Tag Archive for: blockchain

Blockchain hyperledger Project: Collaboration pays off

| 1-6-2017 | Carlo de Meijer |

Recently, I wrote that smaller blockchain consortia are needed. See my blog: Towards smaller and more focused blockchain consortia in  27 February 2017. The Hyperledger Project however may be the exception.

Umbrella

Things look quite good for the Hyperledger Project, described as being an “umbrella” for the developer communities to work on creating open source blockchain and related technologies. The Project receives even more interest from different organizations and industries than ever before since the start of this year. Their collaborative effort seems also to be paying off as the Hyperledger Project recently announced the upcoming release of its first production-ready blockchain: Fabric. And Hyperledger feels “there are still plenty of use cases waiting to be explored”.

The Hyperledger Project

Hyperledger Project is a global collaborative cross-industry effort created to leverage the emerging blockchain and distributed ledger technology. The Hyperledger project, that announced its first members in February 2016, has grown to more than 120, making it the largest blockchain consortium in the world today. These span various industries including finance, banking, technology, manufacturing, healthcare, and the Internet of Things, among several others, with big names such as IBM, Cisco, Intel, JP Morgan, Deutsche Bank, Wells Fargo, The London Stock Exchange and Accenture. Its latest members reflect all of these different areas as well, indicating the future for blockchain looks even more viable than ever before.
Hyperledger aims to enable its member organizations to build robust, industry-specific applications, platforms and hardware systems based on blockchain technology to support their individual business transactions by creating an enterprise grade, open source distributed ledger framework and code base. The goal is to advance blockchain technology’s use in business by developing both a cross-industry open standard and an open-source development library that would allow businesses to build custom distributed ledger solutions.

New Members

The Hyperledger Project continued its strong momentum in 2017. Early March Hyperledger announced that eleven new members have joined the project. The latest members include: Bank of England, Bitmark, China Merchants Bank, Federal Reserve Bank of Boston, Initiative for CryptoCurrencies and Contracts (IC3), Kaiser Permanente, Kubique S.p.A., MadHive, Monax, OSCRE and RadarWin Cyber Technology. Hyperledger also announced American Express and Daimler AG as Premier members earlier this year.
“Growth and interest in Hyperledger remain high in 2017. We’re now at 122 members and seeing even more diverse organizations across industry sectors invest their energy and resources in understanding how blockchain technology can strengthen their own business processes. This new set of members’ combined backgrounds and experiences will be invaluable to the community, as we strive to increase production deployments through this year,” Brian Behlendorf, Executive Director of Hyperledger, stated.

Central banks

Interesting is that now also The Bank of England and the Federal Reserve Bank of Boston are among the new members of the Hyperledger blockchain initiative. They are the first institutions of their kind to become part of Hyperledger, underlining the big interest of these institutions in the new technology. The Bank of England has already pursued a range of applications, including the potential issuance of a digital currency.

Working Group China

The Hyperledger Project, has now also set up a working group in China, mirroring the strong interest in the country. Hyperledger revealed that over 25% of Hyperledger members are from mainland China.
As a result, Hyperledger announced the Technical Working Group China (TWG China) to “help bridge and foster a working relationship between the global Hyperledger community with local technical teams in China”. The TWG China aims to facilitate interactions between Hyperledger members around the world and contributors and technical users in mainland China as well as other regional countries including Taiwan and Hong Kong. The Working Group is also tasked to grow the Hyperledger developer community in China by encouraging technical contributions to the project. TWG China will host and organize meetups, hackathons, training sessions and other community efforts to help push blockchain education, research and development.

Hyperledger Fabric

After the Technical Steering Committee (TSC) of the Hyperledger Project announced the promotion of its “Fabric” blockchain project to an active phase, early March, its first production-ready distributed ledger code base, was released at the end of last month.
“Hyperledger’s TSC agreed to grant the project team’s request to advance the Fabric’s status from Incubation to Active. As a reminder, we see Hyperledger as an “umbrella” for software developer communities building open-source blockchain and related technologies. Fabric falls under that umbrella and is the first of the five Incubator projects to graduate.”

