Westpac and the Australian Stock Exchange have taken very different paths on their journeys with blockchain, but they both agree on one thing: the technology is way overhyped.
Blockchain has hit the “peak of inflated expectations”, according to Gartner’s 2016 hype cycle for emerging technologies, but is yet to reach the point of disillusionment, nor to achieve widespread adoption.
“Don’t believe everything you hear about blockchain. It is ridiculously hyped,” the ASX’s general manager of equity post trade services Cliff Richards told the FST Media Future of Banking & Financial Services conference last week.
“If you can solve your problem without distributed ledger technology, continue to do so. I’ve had people in large organisations say they need to put blockchain in the business case because that’s how they’ll get the money. Not a good reason.”
Blockchain technology is a “solution looking for a problem” - a “completely backwards” approach to innovation, Westpac Institutional Bank’s head of innovation and implementation Mike Baldwin said.
“Nobody really knows how long it’s going to take to get to [mainstream adoption]. And I think that’s the key for distributed ledger technologies - if they only make it a little bit better than what we have today, I don’t think any of us are going to be able to justify the cost, the time, and the effort to bring it to market,” he said.
Reinventing trade
The ASX’s disciplined approach to its own blockchain implementation is showing early signs that its cost, time and effort investment will pay off.
The stock exchange is emerging as the poster boy for blockchain in Australia, providing arguably the strongest example of a practical use-case for the technology to date. It has partnered with fintech firm Digital Asset to replace its CHESS post-trade cash equities system with a private, permissioned distributed ledger system.
It has completed development of a working solution and is now focused on building an “industrial strength platform” while working through the impact of such new technology within the heavily regulated finance industry.
The ASX spent a lot of time understanding the potential friction points and growth areas of the technology, Richards said, to make sure it was the right solution to the stock exchange’s problem.
Amongst a “laundry list of benefits” the ASX identified blockchain’s ability to handle two traditionally big problems with capital markets: double spending and fractured data.
The double spending issue has historically been mitigated by a central counterparty, an entity that sits in the middle of transactions to verify them and maintain a golden source of data so double spending can’t occur.
Blockchain protects against double spending by verifying each transaction added to the distributed ledger against all others to ensure the transaction has not already been spent.
This elimination of the need for a central counterparty in a blockchain environment is "probably its best known benefit," Richards said.
However the “real” problem with capital markets currently, according to Richards, is fractured data, or inefficiencies in reconciliation - an often manual process that frequently means organisations don’t identify errors in their books until year-end or during a periodic review.
“The ASX is the clearing house in the middle to which every other data store has to reconcile their books and records. They can send a message saying ‘please do this’ and we can send one back saying ‘we’ve done it’, but they don’t know whether we’ve done it until the end of day reconciliation is performed," Richards said.
The stock exchange's blockchain solution involves what it calls a “global sync log” where all separate data stores are kept in “perfect, real-time sync”.
“Imagine a world where you keep the same actors on the stage but you connect them through this fabric that gives them a real-time view of the golden source data,” Richards said.
"When you’ve got a real-time connection fabric that doesn’t need to be reconciled, you’ve got a very efficient distribution mechanism of the golden source of truth."
While the parties involved in a transaction will retain a copy of their own transaction data - as would the ASX - all that will be shared globally in the private blockchain is a “fingerprint” (or a one way cryptographic hash) of the transaction to provide cryptographic proof to the log.
Storage and maintenance of the blockchain data is a non-issue because all that is stored is a SHA256 hash, and “there’s only a few million of those a day”, equating to around 4-5TB of data, Richards said.
Once all participants have a real-time view of transactions passing through the post-trade cash equities market, other benefits begin to appear, he said.
“If we start to give listed companies a node .. suddenly it doesn’t take three days to a week to work out who owns your company, you can work it out much faster. If you’re issuing a proxy vote as a company secretary, real-time to all your investors, they can vote and you can see those votes coming back in real-time,” Richards said.
“This is a significant transformation from the way we work today - a message-based reconciliation system - to one where the golden source of truth is available in real-time, and where data privacy is protected.”
Read on to learn about Westpac's rocky journey with blockchain...
Ripples of blockchain at Westpac
Westpac’s less public journey with blockchain so far has involved three proof of concepts in partnership with blockchain start-up Ripple.
