Here is our talk from the CryptoFin Conference from October 2019 in Tallinn about how to disintermediate the banks:
Here is the short summary. We need:
- More tokenization
- Crypto credit-money
- Wealth management automation
Here is the talk:
Here is our talk from the CryptoFin Conference from October 2019 in Tallinn about how to disintermediate the banks: Here is the short summary. We need: More tokenization Crypto credit-money...
Oct 16, 2019 . 20 min read
Here is our talk from the CryptoFin Conference from October 2019 in Tallinn about how to disintermediate the banks:
Here is the short summary. We need:
Here is the talk:
SmartCredit.io is a Swiss-based project launched by veterans in the cryptocurrency, finance, technology, and artificial intelligence fields “The Bitcoin whitepaper defined the base money for the Internet. SmartCredit.io defines the...
Jun 12, 2018 . 3 min read
SmartCredit.io is a Swiss-based project launched by veterans in the cryptocurrency, finance, technology, and artificial intelligence fields
“The Bitcoin whitepaper defined the base money for the Internet.
SmartCredit.io defines the credit-money for the Internet.”
In the traditional banking system, credit money earns interest for the commercial banks. Our mission is to create the first decentralized system of crypto-credit money in the world, empowering people to take back control over their own money — without the commercial banks and fees.
We have been in this space for a long time and would, therefore, like to share some of our expert insights — from articles in our blog from recent years.
We published our first Bitcoin price forecast in the Swiss CFA Magazine in January 2014, where we forecasted a Bitcoin price of USD 10,000. Our price forecast was accompanied by some dismissive laughter. So, we used every opportunity to transfer the message of blockchain’s key values.
We are convinced about the upcoming massive disruption to the traditional banking industry, which is why we published another analysis in the Swiss CFA Magazine in November 2015. Naturally, we attempted to spread the message from within Credit Suisse, where we worked at that time. But, well, private banks are not exactly places for “out of the box” thinking…
Our next article is based on the Swiss banking unit of Credit Suisse and analyzes how much revenue Credit Suisse will lose as a result of blockchain disintermediation. I tried to present this analysis to the upper echelons of Credit Suisse, but you might be able to imagine how it was received…
Up next is the analysis of how core banking processes will change as a result of blockchain disintermediation.
This article and previous analyses provided the key triggers for the idea behind SmartCredit.io.
We analyzed how to combine traditional banking with crypto finance based on the Swiss banking ecosystem one year ago. There have been some minor changes in the landscape during the last year, which serve to confirm our position — crypto businesses will not face any competition to speak of from the traditional banks. Indeed, the playing field is reserved only for new crypto entrants. A huge thanks here goes to the traditional banks!
Once ICOs really started to boom around 12 months ago, we analyzed what could be the best way to invest in ICOs. And we came up with the “lazy approach” — for all of us who lead busy lives… Incidentally, at that time we viewed Antshares/NEO, Ark, Komodo and Singular to be investments worth considering. Interestingly, these crypto-assets subsequently performed in line with our rather positive view. Disclaimer: We also valued a number of other tokens that performed less well.
We realized that more and more investors are streaming into the crypto space. So, last summer, we published an article on how to use modern portfolio management approaches for crypto assets investments. As some of our readers here are from crypto investment funds, we hope to share some valuable insights for your investment fund strategies as well! 😉
We will continue to publish our thought leadership articles and we hope you enjoy reading them.
By the way, our new website, the prototype (with our pilot coming soon), as well as our intro video, are also available. Please take a look and visit SmartCredit.io.
Blockchain technology will bring about changes to client value networks: New alternative financial services providers will emerge, and services that are currently billable will become free or virtually free (including...
Aug 15, 2017 . 12 min read
Blockchain technology will bring about changes to client value networks:
This article looks at the key processes of private banking and considers how they will be impacted by blockchain. We can categorize these processes as follows:
Compliance and regulatory processes, which do not directly add value for the client or the bank, but represent a requirement.
