While there are still many people who believe that blockchain will prove to be a bigger revolution than the internet, the hype is clearly dying down. Josephine Gallagher speaks with experts in Europe and Asia to see where there are still hurdles that need to be overcome—or if they can be overcome.

Blockchain: The industry was promised a panacea—what has been delivered so far is aspirin. While there have been small implementations to date, there are many in the industry who are underwhelmed by this purported revolution.

“I think blockchain by itself is just another technology,” says Huayi Dong, global head of electronic trading solutions at Daiwa Capital Markets. “It has been overhyped with a lot of people saying it is going to change and revolutionize the world.”

Blockchain—used in this story as a catch-all term for distributed-ledger technology (DLT)—is not snake oil. To Dong’s point, it is a technology and it can be valuable—in the right instances. But the hype around this technology has far outstripped its reality. 

While capital markets firms have spent the last four to five years experimenting with this subset of DLT for a myriad of fixes, actual large-scale, real-world rollouts have been few and far between. Granted, a number of internal applications have found some success at banks—most notably in the trade finance world—these have been focused on improving internal processes, but not on solving industry-wide problems.

The so-called promises of blockchain-powered markets have shown little substance to date, particularly as the maturity, cost, and trust in the technology continues to stand in the way—causing some to shelve early projects, with others failing to meet go-live deadlines, as WatersTechnology has covered in the past.

Two of the more ambitious examples of development include the Australian Securities Exchange’s (ASX’s) blockchain-based clearing and settlement equities system and the Depository Trust and Clearing Corp.’s (DTCC’s) blockchain-powered Trade Information Warehouse for settling credit derivatives. While these projects are progressing, they have each repeatedly been delayed due to the need for further development and client testing.  

As a result, the skeptics are growing in number. For this story, WatersTechnology spoke with several industry experts from banks, exchanges, clearing firms, and technology providers to see where there’s still hope for blockchain, and where the naysayers are getting louder.

Herding Cattle

Trust is essential for the success of any large-scale project. That proves truer when it involves the commitment and inclusion of counterparties and institutional clients spanning the industry on a multi-party network. Reflecting on his experience with post-trade projects, Roger Storm, head of central counterparty clearing, risk, and policy at SIX, describes this concept as “a cattle-herding challenge.”

In other words, one of the major roadblocks to blockchain adoption is garnering the support for the technology and onboarding clients to a new and unfamiliar system—especially for something that might be challenging (and costly) at the outset, but that can have long-term benefits. In the beginning stages, this means achieving the minimum viable ecosystem to get the project rolling, in order to explore the technology’s capabilities, conduct testing and tackle performance problems head-on.

There have been certain small examples, but not on a broader basis that the industry can benefit from. It is more in terms of tactical fixes here and there between counterparties as opposed to market structure use cases such as a clearinghouse or otherwise.

Head of derivatives trading at a tier-1 bank

Without a community to nurture its growth—whether that’s employees or groups inside a bank, or larger industry initiatives involving a swath of firms—it is hard to get the ball rolling. This may help to explain the hype—and need for hype—that is pervasive in the blockchain space.

“Any new technology, for it to become ubiquitous, needs to cross the threshold where the network effect kind of becomes self-fulfilling,” says John Whelan, head of digital investment banking at Santander. “This idea of ‘virality’—for example, the telephone is only useful if everyone else has a telephone.”

Added to that is the cost of switching over to a new system. Many industry experts spoken to for this piece are unconvinced of its abilities to perform as well as existing technologies that are cheaper to run. Some alternative database models or shared ledgers include data replication systems, where data is copied from a central location and distributed in seconds to the other user locations. Other examples, depending on the use case, include hashgraphs, an alternative type of distributed-ledger technology that claims to be more scalable than blockchain.

Cliff Richards, executive general manager of post-trade services at ASX, who is heading up the exchange’s Clearing House Electronic Subregister System (Chess) replacement, explains that ASX’s decision to choose a blockchain-based platform, which was built by Digital Asset, over other technologies involved the “quality of trust” it offers for extended use cases beyond just clearing and settlement, such as for syndicated loans.

