Banks and other financial institutions have long been derided as being technologically-stunted organisations, too reliant on outdated processes and legacy systems and slow to adapt to the changing demands of 21st century life.
This is not always fair and, when it comes to the new wave of emerging technologies such as blockchain, many banks are not just keeping pace with innovation, they are leading it.
But what is blockchain technology, and why do the banks care enough to commit an estimated $1.7bn (£1.3bn) a year on blockchain research and development projects?
What is blockchain?
We must distinguish blockchain from its most famous incarnation as the technology that underpins cryptocurrencies such as bitcoin. Blockchain as a technology is a much broader proposition.
A subset of distributed ledger technologies; blockchains make clever use of cryptography, distributed computing and consensus mechanisms.
We could be very technical here, but we will not be.
It suffices to say that a blockchain is a distributed ledger, which can be used to identify ownership and audit transactions of value.
A blockchain enables the creation and maintenance of a replicated, shared and synchronised digital dataset that can be held and maintained in a distributed fashion, crucially without the constituent parties needing to trust each other.
Value proposition of blockchain
An obvious use-case example of a replicated and synchronised dataset that is held and maintained in a distributed fashion by untrusting counterparties is personal banking.
Let us say Kevin banks at Bank A and wishes to transfer £1,000 to Rosie, who banks at Bank B. At present, this transfer requires a number of steps:
The ledgers of both banks (and those of a central bank, in respect of the interbank lending) all need to agree with each other in respect of this transaction.
Now consider how often such transactions happen – literally millions of times, every day. That is a lot of ledger adjustments.
Imagine then a means by which a single ledger is accessible by defined parties.
In our example above, such parties would include Kevin, Rosie, Bank A, Bank B and the central bank.
Policy may dictate that the ledger is also accessible by Kevin's other creditors, his parents (where Kevin is under the age of 18), the tax authority or credit rating agencies.
This would streamline the operation of finance, making it simpler, cheaper and less prone to error. That is a blockchain solution.
Beyond money: blockchain in financial services
The value of blockchain has not been lost on the financial services industry.
A number of large organisations have invested in blockchain-focused research and development programmes, primarily focused on the classic banking our example illustrated above, that is, the maintenance of inter- and intra-business ledgers in respect of their lending.
The Bank of Canada and the Monetary Authority of Singapore have recently announced that they have successfully completed a cross-border, cross-currency transfer using blockchain technology.
This marks the first successful trial between two central banks and, according to Sopnendu Mohanty, chief fintech officer at MAS, demonstrates that, "cross-border payment and settlement can be made simpler and more efficient".
Other notable industry figures include:
So the financial services industry has recognised the value of a new, decentralised system for the transfer of value.
This is by no means limited to money. If we think of value in its broadest sense, we might think of personal data, or real-world fixed assets such as real estate. This is where blockchain gets really interesting.
The financial services industry is seeing an explosion in the level of innovation and investment in blockchain-based solutions that address the transfer of value more broadly. This is partly borne out of necessity.
"Financial services, particularly here in the UK, are under attack from all directions. Customers are demanding more digital and personalised experiences; regulators are demanding increased transparency and data security; and new technology is disrupting the ways in which consumers gain access to products," says Phil Fortio, chief executive and co-founder of Tokenblocks, a London-based start-up that has built a platform upon which the investors can communicate directly with asset managers.
Regulators are also getting in on the action and, in some instances, are actually leading in terms of innovation.
Richard Teng, chief executive of the Financial Services Regulatory Authority at Abu Dhabi Global Market, states that: "ADGM was the first regulator in the [Middle East and North African] region to launch a regulatory sandbox and still leads by adopting a highly agile and robust approach to regulation."
ADGM has launched an electronic know-your-client project, by which it has better understood the utility of blockchain technology to create a platform through which multiple parties can share information in a manner that "prevents tampering and provides a robust audit trail", says Mr Teng.
Key points
Regulators and other public sector bodies should have a clearly articulated strategy and policy in respect of emerging technologies such as blockchain and should seek to provide unambiguous guidance and direction to market participants in order to create an environment that encourages innovation and investment.
The financial services industry continues to invest in emerging technologies such as blockchain and, as their focus broadens from the core maintenance of currency ledgers, a vast array of internal and customer-facing processes are ripe for disruption and innovation.
Tom Grogan is an associate at Mishcon de Reya and Kieran Brown is senior managing consultant at Berkeley Research Group