Blockchain Revolution (updated)

by Don Tapscott

  Although many other applications pique the interest of Wall Street, what interests financial executives everywhere is the notion of using the blockchain to process any trade securely from beginning to end, which could dramatically lower costs, increase speed and efficiency, and mitigate risk in their businesses. Masters said, “The entire life cycle of a trade including its execution, the netting of multiple trades against each other, the reconciliation of who did what with whom and whether they agree, can occur at the trade entry level, much earlier in the stack of process, than occurs in the mainstream financial market.”25 Greifeld put it this way: “We currently settle trades ‘T+3’ (that is, three days). Why not settle in five to ten minutes?”26

  Wall Street trades in risk, and this technology can materially reduce counterparty risk, settlement risk, and thus systemic risk across the system. Jesse McWaters, financial innovation lead at the World Economic Forum, told us, “The most exciting thing about distributed ledger technology is how traceability can improve systemic stability.” He believes these “new tools allow regulators to use a lighter touch.”27 The blockchain’s public nature—its transparency, its searchability—plus its automated settlement and immutable time stamps, allow regulators to see what’s happening, even set up alerts so that they don’t miss anything.

  DR. FAUST’S BLOCKCHAIN BARGAIN

  Banks and transparency rarely go hand in hand. Most financial actors gain competitive advantage from information asymmetries and greater know-how than their counterparties. However, the bitcoin blockchain as constructed is a radically transparent system. For banks, this means opening the kimono, so to speak. So how do we reconcile an open platform with the closed-door policy of banks?

  Austin Hill called it Wall Street’s “Faustian bargain,” an onerous trade-off.28 “People love the idea of not having to wait three days to settle transactions but having them cleared within minutes and knowing that they’re final and that they’re true,” said Hill. “The counterpart to that is all transactions on the [bitcoin] blockchain are completely public. That terrifies a number of people on Wall Street.” The solution? Confidential transactions on so-called permissioned blockchains, also known as private blockchains. Whereas the bitcoin blockchain is entirely open and permissionless—that is, anyone can access it and interact with it—permissioned blockchains require users to have certain credentials, giving them a license to operate on that particular blockchain. Hill has developed the technology whereby only a few stakeholders see the various components of a transaction and can ensure its integrity.

  At first blush, private and permissioned blockchains would appear to have a few clear advantages. For one, its members can easily change the rules of the blockchain if they so desire. Costs can be kept down as transactions need only validation from the members themselves, removing the need for anonymous miners who use lots of electricity. Also, because all parties are trusted, a 51 percent attack is unlikely. Nodes can be trusted to be well connected, as in most use cases they are large financial institutions. Furthermore, they are easier for regulators to monitor. However, these advantages also create weaknesses. The easier it is to change the rules, the more likely a member is to flout them. Private blockchains also prevent the network effects that enable a technology to scale rapidly. Intentionally limiting certain freedoms by creating new rules can inhibit neutrality. Finally, with no open value innovation, the technology is more likely to stagnate and become vulnerable.29 This is not to say private blockchains won’t flourish, but financial services stakeholders must still take these concerns seriously.

  Ripple Labs, which has gained traction within banking circles, is developing other clever ways to relieve Faust. “Ripple Labs is aimed at wholesale banking, and we use a consensus method, rather than a proof-of-work system,” said CEO Chris Larsen, meaning no miners and no anonymous nodes are validating transactions.30 The company Chain has its own strategy. With $30 million in funding from Visa, NASDAQ, Citi, Capital One, Fiserv, and Orange, Chain plans on building enterprise-focused blockchain solutions, targeting the financial services industry first, where it already has a deal with NASDAQ. “All assets in the future will be digital bearer instruments running on multiple blockchains,” argued Chain CEO Adam Ludwin. But this won’t be the siloed world Wall Street is accustomed to, “because everyone is building on the same open specs.”31 Wall Streeters might want to capture this technology, but they will have to contend with the value innovation it enables, something they can’t control or predict.

  Masters also sees the virtues of permissioned blockchains. For her, only a small coterie of trading partners, some vendors and other counterparties, and regulators need have access. Those select few chosen will be granted blockchain credentials. To Masters, “permissioned ledgers have the advantage of never exposing a regulated financial institution to the risk of either transacting with an unknown party, an unacceptable activity from a regulatory point of view, or creating a dependency upon an unknown service provider such as a transaction processor, also unacceptable from a regulatory point of view.”32 These permissioned blockchains, or private chains, appeal to traditional financial institutions wary of bitcoin and everything associated with it.

  While Blythe Masters is the CEO of a start-up, her keen interest represents broader involvement of traditional financial actors in this sector. This embrace of new technology reflects a growing concern that tech start-ups can also upend high finance. For Eric Piscini of Deloitte, whose clients have undergone a great awakening over the past year, the “sudden interest in tech was not something that anyone was expecting.”33 The enthusiasm is spreading like a contagion into some of the largest and oldest financial institutions in the world.

