Is it the Blockchain or the Blockchain Solutions that are struggling in the Financial Services?
While the concepts and potential of distributed ledger or #blockchain #solutions are becoming better known, the implementation of them in the financial services has run into some fundamental challenges.
Is this a fundamental shortcoming of blockchain concepts in general or the current solutions?
What if there was a new blockchain methodology approach that mitigated the challenges by design as opposed to the current approach of iterative improvements on current, available solutions with diminishing or unrealizable returns?
The current solutions tackle the issue of confirming a shared ledger by different means.
- Proof of Work – puzzle solving
- Proof of Consensus – majority participant voting
- Proof of Stake – majority value voting
Problem 1: Speed and Logistics
Beyond the computing power that is required to run these methodologies, all of them introduce latency, capacity constraints, throughput limitations and ever expanding active memory requirements (i.e. scalability issues) on the networks that run them. Current innovations are attempting to speed these processes up or bi-pass them. Some of these methods include:
Sharded consensus – a divide and conquer mechanism for quicker, fragmented consensus.
Lightning Networks – transactions agreed off the chain and then recorded to the chain later.
For their benefits, do these solutions introduce more risk as it relates to control, integrity and protection from malfeasance?
The core processing of a distributed ledger is the creation and sharing of contracted transfers of value and updates to a shared ledger that records positions of value through those agreed transactions.
Although it sounds counter-intuitive or even improbable, if there was a means to confirm a ledger’s integrity by the transactions alone and without the need either to gain consensus with other network participants or to involve the network in puzzle solving problem, the computing power of the network would only be dedicated to processing and verifying transactions. The latency, capacity and throughput of the network would then be purely a function of the network participants’ processing and communication hardware.
Problem 2: Reality (Securities and Transactions)
Cryptocurrencies are wonderful because they are not “perfected” (i.e. held and proven to exist) by a central authority. Any national currency is perfected by a central bank and any security is perfected by a depository, sub-custodian or transfer agent. Any blockchain solution that deals with securities, which are not issued into and perfected by that blockchain’s network, has to have a relationship with the securities’ perfecting entities or it will not work.
Looking at the publicized blockchain solutions that are being built, they primarily focus on:
- Syndicated Loans
- Credit Default Swaps
The properties that these transactions and markets all have in common is that they are:
- OTC transactions of…
- … unregistered securities…
- …that have a low volume per transacting party and…
- … predominantly only involve cash transactions.
These represent the least complex use cases in the industry. However, in most cases, they still have to allow for the posting of collateral or the transacting in the underlying securities and those positions must easily be settled between the blockchain solution and the current markets in conjunction with the securities’ “perfecting” entities.
While a blockchain solution for the above products may provide benefits, they will be customized rather than holistic and translating them to other types of transactions will be very difficult. Regardless, beyond flexibility, have they solved for the prior issues including: capacity, throughput, latency, ever expanding accessible memory requirements (i.e. scalability issues) and confidentiality?
The financial services businesses are demonstrably very parochial when it comes to products and functions in the industry. Most of the solutions are customized and pursue implementation paths of least resistance. These practices and behaviors will not create an optimal blockchain solution.
Is it the temptation to take an off-the-shelf solution and inflexibility that is preventing the realization of a realizable, innovative solution?
In all the publicized solutions, there are also real, unaddressed challenges of how the market actually works – including short transactions and financing. The obvious use case is market making but what about a Fund Manager selling a security that is on loan by his/her custodian to a Broker who sold it short for margin financing to a Hedge Fund and the settlement of that sale was to a broker who sold it to another investor whose money, for now, is in a money market fund, not in his/her custodial bank account?
What distributed ledger entry do you reference for securities and cash that you don’t own or can’t point to at the moment of execution?
Without a consideration for all the above issues, any blockchain solution for the financial services comes up short (no pun intended).
