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The Weekend Read: Sept 18

Chris Khan (R3), Roman Dahl (Nordea), David Rutter (R3) at our recent European Members' Conference

Chris Khan (R3), Roman Dahl (Nordea), David Rutter (R3) at our recent European Members’ Conference

R3 Recap

I just got back from a very full and rewarding week in our London office, highlighted by our third Members’ Conference on Tuesday. Many thanks to all the participants, as we had 44 institutions represented, including talks by 11 different members and topped off by two live demos. Perhaps most impressive was the energy carried over from the Monday night cocktails all the way thru to the end of Tuesday’s session…

One of the day’s presenters and R3 colleague Ian Grigg filed this short post on Corda and our introductory white paper. The post reviews two big considerations/requirements that drove the Corda design work: privacy (you need it!) and consensus:

The reason for [proof-of-work] was that we cannot trust the sybil element of an open access system – necessary to ensure the fabled censorship resistance. But in the institutional market, they know how to trust each other. They’ve been doing that for 100s of years. Literally – with letters of credit, trade finance, introductions, short term loans and interconnects, relationships.

[SNIP] Without proof of work, and without the public blockchain, we are really talking about a completely different animal to Bitcoin. And that’s what Corda is – a redesign from the base requirements of the institutions.

A good companion read is the recent public disclosure of the GS patent filing for FX on a blockchain, as the main themes are extremely consistent w Corda’s core requirement set:

Essentially, Goldman wants to merge the benefits of blockchain technology—speed and efficiency—with other technologies that offer privacy, security, and compliance with regulatory guidelines. For example, Goldman’s version of the blockchain would allow for private transactions only visible on a need-to-know basis; permit regulators to access the database; and adhere to anti-money laundering regulation and Know Your Customer laws, which require that banks confirm the identity of their customers.

Tim Grant makes mental note to pack shorts next time

Tim Grant makes mental note to pack shorts next time

And a sartorial shout out to our Stafford Lowe for keeping it real Bermuda style (and boos to the staff photographer for not capturing the full glory of the Bermuda shorts!) in this feature on Bermuda Reinsurers + blockchains.

Banks Bruised and Battered

McKinsey released a report on the state of banking and, well, it aint pretty:

Firing people won’t be enough to save the world’s biggest banks from technological and regulatory changes that have reshaped the industry — whole businesses must go, according to McKinsey & Co. Almost every bank will have to quash aspirations to be all things to all customers so that they can eliminate fixed costs, the consulting company said Wednesday in a report titled “Time for Tough Choices and Bold Actions.” Only three to five global full-service banks will survive, McKinsey said.

Meanwhile, the FT stood for (F)in(T)ech this week as there was a barrage of articles, but effectively helped the FT cover all bases by both deflating and inflating the fintech bubble: Cyber attacks raise questions about blockchain security and Banks find blockchain hard to put into practice and UK regulators are the most fintech friendly and Fintech start-ups put banks under pressure.

RegTech (cont.)

The Bank of England released their Consultation Paper on a potential new RTGS. This includes mention of Central Bank Digital Currency (CBDC) on page 18 and distributed ledgers on page 42. Lazy pull quotes below!

The Bank does not propose to extend direct participation in the new RTGS service to non-financial corporates or households in the United Kingdom. This is for two reasons: (a) Such a change in access would raise fundamental questions about the nature of banking, the shape of the financial system and the role of the central bank that need to be researched over a longer timeframe. (b) Attempting to accommodate a dramatic extension of access would create very material technological and security challenges for RTGS that would have significant implications for the cost and timeframe for renewing the system and would fundamentally alter the resilience and operational availability requirements of the service.

[SNIP] The research conducted so far in the Bank and elsewhere shows that asset transfer and gross settlement can successfully operate on a distributed ledger, and demonstrates many of the features of network resilience in a small-scale application. In its current state, however, this work has also highlighted that the technology is not sufficiently mature to provide the exceptionally high levels of robustness required for RTGS settlement. Further work is required to address privacy and system scalability in particular, and these and other topics suggested by this initial work will drive the Bank’s future research programme on this technology.

A bit of cold water, but one that is balanced by continued research and engagement in the space. Speaking of engagement, Hong Kong joins the party of fintech accelerators supported and hosted by government authorities, much like the FCA in England and MAS in Singapore. And ISO has approved the proposal by Standards Australia to lead an international tech committee “to build a uniform approach to the technology.”

