R3 Research provides compelling analysis and insight into the enterprise blockchain industry and specific practical applications across cash, payments, capital markets, trade finance, insurance and identity.
The $1.5 trillion trade finance gap will not resolve without re-architecting global networks. Blockchain is often thrown around as the answer, but what exactly does that mean? This paper explores how the application of a decentralized ledger technology would impact the three root causes of trade finance gaps: low profitability, compliance costs, and lack of information. We take a design approach with a focus on the technology rather than the applications that are built on top in order to distill the fundamental changes that will occur by switching from centralized to decentralized solutions. The analysis shows that the application of blockchain will make trade finance safer, faster and more secure. We provide suggestions for how developers can design top of stack applications to take fullest advantage of blockchain to make trade finance more even and inclusive.
Alisa DiCaprio, Benjamin Jessel
Available on CAPCO’s website here
Central banks around the world have implemented Liquidity Savings Mechanisms (LSMs) in their large value settlement systems. This has been done to reduce the liquidity demands that come from interbank wholesale settlement. Today, central banks use a centralized queue to match offsetting payments. Central operators can neither assess the importance of payments, nor assess each commercial bank’s relative cost of liquidity provision. Decentralized LSMs would allow individual participants to make competitive netting proposals that reflect their current conditions in real time. This approach could address the problems of imperfect information, incomplete information, and prefunding hard limits. A decentralized system could reduce liquidity demands and potentially increase social welfare for all participants.
Adam Furgal, Rodney Garratt, Zhiling Guo, Dave Hudson
Given increasing physical cash in circulation in many areas, a cashless society is likely not achievable soon for most countries. However, there are certain countries, particularly the Nordics, where the rise of digital payments is accompanied by a decrease in physical cash. While consumer preferences may drive towards a near-cashless society in these countries, a fully cashless society is not possible without first addressing several obstacles. First, a credible technical solution would need to exist as a substitute for physical cash, given the risks to consumers of strictly holding money with defaultable private sector institutions. Second, laws and regulations regarding the use of physical cash would have to change. We discuss high-level designs for how a retail-facing central bank-issued digital currency (CBDC) could be built on R3’s Corda and evaluate legal changes in Norway.
Kevin Rutter, Morten Wilhelm Winther, Simonsen Vogt Wiig Law Firm
Multiple central banks have conducted experiments with blockchain for domestic settlement between commercial banks. While progress has been made on domestic interbank settlement, there is not a clear approach for cross-border settlement. Today, interbank payments between currency zones require correspondent banking relationships, Continuous Linked Settlement (CLS) accounts, or a combination of both. This paper discusses several options that involve distributed ledger technology (DLT). The first group of models would heavily involve central banks, the second group involve a trusted third party and a more passive role for central banks. The models are evaluated based on monetary supply implications, impact on liquidity management for commercial banks, settlement risk, credit risk, and complexity for central banks. This preliminary exploration intends to inform future work with international payments.
By: Xiaohang Zhao, Haici Zhang, Kevin Rutter, Clark Thompson, Clemens Wan
With the potential existence of multiple blockchains, interoperability across chains is a key concern. This paper explores various strategies for interoperability, and considers security and governance models in the financial services industry that may be impacted by increased interoperation. It also includes examples of interoperability across different financial use cases.
The European General Data Protection Regulation (GDPR) comes into effect on 25th May 2018. This paper assesses if and how the GDPR applies to public and private or consortium blockchains. The paper focuses on the crucial question of whether blockchains fall within the scope of GDPR, especially if personally identifiable information is processed. The paper proposes that this is most likely true and that with public blockchains the data is not simply anonymous. Finally, the paper describes the main obligations and requirements under the GDPR by which blockchain companies must abide.
Is a single global network or are multiple business networks the right structure for a distributed ledger ecosystem for trade finance? The answer will reduce uncertainty for market players and enable faster implementation of distributed ledger solutions. This paper considers the trade-offs between a single universal global network versus multiple business networks. For a universal global network to succeed, regulators would need to come to a consensus over legal and regulatory standards globally. In the specific context of Asia, multiple interoperable business networks more closely align with the existing diverse regulatory environment.
Maintaining data quality, reconciling trades, and exchanging assets between financial institutions using legacy information technology (IT) systems is expensive, slow and complex. Given the costs of integration and interoperability, this paper argues that distributed ledger technology product competition at the application level is more critical than competition at the platform level. By building an ecosystem on top of a platform, financial institutions can benefit from network effects and address historical IT complications.