In the following table, key banking processes are divided into the “1st level Category” and the “2nd Level Category”:
Client opening processes — these processes are related to opening new client relationships. It encompasses KYC (Know Your Client) and establishing who is the beneficial owner or the real owner of the assets.
Client opening also covers product opening processes. Different products require different setup parameters from the client. For example, when ordering a credit card, you can specify whether it is “silver”, “gold” or “platinum” and whether there a need for a partner credit card (with corresponding fees).
Some products might not be allowed in some jurisdictions (determined by the client’s domicile) or, for example, US persons may be excluded from the offer (regardless of jurisdiction).
Client compliance processes — there is a high level of client activity monitoring that takes place in modern banking; most of this is determined by regulations, but not exclusively. For instance, if a bank has given a mortgage to a client who then decides to transfer assets out of the bank, the client would quickly receive a phone call from their relationship manager.
But this also relates to flow-of-funds analysis (if clients make larger payments, they might need to add additional justification for these payments) or AML-related (Anti-Money Laundering) issues. Regulatory client reporting, such as FATCA, AEI, withholding tax, MIFID, etc., also fall under the same category.
Client tax reporting is likewise covered by this category. Clients are provided tax documents that are required each year. If a client decides not to submit these documents to the relevant tax authorities, the tax authorities will still obtain digital access to these documents via the AEI (Automated Exchange of Information).
Client profile updates are also relevant here. This concerns keeping client profiles up to date (regarding domicile, nationality, etc.), as this information determines which products can be offered to which clients. Indeed, it can also determine that certain clients cannot be contacted actively at all, for example, if they are offshore clients in certain domiciles.
Sales management processes — this involves a lot of client profitability analysis (which is always running in the background) or client potential analysis (which is about identifying additional suitable products for specific clients). These processes are intended to identify which customers are “good” and which products may be sold to these customers.
Banks earn their revenue by selling financial products to clients; banks are not altruistic organizations that seek to serve the common good in society. They want to sell, sell, sell. And there are also fee structures that are not always transparent (one could speculate that this is deliberate).
Of course, there are product suitability processes in place. Lehman Brothers structured notes (a global financial services provider that declared bankruptcy after the Lehman Brothers default) are not suitable for grandmothers, for example. Advisory risk processes would also not allow a 100-percent portfolio allocation in structured notes (which would be subordinated claims, if the issuer went bust).
Client reporting processes are likewise included here. They provide clients with helpful summaries about transactions or the investment performance of their assets.
Client transaction processes — these mainly relate to payments and client trading.
Portfolio management processes — here we have a full stack of processes starting from creating the Investment Policy Statement (IPS) and ending with the client portfolio review with the client.
Every client has an IPS which is determined by their ability to take investment risk, their willingness to take investment risk and the constraints issued by the client (for example, no investments in the tobacco sector). All investments should always be made in accordance with the IPS.
Each bank defines the strategic asset allocation (the range of assets that should be invested into specific asset classes) and the tactical asset allocation (which is a more short-term form of asset allocation). This is usually performed by research departments.
This process category is advice-intensive. And this advice is and will continue to be, the core competence of banking.
Credit processes — this category refers to lending and the associated monitoring of risks. This is the process category in which banks generate most of their revenue.
The key process here is the client credit risk calculation. This risk determines the loan interest rate. It is dictated by client income, other obligations, the amount to lend, family circumstances, and other factors.
Another key process is credit payback monitoring: Is the client still able to repay the loan and are any adjustments required? If the client is unable to pay back the loan, the client default handling process is initiated.
Client closing processes — the costs for clients to switch banks are relatively high in the traditional banking system. If a client changes their banking relationship, it is necessary to transfer their assets to another bank. This is a costly process that also takes a lot of time.
In the previous article, we looked at how private banks generate revenue and how this would be impacted by blockchain disintermediation:
But let us consider client opening, client compliance, and client closing — since the client would be in control of their own assets and their switching costs for blockchain-based assets would be minimal, clients will be much less tied to banks than they are currently. This will bring major changes to this process category.
