Bitcoin, blockchain, distributed ledger technology (DLT) and distributed consensus ledgers (DCLs) are the buzzwords of the payments industry, with many taking an interest in the financial revolution that they could bring. The bitcoin-inspired technologies have the potential to remove intermediaries of all kinds from the financial ecosystem. And in the world of corporate payments, the technology could potentially change how reconciliation is done, as well as enabling contracts to be embedded into transactions. In short, the inefficiencies of correspondent banking could be removed, and blockchain could transform the way that corporates go about their business.
Investment in blockchain companies has been accelerating, and, according to Needham & Company, $600m of venture capital investment is forecast for 2015. The large figure is symptomatic of the blockchain buzz, which was also reflected in the mood at this year’s Sibos in October. Many of the panel sessions at the SWIFT annual conference in Singapore lapsed into discussing blockchain, even when it wasn’t on the agenda.
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"Banks are navigating through the hype," says Accenture in an October 2015 report entitled Distributed consensus ledgers for payments. It also carries a warning: "The post-hype ‘trough of disillusionment’ for DCL looks imminent," it adds.
Gottfried Leibbrandt, CEO of SWIFT, said in his Sibos plenary speech that DLT could be used by banks in private networks to transfer assets. "I would like to think that SWIFT is well placed to host such blockchain communities," he said. He was also cautious: while showing photos of the Concorde, and a man wearing a jet backpack, he said that blockchain – like the supersonic plane – could end up being a technology that showed promise but never achieved mass adoption.
Despite this, many are keen to experiment. Tim Swanson, director of market research at innovation firm R3CEV, says, "Most of the large global financial institutions have been kicking the tyres on blockchain technology."
These include Citi and BNY Mellon, which have both developed their own cryptocurrencies. And UBS’s blockchain lab in London, Barclays’ accelerator programme and DBS’s hackathon for developers are just some of the initiatives in the industry.
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By GlobalDataPeer-to-peer payments
Blockchain is revolutionary in the sense that it removes the need for intermediaries. With peer-to-peer payments there is always a danger of ‘double spending’ – where a payment could be made twice – which is why there needs to be an intermediary to keep a record of the transaction. Bitcoin created a way to do this without relying on financial institutions.
With bitcoin blockchain technology, if Peter wants to pay Paul, he can send him a transaction message that is signed with his key. A distributed network of computers works through the cryptography in the message to validate the transaction. When a consensus is reached by the network, the transaction is added to the latest block in the chain. This forms part of the shared ledger, which, in the case of bitcoin, is public and available for anyone to see. People can transact between themselves and rely on the shared public ledger for reference, rather than the bookkeeping that banks do between themselves in the traditional payment process.
Cliff Evans, global CTO digital for consultancy firm Capgemini, says: "Blockchain has fantastic potential in changing the way that processing is done. The world as we know it – in transaction processing – has had to rely on a centralised database that is protected by large data centres. Blockchain distributes the processing so you do not need a data centre," says Mr Evans.
Applying distributed ledgers to corporate payments would reduce processing time and costs, and potentially make sending an international payment as cheap and easy as sending an email. Ripple is already applying distributed ledgers to payments and is addressing the inefficiencies of the correspondent banking system. With Ripple, which can be integrated into bank systems, corporates and banks can bypass the chain of agents in correspondent banking, and transact directly with each other.
A payment can take days to reach its destination and while it is in transit, the bank or corporate has to keep the funds in its account – sitting idle, unable to be put to better use – until the transaction is complete. This happens with banks and corporates in accounts all over the world, in numerous currencies. This collective float for international payments of millions, if not billions, of dollars, makes the financial system as a whole inefficient. There is also a foreign exchange risk for corporates as the value of the currency could drop during the time it takes for the transaction to be completed.
In October, when Ripple announced its latest solutions to the market, Chris Larsen, CEO and co-founder of Ripple said: "It is hard to believe, but outmoded payment infrastructure forces banks and their corporate customers to prefund foreign accounts for international payments, but then provides few assurances that cross-border transactions will actually settle. With Ripple’s new solutions, banks can now achieve real-time, certain settlement at the lowest total cost possible."
Smart contracts
Mr Evans explains that another feature of blockchain technology that applies to corporate payments is smart contracts. Bitcoin is permissionless and public, but it is also possible to create permissioned ledgers for closed communities with a specific purpose. This is what Ethereum allows groups to do. For example, a ledger could create an audit trail of ownership, such as a land registry, or a solution like Everledger, which has a transaction and ownership history of diamonds.
