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June 30, 2015 10:38 am

Banks and exchanges turn to blockchain

Philip Stafford

Wall St lured by efficiency promise of the technology behind bitcoin

Bloomberg

he blockchain the technology that underpins bitcoin has been called the future for
financial services infrastructure. Now banks, clearing houses and exchanges are becoming
increasingly excited at the prospect of blockchain fundamentally transforming their business
models.
Last week Nasdaq said it would use blockchain technology from US start-up Chain to underpin its
new private share-trading market, in one of its most high profile applications to date. Former New
York Stock Exchange chief Duncan Niederauer and JPMorgan banker Blythe Masters have also
lent their support to start-ups exploring its use.

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Blockchain technology continues to redefine not only how the

exchange sector operates, but the global financial economy as a whole, says Bob Greifeld, chief
executive of Nasdaq.
To its supporters, it marries the major preoccupations of Wall Street and Silicon Valley: tougher
post-crisis regulations and cost-cutting on one side, community-agreed technology and new
peer-to-peer structures to move money around the financial system on the other.
This model, however, is fundamentally different to the financial industrys current approach of
using overlapping centralised ledgers. Settling trades can take days, is often expensive and, for
many banks, is partly done by humans.
The blockchain and the bitcoin assets it tracks set out a way to create an unforgeable, unchangeable
ledger of asset ownership.
Transactions between bitcoin users are broadcast to a network of computers. The latter, known as
miners, gather together blocks of transactions and compete to verify them and receive monetary
incentives in return for being first. The blocks are secured by cryptography and other computers
can verify the work. The cost of running the network is borne by the anonymous owners of
servers. The open source code means it can be widely distributed, making it highly decentralised
and difficult to change.
Banks and exchanges see a ledger updated in minutes as saving millions in collateral and
settlement costs to third parties. New post-financial crisis rules have forced more over-the-counter
derivatives to be processed through centralised clearing houses. That has increased demand for
collateral to be sent around the financial system rapidly in order to be used as insurance for cleared
derivatives trades.
A recent report by Santander InnoVentures, Anthemis and Oliver Wyman estimated distributed
ledger technology could cut $15bn-$20bn from banks costs for cross-border payments, securities
trading and regulatory compliance by 2022.
Banks are developing other ideas, such as programming smart contracts that can verify and
execute commercial agreements.
As with any new technology, experimentation abounds. For a start, enthusiasts debate whether the
blockchain even needs a digital token like bitcoin. For some, it is an article of faith that ensures
miners are incentivised to do the work.
Some start-ups, such as Ripple and Chain, are trying to create distributed ledgers with identifiable
owners of assets and settlement finality. They argue an authoritative and unforgeable ledger for
securities and derivatives is impossible, since legal enforcement of contracts requires people to
prove ownership.

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A lot of bitcoiners dont realise how finality and settlement works with title transfer. You need to
identify people or its a big waste of energy, says Tim Swanson, a consultant advising start-ups
including Hyperledger, Clearmatics and R3CEV, a venture capital group.
Clearing houses, set up to manage systemic risk, are also special cases, he adds. If participants
fail then the operator will probably move to centralise the credit risk which was the purpose of
the clearing house in the first place.
Identification of the true owners would be vital if the blockchain is compromised. At present the
longest chain of blocks the one with greatest sum of work done is accepted as the ledger. It is
protected because any actor attempting to modify it would have to have control of enough
computing power to overtake the genuine block chain as the longest.
In reality mining is controlled by a small group of actors. If one controls the majority of the
networks computing power even temporarily they could alter the ledger, says Robert Sams,
founder and chief executive of London-based Clearmatics.
The law will not treat a ledger record as authoritative if everyone knows that the current longest
chain contains blocks generated by an anonymous attacker who replaced a bit of history that was
chronologically prior, he says. In financial markets theres always a mechanism to correct an
attack. In a blockchain there is no mechanism to correct it people have to accept it.
Others worry that the blockchain is growing too big and inefficient to deal with a growing number
of transactions. New lines are added on to the bitcoin block every 10 minutes.
Consequently, others are talking about so-called sidechains that can process trades in
milliseconds, interoperating with other blockchains. At that point, critics say, an interlinking
network begins to look like the existing infrastructure.
For now many start-ups accept they cannot go around the system.
Its very important to work with existing market participants, says Adam Ludwin, chief executive
of Chain. The mantra of Silicon Valley is: Move fast, break things. That mantra doesnt apply in
financial services.

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