finance processes, benefitting multiple parties across its value chain,” – Khoong Hock Yun, assistant chief executive of the IDA’s Development Group. The consortium now plans to conduct further testing on the concept’s commercial application with selected partners such as corporates and shippers.

Remaining challenges

As evidenced by the recent announcements of successful international trade finance transactions via blockchain, promising to transform trade finance over the coming decade for business around the globe, streamlining the trade finance process, cutting time and expense from the process, the real-world use of the technology in trade finance will see a growing trend. It however could take a while before the technology will take off in a massive way and will fundamentally transform trade finance.
Going forward, the big challenge for banks wanting to employ blockchain at scale for trade finance will be the interoperability of different blockchain or distributed ledger systems. Another issue that needs to be addressed seriously is integration. How will buyers, sellers, and any required trusted third party/intermediary, interface to the network? Without having to implement an entirely new technology infrastructure, the parties involved in the trade finance process will need flexible tools to map and process documents and payments.

“The introduction of blockchain in your company will require the well needed time. You will have to address the enterprise issues around transaction audibility, visibility and integration into existing business functions. Without this, a profitable integration of the blockchain in the company will prove to be a difficult story” .

 

Carlo de Meijer

Economist and researcher




More articles about blockchain from Carlo de Meijer:

 

 

Blockchain and Central banks: a Tour de Table (Part II)

| 2-2-2017 | Carlo de Meijer | treasuryXL |

We found this article of our expert Carlo de Meijer and wanted to share it with you. This is the second part of this article, after Part I,  and a slightly shorter version than the original.
A year ago central banks were looking at the blockchain technology, mostly because they wanted to understand what private banks were talking about. The central banks are now embracing the blockchain technology to revamp their own infrastructures. Major central banks worldwide have spent the past year organising their own working groups dedicated to exploring blockchain technology and digital currencies. They thereby try to work out answers to the big questions: how would turning its cash digital affect the economy and financial stability? And determine whether the technology would be robust enough to stand up to hackers.

Central banks and blockchain experiments

Central banks are now even experimenting with digital currencies. A growing number  have made public their efforts in the digital currency and blockchain spaces. Several – and really the most enthusiastic – central banks, including the Bank of England, the Banque de France, the People’s Bank of China, the Bank of Canada, the Central bank of Russia, the Dutch central bank, and the Federal Reserve in the US, are exploring the concept of issuing their own blockchain-based digital currency. Countries like Barbados,  Senegal and Tunisia even introduced their block-chain-based digital currency. Other central banks have expressed stated their intent to develop interbank payment systems based on a blockchain. The European Central Bank recently announced a new research undertaking in partnership with the Bank of Japan. And last month the US Federal Reserve released its first major research paper on blockchain.

Tour de Table

What are all those various central banks doing. In an alphabetical order we will investigate the various initiatives.

Argentina
The Argentinian government and Central Bank authorities are focusing on finding innovative solutions. They have asked the blockchain community to join efforts to “eradicate financial exclusion, transfer the financial industry, promote financial opportunities and reduce inflation”.

The Central Bank of Argentina in narrow cooperation with the Ministry of Production and the Innovative Ministry organised the “Financial Innovation Hackathon” in November last year. On the first day of the hackathon, central bank vice president, Lucas Llach, talked about how blockchain could be a source of innovation in the financial industry. Though Mr. Llach said that its focus now is to work on improving new payment methods, he however added:

Australia
The blockchain issue is also on the radar of the Reserve Bank of Australia. Its head of payments, Tony Richards, said in February last year the RBA “has not reached a stage where it is actively considering this but in the more distant future it is even possible that we may see a digital version of the Australian dollar”. In a recently published paper the RBA however expressed a reserved view on the role blockchain and distributed ledger technology may play in the equity market in the short and medium term. The RBA paper highlights challenges associated with the transition to a new market blockchain-based structure including risks and technical challenges.

Barbados
In a sense, money issue on a blockchain is already happening on the island of Barbados. Early last year tech startup Bitt launched a blockchain-backed Barbadian Dollar, with the support of the country’s Central Bank. The Barbados central bank approved issuance of digital representations of the Barbadian dollar, each equalling a dollar issued by the Central Bank of Barbados, using blockchain. The approved platform, operated by tech startup Bitt, allows users to transact with each other. The ultimate goal is to digitize all the different fiat currencies of the Caribbean region in the hopes of providing the citizens a service that enables them to instantly send money anywhere.

Canada
The Central Bank of Canada last year teamed up with the country’s five largest banks and the R3CEV banking-backed consortium for the “Project Jasper” to create a blockchain enabled currency. In a simulation run last summer, the central bank issued so-called CAD-Coins on to a Ethereum blockchain platform. The banks used the CAD-Coins to exchange (fictional) money in the same way they normally do at the end of each day to settle their master accounts. A great deal of testing however is still necessary before the Bank of Canada can decide whether distributed ledger technology is “ready for the real world”.

China
China’s central bank is looking to recruit blockchain experts to study the technical architecture of digital currencies. The central bank has been working to create and issue a digital currency for years in order to replace cash, the bank’s governor, Zhou Xiaochuan, has said previously. Blockchain technology is among the systems it has examined, such as a series of other digital ledgers that can be reconciled efficiently. The central bank would still retain control over the country’s money supply. A timetable for the launch of China’s sovereign digital currency has not been announced, as of yet.