  Barclays is one of dozens of financial institutions exploring opportunities in blockchain technology. According to Derek White, Barclays’s chief design and digital officer, “technologies like the blockchain are going to reshape our industry.” White is building an open innovation platform that will allow the bank to engage a wide array of builders and thinkers in this industry. “We’re keen to be shapers. But we’re also keen to connect with the shapers of the technologies and the translators of those technologies,” he said.34 Barclays is putting its money where its mouth is, cutting tens of thousands of jobs in traditional areas and doubling down on technology, notably by launching the Barclays Accelerator. According to White, “three out of the ten companies in our last cohort were blockchain or bitcoin companies. Blockchain is the greatest evidence of the world moving from closed systems to open systems and has huge potential impact on the future of not just financial services but many industries.”35 Banks talking about open systems—mon Dieu!

  The Financial Utility

  In the autumn of 2015, nine of the world’s largest banks—Barclays, JPMorgan, Credit Suisse, Goldman Sachs, State Street, UBS, Royal Bank of Scotland, BBVA, and Commonwealth Bank of Australia—announced a plan to collaborate on common standards for blockchain technology, dubbed the R3 Consortium. Thirty-two more have since joined the effort and every few weeks a new batch of the industry’s Who’s Who signs up.36 Questions remain about how seriously these banks are taking the initiative. After all, the barrier to joining the group is a commitment of only $250,000, yet R3’s formation marks a clear leap forward for the industry. Setting standards is critical to accelerate adoption and usage of a new technology and so we are optimistic about the initiative. R3 has poached some of the leading visionaries and technical practitioners in the sector to move the ball forward. Mike Hearn joined in November, adding to a team that includes Richard Gendal Brown, formerly the executive architect for banking innovation at IBM, and James Carlyle, now chief engineer of R3 and ex–chief engineer at Barclays.37

  In December 2015, the Linux Foundation, in collaboration with a huge group of yet more blue-chip corporate partners, launched another blockchain initiative, dubbed the Hyperledger Project. This is not a competitor to R3; indeed, Hyperledger Project counts R3 as a founding member, along with
Accenture, Cisco, CLS, Deutsche Börse, Digital Asset Holdings, DTCC, Fujitsu Limited, IC3, IBM, Intel, JPMorgan, the London Stock Exchange Group, Mitsubishi UFJ Financial Group (MUFG), State Street, SWIFT, VMware, and Wells Fargo.38 Still, it demonstrates how seriously the industry is taking this technology and also how reluctant it is to embrace fully open, decentralized blockchains like bitcoin. Unlike R3, Hyperledger Project is an open source project that has tasked a community to develop a “blockchain for business.” This is certainly laudable and may very well work. But don’t be mistaken: This is an open source project designed to build gated technologies by, for example, limiting the number of nodes in a network or requiring credentials. As with R3, one of Hyperledger’s priorities is standard setting. David Treat of Accenture, a founding member of the group, said, “Key to this journey is to have standards and shared platforms that are utilized across industry participants.”

  Blockchain has also opened up a broader discussion about the role of governments in overseeing the financial services industry. A “utility” conjures images of natural monopolies, highly regulated by the state. However, because blockchain technology promises to reduce risks and increase transparency and responsiveness, some industry players suggest that the technology itself functions like a regulation.39 If regulators can peer into the inner workings of banks and markets, then surely we can simplify some laws and repeal others, right? This is a tricky question to answer. On the one hand, regulators will have to rethink their oversight role, given the breakneck pace of innovation. On the other hand, banks have a track record of acting without integrity when government steps away.

  Will the big banks reign supreme by deploying the blockchain without bitcoin, cherry-picking elements of distributed ledger technology and welding them to existing business models? R3 is only one of many signs banks are moving in this direction. On November 19, 2015, Goldman Sachs filed a patent for “methods for settling securities in financial markets using distributed, peer-to-peer and cryptographic techniques,” using a proprietary coin called SETLcoin.40 The irony of a bank patenting a technology originally intended as an open source gift to the world is not lost on us, nor should it be on you. Perhaps this is what Andreas Antonopolous feared when he warned an audience that banks would turn bitcoin from “punk rock to smooth jazz”?41 Or perhaps banks will have to compete with best-in-class products and services amid radically different types of organizations whose leaders oppose everything these companies represent.

  The financial utility of the future could be a walled and well-groomed garden, harvested by a cabal of influential stakeholders, or it could be an organic and spacious ecosystem, where people’s economic fortunes grow wherever there is light. The debate rages on, but if the experience of the first generation of the Internet has taught us anything, it’s that open systems scale more easily than closed ones.

  THE BANK APP: WHO WILL WIN IN RETAIL BANKING

  The Google of Capital—that’s what Jeremy Allaire is building, “a consumer finance company providing products to consumers to hold money, send money, send and receive payments; the fundamental utilities that people expect out of retail banking.”42 He sees it as a powerful, instant, and free utility for anyone with access to an Internet-enabled device. His company, Circle Internet Financial, is one of the largest and best-funded ventures in the space.

