Preparing for Blockchain innovation at Australia’s major banks
The views expressed in this article are Michael Southwell’s and Nick Groves' and do not necessarily represent the views of their respective employers.
The banking and FinTech industry is quickly rallying around the concept of Blockchain and its capabilities as a technology. Global institutions are partnering with start-ups to explore Blockchain capabilities, while regulators contend with the potential implications from a governance perspective.
Blockchain has emerged as one of the latest developments in the midst of a digital transformation in the finance sector.
However, while much of the focus centres on technical capabilities, strategic capacity is also receiving significant attention. Only recently, digital currency insights publication Brave New Coin identified five major use cases for financial Blockchains, comprising smart contracts, smart assets, closing and settlement, payments and digital identity.
In Australia, many banks including the Big Four are taking a two-pronged approach – strategically and technically – to assess and adopt Blockchain technology. However, with no ‘one size fits all’ solution, the approach is proving both dynamic and progressive at the same time.
Ahead of Blockchain 2016, Michael Southwell, Director of Payments - Global Transaction Services at Westpac and Nick Groves, Executive Manager, Group Strategy at ANZ, share exclusive insight into the latest developments aimed at understanding and harnessing Blockchain technology.
Assessing Blockchain capabilities at Westpac
Westpac recently formed an internal think tank to bring specialists from across the business and share ideas and experiences. And in December 2015, the bank hosted the Blockchain Design Challenge at Stone and Chalk – a Sydney-based FinTech incubator.
One of the key people involved in these efforts is Michael Southwell, Director of Payments – Global Transaction Services at Westpac. Through this role he focuses primarily on new, transformative solution development, rather than innovation in the bank’s existing product set.
This focus includes emerging technologies like Blockchain and the New Payments Platform (NPP), as well as developments in the FinTech space to understand what opportunities exist for customers.
Before even considering Blockchain technology as a solution, Michael considers several key issues to define why and how it could be relevant to Westpac:
- If the solution requires a distributed or centralised ledger – much of the focus on crypto currencies and Blockchain is the distributed nature of the ledger. However, in many cases a ledger does not need to be distributed (it would be more efficient to keep it centralised, as most ledgers today are). De-centralised ledgers are more resilient, but resiliency often isn’t necessarily the most important attribute.
- If the solution operates in a trustless environment; or if a strong degree of trust is already established between participants – this comes down to determining whether or not the readers and writers to the ledger are trusted. For example, with Bitcoin there is no trusted counterparty, which then requires a lot of time and effort from the de-centralised network to figure out how to reduce or eliminate fraud. Whereas with a permissioned ledger, participants would know who the counterparty is and have trust, making processing more efficient.
- If there is any economic advantage adding information on Blockchain – determining how the technology would be more efficient than existing solutions, or produce a greater economic incentive than other solutions in the market. This last consideration can have the biggest influence on applicability of potential solutions, because if there is no additional money to be saved or made, there’ is very little reason for participants to change their behaviour.
These considerations play an important backdrop to Michael’s approach in assessing the potential, applicability and capability of Blockchain technology.
Hackathon developments
“For the Design Challenge, we brought together a number of people from both within the bank and across the community,” he says.
“Organisations like IBM, PricewaterhouseCoopers, King and Wood Mallesons, Optus, and other interested parties from across the business and academic community. The Design challenge serves as a lead-in to a two-day Hackathon that we’ll conduct in late May.”
Michael will work with 12 to 16 different internal and external teams to create several live Blockchain solutions during the Hackathon.
While he admits it is early days, Michael notes that this type of event has proven to be the best way to engage the right expertise, as well as understand what the opportunities are for adopting and applying Blockchain technology.
“We’ve been quite surprised at how excited people are to get involved and how much institutional knowledge is already there that we just weren’t aware of. I think many people have been following this for several years and are quite excited that the bank is getting involved, so that they can share their insights and turn it into something that could potentially benefit our customers,” he remarks.
The Hackathon is an important pre-cursor to ironing out how Blockchain technology will benefit the bank’s customers – acknowledging that there is no ‘one size fits all’ solution. According to Michael, while there is a lot of interest in the topic, there is also confusion around the terms of Blockchain, Bitcoin – let alone cryptographic hashing, public-private key encryption, and the various ledgers, side-chains, and other features of Blockchain .
“They’re all different parts of the solution, but every solution doesn’t need to include every feature. I think, ultimately, we’ll see a proliferation of different Blockchains that are all fit for purpose,” he observes.
Impact on global remittances
At the same time, Michael believes it is too early to tell what the magnitude of impact will be on global remittances, but notes that a lot of time and effort are being invested in companies like Ripple and R3.
“I expect we’ll see some movement in this space, eventually. It’s important to remember that international remittances and inter-bank transfers are systemically important parts of the global payment system.”
There are several key stakeholders in developments related to Blockchain and global remittances, including commercial banks, regulators, central banks and the Bank for International Settlement – which issues guidelines on systemically important payment systems.
However, competing priorities between them could make it difficult to formalise agreements and outcomes in the near future.
“Payments are very important but they change slowly. You had cheque-based payment systems and then you had direct entry-based payment systems and now we’re going to real-time payment systems.
“There’s a lot of compliance, regulatory work and understanding of what the impact of these changes would be on the economy before everyone is comfortable with moving to the next generation,” Michael explains.
Considerations for crypto currency payments between banks
In the current environment, it is not entirely clear if today’s generation of crypto currencies are sustainable in the long-term – something Michael says stems from an odd characteristic.
“Crypto currencies like Bitcoin can be seen as a commodity because they’re mined, you have to consider the cost of production and remaining Bitcoin ‘reserves’ into the price. At the same time, they can also be seen as a fiat currency, as they don’t have any intrinsic asset backing them. There’s no gold standard sitting behind Bitcoin, for example.