Denmark
The central bank of Denmark plans to issue blockchain-based E-krone as its reserve currency. The central bank says “blockchain technology, or a variety of that, for example” would be an obvious model to use for virtual currency. Governor Lars Rohde says pros include lower transaction costs. Using such a virtual currency would also make crime harder and improve financial oversight. But when it comes to the societal implications of switching to such a model, Rohde says the Danish central bank still has “more questions than answers.”

Europe
The European Central Bank and Bank of Japan agreed to launch a joint research project to study potential use cases of blockchain technology for market infrastructure. This initiative comes after the ECB revealed that “it is open to taking a closer look at exploring the potential for blockchain technology as a means to further innovation among central banks around Europe”. The bank is “toying with the idea” of tapping distributed ledger technology, among other options, for its renovation of the Target2 real-time gross settlement system and Target2-Securities platform. If this is to happen, more research into the technology is needed, prompting a collaboration with the Bank of Japan which will see findings released next year.

Finland
Also the Bank of Finland joined the growing list of worldwide central banks interested in blockchain technology. Finland’s central bank, collaborating with the Ministry of Finance, held a seminar in November, aimed to discuss “blockchain technology’s risk and rewards in order to forward innovation in the country’s economy”. They thereby  gathered together with the country’s leading researchers from universities, think-tanks, and various industries, to discuss the possibilities offered by distributed ledgers.

 

France
The Banque de France, the country’s central bank, has revealed details about a blockchain experiment for the identification process within the Single Euro Payments Area (SEPA). As well as security reinforcement, this experiment aims at exploring possible consequences of decentralised ledger management functions of SEPA Credit Identifier. The first testing was carried out in July last year in cooperation with the IT-startup Labo Blockchain, a group of French banks, and Deposits and Consignment Fund (Caisse des Dépôts et Consignations). For the experiment, the bank provided the participants with necessary software elements to be installed in external clouds or in their trial IT systems. The central bank stated that a “comprehensive assessment” will be carried out in the coming months to understand the results of the experiment. During January 2017, more details of the experiment will be revealed at a conference organized by the French Payments Committee in Paris.

Germany
The Bundesbank, jointly with Deutsche Börse, is testing the functional prototype of a blockchain-based system for the trading and settlement of securities. Designed to provide the technical functionality for the settlement of securities in delivery-versus-payment mode for centrally-issued digital coins and the pure transfer of either digital coins or digital securities alone, the two institutions plan to develop the prototype further over the next months so that they can analyze the technical performance and the scalability of this kind of Blockchain-based application.
Some of the features of the prototype presented include its capability to be used for blockchain-based payments and securities transfers and the settlement of securities transactions against both instant and delayed payment; and its ability to maintain confidentiality/access rights in blockchain-based concepts on the basis of a flexible and adaptable rights framework. It can also enable the general observance of existing regulatory requirements; identify potential to simplify reconciliation processes and regulatory reporting; and implement a concept based on a blockchain from the Hyperledger Project. It is also capable of settling basic corporate actions such as coupon payments on securities and the redemption of maturing securities.

Hong Kong
Hong Kong’s de-facto central bank, the Hong Kong Monetary Authority (HKMA) intends to launch an innovation hub that will test blockchain and distributed ledger solutions. The HKMA has begun work on the initiative with the Hong Kong Applied Science and Technology Research Institute (ASTRI), an initiative founded by the government to enhance its competitiveness in technology.

The Hong Kong Monetary Authority (HKMA) recently has published a new white paper on distributed ledger tech. The HKMA produced the paper in partnership with ASTRI. The white paper release is only the first step in a wider process, HKMA chief executive Norman Chan said the government is planning further research. And ASTRI is looking to publish a follow-up paper sometime in the middle of next year, building on its past findings and exploring “whether some of this work can be put into action”.

India
The Institute for Development and Research in Banking Technology (IDRBT) established by the Reserve Bank of India – India’s central bank – recently explored blockchain applicability to the Indian banking and financial industry by conducting a workshop with bankers, academicians, regulators and technology partners. The participants produced a White Paper detailing the areas of adoption in the financial sector in India. The Institute also attempted a proof-of-concept on applying blockchain technology to trade finance with the participation of banks, National Payments Corporation of India and a solution provider.

Japan
The Bank of Japan – the county’s central bank – is showing increased interest in blockchain and distributed ledger technology. Accordingly, the staff in the Payment and Settlement Systems Department of the Bank are deepening their understanding of new technologies by test-driving distributed ledgers. These trails by the bank’s staff simply aim to understand the mechanics of DLT, rather than (already) applying it to the Bank’s own liabilities or its payment and settlement systems. Considering the Japanese government and the central bank’s optimism towards the blockchain technology, it is highly likely that they will lead various projects to help banks integrate blockchain platforms in their existing systems.

Netherlands
The Dutch Central Bank (DNB) is exploring blockchain technology as a way to create a permanent digital replacement of cash. The DNB set up a successful three-months trial to run an experimental virtual currency derived from blockchain software, DNBCoin, but nick-named Dukatons (after a 17th century silver coin used in the Netherlands). This DNBCoin could end up being the digital currency issued by the Dutch central bank. Most of the details regarding this project however remain still unknown for the time being.
The Dutch Central Bank has also revealed plans to prepare an experiment aimed at assessing if an entire financial market infrastructure (FMI) can be built on a blockchain, that is much more difficult to hack. The experiment envisions how an FMI’s internal operations could be distributed among participating nodes. To hack and disturb the market infrastructure an attacker would need to gain more than half the computing power running the nodes.

