unbundling of financial services: the blockchain(s) revolution

Unbundling Of Financial Services: The Blockchain(s) Revolution

Special Thanks To Many Smart People Whose Work Made This Easy To Compile and Helped My Thinking

• Alex Batlin @AlexBatlin• Richard Gendal Brown @gendal• Jake Carter @jakecart• Jack Gavigan @JackGavigan• Gideon Greenspan @gidgreen• Ron Quaranta @ronqman• Meher Roy @MeherRoy• Robert Sams @codedlogic• Chris Skinner @chris_skinner• Michael Smolenski @mikesmolenski• Tim Swanson @ofnumbers• Mark Vigors @Mark_Vigors

Definition from MultiChain

• “If two transactions attempt to spend the same output, then only one of those transactions will ultimately be accepted. A blockchain acts as a unified mechanism to detect and prevent these conflicts across the network.”

Bitcoin Blockchain

Definition cont’d

• “The blockchain is structured as a series of linked blocks, in which each block contains a set of transactions that don’t conflict with each other or with previous blocks, starting from the first block created in 2009.”

• Designed to stop Sybil attacks through “mining”.

• Blocks created by solving algorithms.

Definition cont’d

• Incentivized by “block reward”. This is 25 bitcoins, but will halve in 2016.

• It halves every 210,000 blocks.• Consensus generated through Proof of Work.

Replicated, Shared Ledger

• Shared: Because multiple entities can read or write to the ledger simultaneously with precedence of transaction maintained across all nodes.

• Replicated: because every processing node has a complete and synchronised copy, rather than relying on a powerful central entity

Permissioned vs Permissionless Ledgers

Permissionless Ledgers

• No central authorization is required for a new participant to utilize the ledger.

• Censorship resistant• Something that you can own outright and transfer to

anybody else without permission• Censorship-resistant digital bearer asset• Implies an open, neutral platform that could be a driver

of permissionless innovation.• Innovation and experimentation in digital value transfers.• Blocks can be reorganized.

Permissioned Ledgers

• Access to the transaction scheme is governed and controlled either by the existing participants or a central authority.

• Industry Level Systems of Record• Technologies that allow multiple firms to run a private, shared

ledger of some sort. • Mutualise the cost of running and securing a single logical

ledger, copied across your firms so you each have your own copy and so aren’t reliant on a powerful central entity for access

• Move from each firm having its own systems of record to having systems of record at the level of the industry

• Blocks not reversible.

Why do this?

• If we all agree that this shared ledger is authoritative for records(e.g. who owes what to whom )

• Then could we not also use the ledger to execute shared code ie smart contracts

• That models the terms of a contract between parties? e.g. delivery rebates

• That is inter-firm business logic? e.g identity management – address updates

Different Types of Ledgers

What are the characteristics of a distributed ledger?

Distributed Ledger

Independent permissioned

blockchain

Distributed virtual

machine (Turing-

complete)

Smart contracts

govern off-chain assets

Network achieves

settlement finality

Permissioned blockchain

Legally accountable

validators

Settlement finality

(irreversible)

Suitable for off-chain assets

(securities, fiat, titles)

Sidechains & The Lightning Network

Sidechains

• An innovation proposed and developed by the startup Blockstream

• The creation of new blockchains “pegged” to Bitcoin, so that value can be transferred between them.

• Idea: many permissionless ledgers each with its own rules, protocols and features all underpinned by Bitcoin.

Sidechain Elements

• Confidential Transactions• Segregated witnesses- removes transaction

malleability.• New opcodes- makes whole new forms of

transactions possible.• Basic Asset Issuance- clients can issue their

own assets: stocks, bonds, vouchers, coupons.

The Lightning Network

• Allegedly move bitcoin transactions off the blockchain, w/o sacrificing security/verifiability

• Allows for creation of “micropayment channels” across which multiple bitcoin payments can be performed securely “off chain”

• Except for the initial transaction that starts channel• No counterparty risk: if dubious, channel can be closed and

transaction kicked up to blockchain; settled there.• In channel payments are instant, unlike current situation.• Can route payments across paths, secure trusted intermediaries.• Could scale bitcoin transactions to billions per day

Problems with Sidechains and Lightning Network

• Both options would require a fork of the existing bitcoin protocol.

• The code of a specific coin can be upgraded and altered to help the coin flourish.

• These changes must be made very carefully to keep new coins compatible with older coins.

• Applications accessing and altering blockchain must all be able to read and write the data correctly and consistently.

Smart Contracts

What are they

Definitions

A smart contract

• Is a simple rules engine; cryptographically assured business logic that has the ability to execute actions based on triggers and move value.