Client assets would not be listed on the banks’ books like they are today. Client assets would be controlled by the respective private keys and secured on the corresponding crypto-asset blockchains. If a client needs portfolio management from a bank, in the future they could set up 1:2 multi-signature access (signature one for the client and signature two for the bank) for the asset manager.
Sales management processes will likewise transform due to the following:
The key question here is how exactly will the timeline of blockchain disintermediation unfold.
Technology adoption can be expressed using an S-curve comprising the following adoption phases:
We would probably not be inaccurate to assume that less than one percent of the working population in OECD countries currently own any cryptocurrencies — this comes under the “Innovators’ Phase”. Real business value will develop from the middle of the “Early Adopters’ Phase” — from an adoption rate of ten percent.
It is difficult to forecast when an adoption rate of ten percent will be achieved, but we could estimate a time frame of three to five years. This adoption will not only involve “owning tokens” but also “value-adding business services”, including banking, meaning there is a real impact on banking processes and banking revenues.
This analysis can be summarized in the following table:
Blockchain disintermediation will affect key banking processes, such as client transactions, portfolio management, and credit processes. They are all among the key processes in which banks generate revenue today.
On the one hand, there will be huge opportunities for crypto/fintech companies to focus on these areas. On the other hand, traditional banks will have to seriously rethink their future processes and revenue streams.
1. The S-Curve of technological adoption: https://medium.com/@mcasey0827/speculative-bitcoin-adoption-price-theory-2eed48ecf7da
The traditional banking business is based on fiat currencies. Conversely, a diverse range of cryptographically secured digital coins underlies the crypto-asset industry. In previous articles, we looked at how traditional...
Aug 19, 2017 . 10 min read
The traditional banking business is based on fiat currencies. Conversely, a diverse range of cryptographically secured digital coins underlies the crypto-asset industry. In previous articles, we looked at how traditional banking revenues will be intermediated with blockchain technologies and how the key banking processes will be impacted by blockchain disintermediation.
Now let’s consider the big question: How will traditional banking react to emerging crypto finance?
Four response strategies are possible and this article will explore these options in greater detail:
· Do nothing — continue to run the business without adjusting course
· Wait and see — monitor the situation on an ongoing basis and develop internal capabilities
· Gradual integration — try to selectively integrate crypto-finance products into traditional banking
· All-in commitment to crypto finance — shift fully to crypto finance
These strategies can be positioned on a product offering/capability matrix as follows. Here, the product offering dimension describes how advanced the crypto-product offering is, while the capability dimension indicates the degree to which advanced crypto-finance capabilities have been developed and are available to the banking organization:
This article will explore each of these strategies in further depth.
This strategy involves taking no action at all. Essentially, it represents the delegation of decision-making on an active response strategy to a point in time in the future.
This response strategy can be considered in relation to the client base of a given traditional bank:
· For private banking, i.e. the wealth management branch of traditional banking, most clients are found in the 50+ age group. All private banks have online banking channels, but usually, less than a third of the client base are actually using these online channels. Obviously, it could be difficult to explain the benefits of crypto products to technology-adverse clients, which in turn would result in this strategic choice.
· However, retail banking is different. This branch of banking serves everyday needs; it’s about payments, credit cards, and small loans. These are the financial services that 95 percent of people regularly use. The retail client segment also has a greater affinity with technology. For this reason, it is possible to explain to them the benefits of crypto finance, including inexpensive and fast cross-border payments in the remittances, use case.
This is also associated with a “copycat” strategy. Sometimes it can be a good idea to let other banks make the first moves — to become the pioneers and also to make costly mistakes. This would allow others to learn from their mistakes and imitate successful strategies. Nonetheless, the total market capitalization of crypto-assets is approaching USD 150 billion; this market cannot remain ignored for much longer.
An extension of the “do nothing” strategy would be the “wait and see” strategy. This entails monitoring the market, analyzing competitors’ strategies and incrementally developing the internal know-how.