Nigeria
Concerned about the rapid growth of blockchain experiments all over the world, Nigeria’s Deputy Governor of the Central Bank of Nigeria has “sounded the alarm” for relevant agencies to begin to take the disruptive technology more seriously. Speaking at an event organized by the Nigeria Electronic Fraud Forum (NeFF), Deputy Governor Adebayo Adelabu described the “blockchain revolution as a “swim or sink” situation. He noted the need for regulators and operators in the Nigerian financial system to be well informed and not left out in the blockchain technology.
For that reason the Central Bank of Nigeria (CBN) and the Nigeria Deposit Insurance Corporation (NDIC) have instituted a joint committee to look into the effects of the crypto currency and other blockchain technology and its effect on the Nigerian economy.

Russia
In February last year the Bank of Russia – the Russian central bank – established a ‘working group’ to study blockchain technology, in an effort to understand and look for the viability of its real-world applications in the Russian financial market. By April, a report revealed that the Central Bank was considering allowing banks to record and store data of all their transactions on a blockchain. And in July 2016, the Bank of Russia set up a consortium of banks that counted as Russia’s first blockchain consortium.
The Bank of Russia has developed and tested on an Ethereum-based blockchain prototype called ‘Masterchain’ for financial messaging, to be used by banks in Russia.A number of country’s largest banks and financial institutions took part in developing the Masterchain prototype, including Sberbank, Alfa Bank, Bank Otkritie, Tinkoff Bank, and Qiwi. The ‘Masterchain’, as explained by the central bank, is ‘a networking tool’ for participating members using blockchain technology. The platform enables for “prompt confirmation of data actuality” to a transacting customer. The innovation also makes instant communication possible between counterparties among the platform, while assuring confidence in financial transactions.

Senegal
Senegal has recently become the third country in the world (next to Barbados and Tunisia) to introduce a digital currency based on blockchain technology. Named eCFA, the digital currency will be legal tender and is to circulate alongside the current fiat currency, CFA Franc, is. Senegal’s eCFA comes from a partnership by Banque Régionale de Marchés (BRM) and eCurrency Mint Limited, where BRM will issue the digital tender currency, the eCFA, in compliance with e-money regulations of the Banque Centrale des Etats de l’Afrique de l’Ouest (BCEAO), the Central Bank of the West African Economic and Monetary Union (WAEMU). While the eCFA will use the blockchain to keep track of transactions, it will be issued and regulated solely by the central bank, but confer the benefits of transparency and cryptography to prevent counterfeiting and fake transactions. After Senegal, WAEMU will introduce the eCFA in Cote d’Ivoire, Benin, Burkina Faso, Mali, Niger, Togo and Guinea-Bissau.

Singapore
The Monetary Authority of Singapore (MAS), the country’s central bank, and the Singapore stock exchange are to launch a pilot project called Utility Settlement Coin with eight local and foreign banks to test the use of blockchain technology for interbank payments. Singapore’s DBS Group, HSBC, Bank of America, JPMorgan, Credit Suisse, and Bank of Tokyo-Mitsubishi UFJ are all working with MAS on the program with support from the global banking consortium R3CEV. R3 blockchain research lab and BCS Information Systems will support the project.

Under the pilot system participating banks will be able to pay each other directly with this digital currency instead of first sending payment instructions through MAS, and banks will be able to later redeem the digital currency for cash. Banks will thereby deposit cash as collateral with the MAS in exchange for digital currency issued by the central bank.
Eventually, the project could result in a payment system for participants to transact in different global markets round-the-clock that are today limited by time zone differences and office hours. Participating banks The next phase of the project will involve transactions in foreign currency, possibly with the support of another central bank.

South Africa
The central bank of South Africa is also looking into the applicability of the blockchain technology in the industry of finance. The Reserve Bank of South Africa’s governor, Lesteja Kganyago, publicly expressed the organization’s “openness” towards blockchain technologies and their intent to help startups come up with innovative solutions using the technology.
The central bank is particularly concerned with the technological and security-related issues blockchain platforms may present. Both the government and central bank of South Africa agree that the blockchain technology and cryptocurrencies need further guidance and assessment from the government before it can be offered to organizations in the public sector.

South Korea
The Bank of Korea has published a report titled “Present Status and Key Issues of Distributed Ledger Technology” detailing policy issues which could hinder the growth of distributed ledgers and also estimates the cost-cutting effect of the application of the blockchain technology. The report mentions that blockchain implementation could save the bank about KRW 107.7 billion (16% of its total costs).
The Bank of Korea is considering implementing a supernode to help mitigate privacy concerns, should it seek to adopt distributed ledger technology. Furthermore, the report recommends implementing the technology for major settlement services such as the BoK wire+ (Bank of Korea settlement system). Addressing privacy issues, according to the report, would require PKI based Key Exchange, Supernode (Central Manager) – who will have access to transaction information along with the trading partner, and Confidential Transactions which will be applicable to distributed systems and maintain anonymity and make deals with parties to access deal information.

Sweden
Riksbanken, Sweden’s central bank, is also thinking about using the blockchain to issue digital money.
The plans to issue an “eKrona”, a blockchain-based digital version of the Swedish Krona, was recently disclosed by the deputy governor of the Riksbank Mrs. Cecilia Skingsley. It is however still in discussions whether digital currencies should complement notes and coins, or replace them. The Riksbank currently is “in the early stages of exploring the idea and is launching a project to explore various possibilities.” Right now it is too early to hope for a quick introduction of the eKrona. Several issues – like traceability, interest, and delivery – have to be examined. Also, the Riksbank does not know which technology it will use to build the eKrona at present. The blockchain is one of the several technologies the Riksbank will look at.

Switzerland
At the kick off at the SIBOS conference last October in Geneva, the president and chairman of the board of Switzerland’s central bank Mr. Jordan described a financial system “turned on its head” by blockchain and distributed ledgers.
“Such systems could render the reconciliation of transactions and balance data between banks and the third-party system obsolete. The paradigm seems to have been turned on its head. Decentralization, not centralization, now appears to promise the greatest efficiency gains.” Jordan said the Swiss National Bank is now in discussions with market participants, regulators and other central banks about what to do next.

Tunisia
Tunisia is one of the early adopters of a blockchain-based digital currency. Late 2015, Tunisia had over half a million people using its digital currency, eDinar. The country’s post office, La Poste Tunisienne, then announced it would partner with Monetas and DigitUs to integrate the country’s digital currency with blockchain technology. This digital currency is issued solely by the Tunisian central bank.

Ukraine
Ukraine is now also exploring the potentials of an electronic money concept. As part of the nation’s Cashless Economy project, the National Bank of Ukraine (NBU) is to issue a blockchain-based digital version of the Hryvnia by next year. At first the currency will circulate alongside its physical version.

United Kingdom
Within the Bank of England, a team is already considering what a central bank-issued digital currency could mean. They have worked with PwC’s blockchain team in Belfast to help them develop a Proof of Concept and explore blockchain.
The Bank of England has released a significant Blockchain paper “Macroeconomics of central bank issued digital currencies,” which discusses the macro-economic consequences of a central bank making a digital form of cash available to the general public. In the model, digital cash is created only when the central bank purchases bonds from households or investors. This central bank digital currency, implemented via distributed ledgers, would compete with bank deposits as medium of exchange. However, banks would still be able to create money.
The model suggests that the introduction of digital cash would have some key benefits: it could boost GDP by around 3%, due to “reductions in real interest rates, in distortionary tax rates, and in monetary transaction costs”, it could give the central bank (via countercyclical CBDC price or quantitative rules) a second monetary policy tool to stabilise the economy; and, it could improve financial stability.

United States
The Federal Reserve is also taking a much closer interest in blockchain and what it can offer to the financial sector. The Federal Reserve released a report on Distributed Ledger Technology (DLT) or blockchain early December last year. The document reviews the potential and challenges for the new technology to disrupt and benefit financial services.

The Fed believes utilisation of DLT will become clearer as the technology matures. They further state:
“The driving force behind efforts to develop and deploy DLT … is an expectation that the technology could reduce or even eliminate operational and financial inefficiencies, or other frictions, that exist for current methods of storing, recording, and transferring digital assets throughout financial markets.”
Without making any grand predictions the authors believe DLT adoption will require future research to better understand the impact to the financial industry. Challenges to mass adoption include a list of risk, business and technical hurdles.

If you would like to see the full article please click here.

 

 

Carlo de Meijer

Economist and researcher

 

Blockchain and Central banks: a Tour de Table (Part I)

| 27-1-2017 | Carlo de Meijer | treasuryXL |


Our expert Carlo de Meijer, distinguished blockchain specialist, has published an article that is worth sharing with you. This is Part I and Part II will follow soon. May we invite you to comment or share your experience with this intriguing topic:

In April last year I wrote a blog on blockchain and monetary policy. In this blog I went into a number of still unanswered questions posed by the European Central Bank around blockchain technology. There was a big uncertainty about the impact of this technology on the future role of central bank money and on monetary policy.

 

While at that time many financial institutions and startups already paid a lot of attention to this technology, only a handful of central banks were interested in blockchain with the most vocal being the Bank of England. Since than a lot has changed with a growing number of central banks around the globe starting to recognise the potential for blockchain to help them in obtaining their key objectives: stable financial system and efficient financial markets. In the first part of this blog I will try to answer why there is nowadays so much interest amongst central banks in blockchain technology, what are the main benefits and what are remaining concerns. In the second part a Tour de Table will be given, looking at the various initiatives of the central banks.

Central banks are experimenting with blockchain

Several central banks are or have been experimenting with different versions of blockchain-backed systems. A growing number are questioning the point of creating digital currencies, such as the Danes. But they are not alone. Also the central banks of Sweden, Japan, China and Russia have launched similar efforts. Others such as the central bank of Singapore and Canada have already tested blockchain-based currency systems for internet payments, while also the Reserve Bank of South Africa has expressed their optimism towards the blockchain technology and its potential impact on finance. The European Central Bank recently announced a new research undertaking in partnership with the Bank of Japan. Earlier last month the US Federal Reserve released its first major research paper on blockchain.

Why is there so much interest?

But why are so many central banks now embracing blockchain, seriously exploring their potential.

The turning point was a three-day event in Washington , hosted by the World Bank, the IMF and the US Federal Reserve where representatives from more than 90 central banks worldwide expressed broad interest “in how the technology might impact both the banks they regulate as well as their own regulatory practices”.

Central banks’ interest in deploying a blockchain “comes in step” with moves by the big banks to use the technology to ease cross-border settlement transactions and overhaul antiquated back-office infrastructure. Experiments by banks with distributed ledgers as a way to settle trades and record data and transactions, have clearly shown its potential to reduce costs and increase the efficiency of its operations. The distributed ledger and its potential to simplify the record keeping, tracking and accounting process makes it hard to ignore by central banks.