After a presentation, earlier this year, by William Mougayar, renowned author of “The Business Blockchain” (available on YouTube: https://www.youtube.com/watch?v=l5hK4YKxPSo ), the moderator’s first question after the presentation (at 18:45 into the video) was “What about the scaling issue?”. Mougayer’s response was telling. He basically said that this was a known issue and there are smart engineers working on it and someone will solve for it.
While altruistically optimistic but not definitive, does that response and the questions above about current solutions’ shortcomings make an extract from a Gartland and Mellina Group press release, made earlier in the year, worth a second read?
“Blockchain #technology, the new frontier in transaction processing, offers powerful real-world financial applications but presents a number of challenges that must be overcome before it can be adapted to securities transactions. Secure, near real-time trading, settlements, and reporting would significantly reduce the capital requirements and costs associated with enterprise processes #banks and brokerages currently use for post-trade operations.
Principals at Gartland & Mellina, a management consulting firm focused on the financial services industry, have been engrossed in the research and development of this new blockchain technology application to better approach future client and industry needs. GMG’s Managing Director and Blockchain Solutions Lead in the Financial Services Strategy and Solutions Practice, Paul Dowding, explains, “By understanding the current utilization of blockchain as used in cryptocurrencies, we identified the core challenges involved in applying the technology to the financial services industry as a whole. By resolving these challenges, we were able to design a unique, holistic set of blockchain solutions for the whole industry that is product, transaction and functionally agnostic.”
GMG’s solution solves the core challenges of applying blockchain technology to the financial services industry by offering:
- Flexibility for Coding and Control: We designed a mechanism to create complex, multi-leg, dependent transactions within the primitive, (stacking, read-write, conditional flow) coding logic of blockchain technology
- Scalability & Volume: Our innovative blockchain ledger design and approach handles the significant memory, capacity and volume requirements of a high volume and high capacity continuous record
- Anonymity and Integrity: The GMG blockchain has the means to retain client and trade confidentiality, even on a shared ledger
- Suitable Blockchain Methodology: GMG maintains ledger integrity through a new real time, high volume, low latency processing design
- Contingent, transaction legs: We created a flexible option securing the settlement of dependent transfers of different assets such as DVP/RVP (sell-side fills and buy-side allocations), collateral substitution and FX
- Financing & liability-driven assets: Our blockchain solution accommodates lending, collateralized and default transactions
- Non-Ledger referenced transactions: The blockchain allows for future dated, accrued and short transactions
- Interface with Current Markets: Asset value can be transferred between the blockchain and current markets
- Interoperability: GMG created a product, process, functional and blockchain agnostic environment
- Current Regulatory, Risk, Credit, Custody, Performance & Accounting Reporting: Data acquisition and interpretation is significantly enhanced by blockchain ledgers
This revolutionary design and approach helps GMG overcome many of the challenges facing the financial services industry today. It addresses growing industry needs for superior security, enhanced data acquisition, quicker transaction times, scalability, and lower costs. John Gustav, Partner of Financial Services Strategy and Solutions at GMG said, “Blockchain technology is considered by many to be the key ingredient to disruption within the financial services industry. It certainly has the potential to create a paradigm shift similar to the way the internet did. Our holistic, product-agnostic approach to blockchain is very different from the other publicized solutions within the financial services industry at this time.”
With blockchain technology, a decentralized network stores the value of all investor assets in encrypted records. This allows contractual transactions, transfer of value, safekeeping and settlement for asset positions to occur digitally in near real-time without the need for a trusted third party. As forging a transaction, stealing or double spending requires overpowering a majority of the computers across the decentralized network at the exact same time, blockchain has an inherent level of security unavailable anywhere else. “Our patents include a generic mechanism to translate financial services transactions into the blockchain’s simple logic and secure code,” Dowding continued. “Benefits include significant cost reduction, near-real-time settlements, new business, product and revenue opportunities and process, and balance sheet and capital efficiencies.” GMG is currently in discussion with different parties to leverage and develop blockchain capabilities as a utility.”
is Managing Director, Financial Services Strategy & Solutions Practice at Gartland and Mellina Group and this article was originally published on linkedin.