“So, when you look at it from that perspective, you have the volatility of the commodities market and the cost of producing the commodity on one hand; while on the other hand you have the volatility of a currency that’s not really tied to a defined monetary policy or central bank.”
His observation reflects why it is difficult to predict crypto currency markets. Fortunes have been made and lost in such attempts. Bitcoin and other current-generation crypto currencies combine multiple sources of market volatility for casual investors (who are not prospectors).
“At some point crypto currencies might be issued by – or in co-operation with – the central bank, and could play a role in domestic bank-to-bank transfers. But even then only if it’s more effective than what’s currently available,” he adds.
With real-time payments platforms such as the NPP coming online, it prompts an important consideration: what is the step change in value proposition that a new generation of crypto currency could provide?
For example, whether or not a new crypto currency will be cheaper, faster, more secure, or more scalable. Michael says unless all of these step changes can be achieved, he doesn’t see the value proposition improving enough for a new generation of crypto currency to replace the existing ones – although it might sit along side existing clearing and settlement streams.
“At the end of the day, Blockchain is a new technology that many of us are still figuring out. It’s an exciting time, but there are still multiple considerations that need to be addressed as companies explore the capabilities and business use cases.”
Exploring bank-grade Blockchain technology at ANZ
As an executive manager at ANZ, Nick Groves is based in Group Strategy, and is responsible for a range of issues aligned with the overarching corporate plan. His involvement in Blockchain began a year ago, when he was tasked with helping ANZ’s General Manager, Group Payments Transformation, to prepare a presentation for the Board of Directors.
“One of the things we recognise as important, and which has been reiterated by our new CEO, is staying on top of the latest happenings in the FinTech scene,” he says.
“We obviously see Blockchain as a very important and exciting trend in this space. I’m working closely with people from our technology and payments businesses to examine how and where we can apply this technology internally.”
Much time is also invested into engaging external partners as well – not only on what technology is out in the market, but how the bank can collaborate with other companies to come up with innovative solutions.
“ANZ’s foray into Blockchain capability revolves around two considerations. The first is how to make the technology bank-grade; and the second is what are the potential use cases. We’re looking at a number of different business-use cases to examine practicality and benefits,” Nick notes.
By addressing these considerations, his team will be able to get the basics right before heading into larger-scale activities. For example, one of the areas being examined is Nostro/Vostro reconciliations – ensuring that information on the bank’s ledgers is fully reconciled to its correspondent banking parallel ledgers as well.
Additionally, there are two major projects through which the bank has taken a lead role in exploring Blockchain capabilities: SWIFT GPII and the Linux Foundation’s Hyper Ledger Project.
The former is a global payments innovation initiative run by global member-owned cooperative, SWIFT, in which 45 major banks have signed up as of December 2015; while the latter is an open source project aimed at advancing Blockchain technology for transaction recording and verification.
“For the Hyper Ledger Project, we are working with companies like IBM, Digital Asset Holdings and many other participants to actually define what banks need from a distributed or shared venture. ANZ is contributing input on what the requirements should be for this technology from a banking perspective, while participants like IBM are contributing computer science theory on consensus models.
“There’s a range of different inputs going into that process, but the idea is we field an open source Blockchain solution that can then be applied via a range of different parties for a range of different problems,” Nick explains.
Permissioned vs permissionless ledgers
When it comes to assessing the application of Blockchain technology, Nick is quick to note that the difference between permission and permissionless ledgers needs to be addressed.
“Banks are built on trust and we need to get our processes right, to preserve our customers’ trust. So, we look at a number of different aspects when we think about Blockchain technology, such as issues around privacy, scalability, system stability, efficiency and the actual cost effectiveness of the system,” he says.
Open public – or permissionless systems – like Bitcoin have received much interest in the way of disruptive solutions, but they have not been designed with banks in mind. Instead, they were intended to facilitate an environment for an open network of ‘pseudonymous participants’.
However, banks do not operate in open networks with these participants, but in networks of ‘know and registered’ participants. As a result, ANZ is focused on permissioned ledgers that are considered more bank-grade.
“It’s fair to say the permissioned space has received less attention and less investment to date than the more permissionless space like Bitcoin, but we’re starting to see interesting solutions emerging. That’s where projects like the Hyper Ledger come in to help develop a bank-grade technology solution,” Nick adds.
Privacy does not only extend to customer-related priorities, but banks themselves. Decisions would need to be made on what data should be shared with other organisations to make a permissioned ledger system work.
And when combined with variables such as system stability and efficiency, governance and standards become issues that need to be addressed.
The initial applications of a permissioned ledger are being considered from a back end perspective, but the bank is keeping a close watch on how Blockchain technology could be used for the front end.
Having a permissioned ledger in the back end introduces an immediate practical benefit – eliminating the need for reconciliation. If two or more banks can have a shared source of truth, for example, much of the process behind reconciliation can be reduced or eliminated.
“At the same time, a permissioned ledger would also enable standardisation across different institutions as well. And once a real-time and fully reconciled view is established, other benefits can then be unlocked, such as liquidity management,” Nick explains.
“We’ve prioritised initial review of Blockchain capability in the back end, because we see it as an area where we can more safely test and examine the technology. But there is definitely scope to see how it can be incorporated in customer-facing parts of the business down the track.”
Michael Southwell and Nick Groves are featured panel participants at the Blockchain Summit in June. They will be joined by specialists from organisations including Community Mutual Group, Coinjar, ING Direct, Kiwi Bank, Rabobank (USA) and NAB to name a few.
Download the brochure or visit www.blockchainsummit.com.au to know more.
This article was originally published as an insights feature for the Blockchain Summit. For more content on Blockchain developments - including an exclusive article with ASX - please visit: