Markets Learn Painful Lessons as Blockchain Grows Up

Even in an industry known for its tendency to obsess over the newest tech fads, blockchain stood out as the frosted tips of fintech. 

When it first emerged as an area of interest, blockchain, and distributed-ledger technology (DLT) more broadly, was touted as being able to solve problems in everything from highly centralized market structure through to the very foundation of capital markets. Years—and a litany of shelved projects later—some of the hot air seems to have gone out of the room.

People with “blockchain evangelist” in their title have been quietly moved into other roles—or the unemployment line. Consortia with projects stretching across the entire ecosystem of finance have been forced to narrow their interest to a few key areas. Even some of the technology’s earliest proponents have abandoned industry alliances and tried to spin off their own projects.

Johan Toll, head of blockchain product management, market technology at Nasdaq, tells Waters that people have started to realize blockchain is not the answer for everything, despite an enormous number of studies and proofs-of-concept (PoCs).

“With blockchain, you need to learn how to crawl before you can run,” he says. “It’s not the silver bullet for everything so, as always, the business case has to be made.”

This doesn’t mean that blockchain is over, however. Even if they aren’t quite as publicly advertised as in previous years, investments continue to pour in for the technology from banks, venture capital firms and even individual investors. A report from KPMG released in February 2018 noted venture capital investment alone in 2017 reached $512 million, with additional interest in 2018 expected.

And despite the history of blockchain to date being littered with the bones of failed projects, the industry as a whole is beginning to adopt a more nuanced strategy toward the technology, learning from the mistakes of old.

A Problem of Scale

It is easy to see why people allowed themselves to be carried away with the promise of the technology. When blockchain first gained popularity, it seemed like it was the answer to every problem. PoCs and pilot programs abounded for projects as varied as creating know-your-customer databases to overhauling clearing and payments systems. 

Its shared databases and golden record features made it particularly enticing to help replace manual processes and the constant back-and-forth communications that cause inefficiencies and introduce the potential for error, particularly in processes like reconciliations. So, companies and developers began to try to solve most business issues with DLT, just to see where the limit of the technology could be. 

This experimentation has, however, led to rationalizing. Projects like the Depository Trust & Clearing Corp.’s (DTCC’s) blockchain platform for clearing repurchase agreements, or repos, have been shelved, with the company choosing to follow through with other projects around the technology. 

SIX Securities Services scrapped its securities processing project, while BNP Paribas paused its venture with SmartAngels to register investor payments, a project it announced in 2016. Projects around syndicated loans on a distributed ledger, like those from NEX and Symbiont, have either gone quiet or dropped out of the limelight. NEX declined to comment but Symbiont co-founder and CEO Mark Smith says the project “has gained momentum in the space by partnering with four global banks to not only be customers, but also investors.” He adds the team are continuing to build smart contracts to handle the full lifecycle of a loan on a distributed ledger.

Companies have also decided to continue with blockchain but restructured the parameters of their projects, like moving from a proprietary venture to one done through a consortium, which is what happened with BNP’s private equity blockchain, or dropping some initial partners—which was the case for a precious metals post-trade blockchain between startup Paxos and Euroclear. The partnership ended in July last year, but Paxos made it clear it will move the project through the production pipeline regardless and hopes to roll out the first stage of the platform in a few months. 

The DTCC—which was partnered with Digital Asset—managed a successful PoC in February 2017 with its repo blockchain project, hoping to better manage netting of repo transactions and let the firm calculate new settlement amounts that will be recorded to an immutable and transparent ledger. SIX was also working with Digital Asset for a blockchain-powered securities lifecycle processing system, which the company said was important to understand the technology and get ahead of the game. For BNP, its blockchain projects were a chance to explore the possibilities of the technology for the listed securities market. 

SIX declined to comment for this article. While the DTCC, Digital Asset and BNP Paribas were able to give some details as to their decisions to move away from these projects, they said they could not get into particulars as to their decisions to abandon them.

More than the Tech

One of the primary issues blockchain development faces is not necessarily its viability, but rather its inability—as of yet—to meet the industry’s demands in terms of scale. Any technology that aims to make the financial services industry more efficient by replacing older transactional systems, must be able to at least handle what it has to process. For firms like the DTCC, which settles equity trades in US markets, this means many thousands of transactions per day. Waiting for scalability to be resolved has influenced why some projects have been moved off the production pipeline. 

It’s a curious case of the market’s mentality catching up and overtaking the technology—even though attitudes have matured, the technology is still in its relative infancy.

Jennifer Peve, managing director, business development and co-head of the office of fintech strategy at DTCC, says the use-cases brought to production must take into account where DLT currently is, and if the project can wait until the technology is a little bit more mature. 

“I think it’s important to assess the maturity of the technology based upon the use-case that you want to implement,” says Peve. “At this point in time, the technology has not been truly tested or implemented within the financial services industry at scale.”

She notes the technology still has a way to go before it has not just the ability to process the huge volume of transactions that pass through the DTCC’s systems—in 2017, it settled $1.61 quadrillion worth of securities—but also widescale adoption, as the industry still grapples with understanding how it can fit within current systems.