"Corporate payments are usually linked to some form of contract, such as a purchase order. With a smart contract you embed terms and conditions into the blockchain ledger," says Mr Evans. For example, the smart contract would have terms such as, if x then y; if the goods have been delivered, then the payment can automatically be released.
The smart contract is self-executing and removes the need for an intermediary. When buying a house and exchanging contracts, usually the funds are kept in a holding account by a third party – a solicitor – to make sure that one party isn’t left without the house, or the other without the money. With a self-executing smart contract, in theory, the contracts could be signed, the ownership transferred, and the funds sent, without the need for a solicitor to sit in the middle of the transaction.
Also, notes Mr Evans, the smart contract would work well where there are many parties involved. When goods are shipped, there could be a number of transactions linked to their arrival, such as customs duty, shipping costs, or storage fees. Once the goods have arrived a smart contract that links all these transactions can enable all the payments are made when certain conditions are fulfilled.
This does not just have the potential to change how things are paid for, but also how corporates do business. For example, in January 2015, IBM released a draft paper on ADEPT, a system that is a ledger for devices that connects an internet of things environment – where machines talk to each other – with smart contracts. In practice this could mean that when a washing machine is out of detergent, it triggers a condition in the smart contract so that more detergent is ordered from a retailer, and paid for.
Needham & Company’s report gives another example: a self-driving car could pay for a parking spot when its passenger gets out of the vehicle. Or an AirBnB host could have a smart contract that links the guest’s payment with a digital access pass to the room, which wouldn’t work once the stay has ended.
Devil in the detail
These examples, however, are merely indications of the potential of the technology and the industry is still in an immature, experimental stage of development. "When you talk about the capabilities, it is ok to talk generally about DLT or the blockchain. But when you do use cases, which set of protocols to use then becomes important. That is the first stumbling block," says Ms Glyptis.
"For the value to be delivered on DLT capability, you need a network effect, economies of scale," adds Ms Glyptis. While banks and technology companies are working on their solutions, various ledgers are being developed. "If you talk to start-ups they are very comfortable with the parallel blockchains existing. When you talk to financial institutions, unless you have the network effect or economies of scale you are just running expensive infrastructures in parallel," she says.
This issue with distributed ledgers is being addressed by R3’s initiative with banks. As of 2 November 2015, the consortium comprised 25 banks, which have joined the group to work toward creating industry-wide standards, as well as designing and applying the technology.
Some of the issues the industry is currently grappling with, says Ms Glyptis, are what an industrial implementation would look like, how it would plug into the existing infrastructure, and if two systems – the old and the new – have to run in parallel, what the benefits would be.
"We all agree that distributed ledger at scale would completely replace reconciliation as we know it," says Glyptis. There are many issues that need to be worked out, including the immutability of payment. Verification and validation of a payment cannot be changed with blockchain, which many see as one of its advantages. However, if there is an error that needs to be changed, there is not currently a method of fixing it, says Ms Glyptis.
Mr Swanson says that the biggest issue for the industry at the moment is "expectations management". He notes that nobody has built anything to scale and he compares some of the claims about bitcoin-inspired technology to the Linux movement. When that operating system was being developed, there were claims that IBM, Microsoft and Apple would be destroyed by the open-source software.
"Why did Linux on the desktop not take off? Because people want an OS [operating system], they did not want a hobby," says Mr Swanson. He draws a comparison with the bitcoin movement and some of the grand claims that have been made. "Bitcoin is very consumer unfriendly – you have to be a genius to understand how this works."
Mr Swanson believes there has been a lot of noise created by companies working in this space and there is a danger of them "over-promising and under-delivering". Given all the venture capital investment, Mr Swanson says, "If this industry does not deliver an industry-ready ledger in 18 to 24 months, it will have burned a lot of goodwill."
He compares the situation to the 1970s and 1980s when investment in artificial intelligence research dried up after initial claims were not delivered upon, creating an "AI winter". It’s possible, says Mr Swanson, the same thing could happen to blockchain research.
Mr Evans at Capgemini notes that the potential of blockchain and distributed ledger technology will bring a significant paradigm shift and a different approach to the way business has been done before.
"The question is, ‘Where will you see people making actual use of it?’," asks Mr Evans. He expects that it will be closed communities that will find value in the technology and develop specific use cases, and they will be the link to it becoming more widely adopted. "You have to have the business model as well as the IT model," he notes.
Ms Glyptis makes the comparison with other revolutionary technologies, and argues that the process of creating the steam engine from the lab to something that powered the industrial era took a number of years. "Opportunity up close looks like hard work," she adds.
"What I suspect will happen is that it will go quiet and people who are genuinely working on this will continue to do so – that is not necessarily a bad thing," she says.
