Season greetings 2016 !

Blockchain technology has been blooming in 2015, let's see how all those products will hit the market in 2016. Lot of fun and excitement in perspective !

All the best for 2016 !

Blockchain deploiement

A very promising technology

As mentioned already a few times here, Blockchain is a very promising technology in particular for financial services. In a recent study the consulting firm Oliver Wyman suggests that using Blockchain, banks could save per year by 2020 between 15-20B$ in infrastructure costs.

In the recent finnovasia meeting Stephens from UBS confirmed that blockchain will bring a real disruption 

But some limitation factors
 
This will not be achieved without using the technology at its full scale: the less native is the implementation, the more effort will be needed to ensure consistency with the existing systems. But there are some factors limiting the full adoption: some ecosystems are pretty complex. Securities for example, involves a lot of actors working together (clearer, exchanges, custodians, brokers, ...) which means that a full native implementation requires an agreement among all these actors on one standard.

Those ecosystems have been incrementally built over decades if not centuries. As described in a previous post, banks will need to define an integration strategy to gradually expand the blockchain grip.

Not a global deployment but some starting points identified

If a global deployment of such disruptive technology is quite unlikely (also due to the blooming technology offerings), in the finnovasia session about blockchain, as reported by Coindesk some starting points have been identified :

• Stephens for UBS said that blockchain will replace several hundred of internal ledgers.

• Alex Edana form WIP Solutions CEO said : "Australia will be the first market on the blockchain in three to five years," he said. "There, you only have [a small number of] banks and a couple exchanges."

This reinforcing the idea that the smaller, the easier. Small eco systems like Australia with less legacy will adopt blockchain faster.

It also shows that there is a benefit for large organizations to adopt such a technology internally in order to rationalize their internal processes. Remember that large organization do a lot of trades internally in particular between sales and trading center. Those trades are booked in each branch and need to be reconciled all time.

 

Hype curve ?

Hype curve @Wikipedia

This phenomenon in technology adoption is very well known. Blockchain will make no exception: the hype will grow and as first implementations will be partial, returns will be disappointing and hype will drop massively. Then little by little the small scale projects will demonstrate returns and will grow incrementally.

"Rome was not built in one day"

Why nations fail ? ... and why companies fail ?

Why nations fail ?

In this very inspiring book, called why nations fail ?, Daron Acemoglu and James Robinson demonstrate with a number of in depth examples that disappeared civilizations have failed because they have not been able to incentivise their citizens in creating value. 



Extractive civilizations are the ones where the elites try to extract the larger value from the citizens without giving any thing back. Value is extracted not only through taxes but also in redirecting towards the elites all the possible value, controlling monopolies, not respecting property and in some cases not even respecting the human rights of their citizens. 

In such a context, why should citizens be motivated in putting huge efforts in generating value when this value will be captured by the elite ? 

Among the number of examples brought by the authors to illustrate this theory, one is  fascinating : the Venice republic. This small town has been able within a very short time to expand its influence to whole Mediterranean area and in an even shorter time, they have collapsed completely !

Why ?

The reason why Venice republic has been so successful is that they have invented an inclusive governance in which the citizens were paid back from the efforts they put for generating value. As an example, Venice republic invented the joined venture: a shared model between navigators and merchants was in place to incitivise navigators to explore and trade with remote countries. Back to Venice those successful explorers were getting a reasonable part of the cake and were gaining influence within the city as the governance model was open to new comers. 
This illustrates the creative destruction coined by Joseph Schumpeter. 
Of course, creative destruction comes at the expense of established players and this is the very reason why elites are getting increasingly reluctant to support such an approach. They have climbed the ladder and they don't want to be challenged or even worse to be replaced by new comers.
This is exactly why, after years of success Venice republic failed : governance changes stopped the inclusion of new comers establishing a status quo among the established players. This froze innovation and growth and lead extremely rapidly to the decline.

What about companies ?

A strong parallel can be made with companies which are somehow similar to states : they set up  a governance  model which can be more extractive or more inclusive. Normally when they are small, they favour initiative and growth and tend to be more inclusive. Later, being established, they become extractive, extracting the more value possible from their employees and keeping the status quo as much as possible making them becoming in the end irrelevant. 

This theory about inclusive vs extractive approaches also explains the success of transformational leadership which aims at developing employees instead of only extracting value from them.

Goldman Sachs patents blockchain technology for Securities

Securities settlement  is a rather cumbersome process coming from the old days when securities were still materialised. The whole process is still needing some days to complete (between 1 to 3) generating some credit risks in the meanwhile.