While the DTCC shelved its repo project, the firm will be pushing through the “replatforming” of its Trade Information Warehouse Initiative, essentially a database for the reporting of credit derivatives, which will be replaced with a blockchain-based system. It’s currently being built by IBM, Axoni, and blockchain consortium R3 and is slated for release sometime this year. Peve says the initiative is its largest implementation of DLT so far as more transformational projects, including those that require critical mass adoption, will need to wait until the technology is better able to scale. 

James O’Neill, managing director for operations risk at Fidelity Investments, also notes scalability could still be decades away, so in the meantime other options might be worth exploring. The firm has been a proponent of DLT, particularly through its Fidelity Labs research and development arm.

“Blockchain [today] does not have the scalability yet but as we build that scalability, we need to look at other ways to interoperate,” O’Neill says. “Fidelity takes a slow approach to technology. We want to understand the technology and how it fits into regulations.” 

Nasdaq’s Toll adds that the exchange is keeping a close eye on how fast scalability improves, especially as its projects come up for review. He says the rapid evolution of the technology and its march toward handling processes in larger scale shows it is maturing, though he acknowledges it needs to go further so scaled testing can begin.

As the industry looks through its slate of blockchain initiatives, proponents of the technology say it has proven itself for various use-cases. Peve points out PoCs often work out because the technology does work, so any hesitation is a matter of the technology not yet able to scale to the needs of the larger industry.

Yet others say that it’s the reason a company chooses to deploy DLT, not the maturity of the technology, that ultimately determines success.

Lessons Learned

Chris Church, chief business development officer at DLT specialist Digital Asset Holdings, is one. He says the most important element to consider when determining which distributed ledger project to pursue is not the technology itself or its maturity but rather the business case. 

“People should always look at the business case and not the technology—ask what is the business case, the problem that needs to be solved—before trying to see if the technology fits it,” Church says. 

The experimental phase of the technology is not truly over, as companies are still determining the best use-cases for blockchain to be deployed.  But, they say, the process is far more circumspect now as the business case must be proven first before more money is invested. Church notes use-cases are more important as they inform how fast to develop the program and which technology best solves any issues. 

Firms have learned their lessons from the more experimental phase of blockchain, as DTCC, BNP and Paxos have reevaluated their pilot projects. Each says it undertook a rigorous evaluation process, similar to what is done for other business and technology investments, before deciding which can continue to be pursued. 

“We’ve learned a lot of things over the course of the last year and we share those lessons learned with the industry so they can apply them to other use-cases. All of this has been about building that operational confidence and collaborative development to continue the progress of the technology,” DTCC’s Peve says. “One of the biggest lessons with regards to blockchain is that the value comes in changing the business process and introducing standards around that process. It’s less about technology and it starts with how we are actually going to change a business process. The technology itself doesn’t provide standards for you; it helps to enable or enforce them.”

Moving projects aside also brings lessons on how the technology should be used in the future, particularly around the idea of interoperability. 

Jean Devambez, global head of digital and acceleration at BNP Paribas, says one of the biggest lessons the bank learned was to work on providing interoperability considering the future does not guarantee one blockchain framework to take center stage but rather multiple ones, like R3’s Corda, Ripple and Ethereum. 

“Blockchain needs interoperability. There is no single blockchain—that is just impossible,” says Devambez. “There will be more platforms on blockchain and if you don’t want an illiquid market, what we have to provide is a guarantee that these blockchains will interoperate with each other. This is why we put a strong focus on—and prioritize—interoperability.”

He adds that BNP also learned to deploy blockchain on permissioned ledgers that have a larger network as small networks do not need to employ blockchain to build consensus or share information. As a result of these lessons, the bank has been able to reevaluate how it goes about the projects it works on, including its private equity blockchain project.

“We have reoriented some projects. There was one project on private equity where we decided to go in a more architecture mode,” Devambez says. “We decided to stop our proprietary project to be part of a newly created consortium because in this use-case we discovered that it made more sense to do it jointly with others in the LiquidShare initiative. It is good technology but you have to think about the business case and sometimes it makes more sense to do it jointly.”

By moving to a consortium—LiquidShare counts BNP, Euronext, Euroclear, Caceis, Caisse des Dépôts and Societe Generale in its membership—Devambez hopes to spread out the cost and value of the project. 

What Works

But this does not mean blockchain for larger transformative projects will not work at all, and some companies are even betting big on the technology despite concerns over scalability. The Australian Securities Exchange (ASX) is pushing through with its project with Digital Asset to replace its Clearing House Electronic Subregister System (Chess)—the exchange’s equities clearing system—with DLT. Unlike other blockchain projects however, Chess needed to be replaced as it was in its end-of-life stage, so a whole new system had to be developed. ASX chose to deploy blockchain for Chess late last year and has said it is considering using the technology again for its fixed-income clearing system called Austraclear. 

While blockchain moves toward scalability, some firms are pushing forward with their projects, even if these are ones other firms have shelved. Broadridge Financial Solutions, for example, recently patented its proxy voting and repo blockchain process. JPMorgan also applied for a patent for a system using a distributed ledger to process payments and reconciliation between banks. Calastone, which conducted a successful test of a blockchain for mutual funds, has said it wants to put it into production by 2019.

Largely, though, the decision to move on to blockchain is not dependent on where the technology is but rather what the firm believes it needs. 

Companies still announce new blockchain projects these days, but it may take a while before scalability is solved. In the meantime, though, some smaller projects will be pushed ahead. It’s just a case of separating nuance from the hype.