Hyperledger Fabric is thereby the first project to graduate incubation to production-ready status. It was originally proposed by Digital Asset Holdings (DAH) and IBM as a result of the first hackathon during which a merge between the IBM’s proposal and DAH’s proposal was started. A group of developers from 20 different member companies has been instrumental in making the Hyperledger Fabric a reality.
“In the year since the project entered incubation, the diversity of contributors on Fabric-related projects has grown from nearly no diversity of contributors to 45 percent of the contributors – representing individual contributors or developers working for one of nineteen other companies, be they exchanges, banks, large ISVs or start-ups.” Behlendorf

The goal of Hyperledger Fabric is to supplement large-scale commercial operations of companies with a robust network. It is designed to enable confidentiality, scalability and security in business environments through a modular architecture. It allows components, such as consensus and membership services, to be plug-and-play. Fabric, will be utilized as the base protocol and platform for its member banks and companies looking to use blockchain technology in building both decentralized and private applications.

Various industry leaders and large corporations have expressed their interest to implement Hyperledger Fabric once the codebase is deployed and released. Community members including the London Stock Exchange, DTCC, and Fujitsu, said “they will allocate their resources in maximizing the potential of Hyperledger Fabric by showcasing its use cases in a wide range of applications”.

Loyyal Platform as an example

IBM Blockchain partner Loyyal became the earliest tester of Fabric and joined the Hyperledger Project soon after. They have built a handful of prototypes on Fabric, from the first release of Marbles to the most recent Fabric Composer release. And now they are building out an enterprise-grade loyalty platform utilizing Fabric and its newest features. Loyyal is thereby using blockchain and smart contract technology to reduce loyalty program operation costs through efficiencies and increase revenues through targeting capabilities. The Loyyal platform, built on blockchain, is transforming the loyalty and rewards industry by offering interoperability, multi-branded coalitions, superior liability management and dynamic issuance and redemption options.

 Other Hyperledger Projects

The Hyperledger Project has a special procedure to initiate blockchain projects. Any community member, contributor or partner company can propose blockchain projects or ideas to the Hyperledger Project and once approved, the development for the project will be pursued shortly after that. For Hyperledger projects like the Fabric to be deployed and introduced to the public, the foundation’s Technical Steering Committee (TSC) must unanimously agree that the codebase is production ready. The TSC thereby looks into the technical viability of the code, as well as its adaptability, flexibility, security and functionality to ensure that large-scale service providers will be able to utilize the blockchain technology without any boundaries.

Next to the Hyperledger Fabric, Hyperledger Project nowadays hosts multiple blockchain technologies. Hyperledger’s incubated projects include names like Blockchain Explorer, Cello, Iroha and Sawtooth Lake.

  • Blockchain Explorer

Hyperledger Blockchain Explorer is a “project in Incubation” that was proposed by IBM, Intel and DTCC to create a user-friendly web application for Hyperledger to view/query blocks, transactions and associated data, network information (such as name, status, list of nodes), chain codes/transaction families (view/invoke/deploy/query) and any other relevant information stored in the ledger.

  • Cello

A second project is Hyperledger Cello. This is a toolkit for deploying a Blockchain-as-a-Service, that reduces the effort required for creating, managing, and terminating blockchains. Hyperledger Cello aims to bring the on-demand “as-a-service” deployment model to the blockchain ecosystem, to provide a multi-tenant chain service efficiently and automatically, on top of various infrastructure, e.g., baremetal, virtual machine and more container platforms.

  • Iroha

Hyperledger Iroha is also a “project in incubation” that was proposed by Japan’s Soramitsu, Hitachi, NTT Data, and Colu. Hyperledger Iroha is a distributed ledger project that is designed to be simple and easy to incorporate into infrastructural projects requiring distributed ledger technology.

