Q&A with Simon Warner, Head of Global Fixed Income, AMP Capital
Q: Simon, there’s been a lot of talk about Bitcoin lately; what is it and why is it significant?
A: Bitcoin is a form of digital cash that enables value to be transferred between two agents electronically and without the need for third-party verification of the transaction. This means that transferring Bitcoin is very cheap and fast, opening the viable potential for smaller exchanges of value. Bitcoin has the potential to disrupt the payments system, bringing into question the role of banks and the way they maintain a ledger of transactions.
Q: What’s the connection between Bitcoin and Blockchain?
A: The underlying technology of Bitcoin is a public Blockchain. This is a piece of code that verifies that a transaction between two parties has taken place. The verification process takes place through a system of distributed trust. This means that multiple parties are working on matching and verifying transactions simultaneously and are rewarded by being awarded Bitcoin. This process of verifying transactions and being rewarded is referred to as mining.
Q: Can you tell us more about Blockchain?
A: Blockchains are shared databases that were invented as part of the underlying infrastructure of Bitcoin. Changes to the database are agreed collectively across agents in the system and not by a central authority. Blockchains use cryptography to allow participants to submit and agree changes. Once changes are made (blocks are added to the chain) they are very difficult to alter. This adds security and transparency to the database.
It’s worth noting that Blockchains are commonly referred to as distributed ledgers and permissions can be either public (Bitcoin) or private (a single agent). One of the promises of distributed ledgers is that they can help speed up settlement times therefore lower cost. Unfortunately, the prospect of greater speed and efficiency is intertwined with the lack of legal recourse outside the system. This is a key constraint for the wholesale adoption of Blockchains in financial markets.
Q: Is the system secure?
A: The system is secure and stable as long as the verification of the database occurs across a sufficiently large and diverse set of agents. If the system is concentrated then it becomes vulnerable to a 51% hack. This is a situation when one agent dominates the verification process and can unilaterally change the database.
Q: Have there been any recent developments?
A: Over the past year, there have been many developments in the area of permissioned Blockchains in financial markets. It has been a major area of venture capital interest since it’s hoped that Blockchain technology can speed up settlement and processing times to reduce cost and risk.
Distributed ledgers are more richly thought of as a Blockchain-supported database overlaid with a set of smart contracts. Smart contracts are legal documents that specify an exchange in the event of certain criteria being met. Splitting the components of a distributed ledger in this way enables a deeper understanding of the applications of Blockchains. Applications are likely to be in the form of databases as much as ledgers.
Q: How are financial institutions applying Blockchain?
A: Many financial institutions are experimenting with Blockchains and security settlement is an area that could see the first wave of applications. R3 is consortium of 22 banks that is investigating how to use the Blockchain technology to speed up security settlement. They hope to use a private Blockchain that is maintained by its members as a way to speed up the settlement system from 2-3 days to 10 minutes. This would reduce settlement risk and counterparty risk and lower cost.
Nasdaq is also looking at ways of using Blockchain technology to cheaply maintain the share register for small companies. In this instance, the Blockchain is being used by a single provider as a way to encrypt a database. Regulators find the use of the Blockchain appealing because it fosters transparency, a single source of truth and will aid in monitoring systemic risk.
The Australian Stock Exchange (ASX) is also using Blockchain technology to update its existing CHESS registry system. It has invested in a high profile Blockchain start up called Digital Asset Holdings (DAH). An important dimension of the ASX’s adoption of Blockchain technology was the need to update its existing systems. The extent to which the final adoption of the technology is a permissioned Blockchain or a private Blockchain remains uncertain. DAH is also working to standardise and streamline settlement in syndicated loans.
In these examples, Blockchain is being used as a common language to tackle well-known problems, something that is perhaps the most powerful function of Blockchain in financial markets.
Q: Are there any other interesting applications?
A: There are interesting Blockchain applications in the areas of trade finance and supply chains. In these spheres, verifying that goods have reached a port or that a supplier delivery has been made is an important impediment to settlement, causing unnecessary capital costs.
Bank of America, Standard Chartered and DBS are running experiments to improve trade finance where sensors will detect when a shipment has arrived. Similar experiments are being conducted in the agricultural supply chain where payments are made on the delivery of a commodity. In the emerging individual solar power generation market, households could sell and settle power directly to consumers over a Blockchain. These are examples of a confluence of Blockchain, smart contacts and the internet of things.
Other applications of Blockchain are in areas of verification and information sharing. For example, Everldeger is a company that uses Blockchain technology to track the providence and certification of diamonds. A diamond can be tracked from the mine to the owner over a Blockchain. Importantly, ownership of the diamond is not recorded or transferred on the Blockchain, only its origins and movement. Similar applications are being trialled in wine and luxury goods.
Q: What are the strategic implications – why should investors care?
A: The strategic implications of Blockchain technology are widespread. Narrowly, there are opportunities from reduced settlement time and expense. With this, there are some considerations surrounding the ownership of records and breadth of assets to be stored on a Blockchain. More broadly, there are opportunities to improve customer knowledge and service through shared database technology. This increased knowledge and intimacy can be used to develop superior products and services for clients. There is also a role for Blockchain to help determine, track and explain investor goals.
Q: What’s AMP Capital doing about it?
A: We’re continuing to monitor this space in order to take advantage of any cost saving that Blockchain applications offer. In addition, we’re exploring the ways that this technology can be used to support the products and services that we offer our customers.
Q: Adoption – what’s the likely timing and impact?
A: Widespread adoption of public or private Blockchains is uncertain. The initial impact is likely to be felt in middle and back office functions where Blockchains can help speed up settlement. In my view, the impact of Blockchain is likely to be an evolution rather than a revolution.