This offers a strategic option for traditional banks. If cryptocurrency adoption increases and if clients’ demand for crypto products grows, then a crypto offering can be developed on existing internal capabilities.
Implementing new products in traditional banking is relatively complicated and costly. However, if initial frameworks are already in place in traditional banks, this will result in smoother implementation.
Bridging the gap between the fiat and crypto world and developing these two sectors in concert is key to this strategy.
According to this strategy, crypto products are gradually integrated into the existing offering of respective banks. For instance, this could start with the following simple products:
· The topic of remittances is often discussed, but thus far this service has not been supported by traditional banks. The “cannibalization” of respective strategies is one reason for this. However, offering remittance products would enable banks to include additional client segments as well as profit from additional offerings beyond this segment, for example through credit card revenues.
· International fiat-crypto proxy accounts could be useful products for international companies. International companies need international banking accounts, but transferring funds between these accounts take time and incur considerable costs. These transfers could be accelerated while reducing the associated costs by using fiat-crypto proxies.
· Another example of possible products includes smart contract-based lending. Banks would earn revenue from the usual interest rate, but the additional margin on top of this interest rate would be almost zero since the operating costs of this form of lending would be eliminated. Corporate clients who use this lending facility would benefit from lower interest rates than usual (due to the eliminated margin).
· Investments products like funds for crypto assets are also conceivable. Due to the fact that crypto-assets exhibit valuable performance characteristics as well as valuable volatility characteristics, they would represent a useful addition to the alternative assets category within client portfolios.
Examples of this strategy include:
· SwissQuote, a Swiss bank, is cooperating with the fiat/cryptocurrency exchange Bitstamp in order to offer its clients the possibility to trade directly with Bitcoin.
· Falcon Private Bank, likewise a Swiss bank, offers to its wealth management clients the possibility to invest in Bitcoin products.
So far, these are the first two examples in Switzerland — in a country with around 250+ regulated banks. We assume that additional banks will follow suit.
On the one hand, the banks are able to present themselves as innovative and, on the other, they offer meaningful products to their clients, which also generates revenue for the banks. Banks can develop their internal capabilities for crypto-product offerings and achieve quite a competitive advantage in the process.
This would imply dropping traditional banking and converting the bank into a fully-fledged crypto institution that would offer the following products:
· Payments (already available in crypto finance)
· Custody (already available in crypto finance)
· Credit cards (already available in crypto finance)
· Lending (not yet fully established in crypto finance)
· Wealth management (not yet available in crypto finance)
At present, this strategy might be challenging for traditional banks, especially in view of their current client base. Around 99 percent of clients do not own any crypto assets and those who do own crypto assets would rather not go through the traditional banking system.
However, since several key cornerstones of traditional banking are already available in crypto finance, we can anticipate that solutions for remaining areas will also be developed, which in turn would enable this “all-in” strategy.
The distribution of these strategies are currently as follows:
· Most financial institutions are currently pursuing the “do nothing” strategy
· A limited number of institutions are applying the “wait and see” strategy
· A very small number of institutions are following the “gradual integration” strategy
· The “all-in commitment to crypto finance” strategy cannot be observed currently
We can anticipate the following strategic moves towards increasing blockchain capabilities in traditional banking:
· Progression from the “do nothing” strategy to the “wait and see” strategy
· Progression from the “wait and see” strategy to the “gradual integration” strategy
It will probably take a while until the “all-in commitment to crypto finance” strategy is implemented. The main factor for this will be the mass adoption of crypto-assets. However, if this strategy is implemented, we will see the increasing erosion of traditional banking revenue.
1. Swiss financial center opens up to Bitcoin: https://www.swissinfo.ch/eng/-game-changer-_swiss-private-bank-accepts-bitcoin/43328354
3. How private banking processes will be impacted by blockchain disintermediation
Many banks are participating in a range of blockchain consortia and are looking for ways to apply blockchain technologies to improve their internal processing. Here, the approach is to essentially...
