Blockchains and Banks: The Blind Date has begun

Pratima H

INDIA: When one first stumbles upon the words – hard fork and soft fork, one is inclined to check if it’s some cooking reality show running by mistake. But no, this is about money, of all things, and withal, money in an entirely new form – the formless.

While the world in general and laymen in particular were still miles away from getting their heads around the very idea of a crypto-currency like Bit coin, a parallel world on the other side had already started banging heads together over a fork in a Blockchain.

The whole hard fork vs. soft fork debate stirred up after DAO (or Ethereum‘s first Decentralized Autonomous Organization, and also the platform’s most prominent project, that was holding millions of dollars of capital by investors) lost most of its money to a totally unexpected hack. The very stroke that the theft transpired by using the platform’s own key tenets is another day’s discussion, but the thief also managed to rob the platform and its family of all calm and peace.

To ensure that investors got their money back, there were two choices hinging on the core principle of immutability – one possible by breaking it, one possible by preserving it. To bring the DAO code back to the point prior to the original attack meant a hard fork, by the way – which meant fiddling with the fundamental principles of a Blockchain.

The forks notwithstanding, banks and financial players have started inspecting their own cutlery in a new course. Blockchains may be new, and a lot unusual – but they can’t be wallflowers anymore. Not if people are stealing millions out of them, hence proving that people may be putting millions into them – today or some day.

And why would that happen?

First: Grasping the Ether

It’s simple and yet not immediately so. A Blockchain can be understood as a digital, distributed ledger system that records an asset’s movement and ensures point-to-point tracking of information on transactions that map the asset’s journey. The idea was to make it quite crypto, quite digital, quite decentralised and therefore – tamper-proof.

In doing that, a blockchain, of course also challenges the models that we, banks, governments, regulators etc are used to – no intermediaries for utmost trust in the system. The code happens to be in the driver’s seat this time.

With cryptographically protected linkages, groups can also update the ledger, or clear or block transactions constantly with help from preapproved rules but without any need of an intermediary.

The lists are themselves enough as people self-update them, and they are available for anyone to inspect.

It can also be explained as a distributed database which can only be written in consensus but read by anyone, a mix of irony and developer-brilliance alike.

Now if that’s what they are, they would definitely transform the financial system as we know it today. Would this flip be for the good or the bad - you can’t help wondering.

In theory, we can already start concocting ideas of a system that is less expensive, more sturdy, very efficient, unprecedented on the strength of authenticity of transaction data and truly democratic thanks to the core of individuals and not institutions running it.

Thinking of the Internet as a reference here suffices to conjure up images of a new world order altogether.

Now isn’t that exciting? Or is it something opposite?

Rajashekara V. Maiya, Associate Vice President & Head – Finacle Product Strategy prefers the former suggestion and surmises that the most exciting aspect of this technology is its ability to be deployed across various areas, bringing decentralization to the table, thereby eliminating the need for middlemen.

Plus, it further reduces expenses, considerably, deletes unwanted steps involved in a transaction thereby saving time, and allows transactions to be concluded in an extremely secured environment.

He’s hitting the nail. Experts have ventured far and wide on the kind of efficiencies, transactional security, transparency, safety, security, speed, accountability and accuracy – all that at a lower cost compared to current high-cost ledger platforms – that blockchains usher in.

In fact, the right applications and new smart contracts branching out of such a platform can lead to many banking-side upshots like: Swift banking experiences, simplicity in business processes, processing time gains, new revenue models and the possibility of wiping out the cost of clearing house.

It makes areas like international money transfer, stock trading, smart contracts exciting: Deepak Sharma, Kotak Mahindra Bank

Like Deepak Sharma, Chief Digital Officer, Kotak Mahindra Bank, picks out - the most exciting thing about Blockchain is those disruptions and potential opportunities that arise because of decentralisation across different areas such as international money transfer, stock trading, smart contracts etc. “Various enterprises and regulators globally have started exploring the blockchain technology to explore its impact and applicability in different areas.”

