Growing interest in blockchain technology has been sounding alarms throughout the financial world. But there’s a way to investigate, evaluate, and assess this new technological opportunity without pushing the panic button.
Let’s examine the attraction of blockchain and the issues that financial institutions must consider.
Some blockchain basics
Blockchain—a transparent, tamper-proof, distributed consensus ledger, was first introduced in 2009 as the underlying operational platform behind bitcoin.
The technology can be attractive to customers because it transfers money faster, while cutting out the middle man—banks—as well. For example, a customer in Charlotte, N.C., can send funds to a vendor in Chongqing, China, within minutes, while saving money on fees traditionally charged by banks and other third parties.
Thus, the blockchain—with or without a digital currency such as bitcoin—threatens to interfere with the margins and business models of the finance world. The technology is also challenging banking institutions’ longstanding platform as intermediaries.
Last year proved particularly remarkable for the technology, as it attracted close to $1 billion in investments for both bitcoin and blockchain firms, according to industry reports. Some banks are excited and inspired by the innovation. However, there are many that apprehensively await the potential and unknown effects that this emerging technology may have on their traditional business lines.
A handful of leaders are already experimenting with the technology, hoping to benefit from reduced costs and increased influence and reach. Their goal is to identify and eliminate inefficiencies found within the traditional system. Bankers can expect to hear more about blockchain innovation labs and R&D investments in the months to follow.
Acting like fintech players
Banks are worried that their own innovations around blockchain will cannibalize their existing revenue streams. Other factors, such as costs sunk into legacy technology and networks, make the decision to deploy blockchain even more difficult.
Further, the new technology demands dramatic cultural shifts towards disruption and innovation from within—which bankers in traditional organizations can find worrying. However, given the looming threat of blockchain, many banks have rallied their forces to begin thinking and acting more like fintech companies.
In our view, banks that identify as being a bank first—and not a technology company—will be outperformed and could ultimately be outpaced.
Some banks are opting for internal innovation—funding experimentation and R&D in hopes of striking blockchain gold. This may not be as productive as co-innovating with a consortium, such as R3—which is focused on creating blockchain standards and is already working with a handful of leaders. Recently the company announced a partnership with Microsoft. (Read “Microsoft, bank group team up for blockchain”)
Banks working in isolation fail to appreciate and fully understand that blockchain is an open, internet-based network that relies upon the community for scale and muscle. Such isolated banks are unable to experiment effectively as the R&D path is known to be complex and execution challenges do exist.
Banks are fortunate to have dozens of use cases to experiment with at their disposal, though prioritizing them from the perspective of market attractiveness can be difficult.
[Editor’s note: The term “use case” comes from Unified Modeling Language, a standard used by developers, and is a list of actions or event steps involved in an experiment. Use case analysis represents a method for analyzing the requirements of a software engineering project. A use case defines the interactions between external actors—which can be a human, an external system, or time itself—and the system under consideration to accomplish the organization's goal.]
Banks also struggle in determining which tools are best to employ in their testing, e.g. proprietary tools with intellectual property right restrictions, open source, etc.
Some banks may also be considering investment in proprietary firms to gain a competitive advantage. Converting a successful proof of concept into a business-justified real-world product is no easy task.
Streamline use-case rankings
So, how does an institution work its way through the blockchain maze?
The secret lies in describing the following aspects that simplify use case ratings later:
• Primary and secondary actors—the external factors that will be interacting with blockchain technology.
• Business activities required inside the blockchain.
• Existing support activities (outside the blockchain) that need modification and new activities (outside the blockchain) that need to be created.
• Phased experimentation options.
Using business and technical factors can simplify rating use cases on complexity. These include:
• Business factors: Complexity of business process/rules within the blockchain; complexity of business process/rules outside the blockchain; number of parties inside/outside the organization that would need to adopt the technology.
• Technical factors: Implementation complexity of core blockchain platform features; complexity of data validation/business rules/variety of sources for activities outside the blockchain and number of integration points.
Once the use case complexity has been rated, banks can then judge its attractiveness by considering:
• Traditional factors: New revenue potential, existing revenue at stake, net cost saving potential, customer experience improvement, complexity/cost of any proof of concept and pilot.
• Novel factors: Whether an idea is a competitive advantage for the bank or an ecosystem of players and synergy with bank’s incubator/accelerator companies.
It has been found that use cases with unique, competitive advantages for a single bank or a few partners (or those that do not require ecosystem adoption) prove more attractive than other choices. For example, securities settlement via blockchain among two or three large trading partners can yield significant efficiency and cost benefits.
Alternatively, when highly attractive use cases are paired with higher implementation complexities, it has been found that experimentation can often be phased out. This effectively lowers complexity and enables fail-safe, fail-early execution.
For example, reference data enrichment using blockchain in securities trading is an attractive use case as it eliminates redundant data enrichment and validations by multiple parties. However, changing the way reference data is handled and securities are traded by multiple players can be quite cumbersome. Such complexity could be phased out by first establishing that there is cost savings and efficiency improvement by consolidating most repeated reference data enrichment steps. This may not require conducting even a single trade. After proving the optimal set of reference data enrichment steps for consolidation, experimentation could then turn towards conducting trades using the new model of enriched reference data shared by the players.
A combined effort employing use case complexity and attractiveness exercises—set to a fast-paced consultative approach—will clear the path for effective blockchain exploration and implementation.
About the author
Hari Subramanian is a consulting partner for banking and payments at Wipro Ltd. He has over 25 years of experience in financial services and telecom as well as ten-plus years of management consulting knowledge in banking and payments. He focuses on emerging payments and leads Wipro’s initiatives in this space. Hari blogs regularly at www.harisubramanian.com.
Other contributors to the article are: Sriram Rajagopalan, innovations team; Chetan Ghadge, solutions head, banking and payments; and Kartik Burman, principal consultant, banking and payments.