Jul 12, 2017 . 5 min read
Many banks are participating in a range of blockchain consortia and are looking for ways to apply blockchain technologies to improve their internal processing. Here, the approach is to essentially carry on “business as usual” but achieve efficiency gains. Banks are able to increase their effectiveness with the help of blockchain technologies.
However, the change in ecosystems will not only facilitate improvements to internal processes. It also means that clients will receive blockchain-based service alternatives and require fewer traditional banking services for their value networks.
In current value networks, clients have very much been tied to their banks. The cost of changing a banking relationship is relatively high, and this has made it quite easy for banks to generate revenue. The changes facing value networks will significantly reduce exit costs for clients, while the cost models of banks will become more transparent. Clients will be able to switch easily between financial services providers and select the best fit for their needs.
The following figure visualizes this change to value networks. As discussed, banks clearly lie in the center of clients’ value networks at present. But as alternative blockchain-based services emerge, clients will start to use these alternatives, thereby reducing their dependency on banks.
This results in a revenue decline of the banks. But how big is this impact and what will be the timeline of this impact?
This analysis looks on:
· How banks are generating revenues at the moment?
· How blockchain-based business models will disintermediate banking revenues?
· What will be the timeline of this transformation?
Let us evaluate the key components of banking revenue based on the Swiss unit of Credit Suisse. This division encompasses retail banking (for clients domiciled in Switzerland), private banking (wealth management), and commercial banking (one-third of companies in Switzerland maintain a banking relationship with Credit Suisse).
The revenue figures are publicly available in the investor section of the Credit Suisse website. Here are the revenues for the first quarter of 2017:
The key components of banking revenue are as follows:
· Net interest income
· Recurring commissions and fees
· Transaction revenues
This refers to the revenue from money lending. At this point, we will not discuss the degree to which banks lend depositors’ funds or create new money during the lending process. However, we can assume that approximately 97 percent of electronic money in Switzerland is created by commercial banks during the lending process; the other 3 percent is created by the Swiss Central Bank.
Lending incurs a cost to banks; reserve ratios have to be applied, parts of loans have to be covered by core capital and/or high-grade capital instruments, high-grade financial instruments and so on. These guidelines are defined by the regulator and are binding for the banks. Thus, although banks create money in the lending process, this money creation is not free for the banks. There are costs associated with lending money which are determined by banking regulations and capital markets.
Now let us return to net interest income: It comprises the difference between the price of money which the clients pay and the cost of lending. This is the category in which banks generate most of their revenues (assuming client risks are properly assessed). If the economy is booming, there is more money creation and more revenue in this category. In the event of an economic slump, the reverse is true.
These concern the revenues raised from custodial accounts, banking packages as well as portfolio management fees. Banks love recurring revenue, following the idea of “sell once, collect revenue over many years”. As the exit costs for clients are relatively high, clients are locked in, thereby providing a stable stream of revenue for banks with relatively low maintenance costs.
Transaction revenues refer to payment fees, fees for buying and selling shares, mutual funds, and ETFs. Essentially, these fees are connected with either the business or investment activity of bank clients.
Net interest income will be substituted by smart contracts. In this scenario, clients would not need a bank. Lending would be conducted using automated lending facilities. However, some lending is performed on the basis of advice, and this advice-based revenue will remain available to banks. Nonetheless, this would only account for a small part of net interest income. We estimate a conservative level of around 50-percent revenue disintermediation in this respect.
In the case of recurring services, clients will hold their assets as digital tokens on blockchains, rather than in custodial bank accounts. Banking packages will not be required, as they will be replaced with blockchain-based products (the cost of which is close to zero). Only advice-based services will continue to generate revenue for the banks. In this context, our conservative estimate is a degree of revenue disintermediation amounting to two thirds.
Transaction revenues for payments and trading will reduce significantly. Clients will no longer need banks for these services. However, advice-based fees for complex transactions will remain unaffected. But again, this only represents a small part of current transaction revenues. Here, we conservatively estimate a degree of revenue disintermediation of around two thirds.