  • Sawtooth Lake

Hyperledger Sawtooth Lake is a modular blockchain suite. It supports both permissioned and permissionless deployments. Sawtooth Lake includes a novel consensus algorithm, Proof of Elapsed Time (PoET), targeting large distributed validator populations with minimal resource consumption. Transaction business logic is decoupled from the consensus layer into so-called transaction families that “allow for restricted or unfettered semantics”. Hyperledger Sawtooth Lake is contained in a single repository.

Hyperledger Project appears more promising

“Success of ‘clubs’ or consortia depends on the set up and governance, the stated aim, and also on the degree of alignment of interest of member organizations”. ”Models such as the open-source collaborative Hyperledger effort ultimately appears more promising when the aim is mainstream, commercial adoption”.Milan Salaba, partner at Deloitte

 

Carlo de Meijer

Economist and researcher

 

From Fintech to Regtech… from potentially disruptive to leaner compliance opportunities

| 31-5-2017 | François de Witte |

On 18/5/2017, I attended a seminar covering the topic “From Fintech to Regtech… from potentially disruptive to leaner compliance opportunities” organized by The Finance Club of Brussels, the Free University of Brussels (ULB), the Solvay Finance Society and Thomson Reuters.

Introduction

Fintech describes a wide range of innovation in financial technology, going from payment systems to lending and trading platforms.
Fintechs are seen in many cases as potential disruptors of the traditional intermediation of heavily regulated banks and other financial institutions See also my articles on PSD2 further down.
However Fintechs can also be enablers, helping banks and financial institutions to streamline their regulatory reporting and compliance, or help the disruptors in coping more easily with compliance in the future.

Setting the scene

Fintechs are playing an increasing role. The investments in Fintechs exceeded EUR 25 billion in 2016, and they bring a real digital revolution. Fintechs are perceived to foster the Digital Revolution, but equally to increase the digital divide in our society between the skilled and/or wealthy and those who are not.

Regulatory compliance is time-consuming and expensive for both financial institutions and regulators. The volume of information that parties must monitor and evaluate is enormous. The rules are often complex and difficult to understand and apply. There is a lot of data to be analyzed. Much of the process remains highly labor-intensive, or still depends heavily on manual inputs.

The Regtechs can be considered as an outgrowth of Fintec. Regtech use digital technologies— including big data analytics, cloud computing, robotics, behavioral analysis, blockchain technology and machine learning to facilitate regulatory compliance. Amongst  other things, Regtech applications automate risk management and compliance processes, enable companies to stay aware of regulatory changes around the world, facilitate regulatory reporting and support strategic planning.

In recent years banks have seen opportunities to ask Fintechs to solve their large regulation and compliance issues. They can change the paradigm of banks from heavy IT releases to agile sprints, from integration to standardizing protocols, from static functions to workflows.

Hence financial institutions are more willing to consider using Fintechs for getting more efficiency. During the seminar, somebody of the panel mentioned: “Collaboration is the best innovation”. Banks can also help Fintechs thanks to their experience in managing large databases, managing risks and providing the required critical mass.

We have seen some applications recently in areas such as the KYC (Know Your Customer) domain.

Regtech – some other considerations

However, as mentioned during the seminar by Antonio Garcia Del Riego, Head of EU Corporate Affairs at Banco Santander, in Europe there remain obstacles in using Fintechs. The Bank Regulators in Europe expect the banks to deduct the goodwill from the core capital of the banks. This implies that software investments cannot be capitalized and need to be written off immediately in the P&L. A second challenge is the ability to attract digital talent, given the fact that the regulators limit the way in which the remuneration can be paid, whilst startups can be very creative here.
For the regulators, there also remain challenges. Once banks will have automated their reporting, the regulators will have to follow. They also will have to attract digital talent, to treat all these data in an automated way. If they do not succeed in this, they might challenge the use of Regtechs, and this is not what we want.

Regtechs can potentially offer similar benefits to regulators as they do to financial institutions. We recently observed that some (quite few) Regtech providers have emerged to serve the significant needs of regulators. There have seen recently some examples in Fintechs bringing behavioral models to the regulators, or new cognitive technology or the use of Blockchain technology (smart contracts), to trigger automatic alerts for the regulators when the banks exceed some thresholds.

