Distributed ledger technology (DLT), more commonly known as Blockchain, was originally invented in 2008. It allows groups of individuals who are anonymous to establish trust with each other by achieving consensus. More specifically, it is a shared database that updates itself in real-time, with the ability to process and settle transactions in minutes using computer algorithms, without the need for third-party verification, making these transactions highly secure.
PRINCIPLES OF BLOCKCHAIN TECHNOLOGY
There are some basic principles underlying blockchain technology:
- A distributed database: Each entity on a blockchain can access records on the entire database, but no single entity controls the data or the information.
- Peer-based communication: Communication is not through a central node, but occurs directly between peers. Each node stores and forwards information to all other nodes.
- Transparency: All transactions and associated values are visible to anyone with access to the system. However, each user can choose to provide their identity to others or remain anonymous.
- Permanent records: Once a transaction is entered, the records cannot be altered as they are linked to every transaction record that came before them in the “chain”.
- Computational logic: Due to its digital nature, blockchain transactions can be tied to computational logic and in essence, programmed. Users can set up algorithms and rules that automatically trigger transactions between nodes.
The potential financial impact of this technology is yet to be realised, but expectations are high. For instance:
- According to a report by Accenture, blockchain technology could reduce infrastructure costs for eight of the world’s 10 largest investment banks by an average of 30%, translating to $8 – $12 billion in annual cost savings for those banks
- McKinsey & Co predict that blockchain will drive savings of $50 – $60 billion in cross-border B2B payments, and $3 – $5 billion in cross-border P2P payments
- UBS Wealth Management says that blockchain could add as much as $400 billion of annual global economic value by 2027
- A recent World Economic Forum report predicts that by 2025, 10% of GDP will be stored on blockchains or blockchain-related technology
APPLICATION IN PAYMENTS
The technology could therefore have significant impact on the payments industry. More specifically, it could enable the following:
- Security: Most banking systems are built on a centralised database, creating a single point of failure that is more vulnerable; once hackers breach the one system they have full access. Blockchain-based platforms are almost impossible to infiltrate as it would require access to every computer system on the network simultaneously to succeed. Also, since each transaction is tied (in the chain) to previous transactions or records, and viewable by all participants of a blockchain distributed ledger, tampering with the data would require that the hacker also change all the previous records in the blockchain. Finally, participants can opt to set up a private or public blockchain; a private blockchain limits the number of participants that are verified and trusted.
- Know your Customer: Financial institutions spend $60 – $500 million per year to keep up with Know your Customer (KYC) and customer due diligence regulations according to a Thomson Reuters Survey. Blockchain would allow the independent verification of one client by one organisation to be accessed by other organisations so the KYC process wouldn’t have to start over again.
- Processing speed: The distributed ledger could make it possible to connect all the parties in a financial trade in real time for faster processingof a payment. For instance, if you use another bank’s cash machine (ATM) today, that bank must contact your bank to make sure you have enough funds in your account before dispensing the cash. If both banks used the same blockchain ledger, the bank could dispense the funds instantly without waiting for approval. In practice, this would need to be tested – although the transaction itself will register on the blockchain instantaneously, the funds would still need to move through existing systems, which may not always show improvements in speed.
- Audit trail: Distributed ledger technology can be leveraged by banks for their compliance efforts. The transparency of information and permanence of records makes it nearly impossible to alter or manipulate the data, so banks no longer have to keep redundant audit trails of transactions; the transaction ledger is the audit trail. Regulators and auditors have the capability to review transaction flows and controls directly within the network as all transactions are transparent to others in the network, and are therefore verifiable.
INVESTMENT IN BLOCKCHAIN
It is not surprising that banks and other fintech companies have blockchain as one of their key priority areas to explore.
- A PWC study found that total investment in blockchain startups was $1.6 billion in 2017, which is an increase of just over 2100% since 2015 (from $72 million).
- Similarly, the banking industry is also expected to spend ~$300 million on blockchain technology this year, according to McKinsey & Co.
EXAMPLES OF BLOCKCHAIN IN PAYMENTS & FINTECH
- MasterCard announced in November 2017 that it will be opening up access to its blockchain technology via its API; for the first time, MasterCard is offering the ability to send money over a blockchain rather than by swiping a credit card. MasterCard plans to implement the technology initially in the realm of business-to-business (B2B) transactions. The company believes its blockchain technology will help to address challenges involving speed, transparency and costs associated with cross-border payments. Besides payments, MasterCard envisions that companies could use its blockchain to track the movement of pharmaceuticals as well as luxury goods such as handbags and diamonds, thereby reducing fraud by providing “proof of provenance.”
