For all the hype around distributed ledger technology it’s most valuable use may be within the simplification of centralised systems.
When Bitcoin was conceived in 2009 it was done so as an alternate to traditional fiat currencies. The first iteration of blockchain implementations posited themselves as removing the need for government trust, delivering financial, or technical, transparency and empowering the “joe public” to regain control of their financial freedom.
In the beginning Bitcoin’s trust-less nature led to a new way of connecting with counterculture activities which historically had relied upon typical currency or sometimes humorous alternatives by accessing non-anonymous but distributed discussion systems. Within a few years, and in many cases motivated by individual financial gain, various spin offs have evolved into a plethora of solutions solving an endless number of problems. These include(d) solutions to settlement, distributed computing, foreign exchange, identity, cloud storage, purchasing goods, privacy, real estate and many many others.
Fast forward to 2017. Ethereum, a two year old, crowdfunded, blockchain based state machine, was discovered by the mainstream. This coupled with the birth of the “token” and initial coin offerings (ICOs) with the first notable example occurring about a year before called The DAO, triggered an avalanche of “revolutionary” concepts which espoused the benefits of decentralisation, spurned the control of centralised governance and promoted the engagement of the commoner. Nearly a trillion dollars has been “invested” in thousands of “instruments”. Many are dubious in nature, most, technically, variations on common themes. Many of these themes were problems, perhaps less efficiently, already solved by traditional financial services.
The hype-cycle continues to accelerate. Some enlightened people who have long observed emerging technologies, are at pains to point out, that according to Gartner’s research “blockchain” reached the tail end of it’s “peak of inflated expectations” and is now about to go through it’s “trough of disillusionment”.
So Blockchain is Dead?
The uncontrolled nature of most of these new technology deployments, coupled with the distinct lack, at least initially, of Wall Street involvement has led many of participants in the global financial system to either attack or deride the popular buzzwords, notably Bitcoin and ICOs, associated with blockchain technologies. The words “blockchain”, “distributed ledger technology”, “Bitcoin” and “Ethereum” are often used interchangeably by those without a deep understanding of the specific and technical differences that each of these nomenclatures implies.
Despite significant investment into these concepts (keyword: concepts), in any situation where large organisations, who compete with each other for financial gain, seek to cooperate, there is inevitable arguments, delays & fallout. The end result, at least initially, is that most of the adoption of blockchain by financial institutions has focused on removing the many middlemen, and technology stacks, between them. These direct relationships ease the regulatory & systematic friction commonly encountered by large organisations when implementing new technologies.
The Elephant in the Room
In most developed nations the regulatory environment for financial services imposes a significant number of reporting, control and assurance requirements and expectations. These are enabled by technology and translate to systems with many layers executing, checking, checking the checker then re-verifying daily, monthly and yearly. A government sanctioned method of identity is usual.
This combined with the demand by customers for a plethora of new products has led to huge technology investments by the banks. “Banks spend about 7% of revenue on technology or about 9% of total expenses”. It stands to reason that Australian banks, my home country and by some measures the most profitable in the world, have launched ambitious projects to deliver on community, regulatory, customer and shareholder expectations.
Australian banks, the Citi analysts suggest, have led the way in overhauling legacy systems. […] Citi reminds us that when Commonwealth Bank of Australia announced a replacement of its core IT system in 2008 […] the final price tag was A$1.3 billion over five years.
In the non-technology space the regulatory environment has remained rigid, while the technology has evolved around it. The foundation of a customers relationship with their bank is one of mutual trust. Trust that a person’s identity is truly them (KYC — Know Your Customer). Trust, that a bank is not complicit in delivery of nefarious activity (AML — Anti Money Laundering). Trust, that with or without intent, a bank’s employees do not corrupt the process of delivering financial services. Trust that banks balance their obligations effectively so that when a member of the public wishes to withdraw money they can do so quickly and seamlessly.
Achieving even the baseline of this obligation inevitably translates to significant technology requirements with software and outsourcing equal second only to the labour costs of looking after all this infrastructure.
The main reasons for this are many and varied. In future posts I intend to explain this a bit more in-depth but ultimately it comes down to duplication of technology systems. Fundamentally, in order to provide the various regulatory and customer requirements, banks typically implement multiple software systems catering to specific outputs.
Core Banking — Due for a rethink.
A customer’s interaction with a bank happens in a limited number of ways, notably online banking, telephone banking and in-person at a branch. One could be forgiven for assuming that in order to deliver these services banks require only a limited number of technology systems.
Those of us who have worked within the technology area of financial services know for a fact this couldn’t be further from the truth. In fact, many have made a career at resolving what is commonly referred to as “hairball architecture” with an entire industry of certifications for, “Enterprise Architecture”.
All of this starts when a bank decides on a core banking platform. Typically the primary “oracle” for the mathematical aspect of financial services (versus the customers personal information, compliance, marketing etc) core banking is ultimately the system which consolidates your account transactions and balances, calculates your interest payments and reports on a banks balance sheet.
Of the 25,000 banks estimated worldwide, most deploy core banking software from less than 20 established vendors. In this market there is a high barrier to entry due to the risk of disruption to a banks services, the use of technically complex but unproven software and the potential for regulatory scrutiny in the event a rollout does not go smoothly. This, coupled with typically high capital liquidity requirements, effectively blocks a software startup from being able to prove their technology. The result is very few new vendors are entering this space. This leads to established players consolidating their market share.
Despite this, there are an increasing number of Neobanks popping up around the world. These “soon to be” banks espouse their nimbleness, non-legacy deployment, adoption of emerging standards and strictly virtual existence, keeping their costs low and customers happy. Most of these are deploying new builds using “off the shelf” vendors primarily to improve their speed to market while a minority are balancing their regulatory obligations with managing a development team, no small feat.
If one was to look 10 years into the future, both of these approaches will have a technical architecture which will eventually look much like the established players they seek to disrupt.
The road to blockchain based core banking
Core banking platforms have remained unchanged for at least a decade. Side by side with banks (neo or otherwise) has been the blockchain movement although most participants seem focused on it’s apparent public applications.
Using concepts from this flurry of activity though provides an opportunity for smart contracts making per-instance products possible. This can also be coupled with the extension of already adopted cryptographic verification in use in the banking sector.
Here at Biza•io our vision is one where established financial service providers leverage the ever changing innovations occurring in the Blockchain & Fintech spaces in order to enhance customer experience, maintain compliance and increase transparency.
I hope you, the reader, can join us on this journey as we fundamentally rethink how banking technology is delivered.
About the author
Stuart Low is the Founder & CEO of Biza•io, a provider of open banking and blockchain software solutions. He was previously the Head of Innovation at Rabobank Australia & New Zealand. Stuart has 20 years IT experience including hosting, ISP, cloud, enterprise storage and datacentre infrastructure. Stuart has a keen interest in blockchain and has been following it’s development since 2012.