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Date: 20/02/2017

Title: Blockchain – Hype or Reality?

Teaser: Over the last few years, Blockchain and distributed ledgers have become the new buzzwords accompanied with the idea that it will change the world for good since it will help to reduce fraud risk, enable better compliance and ensure faster transaction finalization. But what is   the real impact of these buzzwords on us?

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Blockchain – Hype or Reality?

Over the last few years, Blockchain and distributed ledgers have become the new buzzwords accompanied with the idea that it will change the world for good since it will help to reduce fraud risk, enable better compliance and ensure faster transaction finalization. But what is   the real impact of these buzzwords on us? While it is undisputed that these topics create significant new opportunities for everyone involved, distinguishing current reality from hype remains a battle for most of us and one on which we seek to shed some light.

Author: Dennis Flad (Prospire)

The importance of trust

Trust forms the foundation of our society and can be defined as «assured reliance on the character, ability, strength, or truth of someone or something» or simply put «one in which confidence is placed». Whether you are crossing the road, flying in a plane or paying a bill, you trust the people and systems to act and behave as you expect them to, without think- ing too much about it. Trust is, however, not always easily established or maintained and additional measures are needed to strengthen confidence in a specific system, e.g. the police and legal systems to maintain law.

If money or assets are involved, trust becomes even more difficult to obtain, especially in transactions outside our own society or legal framework. For centuries, banks have stepped into this gap and have been responsible for not only providing trust in the global financial system, but also building trust with the participants in the system. While people may not know or trust the other participant in a transaction, they will still often complete the transaction if they trust the bank.

However, numerous scandals involving banks have harmed the trust not only of consumers and corporates in the banking system, but also of the regulators and politicians. The establishment of new peer-to-peer services mainly in the areas of lending, foreign exchange and payments are as much a result of a more digitalized and interconnected world as a consequence of the banking trust crisis.

Restoring trust

The vision of Bitcoin, for example, was to deliver a currency to transact on a peer-to-peer basis, globally, without a central party like banks being involved. The digital currency itself was not the revolutionary part, it was the cryptographic protocol that allowed for each unique transaction to be externally and automatically validated by multiple independent notaries (in Bitcoin terminology so-called «Miners») that was of most interest to the world. Cryptography validates transactions prior to execution and increases the trustworthiness of transactions for all parties involved, thereby ensuring that transactions are unique, true, performed by the real owners, irrevocable and as a consequence of these criterias, final.

Each transaction is locked on a decentralized ledger called «the blockchain», which eliminates the risk of failure in a single location, since all the ledgers are mirrors of each other. Changing one ledger would therefore not result in «adjusted» truth, since all ledgers should be consistent at all times.

Blockchain is, however, not the only technology and protocol to allow externally validated transactions. Solutions from the Swiss-based company Monetas, or the US-based company Ripple, do not work with blockchain, but follow a similar principle as there are also a cryptographic protocol and external validators verify each transaction. In comparison to the concept of one, multiple stored «blockchain» ledger, these alternative solutions permit transactions between accounts in different private or public ledgers. Apart from allowing interoperability between different networks and central or decentral ledger solutions, one of the reasons for these alternative solutions was to address the perceived risk regarding unauthorized access to sensitive personal data. With localized ledgers, and the Interledger Protocol, better protection of sensitive client data for a transaction can be ensured since it is only stored in controlled locations and the accountability of the data protection is clearly defined.

New opportunities

The security and speed with which transactions are performed using blockchain and cryptography highlighted opportunities for which we are only now starting to see some of the solutions in the proof-of-concept or pilot phase. Only a few solutions are in production and none have yet reached the mass market, including Bitcoin. In banking, these solutions include transforming payments, FX derivatives, securities, and loans, and allowing the decentralized tracking of transaction statuses as in Trade Finance. Outside of banking, solutions currently focus mainly on protecting property rights like verification and history of diamond ownership, decentralized property registers to fight corruption, managing the transfer and settlement of music rights and repositories of digital keys to unlock physical assets (such as bikes, cars, houses). The list of new opportunities seems almost endless. But the solutions have one common aspect: They are all brought to market as a network and based on the collaborative efforts of different parties in the value chain.

Three key success factors for distributed ledger solutions

Fundamentally, blockchain is a technology as much as a network of blockchain participants. Although the technology is decentralized and not operated by a central authority, a blockchain or distributed ledger must follow common standards to operate successfully between the participants. These are relatively simple and can be defined as technical and operative standards.