Central banks and public stances: some quotes

Over the course of the past half year many central banks representatives have taken a public stance on their potential use of distributed ledgers and digital currencies. Here follow some of the most interesting quotes.

 “Innovation using these technologies could be extremely helpful and bring benefits to society. The technology has the potential to transform multiple aspects of the financial system” Janet L. Yellen, Chairwomen Federal reserve

 “We are paying close attention to distributed ledger technology, or blockchain recognizing this may represent the most significant development in many years in payments, clearing and settlement” Lael Brainard, Federal Reserve Board

Other interesting quotes include:

“The conditions are ripe for digital currencies, which can reduce operating costs, increase efficiency and enable a wide range of new applications” People’s bank of China

“A state-sponsored digital currency is still on the agenda, and if adopted, the technology could deliver a range of benefits” Russian central bank

 “The technology could be worth using for central banks because it would make for a financial system that does not go down even if the central bank’s computer systems are temporarily taken offline” Mark Carney Bank of England

What are the potential benefits for central banks?

Central banks are now exploring the potential of blockchain and distributed ledger technology. As banks experiments have shown blockchain networks may lead to safer and better payments and securities systems..

  • Make money more easily traceable

The inherent property of immutability and transparency associated with blockchain makes it easier for the central banks to trace the money that is in circulation. It would allow them to track every euro, pounds, dollar or renminbi on every step through the financial system in real-time.

  • Build single shared record

Central banks are also interested in blockchain technology as a way to build a single, shared record of all transactions among several institutions. The central banks hope they can use the decentralised method of record-keeping to complete and record transactions in the real economy more effectively, quickly and transparently. The creation of a standardised way of recording transactions would allow all the players in the system to communicate more seamlessly. That could leave much less money sitting idle while banks reconcile their different ledgers, as now happens.

  • Simplify the settlement process

It has also the potential to create efficiency. Blockchain or the distributed ledger technology has the potential to simplify the settlement chain around securities transactions. The resulting cost reductions, speed of settlement and enhanced transparency may all contribute to more efficient and safer payments and capital markets.

  • Reduce transmission costs

It may also drastically reduce the transmission costs and time associated with cross border transfers, by enabling instant transfers between branches both within and outside the country.

  • Reduce operating costs

The use of blockchain-based digital fiat currency will reduce the amount of banknotes and coins that are in circulation. This will, in turn, reduce the operating costs associated with printing and distribution of currency notes by the central bank.

  • Fight money laundering

The wide spread implementation of blockchain based fiat currency will also help the central banks (and government’s) fight money laundering while eliminating the issue of counterfeiting.

  • Other advantages

The blockchain technology provides a tool to measure leverage in the system and counterparty exposure, and can monitor compliance in real time. It can also answer questions about collateral ownership.

A blockchain could untangle the spaghetti structure of central swap bank lines, which would improve crisis response capabilities.

  • Reach the unbanked

Digital currencies may eventually benefit the developing world too. Because they are low-cost and easy to use on electronic devices, digital currencies may enable greater access to financial services for the billions of the world’s unbanked.

  • Stable financial system

This all should make the financial system more transparent, fast, efficient and secure. According to a Bank of England research paper produced last year, the economic benefits of issuing a digital currency on a distributed ledger could add as much as 3 percent to a country’s economic output, thanks to the efficiency it could offer.

 Remaining concerns

There are however still a range of questions and all sorts of security and regulatory concerns where central banks will need answers for before blockchain technologies are to become a key part of the future central banking landscape.

Questions such as: How may it impact monetary policy?; What are the implications of issuance of central bank digital money?; What is the impact on physical cash?; How would it impact on central bank seigniorage?; What are the implications for the integration of the European capital market?; and What is the impact on exiting projects such as T2S?

In previous blogs I already tackled some of these issues. See: “Could blockchain bring the EU Capital Market Union forward?” November 6, 2016; “Blockchain: What about T2S?” June 30, 2016; and, “Blockchain and Monetary Policy” April 29, 2016.

There are also a number of concerns that are already highlighted, such as assurance around scalability, data integrity, resilience and resistance to cyber-attack. A big concern is regulation of digital currencies. This is a looming challenge that will require cross-border co-operation. Monetary authorities must come together to start thinking about the necessary regulation of digital money that will be flowing around the world.

See my blog: “Blockchain and Regulation: do not stifle innovation!” April 4, 2016.

When can we expect central bank-operated digital currencies?

When a move to official digital currencies might occur is hard to estimate. Central bank-operated digital currencies could be ‘decades away’ according to the more pessimistic (or realistic?). But what is sure is that it will take a number of years before any central bank issues its own currency onto a live distributed ledger. Research is still at an early stage and many puzzles still have to be worked out.

It has become clear that central banks are set to take a much more active role in the development of blockchain technology. But how active that will be is not yet clear. The Fed’s preference at this stage is still to take a fairly hands-off approach and allow banks take lead the way – “as long as they remain within defined guidelines and best practices”. A switch could happen within the next 5 to 10 years. When large parts of the financial system are using blockchain for financial transactions, so will central banks!

 

Carlo de Meijer

Economist and researcher

 

Blockchain: What happened during my stay in South Africa? (PART IV)

|13-1-2017 | Carlo de Meijer |

chains-iiAs you may remember I travelled throughout South Africa in december 2016. Being back home I was curious to learn if there were developments in the blockchain area. A first article was about a number of interesting reports that were launched and start ups. The second article dealt with banks and consortia. I focussed on central banks, market infrastructure and card schemes in a third article. In this last article I want to conclude my ‘blockchain journey’ with information about regulators and advisory companies. 