Commercial and specialty insurance contracts and the resulting financial transactions between counterparties are both complex and costly to administer. Optimizing the operational processes across distribution networks and trading relationships remains a challenge for the industry. Operating inefficiencies cost the insurance sector and its clients billions of dollars annually. Blockchain-based platforms can reduce costs in the core Accounting and Settlement processes by coordinating shared processes and reducing complexity. Blockchain technology can also facilitate the final payment netting between counterparties. We consider design principles for blockchain platforms in the insurance sector and examine R3’s Corda architecture. This whitepaper is suitable for business readers who wish to understand some of the complexities in the Accounting and Settlement processes of this sector or technical architects who need to understand how particular platforms provide value within insurance.
Richard Boreham, Kevin Rutter
This paper explores how central bank digital money might be designed. It uses Fedcoin – a conceptual form of Central Bank-issued Digital Currency – to describe the challenges of establishing a stable cryptocurrency, consider whether the public should have access to central bank money, and discuss technical considerations.
As blockchain technology continues to develop, the concepts of privacy and confidentiality has emerged as key concerns. This paper first analyses current technologies and protocols that enable confidentiality and privacy, and then consider the advantages and disadvantages of certain design choices.
Danny Yang, Jack Gavigan, Zooko Wilcox-O’Hearn
Identity information has traditionally been captured on the individual level, and is limited to what is known of a person. This paper explains that the real value of identity comes from the relationships that can be examined and recorded between any number of persons, and not from information known of a single person.
The “Financial Identity Trilemma Syndrome” arises from the conflict between the three motivators of identity – compliance, security and customer service, and has the potential to shrink the customer base of banks. The paper further explains the importance of context on identity, pinpoints sources of unreliable identity data, and discusses the importance of a feedback loop that ensures the quality of identity information.
Describes different objectives and architectures for wholesale and retail domestic DLT solutions. Specifically, the paper compares JP Koning’s Fedcoin concept with the CAD-coin prototype of Project Jasper, a collaborative effort between six Canadian commercial banks, Bank of Canada, Payments Canada, and R3.
Rising regulatory and compliance costs have led financial institutions to seek solutions using new technologies. This paper considers the role DLT can play in financial compliance and discusses how R3’s Corda handles transaction reporting for OTC derivatives.
Colin Platt, Peter Csoka, Massimo Morini
The problem of derisking is embedded in the lack of transparency in the correspondent banking ecosystem. DLT offers a potential solution – by embedding smart contracts into a correspondent banking utility, the process of due diligence could be faster, safer, and more transparent. The author explores how such a utility might work and its implications for both regulators and banks.
A hybrid approach can facilitate the adoption of production-quality DLT in capital markets. By applying DLT alongside more established technologies, DLT is more likely to meet the banking sector’s requirements on procurement, security and data privacy for capital markets use cases.
Before broad adoption is feasible, DLT platforms will require technical improvements in governance, interoperability, scalability, privacy, and usability. This paper explores the problems and suggests solutions to each.
Central clearing counterparties in derivatives markets play an important role in financial system resiliency. This paper explores the implications of DLT for risk reduction and efficiency improvements. It shows that DLT can both improve account management as well as act as a platform for interaction.
Colin Platt, Peter Csoka, Massimo Morini
Legal recognition of electronic documentation will be a key enabler of blockchain-based trade finance applications. Currently, there is no U.S. regulation or law that adequately recognizes electronic versions of negotiable instruments as such. This paper sets forth the legal obstacles facing the use of electronic negotiable instruments in a decentralized system. To do so, we analyze two specific sets of uniform rules to determine gaps in the current framework. The paper then proposes potential amendments that would enable the use of electronic negotiable instruments on blockchain in trade finance and also looks at the feasibility of creating a rulebook as an interim solution for such use.
Shearman & Sterling LLP, R3, the BAFT DLPC Working Group
After the 2008 global financial crisis, regulatory oversight within the financial services industry increased dramatically, with many new policies requiring more data to be reported in less time. The fundamental properties of blockchain architectures have the potential to provide a holistic solution for regulatory reporting. This paper will examine the current methodologies for regulatory reporting and consider both a theoretical and technical blockchain solution. To create a more tangible understanding, this paper will focus on the blockchain platform Corda and the European regulation MiFID II. This paper then looks forward to how blockchain can be utilized across pre-existing and incoming regulation.