Cryptographic signing of transactions

Problem with current contracts

• Parties each independently write computer programs to model the terms:– Negotiated discounts, rebates and price models. – They do this due to lack of trust

Threats to incumbents

• Displaced by a new generation of low cost technology

• Built in technology supersedes existing auditing & reconciliation processes

• Trade matching, and reporting become obsolete.

• RTGS, Deferred net settlement & Correspondent banking become irrelevant.

How do Blockchains alter the payment process?

Enablement

Blockchains Enable

• Bilateral settlement: Eliminates intermediaries, midpoint failure, delays, lifting fees

• Real-time funding: Minimizes exchange spreads, credit risk, collateral costs

Benefits

• Real-time payments (real-time availability of funds)

• Comprehensive transaction traceability and reporting

• Additional reconciliation information • Lower costs and fees

T + 0: This a Big Deal

Opportunities

• Improve the infrastructure for interbank payments

• Banks largely rely on intermediaries (clearinghouses, correspondents) to settle payments

• As a result, banks incur material costs and risks that can be prohibitively expensive – especially for cross-border and real-time payments.

Increasing Pressure on Banks and Financial Services

From Customers & Regulators

Customers

• Demanding real time payments• Lower fees• More transparency• Better digital experiences (seamless)

Regulators

• Stricter liquidity requirements• More consumer disclosures• Cost of regulation forcing them to leave core

businesses

Challenges for the banks

• Getting banks to adopt new technologies and infrastructure and offer to their customers

• Central, proprietary systems adds complexity and costs to banks.

• A lot of different systems that don’t interoperate w/ each other.

• Disintermediation from their customers transactional business.

• Loss of fee revenue due to move to alternate payment providers or need to reduce/eliminate fees from existing payments products to remain competitive.

Banking Challenges cont’d• In the payments space, the biggest challenges financial

institutions face is the high cost to change and innovate.• Banks are highly risk adverse development and deployment

processes are impediments to agility.• This is exacerbated further by regulator defined system

availability targets.• They have built in payments infrastructure over the years with

one department over high value transactions, another for ACH, another for international, and yet another for handling cards.

• Within FI’s, different organizations have their own budgets and their own IT. Massive inefficiencies, old systems that don’t operate in real time.

Banking Challenges cont’d

• Legacy infrastructure.• FI’s move money from one account to another,

with their own rules.• Cost of infrastructure = cost of transactions.• Account to account transfers are centralized,

passing through clearing infrastructure and into a settlement infrastructure.

• Enormously expensive and slow.

Conclusions

• Convergence of payments (wire payments, checks, cards, transfers) all diff. payment types moving from one account to another using diff. systems and processes. Converge to real-time payments.

Reduction of Costs

Bye Bye Backoffice

Conclusions: The Internet of Money

Meher Roy Ties It Up Nicely

Internet of Money

Source: An architecture for IoM – by Meher Roy

Internet of Money• Value becomes very fluid, converting from one form to another and

transmitted in seconds at virtually no expense.

• Integration of all assets, for all people and all geographies– Fiat money– Shares, bonds, derivatives– Property titles– Airline miles

• Through cryptographic transactions:– Smart contracts– Smart property– Decentralised exchange of securities– Machine to machine transactions– Permissionless innovation

Benefits of IoMBenefit Description

Speed of transfer ~10N increase in global transfer of assets (currencies, equities, derivatives, land titles..)

Settlement Risk All settlement risk becomes virtually mitigated.

Transparency Full history of transactions can be made available.

Audit and Regulatory Universal record of truth. All transactions are permanent and unchangeable.

Big data analytics Deep transaction metadata means customers will be better selected for new products.

Liquidity Decentralization creates new pools of global liquidity

New Markets New methods of arbitration through digital smart contracts.

The Real Lesson of the Internet of Money

• There is a massive benefit to interconnected ledgers rather than one global ledger.

• Each ledger network becomes more easily manageable:

• Especially upgrades• Ledgers operating within national boundaries to

comply with local legislation.• Legal enforcement of malicious actors.

So Why Blockchains?

Blockchains Can

• Pass & process transactions very frequently; heading to T + 0.

• Bitcoin 10 minutes, Ripple 5 seconds.• Double spend is eliminated• Contains a script which identifies custom logic

describing how it should be validated (smart contracts)

Blockchains Can cont’d

• “Sharing of the commons” more than 2 entities involved.

• Peer to peer distributed ledgers.• Reduce transaction fees dramatically.• Increase transparency enormously.

Real Time Settlement of Assets is Becoming a Reality

Contact Me

• Email: george.samman@gmail.com• Twitter: @sammantic