In 1995 an article in Newsweek, “Why The Web Won’t Be Nirvana” contained a list of reasons for why the internet would not change the world. The writer dismissed the possibility that people would buy books and newspapers online or use the internet to shop, buy airline tickets or make restaurant reservations.
He famously said “you can't tote that laptop to the beach” and “how come my local mall does more business in an afternoon than the entire Internet handles in a month?”. Technology has so surpassed his expectations that most people now don’t take their laptop to the beach but instead take their mobile phone which they also use to do their banking, book their holidays and post photos. So with the hindsight of 2016 his scepticism seems ridiculous.
The development of blockchain, or any distributed ledger technology, has been compared to the early days of the internet. At the moment it is hard to know whether the possibilities envisioned by the blockchain evangelists will come true or whether any scepticism will look equally foolish in two decades time.
Axel Pierron, managing director at consultancy Opimas, has stuck his head above the parapet in a report, “Blockchain for Capital Markets: A Pipe Dream”. He argues that blockchain will lead to greater transaction costs, create more complexity and lead to potential losses and legal disputes.
He calculated that if the French and German cash equity market moves to blockchain, the infrastructure cost for the industry to process last year’s volume of transactions would have been between €1bn ($1.1bn) and €600m more respectively. In addition trading on a blockchain system would also be slower and mistakes might be irreversible leading to potentially huge losses.
Pierron told Markets Media that rather than investing in “catch all” blockchain-related initiatives, market participants can solve problems with tried solutions. For example the industry utility model also addresses the “single version of the truth”, such as the data that has been provided by exchanges, while current technology has the ability to provide T+0 settlement.
Europe moved to a T+2 settlement cycle, the transaction date plus two business days, from T+3 in 2014, and the US is aiming to make the same move in 2017. Pierron said: “In the US the DTCC suggested moving to T+0 years ago but the industry back offices were not ready and asset managers also needed liquidity provision from their prime brokers and custodians.”
His report said the blockchain system relies on the “hashing” process that validates and writes every transaction so highly liquid and standardized markets are unlikely to benefit from currently available economies of scale. In addition, the system is only secure as long as the benefits of attacking the network (e.g. modifying a transaction) are below the cost of doing so. “This works effectively in the Bitcoin network where an average transaction is worth around $500, but is unlikely to have similar benefits in the capital markets environment,” added the study.
This scepticism flies in the face of funding to blockchain-related startups which grew from less than $10m in 2013 to $90m last year. In addition, each bank and infrastructure provider has launched its own blockchain project, in addition to the various consortiums that have sprung up.
Last month, for example, seven firms announced the successful test of blockchain technology and smart contracts to manage post-trade lifecycle events for standard North American single name credit default swaps. The group included Bank of America Merrill Lynch, Citi, Credit Suisse, JP Morgan, DTCC and Markit, in collaboration with Axoni, a distributed ledger technology firm.
Icap, the financial technology provider, said in March that its post trade risk and information division had successfully completed a proof of technology test case for a distributed ledger using the multi-asset messaging and matching Harmony network, and blockchain infrastructure provided by Axoni. The division imported matched messages from Harmony and converted them in real-time to blockchain-based smart contracts. The smart contracts were then distributed to nine representative participant nodes on the blockchain network, where trades were permissioned for additional services such as valuation, compression and reporting.
Pierron said the vast majority of blockchain initiatives will fall far short of their targets although he admitted it could be beneficial in low velocity, low volume markets such as lending to small businesses or niche areas not served by the big banks.
Back in 1995 it was hard for most people to imagine the possibilities of the internet, let alone imagine a future iPhone, apps or the spread of social media. Those who made the right bets emerged as winners and others, like Kodak and Blockbuster, fell by the wayside. The financial industry feels it has to invest in blockchain in case it turns out to be the next big thing but it should not forget that it can continue to innovate in other ways.
Even Pierron admitted: “At least blockchain has caused the industry to think about post-trade in radical ways.” That radicalism needs to continue and spread out to all parts of the business, not just the blockchain side projects. Then the industry will really reach nirvana.