He says that as a result of the technology, counterparty clients will have the option to make frictionless data transfers for syndicated loans on the blockchain without interaction from a trusted central authority. The central party will be present only in operating the technology and governing the rule book, while not having access to all the data.

“Part of the reason for choosing the blockchain is to have the ability to have both centralized high-trust use cases through to lower-trust use cases—that was part of the driver,” Richards says.

But making the case for the technology and convincing counterparty firms to migrate to a new system is an onerous task for any firm. Chess has been bolted into the clearing and settlement systems at brokerages and custodians in the region for a quarter century. To migrate, the journey will involve unravelling the data stored in legacy systems, entering a world of standards for messaging such as ISO 20022, and then shifting that onto a new blockchain platform.

When the move was originally proposed, there were plenty of firms that asked, “Why?” Since then, it’s been a test of winning hearts and minds. That can be tough when there’s a certain fear of the unknown.

“I have empathy for our clients because in some ways this is a big change and in some ways, this is not,” Richards adds. “They do have optionality, but I would be remiss not to say that it was a challenge. But the technical and change challenges are actually not the biggest obstacles; the biggest obstacles remain their uncertainty about all the future benefits.”

He says the firm is working to overcome these hurdles through the provision of information forums and engagement consultations to its clients on all aspects of the changeover.

As a way of avoiding market disruption, ASX is also offering clients  optionality when it comes to connecting to the platform. In April, the securities exchange announced the go-live of its Customer Development Environment (CDE), where users can test three connectivity options including DLT node access, and ISO 20022 global messaging standard via AMQP and Swift. The exchange is offering free access to the platform if they choose to connect via a blockchain node in the first-half of 2021 for the first three years to lure early adopters. 

Although, offering the option to connect to the platform via traditional means is necessary to prevent complete disruption to the Australian cash and equities market, some believe it may, in fact, discourage firms from switching to the node connectivity or the new system. “You can have many other ways of doing the same thing. So with Chess, the great thing is that [client firms] are still allowed to use the old system and are not forced to jump on to the new Chess [blockchain system]. But what do you think the adoption rates are going to be?” Dong says 

In a subsequent discussion with ASX, it later confirmed that the old Chess system will be turned off when the switch over occurs but that firms will be allowed to connect to the new platform via ISO messaging or a DLT/blockchain node. 

Blockchain Models

Digging a little deeper into the structure of the technology, it is important to understand some of the reservations around the types of models that exist today. The most widely known is the consensus models, where every individual stakeholder in the network has to verify the content published on the distributed ledger at each node, creating a single version of the truth.

However, the core concern with this, which has planted seeds of doubt in the minds of some participants, is its ability to scale and process enterprise-level transactions. Although some breakthroughs have been made to improve the throughput and latency of blockchain over the last 18 months, Richard Leung, CTO at Hong Kong Exchanges and Clearing (HKEX), explains that existing use cases still have a long way to go before they have the capacity to withstand modern-day transaction volumes.

This is not how the original blockchain concept was intended to be used, because the consensus capability in blockchain is not being utilized really.

Richard Leung, HKEX

In an interview with WatersTechnology earlier this year, Stacey Cunningham, president of the New York Stock Exchange (NYSE), had this to say about using a blockchain-based system to underpin the exchange’s new Pillar trading platform: “Blockchain technology does not support the scale of processing and time of processing that you need in the equity markets if you’re talking about matching trades. There might be some functions within the equity market that can consider leveraging components of blockchain technology, but if you’re talking about the largest exchange in the world, blockchain is not ready to process that.”

While there is no question that the technology still has a way to go to overcome its volume and latency obstacles, proponents hope that more mature versions of blockchain will be able to eliminate the need for reconciliation, which will help ease latency and costs in other areas of the trading lifecycle.