It is clear that advice-based services will remain intact. Most other services, however, could be replaced with blockchain-based smart contracts or digital tokens. The disintermediation impact is shown in the following table:
The timeframe of the change in value network can be expressed using an S-curve. JPMorgan published an S-curve in its assessment, which can be used as a basis for the analysis here.
The next three years will be used to establish and develop shared infrastructure (i.e. service-specific blockchain offers). The mass adoption of these new services will start after three years and this is also when the disintermediation of banking revenue will commence.
Transaction revenues: impact in 3–5 years.
This revenue position will be the first to be impacted by blockchain technologies. Transaction revenues are currently collected as payment fees or fees for trading securities; this will be disintermediated by blockchain-based solutions.
Recurring commissions and fees: impact in 4–6 years.
Infrastructure development could require more time here. For example, in the case of custodial services, we will also need a digital representation of financial assets.
Net interest income: impact in 4–6 years.
In this context, we need digital asset infrastructure as well as smart contract-based solutions for debt products.
Banks are currently focusing on using blockchains in order to improve internal processes. However, as blockchains will enable changes to client value networks, banks will have to prepare to lose significant portions of their revenue to new blockchain-based financial services providers.
The following table shows the expected disintermediation impact and associated timeframe using the example of the Credit Suisse banking unit in Switzerland:
Banks will begin to lose revenue on basic transactions. Most of these services will be free, almost free or subject to significantly lower service fees. Advice-based services will remain within the purview of banks; this includes portfolio management, risk management, and the management of special transactions and products. Indeed, these concern services where specialist expertise is required, and banks will still be required to offer them in the future.
On 11th of October 2016 I participated on Panel Disussion at Hyperledger Meetup in Zurich. It was good brainstorming and with many new ideas. A Panel: Blockchain May Change the...
Nov 11, 2016 . 5 min read
On 11th of October 2016 I participated on Panel Disussion at Hyperledger Meetup in Zurich. It was good brainstorming and with many new ideas.
My friends, myself and my brother published book Blockchain Technology: Einführung für Business- und IT Manager Blockchain Technology - Einführung für Business- und IT Manager OK, it’s in German. However, it’s...
Nov 22, 2016 . 5 min read
My friends, myself and my brother published book Blockchain Technology: Einführung für Business- und IT Manager
OK, it’s in German. However, it’s very praxis oriented and follows always the thought about what is business value and what business models we will have.
Video of the first book presentation is available here. I’m starting to talk at 18:28, my brother follows immediately to me.
If you have more time to watch, then we had here as well very nice presentation about Hyperledger and discussion about Ethereum Classics versus Ethereum.
Introduction Digital Banking is on everyone’s mind — it’s about automating end-to-end banking processes and offering a digital experience to end clients. The focus on Digital Banking is understandable —...
Nov 10, 2015 . 12 min read
Digital Banking is on everyone’s mind — it’s about automating end-to-end banking processes and offering a digital experience to end clients. The focus on Digital Banking is understandable — we are all witnessing increasing cost pressures, regulatory pressures, and a low-interest-rate environment. Digital Banking is the answer from the traditional banking system to these pressures. However, Digital Banking per se causes little changes to the banking ecosystem: in principle banks continue as they are, just operate more effectively.
Most of us witnessed the emergence of the Internet and World Wide Web 2.0 and the new network-based business models that were born. Could the same happen with Digital Banking? Could we anticipate the emergence of Digital Banking 2.0? Would it result in widespread changes in the banking landscape and business models in the same way as Web 2.0 did?
I represent the thesis that Bitcoin and its underlying conceptual technology — Blockchain — may enable revolutionary changes to the banking landscape and the emergence of Digital Banking 2.0.
Bitcoin is a digital currency that enables instant payments to anyone, anywhere in the world. It is based on private-public key cryptography, where the owner of the private key can do transactions with his Bitcoins and where a public key allows anyone to see the number of Bitcoins on a specific address or to send Bitcoins to this address.