  Call Circle what you like, just don’t call it a bitcoin company. “Amazon was not an HTTP company and Google was not an SMTP company. Circle is not a bitcoin company,” said Allaire. “We look at bitcoin as a next generation of fundamental Internet protocols that are used in society and the economy.”43

  Allaire sees financial services as the last holdouts, and perhaps the largest prize, to be fundamentally transformed by technology. “If you look at retail banking, there are three or four things that retail banks do. One is that they provide a place to store value. A second is that they provide some kind of payment utility. Beyond that, they extend credit and provide a place for you to store wealth and generate potential income.”44 His vision: “Within three to five years, a person should be able to download an app, store value digitally in whatever currency they want—dollars, euro, yen, renminbi, as well as digital currency—and be able to make payments instantly or nearly instantly with global interoperability, with a very high level of security and without privacy leakage. Most importantly, it will be free.”45 As the Internet transformed information services, the blockchain will transform financial services, instigating unimagined new categories of capability.

  According to Allaire, the benefits of blockchain technology—instant settlement, global interoperability, high levels of security, and nearly no-cost transactions—benefit everyone whether you’re a person or a business. And what of his plan to make it all free? Heresy! say the world’s bankers. Surely, Goldman Sachs and the Chinese venture firm IDG did not commit $50 million to create a nonprofit or public benefit company!46 “If we’re successful in building out a global franchise with tens of millions of users and we’re sitting at the center of transaction behavior of users, then we are sitting on some powerful assets.” Allaire expects Circle to have “the underlying capabilities to deliver other financial products.” Though he wouldn’t speak to it specifically, the financial data of millions of customers could become more valuable to the company than their financial assets. “We want to reinvent the consumers’ experience and their relationship to money and give them the choice of how their money is used and applied and how they can generate money from their money.”47 Leaders of the old paradigm, take notice.

  Companies like Circle are unburdened by legacy and culture. Their fresh approach can be a big advantage. Many of the great innovators of the past were consummate outsiders. Netflix wasn’t invented by Blockbuster. iTunes wasn’t invented by Tower Records. Amazon wasn’t invented by Barnes & Noble—you get the idea.

  Stephen Pair, CEO of BitPay, an early mover in the industry, believes newcomers have a distinct advantage. “Issuing fungible assets like equities, bonds, and currencies on the blockchain and building the necessary infrastructure to scale it and make it commercial don’t require a banker’s CV,” he said. For one, “You don’t require all the legacy infrastructure or institutions that make up Wall Street today. . . . Not only can you issue these assets on the blockchain, but you can create systems where I can have an instantaneous atomic transaction where I might have Apple stock in my wallet and I want to buy something from you. But you want dollars. With this platform I can enter a single atomic transaction (i.e., all or none) and use my Apple stock to send you dollars.”48

  Is it really that easy? The battle to reinvent the financial services industry differs from the battle for e-commerce in the early days of the Web. For businesses like Allaire’s to scale, they must facilitate one of the largest value transfers in human history, moving trillions of dollars from millions of traditional bank accounts to millions of Circle wallets. Not so easy. Banks, despite their enthusiasm for blockchain, have been wary of these companies, arguing blockchain businesses are “high-risk” merchants. Perhaps their reluctance stems from the fear of hastening their own demise. Intermediaries have sprung up between the old and new worlds. Vogogo, a Canadian company, is already working with Coinbase, Kraken, BitPay, Bitstamp, and others to open bank accounts, meet compliance standards, and enable customers to move money into bitcoin wallets through traditional payment methods.49 Oh, the irony. Whereas Amazon could leapfrog incumbent retailers with ease, the leaders of this new paradigm must play nice with the leaders of the old.

  Perhaps we need a banker with Silicon Valley’s willingness to experiment. Suresh Ramamurthi fits that bill. The Indian-born former Google executive and software engineer surprised many when he decided to buy CBW Bank in Wier, Kansas, population 650. For him, this small local bank was a laboratory for using the blockchain protocol and bitcoin-based payment rails for free cross-border remittance payments. In his view, would-be blockchain entrepreneurs who don’t understand the nuances
of financial services are doomed to fail. He said, “They are drawing a window on the building. Making it look nice and colorful. But you can’t assess the problem from the outside. You need to talk to someone from inside the building, who knows the plumbing.”50 In the past five years, Suresh has served as the bank’s CEO, CIO, chief compliance officer, teller, janitor, and, yes, plumber. Suresh now knows the plumbing of banking.

  Many Wall Street veterans don’t see a battle between old and new. Blythe Masters believes there are “at least as many ways for banks to improve the efficiency and operations of Wall Street as there are opportunities for disruption from new entrants.”51 We can’t help feeling the tides turning toward the radically new. That’s why the Big Three TV networks didn’t come up with YouTube, why the Big Three automakers didn’t come up with Uber, why the Big Three hotel chains didn’t come up with Airbnb. By the time the C-suites of the Fortune 1000 decide to pursue a new avenue of growth, a new entrant has broadsided them with speed, agility, and a superior offering. Regardless of who lands on top, the collision between the unstoppable force of technological change and the immovable object of financial services, the most entrenched industry in the world, promises to be an intense one.

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