Announcements

Congrats to our friends at Ripple for closing their latest round of funding and for the expansion of their partner financial institutions:

“Our mission is to make cross-border payments truly efficient for banks and their customers, and in doing so, lay the foundation for an Internet of Value where the world moves money as easily as information,” said Ripple CEO & co-founder Chris Larsen, “We’re thrilled to have these world-class investors joining forces with us to help make this vision a reality.”

And ICYMI, Hyperledger’s Executive Director Brian Behlendorf published an introduction to the new vision of the Hyperledger Project as An “Umbrella” for Open Source Blockchain & Smart Contract Technologies:

Perhaps most importantly, we can directly address what many have observed as a major challenge with the existing open source blockchain efforts – tremendous levels of tribalism amongst developers. While invigorating, it can also make sharing code between efforts, or talking about common challenges and how to meet them, notoriously difficult. This is true even when the payoff would be less duplicated code and more eyes looking for security holes and other issues.  Multiply that rivalry with the effects of holding fungible currency whose value can be tied directly to the software in question, or open source project brands tightly associated with commercial brands in which developers own equity, and incompatible copyright license paradigms, and working together can be nearly impossible.

At Hyperledger we believe we can provide an answer to this.  Let’s bring these different implementation efforts within the same “home”, with a consistent approach to intellectual property, community collaboration standards, overall branding (“Hyperledger ____”) and an encouragement to either work together or usefully differentiate.  If we do this, it will remove barriers to collaboration, encourage developers to find opportunities to work on common code, and address the potential for confusion and wasted duplication of efforts without requiring a top-down single architecture or personality to dominate.

The Weekend Read: July 24

1. Blockchain Report Bonanza

If only he had a blockchain

If only he had a blockchain

BoE has been exploring the topic of central bank digital currency (CBDC) for many months. Their report this week focused less on the technical aspects of CBDC in favor of exploring monetary policy implications. In short, would CBDC enable a central bank to perform quantitative easing (QE) directly to ‘end users’ and individuals? This could help prevent what some claimed happened in past QE episodes, especially during the Euro crisis, where banks were not “passing on” QE to the “real economy.” Said another way, blockchains could helps central bankers move beyond indiscriminate helicopter drops and instead deploy drone-like deliveries of QE goodness. Our research team has a much more nuanced review of the paper, so please contact us if you would like to learn more.

This is a very well done and welcomingly brief report that attempts to drag asset managers “off the sidelines” and into the blockchain arena. It is also novel in that it argues for both cost reductions and revenue generation.

Both of these reports serve as a nice review from different perspectives. The EY report highlights opportunity and risk from the perspective of tech companies instead of financial institutions. Couple it with this interview with Microsoft and IBM on their blockchain cloud strategies. The Bain piece reviews the payments opportunity, highlighting the oft-cited correspondent banking opportunity but also bringing into focus the ability to achieve cost savings in trade finance. This is an emerging area of focus for banks and for R3, as there is much room for improvement. This article gives just one example of commodity invoice fraud: “Trade misinvoicing is costing some developing countries two-thirds of the value of certain commodity exports.”

Taken together, the four reports show the potential and sketch out some of the challenges, all contributing to answer the “why?” that we hear often from financial institutions. Yet there was another short article that never even mentions “the B word” that answers the why (and why now) question most emphatically: a Reuters piece that highlights “the stubborn costs banks can’t erase.”

But as time marches on, it’s become increasingly difficult to find fat to trim. Long-suffering shareholders have gotten excited about these initiatives only to find they do not move the needle much. Banks are still struggling to meet targets they set, ranging from net interest margins to efficiency ratios and returns on equity.

“It’s tough to take out costs meaningfully from here,” said Patrick Kaser, a portfolio manager at Brandywine Global who invests in bank stocks.

As a result, bank executives are being forced to fundamentally rethink the way they operate and staff their businesses to make them less expensive – without also limiting the amount of revenue they can produce. As they hold the magnifying glass up to the expense ledger – especially in retail banking – they are finding some costs to be particularly rigid.

2. Ethereum Fork and the Death Throes of Classic

The Ethereum community has moved forward to execute the previously discussed hard fork. Our Tim Swanson weighed in on this earlier in the week in his post Archy and Anarchic Chains:

Perhaps the most controversial [issue] is that simply: there is no such thing as a de jure mainnet whilst using a public blockchain.  The best a cryptocurrency community could inherently achieve is a de facto mainnet.

