From blockchain to distributed ledger

In my recent Outlook article for 2017 (Blueprint for future beyond blockchain), I wrote that I foresaw the appearance of various distributed ledger technologies in production use. The recent announcement by the Depository Trust & Clearing Corporation (DTCC), one of our Business Partners, that they will re-platform their Trade Information Warehouse (TIW) for credit derivatives using distributed ledger technology, is an example of these industry developments. The project, led by IBM in partnership with R3 and Axoni, represents one of the first and largest blockchain initiatives on an industry scale, so far.

Having said that, it is important to note that these implementations have little in common with the blockchain of 2008-2014, meaning a shift away from blocks, miners, pervasive data across equal nodes, and the use of multiple consensus mechanisms. Instead, today’s distributed ledger technology is a permissioned, distributed and not really a peer-to-peer network. As the New York Times wrote, the D.T.C.C. project “will not use Bitcoin’s blockchain. Instead it is building something similar to a blockchain, known as a distributed ledger, which multiple financial institutions can update and view at the same time. Unlike Bitcoin’s blockchain, the D.T.C.C. ledger will be open only to invited participants."

These multiple implementations are essentially distinct proprietary platforms, in the form of ‘walled gardens’, to which investment managers, as key industry participants and asset owners on the buy-side, will undoubtedly soon be invited to participate.

A revolutionary change? Not so much

Back when the blockchain hype started, we saw many in the industry arguing that it would mean the end of central clearing parties (CCPs). The near-term future is more likely to see CCPs adopting general ledger technology to create more efficient system, the benefits of which will support asset managers. In an online article by Professor Craig Pirrong, A Pitch Perfect Illustration of Blockchain Hype, he writes, "So the proposal [blockchain] does some of the same things as a CCP, but not all of them, and in fact omits the most important bits that make central clearing central clearing."

He also writes, "I think there will be a role for blockchain. But I also believe that it will not be nearly as revolutionary as its most ardent proponents claim. And I am damn certain that it is not going to disintermediate central clearing, both because central clearing does some things “decentralized clearing” doesn’t (duh!), and because regulators like those things and are forcing their use."

A long time-a-coming

In a recent article in the Financial Times, Oliver Bussmann, former CIO at UBS Asset Management wrote that, "No doubt financial services will follow; when it comes to blockchain, I do not think you can escape destiny. But the dream of a fully blockchain-enabled financial system will take some time to fulfil." Explaining these comments, Bussmann also wrote that, "… as the former group chief information officer of UBS, where we championed blockchain early on, and as an adviser to banks and fintech companies today, I am cautious. My experience tells me it may be a while before we see large-scale adoption in the financial industry."

'Oliver Bussmann'

These views echo my own. Given the current developments of the technology, taking a direction towards a variant of distributed database rather than censorship resistant networks, the question arises on whether these new technologies are indeed more efficient (in terms of running cost, implementation effort and disruptive effect) compared to the existing trusted and centralized model of processing. The old issues of interoperability, ownership, and standards that I discussed in my previous blog post about blockchain remain to be resolved – and quickly, if the technology is to penetrate the buy-side in the near future.

Regulatory challenges may hold things up further

A recent IOSCO Research Report on Financial Technology, highlights the growing intersection between FinTech and securities markets across a number of critical business areas, including applications of distributed ledger technology. The report concluded that the "global nature of fintech creates challenges that regulators should address through international cooperation and the exchange of information."

Given that all the current work on distributed ledger technology has been done without explicit regulatory oversight or endorsement, it is also possible that different regulatory authorities make discouraging moves towards a decentralized market infrastructure. I echo Bundesbank president Jens Weidmann, when he wrote that, “Whatever we do, we need to avoid a regulatory race to the bottom. Rather, we should go for a level playing field."

Conclusion

In the decision-making process, investment managers will need to carefully evaluate the business cases via a considered cost/benefit analysis. We expect most firms to follow a cautious approach, predominately to gain clarity on the longevity and dominance of these emerging platforms. Nonetheless, the current approach of Investment Managers not getting involved actively in learning about the technology, participating or leading Proof of Concepts, does allow the sell-side to shape the emerging technology and its surrounding commercial, regulatory and implementation issues in line with their own interests and for their own benefit rather than for the buy-side.