- Fintech firm R3 and its consortium of 22 of the world’s biggest banks (including names like Barclays, BBVA, Commerzbank, DNB, HSBC, Intesa, KBC, KEB Hana Bank, U.S. Bank and others) have together developed an international payments system that would allow instant transfers of fiat currencies and existing central bank currencies to be transacted via a ‘blockchain inspired’ platform. The payment system is built on R3’s DLT platform, Corda, and relies on shared infrastructure to facilitate workflows. They expect live pilots to commence towards the end of 2018 and broader adoption in 2019.
- Ripple announced that more than 100 financial institutions now have joined its enterprise blockchain network RippleNet. Banks such as Santander, UniCredit, UBS and Royal Bank of Canada view Ripple’s payment protocol and its decentralised global exchange network RippleNet, as a valid mechanism for offering real-time cross-border payments. Many financial companies have subsequently announced experimenting and integrations with Ripple.
- SWIFT and 22 additional global banks (including names like ABN Amro, BBVA, China Construction Bank, Deutsche Bank, Erste Group, FirstRand Bank, JP Morgan, Rabobank and Santander) have joined its blockchain proof of concept (PoC), designed to explore whether this technology can help banks reconcile their international nostro accounts in real time, optimising their global liquidity. They joined a group of six founding banks (ANZ, BNP Paribas, BNY Mellon, DBS, RBC and Wells Fargo) who have been working since January 2017 to test and validate the new blockchain application.
- J.P. Morgan
- J.P. Morgan has created a blockchain payments network called the Interbank Information Network (IIN), with the aim of reducing the number of participants needed to respond to compliance and other data inquiries that delay payments. Royal Bank of Canada and the Australia & New Zealand Banking Group are the first to join the blockchain network, with other banks expected to join soon.
- IBM has begun processing payments over its own proprietary blockchain between banks in the South Pacific as well as Australia, New Zealand and the United Kingdom. They have teamed up with blockchain startup Stellar (a nonprofit organisation that supports an open-source blockchain network for financial services) and payment company KlickEx (a United Nations-funded, Pacific-region financial services firm) to launch a cross-border payment system for banks. IBM blockchain only transmits money in the form of Lumens, a virtual currency created by Stellar.
- Bill & Melinda Gates Foundation – Mojaloop
- The Gates Foundation have launched an open-source blockchain-based payment platform, named Mojaloop, as a payment service for the poor. Mojaloop’s mobile payment software, built as part of the Foundation’s Level One Project, is powered by the Interledger technology, which in turn was built by distributed ledger technology startup Ripple. The foundation is also working with other fintech companies to make Mojaloop easily accessible; an API for mobile systems companies developed by Ericsson, Huawei, Telepin, and Mahindra Comviva will make it easier for mobile money providers to integrate their services with, and build products for Mojaloop.
As with any new technology, blockchain will have its initial challenges as it grows. However, there is no denying that the underlying principle that governs blockchain has great applications across several industries. Within payments, money remittances and trade finance may well be the sectors where blockchain based applications first prove to have tangible value to end users in the near future.
To learn more about Penser’s experience in blockchain based payments, get in touch at firstname.lastname@example.org or +44-207-096-0061
- Transparent Transactions: How Blockchain Payments Can Make Life Easier For B2B Companies (Forbes, Nov 2017)
- Mastercard Will Now Let You Pay With Blockchain—But Not Bitcoin (Fortune, Oct 2017)
- Top banks and R3 build blockchain-based payments system (Reuters, Oct 2017)
- The Truth About Blockchain (Harvard Business Review (Feb 2017)
- Blockchain in financial services (PWC, Nov 2017)
- Blockchain and payments: further on the Gartner Hype cycle? (Finextra, Nov 2017)
- IBM is using the blockchain to speed up and simplify cross-border payments (TechCrunch, Oct 2017)
- McKinsey sees blockchain technology reaching full potential in 5 years (Brave New Coin, Jan 2017)
- Blockchain: Applications in payments (European Payments Council, Aug 2017)
- Practical Examples Of How Blockchains Are Used In Banking And The Financial Services Sector (Forbes, Aug 2017)
- Is blockchain technology secure for your company’s transactions? (CIO, May 2017)
- Why more people will use Blockchain-based payment platforms over banks in the future (The Next Web, Sep 2017)
- How Blockchain Improves Security and Transaction Times (Due, Apr 2017)
- Blockchain gains traction in FinTech as payment networks emerge (ComputerWorld, Oct 2017)