Case for blockchain in financial services characterized by errors

A number of high-profile blockchain experiments in banking and finance have ended in failure this year, undermining the case for the technology’s future in financial services.

The biggest blunder came from the Australian Stock Exchange, which in November abandoned a plan announced seven years ago to upgrade its stock clearing and settlement to a blockchain-based platform. The exchange ordered a fee of US$250 million (US$168 million) and apologized after admitting that it was necessary to restart the project from scratch.

Other initiatives in insurance, banking and shipping have also collapsed, suggesting shared digital ledgers may fall flat in the quest to reform cumbersome operations. Even supporters of the technology warn that users should be prepared for several errors.

“We’re forever coming up with new ideas and killing them if they’re not appropriate,” said David Newns, head of Six Digital Exchange, which issued the first digital bond on a distributed ledger in November. “We’re in the invention space, so we have to think of new things with the expectation that many of these ideas will fail.”

In July, B3i, a consortium of 15 insurance and reinsurance companies, ceased operations and filed for insolvency. The project aimed to reduce inefficiency in premium and claims settlement, and place contracts on blockchains.

We.trade, another blockchain consortium of 12 banks focused on trade finance, also entered insolvency in June. The project had included Deutsche Bank, HSBC, Santander, Société Générale and UBS.

Most recently, Maersk and IBM announced in late November that they were decommissioning TradeLens, a supply chain blockchain solution for the shipping industry, saying it had not “reached the level of commercial viability necessary to continue operations and meet financial expectations”.

The failures have come along with the crisis that has engulfed many of the crypto companies that were trying to build their businesses trading and lending digital tokens like bitcoin. It culminated in the November collapse of FTX, the cryptocurrency exchange – a failure that has undermined the case for buying tokens in the hope of making money.

Nevertheless, some banks are still committed to blockchain technology. “There is a lot of negative sentiment around cryptocurrencies, most recently because of FTX,” said Mathew McDermott, global head of digital assets at Goldman Sachs’ global markets division. “It has nothing to do with the underlying technology.”

Goldman, rivals such as JPMorgan and other financial institutions remain open to blockchain technology, citing the potential for efficiency gains and cost savings. JPMorgan has promoted its Onyx digital asset platform, which connects other banks and financial institutions such as Visa, handling payments linked to about $1 billion of assets a day in currencies and bonds.

But even some of the groups that have gone the furthest with blockchain are wary of its ultimate potential. In November, the European Investment Bank issued its second digital bond using the technology – a €100m two-year deal arranged by Goldman Sachs, Santander and Société Générale.

Using the technology could potentially help streamline issues around documentation and payments, but Xavier Leroy, senior finance officer at the EIB’s non-core currencies and special transactions department, said the benefits so far were limited. “Considering that we are in the initial phase, there are not many at the moment [benefits] “It’s mostly about potential for the future,” he said.

Some blockchain-related projects also rely heavily on existing systems rather than replacing them, particularly so-called distributed ledgers that allow a select group of actors such as banks to share information about an immutable record.

This activity is related to blockchains and cryptoassets, but does not involve the creation and verification of transactions in return for token rewards – a crucial difference from the blockchain on which bitcoin and other tokens are based.

HSBC, for example, describes the FX Everywhere system it uses to settle currencies with Wells Fargo – which has handled more than $200 billion of five currencies – as “blockchain-based”. Still, its distributed ledger technology (DLT) relies on Traiana, a well-established market infrastructure, to act as the first step in the system.

“It is a defining element. Even if we say DLT, people hear blockchain, blockchain, blockchain,” said Mark Williamson, global head of FX partnerships and propositions at HSBC.

FX Everywhere uses consensus algorithms, cryptographic signing and other crypto-related processes. But it “doesn’t require a blockchain,” Williamson said. It also represents a small proportion of the overall business that HSBC and Wells Fargo handle in their foreign exchange trading operations.

A group of technology experts in June told US lawmakers that such “add-on” digital databases were not new. “They have been known and used since 1980 for fairly limited functions,” they said.

Responsibilities to shareholders and regulation may also prevent banks from using the types of blockchains that underpin tokens such as bitcoin.

These blockchains generally require the maintenance of networks of computers that use huge amounts of electricity, in a controversial process called “proof of work,” but shareholders and regulators are pushing companies to invest in projects that are more environmentally friendly.

Banks are equally aware that they must navigate the different ways jurisdictions recognize tokenized investment products. In December, another Swiss exchange, BX Swiss, said it had completed a test trade of tokenized assets on a distributed public blockchain. However, it admitted it would require a separate market license from the Swiss regulator to proceed.

“The challenge is when a set of institutions come together and individual shareholders have to be committed to the journey,” said Keith Bear, a fellow at the Cambridge Center for Alternative Finance. “If priorities change and they don’t meet goals, projects fail.”