Simplicity stands out for Blockchains.

“This simplification also has the direct benefit of minimizing transaction costs by elimination of intermediaries. As the underlying technology that powered Bitcoin, it offers a tested core platform on which industry specific solutions can be built from Finance to Real Estate to Ecommerce to even Government Services. “ adds Deepak Kinger, Vice President, Banking and Financial Services, VirtusaPolaris when he labels it as an elegant solution for simplifying business problems that have the need for transparent and immutable transactions.

The real power of Blockchain is in its extensibility: Deepak Kinger, VirtusaPolaris

But as Kinger drills further, the real power of Blockchain is in what can be built leveraging the technology as foundation. He picks out some examples of solutions that are either already live or in the process of being developed:

- Currency exchange and cross border remittances
- P2P payments
- Trading platforms for various asset classes from equities to gold
- Post trade process and settlements
- Land and automobile ownership registry
- KYC, AML and CDD (Client Due Diligence)
- Decentralized patient records management independent of a specific hospital
- Escrow and Custodian services
- Diamond certification and fraud management services
- Distribution platforms and intellectual property management for digital content including art and music

That doesn’t leave much doubt that Blockchains pack the potential to transform financial markets. And Sandeep Kumar, Managing Director, Capital Markets, Synechron, weighs in how the concept has capital market firms and banks alike excited by digital ledgers, smart contracts and other digital innovations that could dismantle broken, inefficient operations, minimize risk and reduce fraud.

Now before we get carried away, he also inserts a footnote. “Simultaneously, it has intermediaries and financial institutions concerned about disintermediation and is driving a fear of missing out among those firms unsure how to take actionable steps to make their blockchain dreams reality.”

Precisely what one should be asking next – shouldn’t the word ‘disintermediation’ be a thunderbolt for many?

Cryptic Air, De-Centralised Waters

A distributed ledger that springs from a ‘decentralized trust model’ is quite a novelty in itself.

Specially in a financial system where customers are inured to trusting banks for maintaining their accounts and regulators for keeping an eye on everything.

But Kinger reminds - all these are centralized ledgers. In the world where Blockchain is pervasive, the records will move from the centralized agencies to become decentralized. The distributed ledgers will become the custodian of trust, he sketches the new model.

It is imperative to remember that blockchain based applications cannot be used by a bank in isolation. A network of banks should be in agreement to power this technology. Maiya explains how it leverages a network to govern transactions and interactions across a distributed community.

Dr. Pandurang Kamat, Chief Architect- Innovation and R&D at Persistent Systems does not appear to be perturbed when it comes to Distributed, Decentralized, Immutable aspects but he does underline certain open ended manifestations such as Bitcoin turning into a regulatory challenge.

Blockchain’s decentralized distributed ledger has its pros and cons, and ultimately, an implementation will find success based on finding business operations and challenges that a decentralized model is well-equipped to solve, Kumar indicates too. On one hand, certain operations like trade finance are highly-decentralized by nature, and therefore, blockchain could be an incredibly strong application for this type of business.

On the other end, while there are real concerns for intermediaries like SWIFT or the DTCC involved in payments and settlement, their future role will depend on their ability to adapt to new digital operations and add value in kind.

Let’s not forget though what Maiya amplifies. “This governance is managed through a decentralized ledger that has a distributed computing infrastructure and a common protocol. This ensures that fraudulent transactions do not take place.”

Interestingly this very bete-noire can be the very pillar for the platform. Kinger paints decentralization as that key attribute of Blockchain that is helping in creating disruptive solutions across industries. “Generally speaking, decentralization is a good thing because it helps remove intermediaries thereby bringing down transaction costs. Yes, you do need governance but in this case, the distributed ledger of Blockchain provides that as a native feature.”

May be there’s a positive spin to the decentralised flavor somewhere, even for KYC flag-bearers?

Regulators visiting Dentists?

If there are doubts over lack of security or lack of oversight or regulation’s teeth going weak, listen to what Kamat contends. “Blockchain actually allows for transparency and oversight to all participants including regulators.”