The Bitcoin system is based on blockchain technology, which is, in essence, a cryptographically secured, distributed ledger. Old transactions cannot be changed and new transactions are added to the end of the distributed ledger in an unchangeable way. The integrity of the ledger is ensured by a computationally heavy process known as proof of work, which verifies transactions and is executed by a network of anonymous computer owners known as Bitcoin-miners. The Bitcoin Blockchain distributed ledger is available to anyone who participates in the Bitcoin system.
The Bitcoin Blockchain is used to track ownership and transactions between Bitcoin holders, but the Blockchain technology is not limited only to Bitcoins — any transaction with digital assets could be represented with this same Blockchain approach.
Most financial assets have digital representation and hence they could be stored in Blockchain. The transactions between the holders (addresses in Blockchain terminology) could be modeled in blockchain, and they could be available to anyone using Blockchain technology.
Blockchain represents an innovation that could be compared in its impact to the invention of the double-entry bookkeeping system or of the legal form of doing business, a corporation. These last two innovations shaped the way we do business today. Will Blockchain be the next big invention?
Most of the financial industry is based on ledgers which record who owns which assets, who receive payments from these assets, and how to transfer ownership of these assets from one participant to another. But these ledgers are all private to banking institutions. This creates the need for a new ecosystem of participants whose core business is transferring ownership between asset owners.
For example: If client A sells 10 shares of IBM to client B, we see the following transactions: Client A’s custodian transfers shares and receives money, and Client B’s custodian receives shares and transfers money. The process can take up to 3 banking days and there is a middleman (clearinghouse) validating that all runs properly. The middleman will charge a fee for this service.
However, Blockchain technology allows the creation of distributed ledgers between all market participants. This results in new business models that exclude middlemen. Client A and Client B may interact directly with each other using a public distributed ledger. It is obvious that this public ledger-based approach increases the efficiency, transparency, and quality of the transaction execution, and at the same time reduces its total cost.
As I said before, most financial assets can be represented digitally: publicly traded instruments will have ISIN codes, and similar codes are being created for OTC instruments too (UTI from ISDA for example). Digitally represented assets can be stored into Blockchains, including information about who owns how much of which asset. Buy and sell transactions would be as simple as moving a specified number of digital assets from one owner to another in a cryptographically secured way. The transferor of the asset has a private key for the authorization of the transaction; the receiver of the asset has to use his private key for payment authorization. The settlement and clearing of trading transactions would be significantly simplified and speeded up by such an approach.
If all assets of a banking client can be represented digitally, his portfolio can be completely represented by the digital asset registry. A client portfolio could contain digitally represented assets and digital money (Bitcoin, Litecoin, Ethereum, etc.). The client could be able to access his portfolio from any place with his private key; he could execute transactions in his digital assets or digital money with his private key; or he can delegate management of his assets to a professional asset manager by assigning him his private key or by using a multi-signature approach in which specific transactions have to be signed by two or more private keys.
In today’s custody business model, the asset manager either has his own custody (if he is a bank) or uses the custody services of another bank. However, by using public ledger-based asset registries, the client will be the real owner of his assets. The client will not run the risk of bank failures. He will not face situations where part of his assets may be converted into bank equity (based on too big to fail provisions, when bank capital ratios are sinking below regulatory targets) or be lent out by the bank — with Blockchain, the client will be the real owner of his assets.
Another business case for distributed ledgers can be collateral management in the lending process. By registering collateral in a distributed ledger and by specifying for whom and how long the collateral is allocated, we create an effective means of collateral management. The speed of collateral management will be increased, the traceability will be available and transparency for regulatory reporting will be created. Additionally, collateral margin calculation would be simplified as it would become transparent how many times specific collateral is already lent out.
These were some examples of the potential uses of distributed ledgers. One can assume that there will be as many new potential uses of distributed ledgers as there are ledgers today.