REGULATORS

EU Commission Launches Initiative to Boost FinTech and Blockchain Startups

The European Commission (EC) unveiled a new initiative aiming to support Europe’s FinTech and blockchain innovative entrepreneurs. The Start-up and Scale-up Initiative aims to combine all the possibilities that already exist in the EU, but plans on including a new focus on venture capital investment, insolvency law, and taxation.

With the unveiling of the Initiative, the Commission is hoping to bring together several factors to enable blockchain and FinTech startups to develop and grow their business across Europe. Aside from the proposed factors mentioned above other features that the Initiative is proposing include improved access to finance and simpler tax filings. Through the Initiative startups will also gain access to improved innovation support through reforms to Horizon 2020, which funds high-potential innovation through a dedicated SME instrument. The initiative will also connect startups with potential investors, business partners, universities, and research centers.

ADVISORY COMPANIES

Deloitte invests in blockchain Startup SETL

Professional services firm Deloitte has made an investment in London-based financial services blockchain startup SETL. By harnessing the capabilities of SETL’s blockchain, Deloitte can provide their clients with even more practical and transformational solutions.  News of the investment follows the announcement last month that Deloitte, SETL and Metro Bank had successfully trialed a contactless payment card using the firm’s distributed ledger technology. SETL is one of a number of startups worldwide looking to apply the technology to payment and settlement, and it recently became part of a regulatory sandbox initiative launched by the UK’s Financial Conduct Authority.

Deloitte has bet big on distributed ledger technology. To date, the firm has partnered with a range of startups in the space to develop blockchain prototypes. They have already been investing heavily in real-world applications, such as identity management, cross-border payments, loyalty, trade finance and a number of others. Deloitte is currently setting up an EMEA financial services blockchain centre in Dublin that will house a team of 50 developers and designers and is working with five prominent blockchain companies – BlockCypher, Bloq, ConsenSys, Loyyal and the Stellar Development Foundation – on a wide-range of proof-of-concept applications across the financial sphere.

PwC launched its Vulcan Blockchain Platform

Pricewaterhouse Coopers (PwC) recently launched its Vulcan Digital Asset Services based on blockchain technology. The Vulcan offering marks PwC’s continuing commitment to bringing blockchain technology to financial services and other industries. The Vulcan platform that connects identity, money and assets, allows users to spend, share, trade or track any physical or digital asset cheaply and quickly. It enables fintech start-ups and existing technology companies to gain access to PwC’s global client base and co-develop new product offerings. Vulcan’s digital currency services include digital asset wallets, blockchain-based payments (global payment processing), a digital asset exchange (investment and trading services), and rewards and loyalty programs. In addition, the platform provides governance and assurance services, including anti-money laundering, know your customer and reporting tools to ensure regulatory compliance.

PwC is already conducting several pilots in different industries that capture digitized assets and issue customer reward points as digital money. A global banking group and a central bank are piloting the system while an airline and three multi-national banks are also exploring it.

All parts of this article can also be found as a combined article on my LinkedIN page.

carlodemeijer

 

Carlo de Meijer

Economist and researcher

 

 

 

More articles about blockchain from Carlo de Meijer:

 

Blockchain: What happened during my stay in South Africa? (Part III)

| 4-1-2017 | Carlo de Meijer |

chains-iiIn december 2016 I travelled throughout South Africa. My main focus was on the country, the people, the safaris, the Big Five and not on blockchain! Being back home I was curious to learn if there were developments in the blockchain area. A number of interesting reports were launched and there had been growing blockchain and distributed ledger activity in the financial industry from start-ups, to banks, central banks, the market infrastructure and consortia. 

In earlier articles on treasuryXL I focussed on new reports and startups (Part I)  and on banks and consortia  (Part II) while in today’s article I want to write about central banks, market infrastructure and card schemes.

CENTRAL BANKS

Central banks in Japan, Sweden and Singapore, among others , have launched blockchain efforts, with the European Central Bank (ECB) announcing a new research undertaking in partnership with the Bank of Japan on 6th December. The US Federal Reserve recently launched its first major research paper on blockchain.

Japan’s Central Bank Staff are Running Blockchain Trials

Japan’s central bank is researching and testing blockchain to study the possible use of distributed ledger technology for market infrastructure. They are “test-driving” blockchain technology to understand the innovation, according to its governor Haruhiko Kuroda. Speaking at a financial forum centered around digital innovation and Fintech, the Bank of Japan’s governor underlined blockchain as having the potential to “significantly affect” the basic pillars of financial activities – money and ledgers.

ECB and Bank of Japan research DLT for market infrastructure

The European Central Bank and Bank of Japan agreed to launch a joint research project to study potential use cases of blockchain technology for market infrastructure. This initiative comes after the ECB revealed that it is open to taking a closer look at exploring the potential for blockchain technology as a means to further innovation among central banks around Europe. The bank is toying with the idea of tapping DLT, among other options, for its revamp of the Target2 real-time gross settlement system and Target2-Securities platform. If this is to happen, more research into the technology is needed, prompting a collaboration with the Bank of Japan which will see findings released next year.