Some regulators are taking initiatives to foster innovation. In 2016, the FCA (US) created its “regulatory sandbox,” a space where financial services companies are encouraged to test new products without regulatory consequences. Recently the Australian Securities and Investment Commission also created its regulatory sandbox, suggested to establish a new regtech liaison group, comprising industry, technology firms, academics, consultancies, regulators and consumer bodies, and announced that it would host a Regtech hackathon later in 2017.

Other countries have also taken steps to support Fintech and Regtech innovation. The Monetary Authority of Singapore is in the process of developing a regulatory sandbox. We might expect other regulators to also take similar initiatives.

Conclusion

Thanks to their digital technology, Regtechs enable banks and other financial institutions to reduce the burden of compliance. However some steps need to be taken to create a level playing field and some topics will have to be clarified.
One can ask oneself the question how far these innovations can become game changers, awakenings for the banks, or even force them to more transparency and predictability towards regulators.

 

François de Witte – Founder & Senior Consultant at FDW Consult

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More articles on this subject:

PSD 2: A lot of opportunities but also big challenges (Part I)

PSD 2 : The implementation of PSD 2: A lot of opportunities but also big challenges (Part II)

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Blockchain and Supply Chain Finance: the missing link!

| 19-5-2017 | Carlo de Meijer | treasuryXL |

Our expert Carlo de Meijer is our blockchain specialist and publishes his articles on a regular basis. We present his latest article about blockchain and supply chain finance in a shorter version.
Carlo writes: Whereas the focus on the use of blockchain long time has been on payments and securities, an important but still undervalued use case has been supply chain finance. But that is changing. The complexity and scale of existing supply chain finance solutions has posed major challenges in ensuring adequate funding and efficient operations. According to some blockchain technology has the potential to be a game-changer for supply-chain finance. Let’s have a look.

Present state

Supply chain finance (SCF) is a generic term for a wide variety of financing instruments, used to finance various parties in a supply chain. SCF refers to the use of short-term credit to balance working capital between a buyer and a seller, thus minimising aggregate supply chain cost. Businesses can use supply chain financing to build stronger relationships with suppliers, decrease currency risk and ultimately improve liquidity.

Financial institutions offer supply chain financing solutions aimed at improving the purchaser’s working capital, and the supplier’s liquidity, by providing an efficient payables platform to streamline the payment process. Compared to the “old-fashioned” Letter of Credit, SCF now also encompasses new trade finance instruments including factoring, reverse factoring, payables financing, and dynamic discounting. Reverse factoring is the most popular and most widely used supply chain finance instrument. In reverse factoring, receivables are sold to a bank at a discount as soon as they are approved by the buyer. The bank then commits to pay the company’s invoices to the suppliers.

It is important to understand that supply chains are complex by nature; various parties are involved from raw goods supplier, producer and distributor all the way up to the consumer. This has posed major challenges in ensuring adequate funding and efficient operations.

Blockchain and supply chain finance

The question is: what can blockchain mean for supply chain finance and how could it be applied?

A blockchain-based supply chain finance solution more specific via so-called smart contracts will essentially enable all parties in a supply chain finance solution to act on a single shared ledger. A supplier and manufacturer, along with every other participant, will solely update their parts of the transaction, enabling efficiency and an “unprecedented” level of trust and transparency on a ledger record that is immutable.

“If you talk to supply chain experts, their three primary areas of pain are visibility, process optimization, and demand management. Blockchain provides a system of trusted records that addresses all three.” Brigid McDermott, vice president, Blockchain Business Development & Ecosystem, at IBM

Blockchain technology can offer great potential for both corporates and banks in terms of increased control, speed and reliability of their supply chain and at a fraction of the cost of their current infrastructure. Payments made via this digital system can be monitored by both parties, meaning that suppliers are no longer at a disadvantaged positon in the buying process while they wait for processing. Blockchain will speed up the process, giving the two companies more control, and in the long-term would ultimately create more robust supply chains.