Streamlining this process is therefore not only important from an efficiency view point but also from a credit risk perspective. If delivery versus payment is processed immediately,  it will optimise the processing costs and reduce the credit risks.

This is why Goldman Sachs put some efforts and investments in that mater which lead to issuing a patent which has been recently validated.

The idea here is to create a new currency called SETLcoin which will represent any kind of securities (called PIC in the patent). These new coins will be exchanged against other coins like bitcoin.

The patent is describing a coordinator which will ensure the simultaneous completion of the two transaction legs (money against securities).

This reinforces the view BNP Securities has shared in a research paper earlier this year, the securities industry is going to be severely impacted by the blockchain technology. In this paper, BNP presents two possible scenarios : a complete disruption where the market participants trade directly without any central body or a more conservative one where the established actors will embrace blockchain technology.

This patent has been filled something like one year ago and demonstrates how much interest the established actors have for this technology.

Goldman recently confirmed its forecast regarding the disruption blockchain will introduce, this post also shows the amazing investments the blockchain technologies have attracted.

Blockchain integration strategy

Blockchain technology is now generating a big hype in particular in financial services and is envisioned as the magic solution to solve all inefficiencies in particular in back-offices processes.

Even though it is true to say that those processes are sub-optimal and that blockchain can bring a lot of optimisations, blockchain should not be considered as a magic stick!

What blockchain and smart contracts will bring functionally is huge :

• a shared trade representation between the buyer and the seller, short cutting all the tedious reconciliations performed at multiple levels,
• a full life cycle management of the products through automated contracts and this being shared between the buyer and the seller,
• a realtime transaction backbone supporting all type of flows (money, securities, contracts, ...)

This will bring a lot of efficiencies only if there is in place a seamless integration of the blockchain ledger with the existing components banks may have.

To illustrate this, let's take an example on a derivative contract.
There, the blockchain could help in many ways:

• at front-office level, simulating the product with the customer instead of exchanging excel based term-sheets,
• once the product is fully defined and agreed, blockchain would allow an instantaneous booking, the transaction being signed by both parties (the seller in creating the product and the buyer in buying the product),
• the code defining the product would allow to generate all the flows for different events all along the lifecycle (coupons, barriers, termination, ...)
• reporting is also much easier, the transaction database is open and available to any application (even to the regulator ?)

As seen over this high level example, blockchain is impacting all banks' activities from front-office to accounting. Will the promise be delivered if blockchain is implemented as a separate system ? Definitely not!

If not integrated with the existing blocks, it will become a YASR (Yet Another System to Reconcile) bringing some value but creating also additional work to maintain its consistency with the existing blocks. Therefore, beside the tests banks are now conducting, before moving on further steps banks should consider the integration path with existing systems : accounting, market data, back and front office not forgetting risks and reporting.

Without those mandatory steps the full blockchain power will not be released!

Beyond bitcoin

As seen in the previous post, the Bitcoin technology is expanding since a few years beyond bitcoin it self.

More coins to start with ...

The first area of expansion has been in the crypto currency field : many other alternative currencies have been created such as Ripple, Litecoin to address specific needs like faster confirmations, lighter mining, … Those are still only currencies and there are hundreds of those mostly derived from bitcoin and litecoin, bitcoin being by far the one capturing the highest value. They differ mainly in terms of :

• Monetary policy
• Proof of Work / consensus mechanism

And then something more ...

Then came up the idea of using the bitcoin network for other assets than currencies. For this have been created the meta coins like Colored coins (painting a coin to express that it represents something different of a bitcoin) and Master coins

As said by the bitcoin inventor Satoshi Nakamoto, the bitcoin infrastructure is able of transacting other assets than currencies. Historically, the first one has been the Namecoin to manage dns like domain names.Then this concept has been extended to a large range of contracts such as market transactions. This is what is called blockchain v2

And finally everything in the blockchain !

Starting from there, ideas are blooming to use this infrastructure for a number of other domains touching intellectual property, notary, electronic id and even government topics like votes. This is what is called blockchain v3

Blockchain v2

Blockchain V2.0 is aiming to handle contracts and not only currencies. The development in this area is rather recent starting mostly in 2014

The main idea is to use the blockchain infrastructure to store any kind of contract on any asset transacted directly between two parties. This is bringing a generalization of the concept and hurting directly a number of market actors which are providing trust to the two counterparts of a transaction (Exchanges, Clearers, Custodians, …) As listed the technology can be used in a number of fields like :
• Financial transactions
• Public records
• Private records
• Attestations
• Physical asset keys
• Intangable assets like patents, trademarks

Financial transaction are quite close to currencies, the goal is there to trade an other type of asset. For records and attestations the goal is a little different for example your insurance company, instead of sending you a letter to prove that you are insured will send you as a blockchain transaction a proof that you own a contract. This can be reuse to attest that you own the contract you pretend owning.