Bundesbank and Deutsche Börse test blockchain for securities settlement

Germany’s central bank has teamed up with Deutsche Börse to develop a functional prototype for blockchain technology-based settlement of securities. The prototype thereby enables the settlement of securities in delivery-versus-payment mode for centrally-issued digital coins, as well as the pure transfer of either digital coins or digital securities alone. In addition, this technology is capable of settling basic corporate actions such as coupon payments on securities and the redemption of maturing securities, using code from the Hyperledger Project as a basis. Both parties now plan to work on it over the next few months to test its technical performance and scalability. According to the Bundesbank, the project is aimed at providing a basis for further exploring the use of the tech in the securities trading space.

French Central Bank Pilots Blockchain

According to a report issued by the Banque de France it was announced that they tested blockchain technology for potential uses in managing SEPA Credit Identifiers, or identification markers used to establish the identity of creditors within the Single Euro Payments Area. This marks its first publicly acknowledged blockchain trial by the central bank. The trial was conducted with blockchain startup Labo Blockchain in collaboration with the Caisse des Depots et Consignations.

MARKET INFRASTRUCTURE

SWIFT unveils blockchain proof-of-concept (PoC) for bond trading

SWIFT recently unveiled its first proof-of-concept (POC) for managing the entire lifecycle of a bond trade based on blockchain technology. The internal POC demo tackles the issue of asset servicing across the full lifecycle of a bond trade, from issuance to payment of coupons and maturity. For the tests, Swift set up five separate nodes on a simulated network, stretching from Swift offices in California as the ID provider to an account servicer in Virginia and three investing banks in Sao Paolo, Frankfurt, and Sydney. SWIFT expects to see a number of other POCs come to fruition in Q1 2017.

SWIFT intends to sketching out a roadmap of key initiatives planned for 2017. These include working with vendors and member banks to deliver a blueprint for a SWIFT-run distributed ledger and the development of a DLT sandbox. For the latter, SWIFT intends to collaborate with member banks on a select number of use cases for the future application of distributed ledger technology as part of their Global Payments Innovation initiative.

ICAP to process foreign exchange trades on blockchain in 2017

ICAP, a UK-based operator and provider of post trade risk mitigation and information services, has announced plans to start processing foreign exchange trades on blockchain. For that, ICAP brings along its subsidiary Traiana and has teamed up with Axoni, a US-based technology company to supply the code to customers in March 2017. Traiana will thereby act as a messaging hub for forex, fixed income and swaps deals. They thereby provide services to monitor pre-trade risk and automate post-trade processing of financial transactions in listed and over-the-counter trading markets. Also, it will reconciles transaction, reference, market and portfolio data before it is transmitted to regulators, clearing houses or back to financial institutions.

Everex trials blockchain remittance in Thailand

Everex, a financial inclusion blockchain development company seeking to improve access to financial services and markets for un- and under-banked population across the world, has tested blockchain remittance. Over 100 migrant workers transferred money instantly over blockchain to their homes in Myanmar in the last months. Therefore, over 850,000 Thai baht (around USD 24,000) were transferred using the Everex wallet, a mobile and web based app that sends digitized national currencies using Ethereum blockchain.   Overall, average transaction took less than a minute and recorded savings of over 7% in remittance cost and currency exchange rates.

CARD SCHEMES

MasterCard files blockchain patents focused on payments and transacting

MasterCard has filed to the US Patent and Trademark Office (USPTO) four applications related to its work (focused specifically on payments and transacting) with blockchain and distributed ledger technology. The applications focus on methods and systems for authorizing, processing and securing blockchain-based transactions. MasterCard is arguing that a combination of blockchain and its existing payment technology could bring great benefits for those making digital payments. Publication of the applications comes weeks after the credit card company released a set of experimental blockchain APIs.

Lotte Card rolls out biometric authentication based on blockchain in Korea

Lotte Card, a large card issuer company in Korea, has adopted a biometric-based authentication system service in its payment app jointly with Blocko, a blockchain startup. Blocko is the provider of Coinstack, a blockchain-based development platform, and has a large number of references in providing blockchain technology in Korea.   Financial organizations in Korea, including banks, card companies and Korea Exchange, are actively adopting blockchain technology, but this is the first case in Korea of commercialized blockchain technology combined with biometric-based authentication system.

carlodemeijer

 

Carlo de Meijer

Economist and researcher

 

Blockchain: What happened during my stay in South Africa? (Part II)

| 30-12-2016 | Carlo de Meijer |

chains-iiIn the past three weeks I travelled throughout South Africa. My main focus was on the country, the people, the safaris, the Big Five and not on blockchain! Now being back home I was curious to learn if there were developments in the blockchain area. 

A number of interesting reports were launched, amongst others by Euroclear and Deloitte. And there has been growing blockchain and distributed ledger activity in the financial industry from start-ups, to banks, central banks, the market infrastructure and consortia. But also from advisory companies, central government bodies and others.

In my first article on treasuryXL, earlier this week, I  wrote about two reports and startups. I want to focus on banks and consortia in this second article about blockchain developments.

BANKS

BNP Paribas completed its first blockchain-based live cross border B2B payments

BNP Paribas has completed its first live cross-border B2B payments between corporate clients using blockchain technology. The transactions, conducted on behalf of packaging outfit Amcor and trading cards group Panini, were cleared in various currencies between BNP Paribas bank accounts located in Germany, the Netherlands and the United Kingdom. For the ‘cash-without borders’ project, the payments were fully processed and cleared in a few minutes. This highlights the potential of the technology to eliminate delays, unexpected fees and processing errors, and pave the way for real time cash management. The bank has strong commitment to follow closely and further accelerate their participation in a number of market initiatives aiming at improving the corporate payments experience using blockchain technology.

