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The Trading Mesh

Blockchain for financial institutions

Tue, 19 Dec 2017 22:42:00 GMT           

Firms operating in the financial services industry must wonder when this era of digital disruption will end and ‘business as usual’ start again. It is unlikely to happen any time soon because the blockchain, a distributed ledger technology (DLT) with immense transformational potential, is maturing rapidly.

Blockchain is a secure database shared by all parties participating in an established, distributed network of computers. It records and stores every transaction that occurs in the network, and transactions can only be stored if there is ‘consensus’ from all of the computers.

The most famous use of blockchain technology to date is the crypto-currency Bitcoin but the possibilities for financial services firms go far beyond currency trading. Any long, costly asset transfer process, such as real estate purchases, could be transformed. In this example, blockchain guarantees the correct ownership history and removes the need for intermediaries whose role it is to verify transactions, saving other parties time and money.

This year has seen significant momentum develop behind blockchain initiatives in the financial services sector. Regulatory bodies are also keen to keep pace with this disruptive new model and have made steady progress with blockchain trials. For example, the Australian Securities Exchange this year confirmed it had successfully tested the scalability and speed of a DLT-based replacement of its equities clearing and settlement platform.

It is no surprise then that a recent study by Bain & Co found that 80 per cent of executives believe DLT will have a transformative impact on the financial markets, with a similar percentage expecting to adopt it by 2020.

The main challenge for financial services firms looking to take advantage of the blockchain is network security. The permissionless public blockchain used by Bitcoin allows anyone that meets certain conditions to submit to the ledger, but this openness is unsuitable for highly regulated industries. This is why firms are increasingly considering ‘permissioned’ or private blockchain networks. These offer the same benefits as the open blockchain, but with the ability to control who can access the network, submit and read the ledger of verified transactions, and who can verify them.

However, permissioned blockchains still have security concerns at the network level. Attention must be paid to the level of information required to positively identify counter-parties before granting access. Regulators have acted here too: the EU Agency for Network and Information Security recently published a guide for financial sector firms, recommending use of recovery keys, multiple signatures for authorising and processing transactions, and libraries of standardised smart contracts.

Beyond security, firms should also consider whether they have the infrastructure in place to support their blockchain ambitions. As industry analyst Gartner wrote at the launch of its 2017 Hype Cycle: “this technology will lead to a reformation of whole industries… Businesses must think about how to create platform-based business models and what technology is needed to support that move.” DLTs require very large amounts of compute power. Whether this is outsourced or run in-house, an adaptable high capacity network to carry the traffic is a pre-requisite. Furthermore, firms can utilise the latest software-defined networking technologies to manage connectivity to multiple networks, enabling firms to run their blockchains alongside existing corporate networks and access them where needed without impairing the performance of their day-to-day business applications.

As blockchain evolves and moves to the mainstream, the underlying infrastructure is becoming more vital. Firms need the security, flexibility, efficiency and high capacity from next-gen, SDN-enabled networks if they are to be the blockchain disrupters, and not the disrupted.