Where and when? Qualifying near-term opportunities for distributed ledger (‘blockchain’) technology

Those following the blogs in the blockchain series will have noticed an emerging thread of opinion on distributed ledger technology (DLT, ‘blockchain’) in financial services: It’s coming.

I fully accept it will take years for the industry to address the full set of barriers to universal DLT adoption. However, a string of recent milestones by banks (see Singapore’s central bank, Canada’s Scotiabank and the SBI Ripple Asia consortium) have shown that early adoption is possible in areas with relatively modest technical, legal and regulatory demands. It’s hoped that these early inroads will, in turn, enable the industry as a whole to better understand DLT, and address the blockers to more complex use cases.

Questions then turn to how organisations can identify such early adoption opportunities. This can itself be divided into two parts:

1. Conceptual fit: Is DLT fundamentally suited to a given use case, regardless of current practicalities?
2. Near-term feasibility: What challenges would a DLT implementation of that use case need to overcome, and what is the near-term outlook for solutions or workarounds?

The first of these, conceptual fit, is relatively straightforward. Various indicators, shown below, allow for a sense-check of whether a DLT idea is sufficiently ‘blockchainy’:

• A requirement for data to be shared between multiple parties
• A low level of trust between parties – possibly stemming from geographical separation, lack of verifiable references, or inherent incentives for parties to behave dishonestly
• Inability / reluctance to rely on a central authority (e.g. an exchange, trade repository etc.) as a common source of information, in some cases reflecting a lack of trust that extends to state-run organisations
• Potential for contractual ambiguity, which may translate into high incidence of disputes between parties
• Information being held in either non-digitised or otherwise non-standardised structures, leading to significant effort in reconciling statements
• Duplication of logical processes on each side of a transaction (e.g. modelling of cash flows to validate terms of a derivative contract)
• Significant back-and-forth interaction between parties in the course of a transaction, multiplying reconciliation and status tracking effort
• High transaction frequencies, providing a natural incentive for automation

It’s simple to show that many of the most commonly-cited use cases for DLT – cross-border payments, trade finance, Know-Your-Customer etc. – satisfy some, if not all, of these indicators, and we expect the industry to discover more as awareness of DLT grows.

In contrast, assessing near-term feasibility is a far more involved process.

On the technical side, it demands analysis of the privacy, performance and scalability requirements inherent in a use case, which must then be tested against the range of available DLT solutions – themselves continuing to evolve at pace. Legal and regulatory questions must also be tackled, with litigation and compliance risk varying massively depending on the parties involved and data being shared. Sandbox schemes, like that run by the FCA, offer a degree of safety for firms to experiment in this area, but would-be adopters still need to understand the legal implications of their DLT applications.

Beyond the general nature of the use case, those seeking to launch a DLT implementation need also to consider their organisation’s own context. DLT implementations have potential to disrupt a broad section of a bank’s operational architecture, which is generally subject to other competing change agendas under cost and resource constraints. In order to be successful, a DLT initiative therefore has to align an industry innovation opportunity with an area of the bank which is ripe for change.

Added to this are the challenges of multi-party dynamics. Most DLT use cases have no business case unless an organisation can transact with relevant partners, operating on the same network. Hence, such initiatives need to be multilateral from the outset, adding major decision volatility to the process: ‘Should we, as a bank, commit to doing this, before we know who else is definitely in?’

Given such challenges, it would be all too easy to conclude that the effort of identifying and establishing the case for a DLT implementation outweighs its benefits. This does not have to be the case. Up-front costs to explore new DLT concepts can be mutualised across many organisations, by participating in Fintech-led schemes. In particular, consortia such as R3 have proven effective brokers for bringing participants together, with the potential to spawn ready-made networks. The early tangible outputs from such collaborations can then be socialised internally within participating organisations, inspiring interest and building the case for larger-scale projects.

Forecasts that 15% of banks will be implementing DLT in 2017 speak to a clear demand for routes to productionise this technology. And whilst effective partnerships make this very achievable, DLT pioneers face a great deal of groundwork, both inside and outside their organisations, to identify use-cases which are both fit and feasible

Ultimately, those banks willing and able to lay these foundations now will emerge as the real leaders in this space. It is they who will reap the business rewards. It’s a question of when, not if.