In 2014 and 2015 several centralized Know Your Customer (KYC) utilities aimed to address problems with corporate KYC for both banks and their customers. These utilities have had mixed success. While they solved some problems they also introduced new ones. Blockchain technology enables decentralized KYC platforms, which are a new approach. With the correct architecture, these decentralized platforms can maintain direct customer-bank relationships and avoid the pitfalls from centralizing parts of the corporate KYC process. This paper re-views a self-sovereign approach and a bank-sharing approach. Within most jurisdictions, the self-sovereign approach is the most likely to succeed. Further, the paper addresses the advantages, common issues, and disadvantages a decentralized platform offers relative to centralized utilities. Lastly, it suggests that commercial banks coordinate to pursue a decentralized corporate KYC platform.
The fundamental lesson from the trade ﬁnance experiment with digital innovations over the past decade is that centralized solutions in a decentralized ecosystem do not scale. The result has been today’s trade ecosystem where data ﬂows freely within, but not between network participants. Blockchain – as a decentralized system – has the potential to eliminate data siloes and enable existing innovations to scale. But only if application builders incorporate the lessons of past attempts at transformative, global innovation. To facilitate this process, we introduce a network model of technology diﬀusion to explain the rise and persistence of digital islands. We then apply this model to blockchain in trade ﬁnance. This enables us to draw conclusions about the conditions under which connectivity could progress in a meaningful way, and to begin to answer the question “why blockchain?”
Alisa DiCaprio and Alexander Malaket
In order to evaluate how the asset lifecycle for different assets could be managed through smart contracts, this whitepaper considers the support of financial assets on distributed ledgers. The paper concludes that DLT can be a catalyst for a fundamental re-engineering of the post-trade space.
Nigel King, Christopher Saunders, Ian O’Connor, Anton Semonov, Clark Thompson
How can banks evaluate the applicability of DLT? This paper uses an industry business case model to help banks to balance the challenges with the expected benefits of DLT. It evaluates the impact on market participants and surveys the ways that banks could adopt the technology.
This whitepaper covers how money is represented on distributed ledgers. Money-related use-cases are used to summarize business and technical considerations. The paper also explores lessons from crypto-currencies, evaluates their short-comings, and outlines considerations for central banks.
Nigel King, Mark Hornsby, Martin Walker, Ian Grigg
Different use cases require different ledger constructs and consensus mechanisms. After broadly categorizing existing platforms by key characteristics, this paper assesses each category against the requirements of financial services use cases. The analysis concludes that the UTXO model provides the best fit for the financial services industry across many use cases.
From a data architecture standpoint, the design of smart contracts can on take various forms. This is in part because there is currently no formal guidance from regulators or industry bodies regarding the legal frameworks surrounding distributed ledger technology. This whitepaper sets out the questions on which guidance is needed.
Matt Britton, Ian Grigg
Firms are concerned that parallel experiments across different DLT platforms could result in fragmentation, leading to increased costs and risk. After exploring interoperability among different distributed ledger platforms and existing systems, the authors propose an ecosystem of ledgers that can be used within and between institutions.
Nigel King, Sajindra Jayasena, Mark Lauer, Arijit Das, Jared Harwayne-Gidansky, Clark Thompson
Smart contracts are one of the foundations of DLT for financial services. This paper defines some of the key concepts of smart contracts as well as a set of principles and goals needed for adoption. It starts by defining smart contracts, and then considers how they may evolve in financial industry use cases.
Mark Oldfield, Robin Green
Distributed ledger technology is part of a holistic new approach to identity management, which also involves regulators and legislators. This paper explores the use of distributed ledger technology (DLT) to meet the identity information needs of interactions between banks and their customers, and also includes high-level requirements for identity as it relates to shared ledgers.
Nigel King, Nick Skinner, Ian Grigg, Stephen Lane-Smith, Atefeh Mashatan, Craig Maladra, John Vondrachek, Paul Bayer, Christopher Swanson, Henry Roxas, Abbas Ali
Non-functional issues with blockchain adoption include scalability, security, availability, and privacy among others. This paper walks through some of the major non-functional barriers to adoption and raises issues that will need to be resolved in these areas before large-scale DLT can be deployed in the financial industry.
