Blockchain: The Revolution Has Been Over-Hyped

[This is Part Three of a three-part special report examining distributed-ledger technologies and the capital markets. Part One, which went live on Tuesday, looks at how banks are adopting digital currencies. Part Two, which was published on Wednesday, examines the money funding these projects.]

When you listen to the evangelists, it’s easy to believe that blockchain—which has become a catch-all term for distributed-ledger technologies (DLTs), in addition to being an individual subset of the technology—is destined to become a revolutionary solution for the capital markets. But for the purpose of this article, let’s pull back for a second. If you’re a reader of Waters—a B2B publication covering the institutional capital markets technology sector, which is far from the mainstream—odds are that you’ve witnessed firsthand some of the major technological revolutions that this industry has experienced over the last two, three or four decades.

Here are some questions that can help put things in perspective. For all the publicity that blockchain has received, will it be as game-changing for the industry as cloud computing? Will it be as important as the growth of data capacity? Or the growth of datasets, in general? Is data not the key to creating an advantage or preventing a catastrophe? And what’s more important, a back-office settlement system or platforms and algorithms that can analyze massive, unstructured datasets?

Now, here’s another question: Why are there so many press releases pertaining to the latest funding or functionality of XYZ blockchain companies and consortia? [See chart below.] Could it be that for startups, this is simply where the purse strings are opening? It’s a bitcoin-mining gold rush, some might say. It makes total sense that banks and regulators are dabbling in this arena—it would be negligent for them not to. But has the amount of press dedicated to all of this outpaced actual innovation?

There are a lot of reasons to be excited about distributed-ledger technologies. They should help with centralized clearing and settlement—for reconciliations—and they could potentially be useful for anti-money-laundering/know-your-customer (AML/KYC) concerns. But the industry is still at the “should” stage—evidence, at this point, is thin on the ground.

A CTO of a tier-2 investment bank says that we’ve reached the peak of the hype cycle, but that “we’re at minimum five years away from seeing any significant change” caused by distributed-ledger technologies.

New Tech

Make no mistake: This is simply a new technology. But cloud solutions increasingly underpin everything: order-management systems, portfolio management systems, risk analytics systems, execution management systems, email, human resources, internal and external communications—basically everything that capital markets firms use on a daily basis. Advancements around artificial intelligence and machine learning are creating new possibilities when it comes to trading, risk management and surveillance. New so-called big-data technologies are allowing firms to consume exponentially larger and diverse datasets that can be stored, saved, recalled, broken down and analyzed. But a back-office settlement system is what’s going to change the way that capital markets firms do business? That’s a reach.

For this piece of this blockchain special report, Waters spoke with two-dozen technologists in the institutional capital markets space (for our audience, we will not look at the retail banking implications of blockchain). This article is meant to take a step back when looking at blockchain in order to ascertain where there’s more hype than substance. It’s not meant to nullify others’ opinions; it’s simply here to provide a voice to those that are skeptical. 

A Different Look

A CTO of a tier-2 investment bank says that we’ve reached the peak of the hype cycle, but that “we’re at a minimum five years away from seeing any significant change” brought about by distributed-ledger technologies. The CTO also says that for the foreseeable future, his firm would take a “wait-and-see” approach when it comes to blockchain before diverting attention away from front-office trading systems or regulatory requirements. 

Executives at tier-1 banks are not as quick to dismiss the more near-term impacts of DLT, but their companies also are investing a significant amount of time—but not always money—in spreading out their interests when it comes to DLT-focused startups. “We think the best approach right now is to take a leadership role in several industry associations, working groups and consortia, bilateral and multilateral engagements, and ‘proof-of-value’ initiatives,” says one technology head from a systemically important financial institution (Sifi).

The CIO of one of the largest US buy-side firms says that while there’s hope for improved settlement processes, right now the state of blockchain is a lot of hype, and that won’t change until “banks and prime brokers get fully engaged,” rather than just joining consortia and working groups.

Consider those two comments for a second: One sell-side executive says he thinks it’s better to join consortia/working groups, while a buy-side exec says this technology won’t take off until the sell side fully commits. We’re nowhere close right now, in many ways. Again, we’re talking about the institutional space—there’s promise here, but there’s a good chance that for all the talk surrounding blockchain, we’re still five to 10 years away from the meaningful application of the technology in a live, production environment. 

Inappropriate Markets

One CTO of a large bank that is working on blockchain—and who thinks that blockchain will prove to be a significant disrupter for the capital markets—notes that while he believes in distributed-ledger technologies, he feels that any talk about equities or fixed-income settlement deployments are more wishful thinking because “a lot of companies need to align to make them work,” the CTO says. “We will work with the consortia and markets as these develop, but they are not part of our near-term activities.”

Security

The CTO of a large pension fund in the US says he’s still not sold on the security of blockchain and believes that there’s still a lot of work to be done in this realm. “The hype is around its readiness stat, not its potential,” the exec says. “We need people working on it and they need motivation, so in this case hype is not a bad thing,” because it will hopefully bring in more security experts.

This is where there’s another disconnect: Blockchain’s encryption has been widely praised, but for smaller datasets than what finance is used to dealing with. As one hedge fund technologist puts it, the industry should be less focused on the DLT aspects of blockchain and figure out how to take that encryption and proliferate that piece throughout the capital markets.

“You can implement just part of it. Just implement the encryption schemes,” the executive says. “We don’t need to do a whole thing; just pull the encryption part out. It’s the encryption that makes it special.”

Capacity

The one issue that has not come close to being solved yet is scalability—as this is an evolutionary problem. As more people use a unified blockchain solution, there are serious concerns as to whether the technology can properly scale.

Capital markets transactions are exploding, so any DLT solution will have to be able to scale as that volume keeps spiking, as there doesn’t appear to be an end in sight to this hurried uptick.

“If transaction volumes continue to grow—and it’s to be assumed that they will—capacity issues will create disintermediation issues in the chain,” says the CIO of a mid-size investment bank. “How do you answer for that and prepare for that? You can do it for Amazon Web Services (AWS), but can you do it for blockchain?”

Talent

A number of executives interviewed for this article noted that right now, blockchain is being used to attract new talent.

“It’s an attempt to make finance sexy,” says one hedge fund manager. “It’s a buzzword, much like how Wall Street firms have been accused of marketing themselves as tech-savvy, big data firms, only for aspiring programmers to find out that they were sold a false bill of goods.”

But this plan could also backfire, as top-tier programmers are looking to work with new languages, new types of artifical intelligence, and new big-data platforms.

Additionally, some in the space wonder whether the people tasked with looking into distributed-ledger technologies are actually the ones holding it back.

Keep In Mind

Distributed ledgers will prove useful in some form or another; and the space simply represents a new technology, although these solutions have a long way to go before they will “revolutionize” anything, much less the complex realm of the capital markets. 

Obviously, the capital markets exist to make money for investors and corporations. But it’s important to be wary of hyping up a back-office technology that will ultimately have a ceiling, because that distracts us from true technological innovation. AI and machine learning, data storage, big-data technologies and mobility are genuinely revolutionary technologies for our industry. They already exist and are growing without any need for blockchain. Blockchain is the new thing, but is it significant? Maybe. Possibly. But it shouldn’t take our attention away from the technologies that are already revolutionizing the capital markets. 

That said, there’s always a chance that 15 years from now, at a Waters conference, panelists will look at this article and use it as the starting point for why innovation will always eventually find the peak of a hype cycle …and eventually exceed that peak. This article is the contrarian view.