The financial world has spent the past few years trying to decide what to make of blockchain - the automated ledger that supports the bitcoin cryptocurrency. Could it be a gold mine for banks looking to make their back-office systems more efficient, driving costs from the business? Or is it just another techno dead-end, a clever idea but one that lacks sufficient profitable uses to be worth deploying on a large scale?
Banks are now coming forward with commercial applications for the technology. In Hong Kong, Bank of China and HSBC have announced plans to use blockchain to speed up mortgage applications by keeping a register of property valuations. This, they think, will allow them to process loans more cheaply.
Keeping records of valuations is supposedly only the tip of the iceberg. Some think that blockchain could also revolutionise banks’ core payment and trading systems. Its magic ingredient is that it allows users to bypass the need for middlemen and simplifies clearing and settlement by creating an instantaneous and tamper-resistant public record of transactions. The Oliver Wyman consultancy has estimated that if blockchain was used to streamline unwieldy systems, such as those in cross-border payments and securities trading, it could shave $15-20bn annually from global banks’ costs.
With bankers under pressure to cut costs, such efficiencies are attractive. Indeed, 50 of the world’s largest banks have started to look at blockchain and hope to launch their first applications within the next 12 months.
Some think that blockchain could also revolutionise banks’ core payment and trading systems
Exploring the possibilities of a technology is one thing but deploying it widely is quite another, particularly one with as many unanswered questions as blockchain.
First, there is the issue of security. It is a general rule with systems that security is inversely related to the level of access. The more users with permission rights, the easier it is for a corrupt or malicious individual to hack in and cause havoc. The fully distributed system envisaged by visionaries might be very widespread indeed.
Then there is the problem of “bloat”. The data storage required to run a fully distributed capital market, for instance, might be so enormous that the system would be too slow.
Lastly there is confidentiality. For all the cryptography, distributed ledgers are designed to create visible records. That could allow participants to spy on each other’s deals, unpicking profitable patterns.
Of course, there are answers to these worries. The simplest is to move away from full distribution back to a centralised ledger, so instead of sharing data with everyone, you create a hub - or perhaps a small group of hubs - and this holds the data on behalf of the other participants. The snag is that while this bolsters security it would also reduce savings. Rather than contemplate such a massive and costly technical upheaval, many banks might choose to stick with what they have.
There may be ways to cut ancillary costs. The initiative by HSBC and Bank of China is one example. Other areas could include compliance procedures, such as anti-money laundering and “know your customer” rules.
Banks will have to think hard before embedding blockchain in core activities. Like aeroplanes and suspension bridges - other systems that depend on public confidence - banks should beware of stripping away redundancies, such as human oversight, that act as a check against catastrophic failure. Regulators must ensure that in the interest of saving money, banks do not take new and ill-understood risks.
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Source: FT Editorial Comment. 2016. 'Bank safety and the blockchain revolution'. Financial Times / FT.com. October 26, 2016 Used under licence from the Financial Times. © The Financial Times Limited 2016.
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