Mark Oldfield, Stephen Lane-Smith
Manual processing alongside increasing attention from regulators makes collateral management an ideal use case for DLT. Using a business lens, this paper proposes a model for how DLT could automate variation margin and initial margin calculations, and considers how the principles can be applied across the cleared derivatives world.
Matt Britton, Massimo Morini
Oracles provide authoritative ‘off-ledger’ information to distributed ledgers. This is a critical service to financial institutions. After exploring 6 key industry use cases, the authors consider the implications of oracles on existing business models and potential new business models that may emerge.
Carl Worrall, Clark Thompson
This paper defines identity management for financial actors and entities on a distributed or shared ledger, describes key terms and definitions, reviews challenges of identity systems and categorizes the relevant identity-related companies in the startup and utility landscape.
Tim Swanson colorfully and comprehensively evaluates the COIN ETF and describes many of the idiosyncrasies of bitcoin as an asset. Tim discusses price manipulation risks, “The Winkdex,” facilitators for trade in the industry, out-of-band attacks, forks, and also discusses potential risks associated with unregulated exchanges and mining pools.
Clark Thompson and Chris Verhoef propose an experiment that intends to explore legacy code renewal strategies that leverage existing code bases at financial institutions, instead of attempting to develop smart contracts “from scratch.” Clark and Chris make the argument that reusing code assets will be a faster, cheaper and less risky path towards providing a rich functional catalog of smart contracts. Further, this approach would use code built under existing regulatory compliance schemes and, as a result, may be less subject to increased regulatory scrutiny than entirely new development.
Kevin Rutter compares retail foreign exchange (currency) markets with the growing but still nascent cryptocurrency markets. He evaluates the two markets across topics such as regulation, market structure, liquidity, leverage and short selling and derivatives markets. He also discusses the subtle ways that directional risk arises, putting exchanges and brokers (and as a result their customers) at financial risk, depending on whether they employ a principal or agency model.
Clark Thompson describes the potential for distributed ledger technology to provoke fundamental changes to current operating models in financial services. Clark describes the potential for cost reduction and avoidance, the benefits of sharing non-competitive business capabilities, a business capability model, risk reduction and risk avoidance, shared service utilities and externalization, and business change activities.
In this insurance series, Todd Bault first defines insurance quantumization and explains how fiat currency (a CBDC) on distributed ledgers will be “the killer app” for insurance. The second part describes how state management could be the disruption that finally cracks insurance, and that DLT is the “right” tool to facilitate that paradigm. Last, Todd concludes that Corda could be that future operating system for insurance in such a state-based world.
In this R3 Research brief, Kevin Rutter gives an introduction to commercial bank money and briefly discusses some advantages and disadvantages of the current credit creation system. Then he evaluates both cryptocurrencies and central bank-issued digital currencies (CBDC) regimes and their potential to alter the amount of commercial bank money. He argues that the introduction of a CBDC by a central bank would need to be mindful of the potential impact on credit and loaning activity. He states that the distribution of a CBDC could either be an expansionary or contractionary monetary policy decision and argues that initial implementations in advanced economies will likely aim be “neutral” by leaving the monetary supply as close to unchanged as possible.
Vitalik Buterin discusses the opportunities and challenges for private and consortium blockchains. He provides context for the development of Ethereum, touches on potential interactions between public and private blockchains, and discusses the topics of security, scalability, efficiency, privacy, and purity. Vitalik provides key recommendations on each of these themes.
Tim Swanson explains token crowdsales, a funding tool that companies use to generate capital by issuing and selling a native cryptocurrency. The paper discusses how offerings are commonly structured, the risks connected to the fundraising method, and provides examples of fraud. Many of the points made in the paper are also broadly applicable to cryptocurrencies.
JP Koning provides a concise summary of central bank retail and wholesale payments, international correspondent banking, and traditional remittance providers. He first explains the incumbent systems for each of these types of payments, then describes the emerging competition across the payments ecosystem, and concludes with the potential implications for banks. The paper is an accessible introduction to new payments technology across DLT and non-DLT solutions.
George Calle’s overview of initial coin offerings (ICOs) provides groundwork for how entrepreneurs, innovators and regulators can encourage legitimate ventures in the future. He begins by explaining how they are structured by focusing on new features and risks associated with these offerings. He also explores how ICOs may be evaluated by regulators and points out which laws are applicable.