We think it’s important for companies to get the jump on identifying critical business use cases where blockchain can bring business value and improvement to their existing processes today as well as help create new products and services. In that customers need to be laser-focused. Identifying a compelling use case will not only help drive the technology, but will make it easier to fund and implement.
Reducing Infrastructure Costs
The results could have a big impact on your organization. According to a recent report by Santander Innoventures, the venture arm of the Spanish bank Santander, titled “The Fintech Paper 2.0,” blockchain technology could save banks $15-20 billion by reducing infrastructure costs attributable to cross-border payments, securities trading and regulatory compliance.
As a pioneer in payment systems, ACI, which enables more than 5,000 processors and banks to transact trillions daily, has been actively engaged in blockchain technology for the last two years. During this period, we have conducted a number of Proof of Concept (POC) pilot projects with customers and vendors designed to demonstrate the efficacy of the technology for specific use cases. Here is what we found.
Cross-border payments are typically business-to-business (B2B) transactions across one or more national borders, for example when a company purchases supplies from a vendor in another country. Though this form of payment is not prevalent in the U.S., it is big business in Europe. Because there are often large sums of money involved, the transactions frequently have to be cleared by one or more government agencies. For example in the U.S., the Office of Foreign Asset Control (OFAC) checks to make sure that payments are legitimate between trusted parties—the OFAC maintains a list of blocked entities.
Typically, these business payments go through a network of intermediaries including one or more government entities. As a result, it’s not uncommon for these payments to take two to six days to process depending on the countries involved, and cost up to 10 Euros.
For one particular pilot, ACI including three institutional customers in multiple countries along with a blockchain provider. The parties agreed to keep names confidential for the purpose of the POC. They also simulated the participation of a government entity that would have full visibility into the transactions in “real-time.”
ACI integrated its payment engine into each participant’s node, which could inject payments and or be notified of incoming transactions. The government or “central bank” node could see all the net settlement positions for each participant in real-time.
The pilot was successful. Payments were transacted in 5-7 seconds with a cost of significantly less than a Euro. All participants had transparency into their transactions without having a middleman, and the simulated central bank node was able to monitor transactions as well as the real-time cash position of each institution.
Note that distributed ledger technology would also make auditing cross-border payments relatively easy. Rather than physically show up at an institution and have the accountants pull data from multiple systems, audits could simply be given a link to the relevant blockchain.
Most countries have a central bank or government agency that facilitates monetary transactions between financial institutions. In the U.S., that entity would be the Federal Reserve, while in the U.K., it would be the Central Bank of England.
The trouble is that institutions cannot move money any time of day or night. The Fed and various central banks do not transfer money on weekends or holidays. That means there are times when no money is moving between institutions for 2-4 days, as merchants float bills that occurred on a Saturday or over the recent Easter holiday, for example. As a result, the amount of counterparty risk to participants increases.
Recently, the US Fed and the Central Bank of London said that they were considering creating a private blockchain network that would run 365/24/7 and enable institutions to move money at any time. The problem is that current implementations of blockchain technology simply aren’t fast enough yet to handle the volume of transactions.
Establishing a Pilot Project
However, given that the technology is rapidly advancing, ACI established a POC to determine if anytime settlement was doable as the speed improved. Accordingly, we proposed net settlements of “accumulated payments” rather than processing each transaction separately. The reasoning was that there was not much counterparty risk with settling accumulating payments every hour or half hour. The goal was to demonstrate the ability to get funds to merchants, retailers and consumers in near real-time.
The POC demonstrated that anytime settlement was possible. With blockchain, merchants were paid within the hour, minimizing counterparty risk. From a cash flow perspective, the system changed how liquidity works—no more 48 hours of waiting for the money. Intraday liquidity became more accurate. What’s more, the system gives government agents visible risk mitigation. In fact, everyone except the entities holding on to the money were happy, understandably so.
How Fast Can A Blockchain Go?
In the summer of 2015, ACI conducted a volume test. The blockchain system was able to perform 12-15 transactions/second per node. Since that time, there has been a dramatic improvement in protocol speeds from providers. For example, Hyperledger, which is contributing its open source technology to the Linux Foundation, can now run more than 1000 trans/sec on a single node in system.
Speed improvements have come by streamlining the consensus algorithm used to validate and authenticate transactions. That’s where the bottleneck has been. Hyperledger’s improved algorithm is based on the concept of “proof of stake” vs. proof of work, that is, the algorithm gives more weight to parties that have a direct stake in a transaction more than others that don’t, which enables the network to achieve consensus faster.
Other Use Cases
Similar to institutional settlements, international remittance, i.e. sending money to an overseas relative via, for example, Western Union is a timely and relatively expensive proposition that represents an emerging use case for Blockchain. The technology will enable consumers to send money in near real-time with much less expense.
Another use case that shows promise is managing “reference data,” for example, identity management, biometrics and validation data that could be used for payment verification. On the business side, this could also involve the OFAC, ABA directories or SEC trading entities. Using distributed ledgers to address reference data will be one of the topics at ACI’s upcoming annual User Group Exchange Conference, which will be held in Phoenix, AZ.
Currently, most large financial institutions don’t have single databases of critical reference data, but rather multiple disparate databases that don’t communicate with each other. One large ACI customer has offices in 7 geographies and over 350 applications, many with overlapping data sets.
Creating a trusted and transparent “single source of truth,” i.e. central repository for identity management and other key data via distributed ledger technology, could save enterprises buckets of money. Even a simple use case, like transferring funds from a company’s New York bank account to one in London could be transformed in terms of both time and expense, using a blockchain. These could be private blockchain networks or public ones.
The Netherlands Embraces Blockchain
In fact, the Netherlands recently announced its intentions to use blockchain technology to improve government record keeping through the its National Blockchain Coalition, established by the Ministry of Economic Affairs IT team. [See: http://www.coindesk.com/coalition-launches-promote-blockchain-netherlands/]
The coalition will unite more than 20 public and private organizations including the government agencies, universities and private companies from financial, logistics and energy sectors, with the goal of turning the country into a leader in blockchain. Major supporters include ABN Amro, ING and Nationale-Nederlanden, one of the region’s largest insurance companies.
Specifically, the coalition aims to speed up the pace of rolling out blockchain technology within the government and using more government records such as data from the National Office of Identity Data, Chamber of Commerce, and registration records from the Ministry of Security and Justice.
Having a single source of truth makes sense to us and to our customers and we have a noticeable increase in customer queries since the first of the year about ACI’s technical capabilities. Blockchain performance can now support reference data and we’re starting to see some market movement. As it becomes more trusted. we will see early adopters and fast followers.
Watch this space.