Because the bank can see both the original contract as well as the order placed with “Company B by Company A”, it can verify both authenticity and provenance. Further, if the contract tracks manufacturing or transportation events, the bank can also know the state of fulfilment at any given time. What should be quite clear is that the visibility and auditability that are main characteristics of blockchain technology allow financial collaboration across supply chain echelons, not just bilaterally.

The time required from initiation to payment can therefore be dramatically reduced. In addition to the reduced transaction time, other benefits for importers and exporters include reduced bank fees (due to less manual activity on the part of the banks), reduced time for loan approval, and reduced risk of fraud. This way of financing a supply chain is radically cheaper and more efficient than the current way of doing business.

Blockchain: the missing link

Using blockchain may provide a simple system of secure record keeping that allows the bank redeeming CFS “to ensure that the CFS presented by the holders has been used to finance appropriate supply chain smart contracts”. At the same time suppliers using the blockchain system may retain the privacy that is need in their financial transactions with their sub-suppliers.

There are still challenges to be dealt with, too, such as the need to implement paperless trade, issues of data privacy, and how to get all members of a supply chain to participate. If global supply chains are to gain the full benefit of this technology for managing payments and related data, all parties that play a role in global trade must be involved!

By providing this missing piece of the information and supply chain management puzzle, blockchain may become the missing link!

Blockchain SCF projects

Since early this year the number of blockchain projects to improve supply chain finance is growing firmly. Especially IBM is very active in this area and partnered with companies in China and India to work on new blockchain-based solutions. IBM also teamed with Danish logistic and transport company Maersk Line, to create a new solution to digitize the global, cross-border supply chain using blockchain technology. Start-ups are at the same time popping up to help bridge the gap to this new technology, such as blockchain-based financial operating network Fluent, which aims to streamline supply chain finance.
“Blockchains built into supply chains can offer trust and accountability, as well as compliance with government regulations and internal rules and processes, resulting in reductions in costs and time delays, improved quality, and reduced risks,”Arvind Krishna, IBM Research Senior Vice President and Director Yijian Blockchain Technology Application System

 

Carlo de Meijer

Economist and researcher

 

 


You can read more about the different SCF projects in the complete article of Carlo de Meijer on LinkedIn.

 

 

National Blockchain Coalition: No Dutch Polder model!

| 8-5-2017 | Carlo de Meijer |

Now also The Netherlands (I am a Dutchman!) has its broad-based collaborative blockchain initiative. At the end of last month (30 March 2017), there was the official kick-off of the National Blockchain Coalition (“Nationale Blockchain Coalitie” in official Dutch language) (NBC) at the premises of the Ministry of Economic Affairs in The Hague. The National Blockchain Coalition is a collaboration of more than 20 organisations, governmental institutions and knowledge centres. At the same event the action agenda was handed over to The Dutch Economics Minister Henk Kamp on behalf of the partners of the NBC.

National Blockchain Coalition: raison d’être

The creation of the Coalition is an initiative of Team ICT, last year set up by the Ministry of Economic Affairs and is one of the action points in the “Digital Agenda” of the Dutch Government to accelerate the digitalisation of the economy.

The partners in the Coalition are convinced there is increasing need for corporates and government bodies to realise synergies between existing blockchain initiatives, facilitate them and bundle and share the knowledge already gained. Al these initiatives are being brought into the Coalition. But they also agreed that there is a need to create coherence between policy, regulation, supervision, maintenance and execution.

Main goal of the Coalition is to establish the preconditions needed for trusted and reliable blockchain applications. The collaboration aims, by means of collective initiatives, cooperation and knowledge sharing, to enable the Netherlands become front runner in the field of applying blockchain technology.

Some quotes (originally in Dutch!)