Platforms such as Linux foundation’s hyperledger have built in access control – permissioned blockchains: Dr. Pandurang Kamat, Persistent System

In fact, if anything the trail gets stronger for regulators with Blockchain. Sharma and Kamat believe so when picking out aspects of blockchains being immutable and easily verifiable here.

Blockchain’s ability to enhanced time stamping, reduce manual processes and increase visibility due to streamlined, digital operations will all help to make audit trails stronger. In trade finance, as Kumar illustrates, decentralization has made it difficult to recognize fraud, costing businesses an estimated $14 billion a year. These are the types of problems that blockchain can help solve, which would be a win for financial institutions and regulators alike.

The distributed ledgers will become the custodian of trust: Deepak Kinger, VirtusaPolaris

The fact that all transactions on a Blockchain are available on the distributed ledger in transparent manner, and they are secure and verifiable means that there is a natural audit trail, adds Kinger. This makes things better from the regulator point of view and they can drive their policies to build upon the transparency already created by the technology.

The real muscle of such platforms lies in the code and that is what makes them amenable for imagining a world of smart contracts and digital trust finally.

Digital Trust, Huh? Now how big are we cooking those pies in the sky?

Ask Sharma if the trust in 'code' can ever replace 'need for law' and he dismisses the possibility. “We do not see trust in ‘code’ replacing ‘need for law.” But he maintains that open-ness plays an important role from security perspective, managing KYC or compliance in Block chain improves sharing and security.

Kamat responds in the affirmative as he reckons the trust in code to come into play but in a way that codifies the legal compliance and not replaces it. He hastens to warn that open-ness does not equal to trusting code put up by unknown parties, or putting sensitive data in plain text on blockchain. “There are different flavors and manifestations of blockchain platforms and one has to choose the right one.”

Permissioning will be critical for security to define who has access to what type of information: Sandeep Kumar, Synechron

But while there is an open aspect to the blockchain – its success to minimize risk, reduce financial crime and enhance security will depend on a marriage of both code and law. Kumar further weighs in that even as blockchain protocols and regulations are still evolving, successful blockchain implementations will look to the spirit of current compliance frameworks – such as the regulatory desire to digitize more KYC data – and use the blockchain to support those initiatives. Where existing KYC utilities have struggled to achieve critical mass and reduce operational cost and standardize industry policy, a new blockchain framework could succeed.

Is the Spoon Bending?

So, Blockchain offers an opportunity to overhaul existing business models, including banking infrastructure, approach to settlements and customer interactions. It focuses on reinventing and reengineering entire product classes and supply chains both within and outside of the financial services world. Maiya also picks out another possibility. Blockchain networks are also going to have data that can be leveraged by enterprises for deeper insights around customer behaviour, right sell opportunities, product performances, risk management, fraud detection, surveillance, anti-money laundering, real-time processing etc.

Blockchains can overhaul existing banking infrastructure: Rajashekara V. Maiya, Finacle Product Strategy, Infosys

If there is any one extra-ordinarily alluring promise that the blockchain offers financial institutions, it would be its ability to rethink and re-engineer the reality of today’s market, as Kumar squeezes it out.

Various enterprises and regulators globally have started exploring the blockchain technology to explore its impact and applicability in different areas, Sharma lets on.

Kinger also exudes confidence as he states that enterprises, both the new digital-only kind as well as the traditional ones along with regulators should therefore see Blockchain in a positive light.

For all that potential to weld into reality, there are some actual worries and imaginary fears that would have to be sliced. No matter how revolutionary, fresh, breakthrough or subversive it sounds, the blockchain renaissance can, in all possibility, only stay in the parallel world that sculpted it.

Yes the sceptic stays stubborn, despite all the well-measured euphoria.

It’s still hard to imagine when (and more importantly, if) inhabitants of current financial landscape would be looking at this new model as a plausible ‘fork’ in the road - Whether hard or soft.

What makes that tough - in the next part.