Other characterizations of blockchain are non-permissioned-based chains (or public blockchains, accessible by anyone) or permissioned-based chains (private blockchains, accessible through an approval process). Private blockchains are often run by a consortium of firms that opt into the network.

However, in recent years, some say the lines between blockchain ecosystems and permission-based chains have blurred as central counterparties such as exchanges, clearing or financial institutions operate the network—defeating the purpose of a decentralized system, from which blockchain originated over a decade ago.

“This is not how the original blockchain concept was intended to be used, because the consensus capability in blockchain is not being utilized really,” explains HKEX’s Leung. “And in this scenario, if you need something to keep a record, you don’t need blockchain; you can simply use a database for this. So you have to always question whether the rollout and use of blockchain are appropriate.”

As blockchain models continue to evolve, another element of the discussion that has garnered attention is the governance of private platforms, as it may be that enterprise-level blockchains still have to incorporate centralized characteristics, particularly in such a highly regulated industry.

“Something I think is truly not talked about enough is the governance,” said Ben Spiegelman, corporate development lead at Symbiont, speaking during a panel discussion on DLT production at Synchronize Europe on June 19. “So when you are in a permissioned network, someone has to decide who are those new institutions joining that network; if they are bad, who is removing them; and who is going to own that governance. I think that is a big question posed for enterprise blockchains now and in the future.”

• READ MORE: How willing are these blockchain evangelists going to be to hold their hand up and say, “You know what, we tried, but honestly, there are other tools and platforms that are more appropriate for financial technology than blockchain.”? That’s how you lose a job, fair or not.  Click here to read Anthony Malakian’s thoughts on the current state of blockchain development in the capital markets.

Tech Risks

When it comes to the challenges regarding blockchain, people tend to list an array of concerns, such as slow throughput, issues with scalability, the cost of running the technology, attracting industry participants, cybersecurity concerns, and the development of quantum computing, which could threaten the very existence of today’s blockchain networks in the not-too-distant future. Other concerns include fault tolerance or system resiliency. And many questions still remain over how to handle technical glitches or malfunctions on a network that is dependent on producing a single source of truth to every participant.

“Let’s say there are 10 nodes in a [blockchain] community and you are doing an upgrade over the weekend,” Leung explains. “Nine out of 10 [nodes] were successful and only your node was not successful on your premises. What do you do? Do you downgrade all nine of them back to the original version, or do you shut down on Monday for a week of processing? These are the maintenance or technical issues that you have to deal with when it comes to that kind of [permissions-based] blockchain model.”

In this case, where a node fails to update to a new version of the platform, it would become incompatible with the rest of the nodes on the network. These are remaining questions for the central authority running the technology on how they would overcome the potential risk of disruption.

Another aspect of blockchain that isn’t often considered is its compatibility with processing or clearing long-dated instruments that potentially require several months to clear. Blockchain platforms, on the other hand, are expected to be able to process transactions instantly or on a T+0 basis.

“On the derivatives side, for example, if you are buying an option, the typical tenor of a stock option may be three months, so the instrument comes with a natural time lag—that is the nature of the instrument,” says SIX’s Storm. “So as long as instruments have that time lag, there will be a need for [central] clearing services.”

Fear of the Dark

What we know is this: Certain iterations of blockchains have proven valuable to individual institutions and specialized pockets of the industry, such as for trade finance, bank-to-bank transactions, internal databases or smaller market sector use cases. But the industry has yet to witness the technology come through on its mission to power and revolutionize markets.

“There have been certain small examples, but not on a broader basis that the industry can benefit from. It is more in terms of tactical fixes here and there between counterparties as opposed to market structure use cases such as a clearinghouse or otherwise,” says the head of derivatives trading at a tier-one bank.

According to many experts spoken to for this piece, as it stands today, blockchain is best used for non-critical applications. In terms of successful large-scale adoptions that require multi-party involvement, it’s a matter of ‘wait and see’, for now at least.

This article was updated to illustrate clarifications provided by ASX on the Chess switch over.