What does that mean?

Public blockchains such as Bitcoin and Ethereum intentionally lack any ties into the traditional legal infrastructure.  The original designers made it a point to try and make public blockchains extraterritorial and sovereign to the physical world in which we live in.  In other words, public blockchains are anarchic.

As a consequence, lacking ties into legal infrastructure, there is no recognized external authority that can legitimately claim which fork of Bitcoin or Ethereum is the ‘One True Chain.’  Rather it is through the proof-of-work process (or perhaps proof-of-stake in the future) that attempts to attest to which chain is supposed to be the de facto chain.

However, even in this world there is a debate as to whether or not it is the longest chain or the chain with the most work done, that is determines which chain is the legitimate chain and which are the apostates.

Speaking of apostates, it looks like there is a bit of an internecine attack brewing against the “Ethereum Classic” chain. Never a dull moment!

[ed. note: I will be handing over this space to the deep bench of the R3 team through the end of the summer. Enjoy the attacks, forks and twitter battles without me and see everyone after Labor Day]

The Weekend Read: June 19

1. This Week in CBDC

I asked our Tim Grant for the R3 take on the Cad-coin news (see Canada experiments with digital dollar on blockchain), also know as Project Jasper:

“Tremendous progress this week with our Canadian partners as we saw the first public outing (see FTWSJBloomberg) of our ongoing collaboration with the Bank of Canada, Payments Canada (the artist formerly known as the Canadian Payments Association), BMO, CIBC, RBC, Scotia and TD. Our shared goal is to understand the mechanics, limits and possibilities of distributed ledger technology in an experimental wholesale payment system environment. Very much a proof of concept, we are looking to explore a number of key questions related to access, cost, security and resiliency, collateral management and transparency.”

Bank of England’s Mark Carney has a very well written speech that covers Fintech in general and calls out DLT specifically, full transcript here:

FinTech has the potential to affect monetary policy transmission, the safety and soundness of the firms we supervise, the resilience of the financial system, and the nature of shocks that it might face. It could also have profound implications for the Bank’s secondary objective, as supervisors, to facilitate effective competition between the firms we regulate. 

Mr. Fedcoin, JP Koning, is back with another post on the relative merits of central bank digital currency. The post is worth a read for its “so what” comparison with an unsexy system that just works: Fedwire.

2. DAO Danger

The big headline this week was the hack of TheDAO, the smart contract decentralized autonomous organization that recently raised over a billionty dollars in their initial crowdfunding raise. There have been lots of very good posts on this subject in the last few days; a non-exhaustive list includes posts by Vitalik, Emin Gun Sirer, Matt Levine, a few by Peter Vessenes, Ryan Shea.

The news is moving a bit too quickly for this post to stay current, but one non-tech lesson is clear: the massive capital raise and subsequent attention on TheDAO was too much, too soon. One could argue that the massive price run up in Q4 2013 was the worst thing that could have happened to Bitcoin at that point in the technology’s (and community’s) development/maturity cycle. It was like watching a young hoops prospect going pro too early.

For TheDAO, their rush to ‘market’ and the ridiculous sums that it garnered in the crowd funding did it no favors. Stephan Tual, Slock.it’s founder and one of TheDAO’s creators, had the audacity to claim that “the unthinkable happened” in his post-mortem blog post. Let that sink in. Unthinkable?! You created a $150m+ bounty in your v1 software that was running on an extremely complex and young platform. It would be unthinkable for it not to be attacked. Perhaps in retrospect the first crowd raise could have been a bit smaller than ~1/5th the float of Ethereum…

As a palate cleanser from all the above, please enjoy this mini-profile of Vitalik from earlier this week.

And Happy Fathers Day to all!

The Weekend Read: Jan 30

Early prototype from Satoshi

Early prototype from Satoshi

1. RegTech (cont.)

It feels odd to say that regtech is a la mode, but much of the talk at our recent European Members Conference revolved around the (mostly positive) involvement of regulators in distributed ledger innovation. A recent speech by Minouche Shafik, Deputy Governor at Bank of England, highlights the potential role for distributed ledger tech within the evolution of the RTGS payments network:

The emergence of various forms of Distributed Ledger Technology (DLT) poses much more profound challenges because it enables verification of payments to be decentralised, removing the need for a trusted third party. It may reshape the mechanisms for making secured payments: instead of settlement occurring across the books of a single central authority (such as a central bank, clearing house or custodian), strong cryptographic and verification algorithms allow everyone in a DLT network to have a copy of the ledger, and give distributed authority for managing and updating that ledger to a much wider group of agents.

