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One good reason not to buy a jetcar
One good reason not to buy a jetcar
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One good reason not to buy a jetcar

10/03/2016

Dan Barnes

Dan Barnes

Writer

The DESK: Fixed income trading for institutional investors

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The blockchain is the flying car of finance – and it has finally arrived. But before we take the wheel, we need to figure out how to regulate its use

In 1969 a TV programme in the UK called “Tomorrow’s World” demonstrated a computer-run banking system which made payments between banks and shops via the phone network. Described as “the electronic equivalent of many thousand ledger clerks” the programme noted that £6 million of payments were ‘bounced’ each year as a result of cheques being written out for accounts that did not have the funds to support them.

“[The electronic system] is ‘bounce-proof’,” said reporter Derek Cooper. “It simply won’t work unless you have cash or credit at the bank.”

47 years later, we have not yet reached that reality. The system, at least in the UK, is still run on an overnight batch process; real-time processing still belongs to the future.

But if you do want to develop some of the other inventions showcased on Tomorrow’s World – such as a flying car – there are several infrastructural developments that will need to happen at the same time in order to support it. On top of the operational aspects (where do you refuel?) there is the question of where and how you would be regulated to fly, and how the authorities would go about monitoring you.

This question is just as pertinent for the next big thing in finance – the blockchain. A distributed ledger, similar in its function to the computer system described on Tomorrow’s World, the blockchain could  help banks to settle transactions instantaneously. This would remove the problem of ‘bounced’ payments – and therefore the need for reconciliation.

So what will need to happen in the rest of the financial infrastructure if that system is to operate? Clearly, just as with the existing payments network, internal accounting and banking platforms would have to be able to record the transactions in real time or as close as a distributed ledger will transact to real time.

If we expand it out into the securities world, as BNP Paribas and 41 other banks are successfully doing with R3CEV*, one has to ask – how will it be regulated? Some blockchains are built to transact between commercial banks. Others, such as the one proposed by Setl, are developed to work between central banks and commercial banks.

The greatest advantage of the blockchain is that it is always on. Without the capacity for error or disagreement in payment versus delivery – because they are resolved at the point of execution – there can be a system that operates 24 hours a day, seven days a week, in real time.

If that occurs, however, then real-time, full-time regulation is also necessary.

The distributed ledger provides records of every transaction that are fully verified, which could be a valuable resource to regulators. They could be alerted when a transaction is attempted but rejected. Cumulatively, a regulator could develop a record that details which firms are performing more effectively, indelibly on a blockchain. It could ask a bank to improve the rate of failed payments and begin monitoring operational risk. With the blockchain, a regulator can effectively see a bank starting to get into trouble and make the necessary policy adjustments in order to help it – by injecting some emergency liquidity, for example.

The effects of this would mirror what is happening in the insurance sector, where the prevalence of data around client activity is allowing firms to move from ‘protection’ to ‘prevention’:  technology can monitor risks within the home and then allow the homeowner to be alerted before a fire spreads or a flood causes excessive damage.   

However this brings us back to Tomorrow’s World: there are still plenty of structural changes to be made if we are to continue developing and rolling out distributed ledgers for payment and trading systems. All market participants, regulators and other stakeholders must all be onboard and involved in order to ensure that the future is evenly distributed – and that the blockchain can make a smooth landing.

 

*A  firm that is building a consortium of finance houses to standardise an interbank mechanism

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