The US company - whose software is built on distributed ledger technology - has a growing number of banks in its network of backers, including the big four locally.
In early 2015, Westpac trialled a Ripple-based solution as part of a proof of concept that aimed to improve the long and costly process customers need to undertake to transfer small payments to others overseas, Westpac Institutional Bank’s head of innovation and implementation Mike Baldwin said.
“[It’s] a really big problem in Australia: the ability for individuals to make small payments overseas quickly, at a low cost, and in a way that is fully compliant with our [regulatory] obligations,” he said.
“As banks we don’t really have great solutions for that.”
The bank set up three “nodes” - one in Australia, another in New Zealand and a third in Fiji - in partnership with IBM and Ripple on the Ripple ledger, and built a website for the bank’s employees participating in the PoC to register themselves for their transaction.
Participants were given a unique BSB and account number required to perform their transaction, after which they went back to their online banking account to initiate the payment.
“We could then match that at the back-end - identify the sender and recipient, filter it through our sanctions filter to make sure it’s fully compliant - and then we put it into that node in Australia on the Ripple network,” Baldwin said.
The bank's financial markets staff were engaged as “market makers” in the middle to conduct the foreign exchange, with the transaction then hitting the receiving node in either Fiji or NZ where the branch would distribute the funds.
The bank conducted around 45 payments on the production system, with the PoC proving the cash could consistently land in the recipient’s account the next day.
The project was also “really low cost” due to the use of domestic low-value clearing systems on both ends, Baldwin said.
Having proven the time and cost proof points it had set out to achieve, Baldwin’s team built a business case and won funding for the project.
But the team fell short of getting the system fully into production given the integration it would require with Westpac’s existing systems.
“We wanted to make it really simple for customers, we didn’t want to have two portals where they register here and pay there, we thought ‘let’s integrate it with our online banking’. [That’s] costly and time-consuming, and also complex,” Baldwin said.
“So that was a bit of a challenge, and because it took a long time, people started to question why no-one was on the Ripple network yet.”
The bank ended up abandoning the technology in favour of a direct connection to the Philippines through an API. It released the subsequent LitePay product this year, allowing payments of up to $3000 to be made to the Philippines for a $5 fee and at a much faster rate than traditional telegraphic transfers.
“So the first lesson is: if the distributed ledger is really only adding the value of a network, it’s probably not enough to get your business case over the line,” Baldwin said.
After its first proof of concept, Baldwin’s team turned its attention to small-value transfers made by businesses, which were experiencing the same problems as individuals in terms of cost and time headaches.
It decided to work with an overseas bank this time instead of a Westpac branch, and quickly came up against the legal agreements, processes, protocols and standards that would need to be in place.
“That was fine for a proof of concept with one bank. But if we contemplated doing that for a dozen or several dozen banks, independently all those bilaterals would be very costly and very complex - again it shoots the business case out of the water,” Baldwin said.
While the first proof of concept had proven the technical feasibility of using blockchain technology for overseas payments before it fell at other hurdles, Westpac’s third distributed ledger use case was “incredibly compelling”, Baldwin said.
The bank partnered with a dozen other financial institutions for a proof of concept that would allow payments to be sent overseas without a Nostro account (those held by a bank in a foreign currency within another bank, used to facilitate foreign exchange and trade transactions).
“If you’re going to send a payment to another bank and they’re going to distribute the funds for you, they have to get the value somehow,” Baldwin said.
The proof of concept saw the banks all set up wallets on the Ripple network, and using a few thousand dollars in XRP cryptocurrency provided by Ripple, send money successfully back and forth across the globe.
But banks “aren’t going to use cryptocurrency” as part of their normal operations, Baldwin said.
“It’s not backed by a Reserve Bank, it’s sort of an IOU, you’ve got to trust it,” he said.
“But imagine reserve banks all around the world - and they’re already starting to talk about it - creating digital currencies as opposed to cryptocurrencies, which means you put Australian dollars, US dollars, pounds and euros on a ledger, and we could all trade those around on the ledger without needing our Nostro accounts.
“So we’d free up huge amounts of liquidity all around the world; we have it on the ledger but it’s a small fraction of what we have out there today.
"And when you think about the reconciliation of settlements benefits of that in terms of the speed and time and effort, this is a really compelling proof of concept.”
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