The Financial Services Blockchain Journey: 3+1 Adoption Paths

Updated: May 31, 2019

BC Gateways financial services blockchain adoption paths

Blockchain generating increasing interest within financial services

​Blockchain technology, most known for being the technology underpinning cryptocurrencies, is increasingly generating a huge amount of interest within the financial services industry. In the past few years, we have seen the industry move from disbelief towards the realisation that blockchain is indeed real and has immense potential.

The prize on offer is a new architecture and approach to data management where all participants work from common datasets, in near real-time, and where supporting operations are streamlined making duplicate reconciliation processes redundant and a thing of the past.

The technology’s inherent features of decentralisation, immutability, efficiency, cost-effectiveness, and security are driving support for adoption along the entire spectrum of financial services.

Incumbent institutional players, infrastructure providers, and FinTech start-ups are all working on developing potential use cases across vital functions including payments, clearing and settlement, and compliance to further the industry’s journey towards mainstream adoption of blockchain.

Particularly, the technology presents massive potential in non-payment transactions and information-driven ecosystems such as wealth management across time-stamping, regulatory reporting, tax reporting, and fund data distribution and management.

So what exactly is the prize on offer for blockchain adoption in financial services? What is the most likely adoption path to making blockchain ‘real’? And how will the industry’s journey progress into the future?

The blockchain promise and what it means for financial services

As the understanding of blockchain and the financial industry’s attitude towards it matures, the technology is no longer considered for applications in cryptocurrency alone. Instead, it’s perceived to have a much wider potential where it could have a profound impact on critical financial services functions and processes.

Blockchain enables shared databases and a chronological chain of activity of multiple users interacting through complex relationships. It is a decentralised ledger that keeps a record of each transaction that occurs across a peer-to-peer network and provides real-time synchronicity and a robust audit trail. Its design and protocol create an ecosystem where all participants can trust information without having to trust other participants.

Particularly in environments driven by informational transactions, the technology can solve multiple business challenges including:

  • Strengthening data integrity: Using a Shared Source of Truth allows all participants to operate using the same dataset where data origination is verified, and distribution is auditable.

  • Improving efficiency: Maintaining a single ledger for all transactions confirms a complete, consistent, and current view of all transactions at any given moment which drastically reduces duplicate reconciliation processes. 

  • Facilitating business networks: Instead of multiple one-to-one relationships, the shared nature of blockchain-enabled distribution networks helps build a sense of community that eliminates time and money spent on verification as information moves down the value chain.

In financial services, the combined effect of the blockchain promise is reduced cost, complexity and risk. As the industry is desperately looking to shave costs and increase returns to investors, the exploratory phase of blockchain is gradually coming to a close and the adoption of real use cases is beginning to accelerate.

Making the blockchain ‘real’

Even though the understanding of the technology as a concept has matured over the years, the day the blockchain becomes ‘real’, meaning industry-wide adoption, remains somewhat of a moving target.

The mixed messages sent by both institutional players and regulators, which dictate the narrative around cryptocurrencies, have a delaying effect on progressing blockchain applications from Proof of Concept to operational deployment.

As such, making the blockchain ‘real’ is an ongoing journey that will go through at least one of three adoption paths: direct competition, parallel system, or full replacement.

Direct competition: disruptors on the outside

There is certainly no shortage of FinTech start-ups developing blockchain applications, operating on the fringes of the financial services system. These are the ‘disruptors’ that are in direct competition with the existing system and often aim to displace incumbents completely in the process of reshaping the future landscape.

In comparison to big institutional players, they certainly have the advantage of being able to experiment more and take on a level of risk which wouldn’t be possible in a regulated environment.

However, developing a business model that can be monetised is proving to be a challenge as competing with the existing system is making it harder to gain traction – and their solutions often rely on adoption from several counterparties for one participant to realise the benefits.

Indeed, it’s estimated that 90% of start-ups fail as they have difficulty securing users and spend most of their cash resources on development, without validation that there is a real need for the product.

Parallel system: collaborative industry

In a bid to stay ahead of the game and reduce the risk of being displaced, existing participants are working on their own use cases that run in parallel to the existing system to complement or enhance current processes.

Some of the projects are of a limited nature that only develop standalone internal applications, yet the more promising developments are taking place through industry-wide collaboration and industry consortia.

A great illustration of the potential of industry-wide collaboration is the Utility Settlement Coin (USC) project led by UBS. The goal is to make USC the digital cash equivalent of each of the major currencies backed by central banks. This allows banks to enhance interbank financial transactions to reduce time, cost and capital required for the post-trade clearing and settlement process.

Members of the project include Barclays, Credit Suisse, Deutsche Bank, BNY Mellon, Banco Santander, State Street, HSBC, CIBC, NEX, and MUFG.

Yet the collaborative approach is time consuming and typically hampered by the need to achieve consensus where different actors in the value chain have conflicting preferences across technical protocol choices, industry standards, and alignment with internal processes.

The ASX blockchain replacement of CHESS serves as a good example of a tech project which was a brave step when it was announced in 2015, yet already looks like it may be dated by the time it is implemented and straight up legacy within a couple of years more. 

Full replacement: policy mandate

The adoption path for blockchain technology in financial services through a policy mandate will certainly have the greatest impact as it would mean a full replacement of existing systems, yet it is also the slowest approach.

Any policy desire to implement change on this scale would require multiple rounds of consultation before any final directive evolves that market incumbents would be willing to accept.

This path to adoption is less likely to happen on its own volition as it depends on a tipping point for blockchain technology where its operational feasibility has been proven through parallel systems in a range of markets and across several critical functions.

Until the switch to blockchain becomes absolutely necessary and inevitable, a policy mandated adoption is still a long way off.

The 4th path to adoption: ‘Friendly Disruption’

Full-scale blockchain adoption will require a combination of the three previous paths, under a single adoption path BC Gateways refers to as ‘Friendly Disruption’.

The Friendly Disruption path takes into account that the journey towards a global financial services system based on blockchain will require a step-by-step adoption process, rather than a Great Reorganisation at a single point in time. Individual use cases for the technology will be identified and developed that can be adopted within or alongside today’s architecture.

In order to truly reshape financial services, major institutional players need to take a collaborative approach and work with innovators operating on the fringes of the system.

Certainly, the trade-finance collaboration between DBS, Standard Chartered Banks and Ripple serves as an example of a growing acceptance in institutional policy to support blockchain growth by working with outside innovators.

The experimental start-up approach combined with the more cautious institutional approach results in a blockchain journey where tailored solutions address real-world challenges, industry standards are developed, and existing strengths of the ecosystem are preserved.

All while navigating the complex and ever-changing worlds of legal and regulation oversight in a way that serves as the gateway to a possible policy mandate in the future.

For any blockchain application to gain traction and mainstream adoption, it needs to use familiar processes based on industry standards and minimise system re-engineering requirements.

That’s how we can make the technology real. That’s how we can make blockchain easy.