DAC are companies that operate in a decentralized manner like SETI@home does for years, distributing tasks automatically to lots of agents. Distributed applications like blockchain are a first step in this direction : different mining companies operate the same application contributing to the blockchain infrastructure and earning transaction fees for doing this work.

Get rid of the man in the middle!

People say sometimes that blockchain is going to kill banks. This is not so sure, in their core business which is managing risk, all these technologies will help banks to increase efficiency. Some businesses (the man in the middle) will disappear and banks will have to adapt to this new landscape but for example risk transformation they perform will remain.

Ripple is offering connectivity between participants for clearing transactions directly. This is avoiding, for smaller banks the cost of correspondent banks to access the market. Fidor is one example of such a customer.

Ripple is currently pushing the concept further developing a smart contract stored in the blockchain. A smart contract is based on a Specific Domain Language which describes the terms of the transaction. This language can then dynamically alter the contract if some events are triggered. For example if a date or a market level is reached.

Ethereum is developing a full Turing machine on the top of Blockchain. This allows to build smart contracts that will be run in a distributed way and as for miners, the companies running the contract scripts will be rewarded. First version of this platform has been released in July

Bitshares on top of a smart contract technology is building a decentralized asset exchange which is going to be live next month. This exchange also provides the collateral mechanisms securing the transactions among participants

Crowdfunding can also be impacted : funders could directly transact with the company they would like to fund. Swarm for example is bringing crowd funding on blockchain.

All these examples clearlly show the trend we are heading for : connect directly counterparts together, getting rid of the man in the middle.

bitcoin or Bitcoin ?

This weird question is hiding a huge trend : the blockchain revolution. To be a little less cryptic, bitcoin comes in two flavours: a crypto currency (bitcoin) and the technology supporting it (Bitcoin). This is not only a little detail : the technology created for the bitcoin currency can be used for many other purposes and this is waht has been called blockchain v2 (and v3).

Under the hood, bitcoin is made of 3 elements :

The currency itself is only one of those components and the two others are the technology building the bitcoin system. The secured and open transaction database which is the heart of the bitcoin system is called blockchain. Because it stores transactions which appear to be on bitcoin but could be on any other asset, this technology is very attractive and reused in a number of projects under the banner blockchain v2.
The protocol is a peer to peer protocol used to connect all the bitcoin nodes together (remember that bicoin is a distributed system to be resistant to attacks).

What is all this technology bringing ?

Double spending

The Blockchain technology is solving the double spending issue which a very common issue even in the real world : how to avoid that a person is selling twice the same good ? We also face this problem through counterfeit money which is another type of double spending.

This issue is aggravated in an electronic world where everything can be copied infinitely.

Bitcoin infrastructure addresses this issue with the blockchain which validates the transactions in the mining process. All the valid transactions are confirmed by the bitcoin infrastructure and sends back unspent transactions output which are reflecting the new position.

Ensure trust

Trust is also a key issue over an insecure media such as internet. Messages exchange has to be reliable and secure. This is achieved through a peer 2 peer network which is less sensitive to attacks than any centralized architecture. The distribution is a key feature to ensure trust as all nodes run independently. Cryptography is also extensively used to protect content and ensure trust, making sure that sensitive content is not disclosed and that participants have clearly the rights they pretend.

Bring resilience

The distributed architecture not only makes the network more resilient it also avoids to centralize all the information in one location which could be more vulnerable to attacks, releasing sensitive personal data : no more honeypots so attractive to hackers! This is also making the system invulnerable to governments censorship.

The distributed architecture has been built not only to be more resilient to any kind of attack but also to avoid the man in the middle. In traditional processes, trust is ensured by a trusted body (state, central bank, exchange, ...) and transactions are flowing through this body which ensures trusts between counterparts. The blockchain technology brings this level of trust without any man in the middle which will have a huge impact on costs. Ripple which is, among other things, a money transfer agent is often viewed as the “Napster of payment”. It will have the same impact on Financial Services as Napster had on the majors of the music industry .