2. Blockchain Longreads

DTCC released a much-discussed paper on the opportunities, risk and hype around distributed ledgers. The report suggests leaving alone the “not-broken” segments of the market to instead focus on “white space” application areas such as master data management. The report is worth a read in full. I also very much appreciate their endorsement of the R3 model:

This is the opportunity to create an industry-wide initiative to develop the right architecture, prioritize the infrastructure building blocks and support focused and collaborative experiments to help the technology mature.

CoinDesk released their annual State of Bitcoin (now with Blockchain!) report. Among the many icons and charts, these two are the most sobering:

Deloitte adds to the consultant thinkpiece library with a longish report on blockchain opportunities. Much of it treads the same ground of other reports, but its addendum on a KYC use case for banking is interesting, both as a review of the cadre of startups now attacking the space and for the stat that only 17% of the SWIFT banking universe have signed up to their KYC shared service. In the end, identity may turn out to be the killer app of blockchain. Many hard problems in distributed identity remain (the DTCC report called out a few) yet they are problems worth tackling.

Early prototype from the R3 working groups

Early prototype from the R3 working groups

Finally, Forbes’ Laura Shin files a thorough overview of companies (including R3) in the bitcoin+blockchain space, across five areas: Bitcoin, Fintech, Enterprise, Consortia, Infrastructure. Interesting perspective, and due to the Barry Silbert “Homer-mobile” shout out for R3, it allows me the chance for yet another Simpsons pic. Have a great w/e.

 

The Weekend Read: Mar 27

 
1. Bitcoin Bull Corner

As price continues to chop sideways in the broad $200-300 area, a few more positive news stories hit the wires. Noble Markets announced a deal to use Nasdaq’s X-stream trading system to power their exchange. Some took this as Noble being de facto regulated but the deal is purely a tech white label, and CEO John Betts equivocated when asked about the prospects of launching a fully regulated exchange. In other somewhat positive news, Barry Silbert’s Bitcoin Investment Trust “received formal approval for listing on OTC Markets Group’s OTCQX exchange. The fund is listed under the symbol GBTC, and trading is expected to begin early next week.”

2. Bitcoin Bear Corner

Megan McArdle of Bloomberg shared her mostly bearish take on bitcoin’s potential as both a speculative asset and payment system: “the primary risk I see is simply that the allure of bitcoins as money will wear off — and that when it does, bitcoin as payment system will also stop working very well.” Izabella Kaminska continues her assault on bitcoin libertarian shibboleths in her post Bitcoin’s lein problem:

“Indeed, given the high volume of fraud and default in the bitcoin network, chances are most bitcoins have competing claims over them by now. Put another way, there are probably more people with legitimate claims over bitcoins than there are bitcoins. And if they can prove the trail, they can make a legal case for reclamation.”

And if your eyes aren’t watering already, check out this twitter debate, with both sides fully armed with loaded handbags.

3. The Future of Fintech and Banking

Accenture released a very interesting (and graphic heavy!) report on how digital disruption could impact banking. It is worth a read in full:

“Possibly the biggest opportunity from taking an open approach to innovation is in the area of the Blockchain, the protocol that underpins the distributed architecture of the Bitcoin cryptocurrency. It is early days for cryptocurrencies, and it is unclear what the long-term effects of their adoption will be on the financial services industry. However, it is clear that if established players are going to benefit from this revolutionary approach to finance, they will have to engage with a much wider range of technical specialists and developers outside their own organisations.”

The report spends quite a bit of time discussing the risk of banks not doing enough to keep up with the pace of innovation, but if this graphic is any guide, they are starting to try harder (or spend more):

graph

…but perhaps some should be worried about legacy systems, namely Bank of England, which this week released an independent Deloitte report on the recent RTGS outage (with some bits redacted). The Bank has only paid out about £4k in damages, even though close to £300bn of payments were impacted. Now that is a low cost transaction fee network…