Blockchain and Distributed Ledger:  Who Cares?

Payments Leader

Posted on March 18, 2016


Blockchain players, that’s who!  Let’s take a look…

March 2016

The hype around the payments’ world is hitting fever-pitch. As 2016 progresses, there can no longer be any doubt: blockchain and distributed ledger technology is the wave of the future – despite a lack of consensus on what a blockchain is and exactly how it should be implemented. But this is not necessarily a problem. Blockchain can be seen as the highway on which different vehicles operate. Blockchain is a long established technology, but it is the payment vehicles running on the blockchain highway, their designs, capabilities and regulations, that are truly under scrutiny. The bitcoin juggernaut may have grabbed all the fame and infamy, but it is not the only game in town.

The Players Take the Field

In its pure form, blockchain as a distributed transaction ledger of immutable transactions has significant implications across the world of payments and far beyond. But the impact depends on the different players and their position on the field. How do consumers, banks, fintech providers, businesses and regulators differ on the seeming inevitability of blockchain and distributed ledger technology?

In the realm of payments, blockchain essentially champions automation and decentralization resulting in systems that remove the middleman. By enabling a direct contractual interface between two transactional parties, the technology has the power to democratize payments and theoretically make any exchange of value quicker, safer and also cheaper.

Consumers – Utopia

Consumers UtopiaQuicker, safer and cheaper? What’s not to like? Payments are not just about funds transfer; the reality is that consumers are increasingly focused on a richer and more secure retail experience coupled with instant gratification. The underlying technology is somewhat irrelevant.

With compelling promises of borderless funds transfers, instantaneously and at virtually no cost, it is hard to argue against a utopian open payments market, accessible to all. Applications built on blockchain technology also afford consumers a level of anonymity – pseudonymous – not available on bank-operated payment networks. Inevitably, without regulated KYC (Know Your Customer) legislation, this opens up opportunities for criminal activity, money laundering and tax evasion. Ironically, the inherently secure and obfuscated nature of blockchain implementations drives the concerns about misuse.

The potential to provide cheaper and faster international money transfers and bring new efficiencies into the remittance market are good news for consumers. The hype promises being able to shop at the ‘speed of life’; consumers are still waiting for the retail experience to match up to their expectations.

Enterprises – Softly, Softly

EnterprisesPayment processes within businesses, large and small, have multiple considerations: speed, risk, cost, transparency, etc. Established payments technology is safe and proven for high-volume high-value transactions, so who needs to risk a revolution?

Scale matters. Wholesale currency conversion rates change the game when compared to micro-payment rates; the underlying money markets for trading in foreign currencies are very efficient. The spread costs for trading large amounts in liquid currencies can be a fraction of one percent, but when banks have to transfer smaller amounts the costs go up to single-figure percentages.

Enterprises traditionally move more slowly and cautiously than consumers. Technology needs to be tried and tested before widespread acceptance. Blockchain technology still has questions to be answered and there is a need for more real-world use cases before businesses will reengineer their established payments processes.  Blockchain will inevitably simplify and reduce transaction costs in the future, but more importantly, it will also bring down costs and reduce risk when it comes to issues relating to trust where two parties don’t know each other.

Financial Institutions – Disruption

fintechBlockchain applications will disrupt the banking industry precisely because it is a really simple business to disrupt. Banking is a data business. However, the data (money) can be corrupted or leaked, but it functions because you can fully trust the underlying banking system. Blockchain offers a comprehensive solution for banking because it cannot be corrupted – its integrity is beyond question. The revolution is coming whether banks are on-board or not.

Banks understand this, blockchain is now touted as the tool to makeover the entire enterprise: back office, security and trust, auto-KYC, settlement, fraud, capital markets and, of course, payments.

Blockchain isn’t going to circumvent the global banking system anytime soon. But there is genuine desire to make a success of distributed ledger capabilities. The benefits of cutting out inefficient intermediaries and reduced infrastructure costs for cross-border payments, securities trading and regulatory compliance could save billions for consumers and the financial services industry.

Fintech – Gloves Off

fintechFintech predictions for 2016 have been accompanied by more enthusiasm than usual. The amount of money being poured into financial startups is matching the excesses of the dot-com era. However, these billions are probably still a fraction of banks’ legacy IT expenditure. The end game is still unclear. Blockchain could be a transformative tool for business, especially finance, but regulation or moves towards de-anonymization could stunt growth irrevocably.

Fintech has made numerous dents into the world of financial services over the last two decades through technology innovation. But blockchain-based distributed ledger solutions have the potential to make genuine breaches into fully-fledged businesses. Banks often feel insulated from the effect as startups don’t attack head-on. Some fintech providers attack parts of the financial services market, others offer solutions to existing players, while some espouse a cooperative process to innovate.

Fintech providers see the opportunity and are all striving for their piece of the pie. But, hot on their heels are the leviathans of the software market such as IBM, Microsoft, Google, Apple, Oracle, etc. Blockchain-as-a-Service is already a reality.

Regulators – Decision Time

regulatorsGovernments and regulatory bodies around the globe are actively monitoring, testing and researching blockchain and distributed ledger technology with a view to developing standards and regulating use. Of particular interest to governments is limiting the encryption and anonymity capabilities. End-to-end encryption is vital for user anonymity and a major part of the value proposition, but governments are aiming to limit its use – and to counter anonymity altogether – in order to better monitor perceived threats. These restrictive measures could prove disastrous for many applications of blockchain if successful.

Many banking bodies have asked for a ‘light touch’ to regulation of the underlying blockchain technology given its potential to fundamentally change the realm of funds transfer. However, the regulators must wrestle with compliance demands that don’t stifle innovation through unreasonable on-boarding and monitoring processes. The established AML (Anti Money Laundering), KYC and money transmission laws and regulations as applied to established institutions have been heavily criticized for imposing onerous conditions on startups, making it impossible to operate. Additionally, if such standards were extended to other blockchain-based applications, the regulatory approaches could slow down innovation across the entire blockchain space.

The move towards the adoption of private blockchains as opposed to the less controlled nature of public blockchains is an important distinction for financial institutions. Regardless, blockchain technologies remain a powerful tool for innovating payments services while increasing the transparency and accountability of financial institutions to the regulators.

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Payments Leader

Payments Leader from FIS provides insights on credit, loyalty, fraud and emerging payments strategies through blog posts from our industry experienced authors.