The most important technical standards are those which refer to the standardization of the cryptographic blockchain protocol, validation mechanisms, and the rules to calculate the «source of truth» behind a transaction. Because of the standardization of these technicalities, the solution is scalable, increases trust in the system, and is available to all.

Successful networks need not only technical standardization but also operative standards. In simple terms we talk about schemes in which operating standards and obligations between the parties are agreed on a multiateral basis. Even Bitcoin is a very simple scheme with clear rules and responsibilities in terms of how a transaction happens. Everybody can participate in Bitcoin, as long as they accept certain rules when a transaction is irrevocable, undisputable, and final.

Standards alone are, however, not sufficient to guarantee the success of a network or technology. A successful network can be scaled to the number of its participants. New solutions must be able to be integrated into existing systems with minimal effort. If this is not the case, adoption will be low and participants will instead find alternative technologies and networks based on their legacy systems.

How does a Blockchain Transaction Work?

iBob and Alice have wallets/accounts with «digitalized» value like Bitcoins, certificates of a property right (e.g. art, cars, diamonds) or intellectual property (like music). Like all accounts they are registered on a ledger, with the key difference to the existing mechanism, that the ledger is not stored in a centralized location but rather on multiple, redundant ledgers.

If Bob wants to transfer some of the content of his wallet to Alice, they cryptographically sign these transactions with their private keys and submit them using the blockchain protocol to the network community. In this community, validators («Miners») verify that the transaction is unique, authorized and funded by executing a complex mathematical calculation. Once the first validator has calculated it, this validation has only one true result and all validators can confirm it. Only after confirmation by all validators will the transfer of value from Bobs to Alice’s account be locked on the blockchain, the distributed ledger.

Alice can immediately use the new assets on her account for her own transactions and has no need to wait for intermediaries to execute before she has access to her «digitalized» value.

The reality of Blockchain and distributed ledger solutions

Blockchain and other similar solutions unfortunately still struggle with the three success factors mentioned above. For most solutions, increasing the reach of the solution has also been a challenge, as it can be hard to convince customers to take the risk.

While it is fundamental to invest in new solutions and innovation, it can be challenging to build a business case for investment, since it will not immediately increase the customer base, reduce cost, or increase efficiency. Purely cost-saving cases will be difficult to argue as the existing systems will remain productive for a number of years.

Defining where to start, who the partners will be and how to build a pilot are the next challenges. Picking the wrong partner may result in an incorrect bet on the future network. It is also important to remember that a pilot program does not address all challenges of a larger roll-out: Customer offerings, contracts and processes need adjustment, existing systems may have to be upgraded and «teething-issues» with new solutions have to be resolved. This is a growing field, so expect that technology solution providers may struggle at times to deliver on implementations if there are several ongoing at the same time.

How to make Blockchain solutions work for you

While the challenges are numerous, the opportunities it brings are even greater. It is not a question of «if», but rather «how soon» to invest. Some general success factors include:

  • Collaboration — Collaborating with partners, competitors, and different vendors can guarantee the success of a project. Lessons can be learned from each other, while solutions can be enhanced before go-live.
  • Selecting the right partners — Partners should under- stand the legacy as well as the future and be able to apply this to your situations. Consultants should have extensive knowledge of products in the market and practical experience in running pilots and implementing live solutions.
  • Good project management — These projects are at risk of quickly increasing in scope and cost and of moving in directions other than what was originally intended. Having a strong project manager will help companies keep projects in line.
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Fig. 2: Different ledger systems on how transactions run

Few companies want to be «first movers» and are happy to wait on the sidelines while others lead the way and address issues that may exist with new solutions. The fact, however, remains that the world around us is changing, and in some cases the change has already happened and adjustment is needed. In the long run, the opportunities blockchain presents far outweigh the cost and effort. Consequently, collaborating on what potentially may be the biggest change in the history of financial systems will be worth the rewards.

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Arevos — Innovation Advocates

Arevos is a startup of Synpulse Management Consulting Ltd., which focuses on the product management and business development of new technology and innovations for banks, insurance firms, corporates and Fintech. Arevos’ objective is to build bridges between the different parties and to create new common value chains. In this way, it is transforming technology into marketable solutions. Arevos is a believer in the power of networking, with specialists and experts delivering its customers best-of-breed advisory to design its products and solutions. With Dennis Flad, former Head of Product Management Payments, Trade Finance and Foreign Exchange at UBS and Credit Suisse as well as former CEO of Fides Treasury Services Ltd., and Clarette du Plooy, formerly with PwC, Arevos is pooling more than 30 years’ experience to drive forward new solutions and innovations in Corporate Banking, Treasury Management, Payments and Electronic Banking.



Silvan Stüssi

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