Blockchain technology also allows for the implementation of “Smart Contracts” where assets are exchanged on certain conditions against payments. Let’s look again at the example “asset in exchange for payment”. If we have a digital asset that represents an IBM share and if we have a digital means of payment (Bitcoin), then the exchange between Client A and Client B can be executed in one transaction. This new transaction will be added to the Blockchain, it will be cryptographically signed and there will be no way to change it after that. There will be no need for complex 3-banking-days long business processes — everything can be completed within 10 minutes.
This is an example of a basic smart contract. The business logic of a smart contract can be extended in arbitrary ways: there can be multiple participants, there can be escrow services, multiple payment terms, etc. These will be digitally executable contracts between digital assets and digital money. All derivative, future or bond contracts could be represented as smart contracts so that their processing can be 100% automated.
Bitcoin Blockchain is a public ledger and thus is available to any member of a Bitcoin system. Asset registries and transactions between holders of these assets on Bitcoin Blockchain are visible to anyone too. Public ledgers do not have any gatekeepers defining who can or cannot participate.
At the same time, there are several technology providers offering Private Blockchains. These are “mini-Bitcoin” systems, where only the participants of the private blockchains can transact with each other. These Private Blockchains can be use-case specific or participant-specific — for example, private collateral management blockchains for big banks. Private Blockchains would work on the basis of permission, namely there would still be a central instance that will grant or remove memberships to respective blockchains. These gatekeepers would thus have a potential revenue source or even provide new business models.
Every bank has either built or bought their “ledger” systems for managing huge numbers of standardized digital transactions. Middlemen are facilitating the ownership and flows of funds between banks. Both these bank “ledger” systems and middlemen are becoming obsolete.
Both services can be taken over by public or private Blockchain ledgers from new service providers. One bank probably does not want to become a member of another bank’s private Blockchain ledger, where the other bank is the gatekeeper to the service. However, the same bank could be ready to become a member of a private Blockchain of an independent service provider. The private Blockchain would have a higher utility as more participants join, which would attract new participants and so on. It’s the same network effect which is the core for e-Bay or Facebook business models.
This creates room for new market participants whose core business will be running today’s diverse banking ledgers. The businesses of these new service providers will benefit strongly from network effects, however, which will likely lead to the consolidation of these new service providers.
By September 2015 venture capital investments into Bitcoins were USD 921 Mio; the number of venture capital-backed startups was 119 and the Bitcoin sector became the fastest growing startup sector. Investments into Bitcoin companies in 2014 and 2015 match investments into early internet companies in 1994 and 1995. Blockchain and Hybrid startups have received USD 285 Mio in investments, representing 22% of startups in the Bitcoin sphere.
Additionally, there are a number of big banks experimenting with Blockchain technologies, whose main focus is on how to use decentralized ledgers in banking business processes.
Bitcoin may have caused people to overlook the potential of its underlying technology, but based on venture capital investments and on experiments in the major banks, we can say for sure that the Blockchain technology is here to stay.
Digital Banking 2.0, based on Bitcoin and Blockchain technology, will result in revolutionary changes in banking. The role of current players in the ecosystem will change and new players will emerge. Many current services will be provided at a much lower cost basis. Middlemen will lose their positions in value chains in the same way it happened in the music industry about 15 years ago. This will translate into changes in banks’ revenue models, which, together with the entrance of new participants to the market, will trigger changes in business models, and result in complete banking ecosystem changes.
The transactional part of the banking business will change as well. Many of the complexities of ledgers, asset transfers, and collateral management will be simplified, and banks will be able to decrease headcount. Transaction management will become a commodity in the banking business.
However, the advisory process, portfolio management, credit management, and risk management — the know-how intensive disciplines of modern banking — will stay. Banks will simply focus more on their core competencies and less on transaction processing. This will result in an increased focus on know-how intensive areas, which at the end means real value creation for clients.
(This article was first published in Swiss CFA Society Magazine 2015 November Edition)