Citi backs blockchain startup

Citi has invested in blockchain venture Cobalt DLT, ahead of what the company expects will be a second round of funding in 2017. Cobalt DLT is a blockchain startup aiming to bring distributed ledger technology to the processing of foreign exchange trades. Transactions in the FX market are notoriously inefficient and costly. Currently, foreign exchange trades need multiple records for buyer, seller, broker, clearer and third parties and then reconciliation across multiple systems.   Cobalt is now building a post-trade processing network based on distributed ledger technology. The Cobalt DL solution has the potential to significantly improve post-trade services by cutting costs and reducing risk for our industry. Cobalt DL’s FX solution is set to launch in 2017, with 15 institutional participants committed to using the service.

 CONSORTIA

While the number of consortia in the blockchain arena are further growing, the bank-backed R3CEV sees some cracks in the consortium. Some of its biggest founding members parted ways. Big names like Goldman Sachs and Banco Santander are leaving the R3CEV consortium. And new reports are surfacing suggesting that others such as JP Morgan, Morgan Stanley, Macquiries, US Bancorp and National Australia Bank may follow soon.

The R3 consortium has its first Spanish-speaking Latam member

But there is also some good news. Creditcorp, a Spanish-speaking Latin American financial institution, has joined the R3 consortium to design and apply distributed and shared ledger-inspired technologies to global financial markets. The bank provides corporate and personal banking, brokerage services, and other financial services across its six principal subsidiaries in Peru, as well as other South American countries including Bolivia, Columbia and Chile, and is listed on the Lima and New York stock exchanges.

R3 and Calypso to develop blockchain trade confirmation system

Blockchain consortium R3 continues to press ahead with new initiatives, partnering with Calypso Technology to develop a multi-party trade confirmation system running on its Corda distributed ledger-based smart contract platform. Calypso will be the first application partner to adopt the R3 platform, utilising the technology to enable counterparties to see all trade tickets on the distributed ledger so they can be sure they are matching against the correct trade.

JPX to form Japanese blockchain consortium

Japan Exchange Group (JPX) is to form a consortium of financial institutions to run trials of the use of blockchain technology in capital markets infrastructures. The exchange will seek participation from a wide range of Japanese financial institutions in order to gather broad industrial expertise ahead of testing in spring 2017. They will consider a structure for efficient information sharing between the DLT engineer community and financial institutions through efforts such as training on DLT technology. The Tokyo Stock Exchange together with the Osaka Exchange and Japan Securities Clearing Corporation (JSCC) will lead the coalition which intends to create a test environment for Proof of Concept (PoC) using Hyperledger fabric, the open source DLT platform, in cooperation with IBM.

Blockchain applications, consortium for Malta Stock Exchange

Malta Stock Exchange (MSE) has announced plans to research and develop into the blockchain technology, and to establish its own consortium. MSE’s committee will be run by MSE board members, blockchain experts and its chairman. The consortium will be sharing knowledge and establishing connections or joint-ventures with each other to assist fintech companies based on the blockchain technology, to grow by supporting them in designing and implementing blockchain applications. Furthermore, with this consortium, the Malta Stock Exchange could be planning its first blockchain application. It is very likely their first application on blockchain will replace standard stock exchange platforms.

South Korea rolls out blockchain consortium

The Korea Financial Investment Association (FIA), along with 21 financial investments and five blockchain companies, have teamed up to form a blockchain consortium. The group has signed a memorandum of understanding (MoU) to collaborate on projects and share their expertise on blockchain technology. Moreover, the group aims to create business opportunities for the consortium as well as establishing a platform with the member companies. Its future research projects include the establishment of a common platform for personal authentication due in 2017, researching into clearing and settlement automation in 2018 and 2019, and a platform for over-the-counter trading for 2020.

Microsoft creates Asia’s first blockchain consortium on Azure

Microsoft has teamed up with AMIS and the Industrial Technology Research Institute of Taiwan (ITRI) to form Asia’s first and the most advanced consortium blockchain network on Azure. The consortium includes members such us: Ubon Financial, Cathay Financial Holdings, MegaBank, KGI, Taishin, and CTBC Bank. Aim is to further develop blockchain opportunities in the Taiwan financial market.

The pilot blockchain project is developed using ITRI’s technology (to create an internal application program interface (API)) and Microsoft Azure. AMIS chose Ethereum, to develop a permissioned blockchain, an infrastructure specific to the needs of Taiwan’s financial market. As part of the project, ITRI provided its advanced technology to create an internal application program interface (API), while Azure provided high-speed cloud computing to ensure high security and efficiency for the blockchain infrastructure.

XBRL and ConsenSys work on deploying blockchain tokenization standards

XBRL US, a US non-profit consortium for business reporting standard, has teamed up with Consensys, a blockchain technology company, to work on deploying blockchain tokenization standards. The working group aims to establish a standardized method to represent a token across all blockchain networks in order to eliminate transactional friction and reduce processing costs; enable automation and provenance tracking; and allow interoperability of transactions on a global scale.

The working group will establish goals and action steps by early 2017, and is requesting participation from individuals representing technology, finance, and accounting to provide their expertise in developing tokenization standards that can be used worldwide, for all asset classes.

Source: LinkedIN/Carlo de Meijer

carlodemeijer

 

Carlo de Meijer

Economist and researcher