“The Blockchain Coalition stands for innovation and an open network approach. Cooperating on difficult issues that no one can solve on its own”. Minister Kamp

“Developing and introduction of blockchain ask for a coordinated approach of challenges by parties form various sectors. If The Netherlands in this pioneer stadium takes the chances there are, we could become a frontrunner in the blockchain area in the world”. René Penning de Vries, Team ICT

“We as employers organisation are extremely positive about this initiative and its timing. If we (in the Netherlands) collectively shoulder this project, I am firmly convinced that we will be frontrunner worldwide on blockchain.” VNO-NCW chairman Hans de Boer

“Most important lesson is that you cannot pick up this (blockchain) theme alone. Most value will be created if you bring more parties together and unites. That is also one of the main reasons to get to work with blockchain via a consortium”. Mariken Tannemaat, Chief Innovation Officer Nationale Nederlanden 

Partners

This joint initiative has 23 founding partners and 8 sustaining organisations. Because the application of blockchain technology is expected to have a big impact on the financial sector, as well as logistics and energy sector, these are the best represented sectors in the Coalition.

From the financial services side banks like ABN AMRO, ING en Volksbank and insurer Nationale Nederlanden participate.
Other partner organisations are: Havenbedrijf Rotterdam, Enexis, Alliander, de Koninklijke Notariële Beroepsorganisatie, Brightlands, CWI, Inspectie Leefomgeving en Transport (ILT), de KvK, RDW, Rijksdienst voor Identiteitsgegevens, ECP | Platform voor de InformatieSamenleving.
From the government side participating bodies are: Ministeries van Economische Zaken, Infrastructuur en Milieu, Veiligheid and Justitie en Binnenlandse Zaken en Koninkrijksrelaties.
From the knowledge centre side: TU Delft, Universiteit van Tilburg, Radboud Universiteit, Centrum Wiskunde & Informatica, NWO and TNO.
Supportive organisations include: AFM, Betaalvereniging Nederland, De Nederlandsche Bank, de NVB, DutchChain, SIVI, StartupDelta en Verbond van Verzekeraars.

Action Agenda

The action agenda is a joint initiative of the above mentioned organisations. In this action plan it is described which steps the Coalition is going to take in the coming period to realise the various goals. The agenda contains three lines of action to boost blockchain expertise and operational readiness in The Netherlands.
The partners of the National Blockchain Coalitie will primarily focus on the development of digital identities, with which persons, objects and legal persons in the blockchain can perform transactions as part of a blockchain. Working on these identification processes requires the focus on both interoperability (APIs) and standardisation.
”Goal is to create stronger identities for persons, so that repetitive verification is not needed. This is one of the preconditions needed to let blockchain function well”. Program manager Ad Kroft.
Besides that the Coalition will also work on solutions in the field of legislation and acceptation. It is thereby their intention to work on the right conditions under which blockchain can be used.

Also arrangements have been made regarding education, knowledge sharing and strengthen skills. The third line of action is realisation of the Human Capital Agenda to improve the level of knowledge and skills on blockchain, both at an information-technical as well as on social-scientific, economical, legal, ethical and business themes.

Positives

Blockchain has the potential to make business processes more efficient and reliable. The Coalition partners foresee great possibilities within the country for improvement of service delivery, better control of production processes, cost savings, reduction of fraud and reduced cyber risk.The Coalition also foresees positive effects on the autonomy of citizens, transparency of transactions, cybersecurity and reduction of administrative burden.
“Blockchain plays an important role in the further strengthening of trust in the world of digital transactions. This technology brings positive effects for the efficiency of organisations that are active in the financial sector.” Arjan van Os, Head Innovation Centre

No Poldermodel

Collaboration, certainly when talking about blockchain is a necessity. To discuss the rules of the game, agree on common issues etc. But the participating partners in this Coalition should prevent that the final results are weakened compromises (for the sake off!!). The partners in the Coalition should keep in mind that in this field a Polder model to keep everybody satisfied is not the way!!!! Because that will leave the Netherlands behind, not in front. Besides, the benefits of blockchain can only be reaped at the maximum in an international context. And not isolated. This asks for international cooperation.

 

Carlo de Meijer

Economist and researcher

 

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

 

 

 

 

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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.

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Carlo de Meijer

Economist and researcher