Blockchain – the challenges

In my previous article I spoke about the opportunities Blockchain technology could bring. Now I would like to focus on the challenges.

We should remember that Blockchain is just a ledger system, not a panacea for all of humanity’s collective problems. Even in finance, problems are not going to be solved overnight by setting up a peer-to-peer based collective accounting system. But why not? Here are a couple of key reasons:

Regulation

Markets aren’t solely the purview of technologists. Governments and regulators also have strong stakes in how markets are run and should operate, as does local market practice. The current global, EU and domestic laws, rules and principles applying to the financial industry cannot be easily "transposed" to deal with possible Blockchain environments. As the development of Blockchain matures there will be the need for a considerable amount of reinterpretation or changes in the current regulations. Key aspects, such as financial stability, issuer and investor protection, legal certainty and market integrity will need to be addressed before industry-wide adoption of Blockchain. This is important in order to develop and realize the benefits of innovation while safeguarding the interests of participants.

Complexity

The financial system in which we operate is complex. This may seem obvious, but it’s worth bearing in mind how demanding and intricate some of the operations performed by today’s back-offices can get, and that some events can last years due to ongoing follow up. Let’s take for example some non-standard corporate action handling:

One voluntary exchange offer that I remember included close to ten securities of the same issuer, to be replaced by technical ISINS. 22 options were open to the holders of the securities, depending on:

• their beneficial owners’ status (i.e. there were different options available depending on whether the owner was a QIB, non-US citizen, Accredited Investor and so on)
• the proceeds customers were entitled to receive(i.e. a mix of new notes, USD, local currency, global depository receipts and shares)

Extra complexity was derived from the range of locations where the cash and securities should be delivered to, depending on the options selected by the customer.

Trying to code something like this into a smart contract would be pretty tricky in the short term. Moreover the cost of trying to code something like this – especially when it might be a one-off event that never reoccurs - is likely currently to be much higher than just acting on it.

Change risk

In 2015 Clearstream alone handled 138.1 million settlement transactions. Significant amounts of value are changing hands globally via transactions such as these. It’s therefore of critical importance that the system handling these trades is as stable and free of risk as possible; otherwise there’s potential for serious levels of economic instability.

Any technological change implies change risk, and therefore in highly risk-averse sectors like post-trade financial services, changes take time. An obvious example of this is the T2S project to provide a single settlement infrastructure for 21 European countries. The ECB first started discussing T2S back in 2006 – here we are in 2016, a decade later, only halfway through the migration. This is to say that major infrastructure change projects in the post-trade industry take considerable time and resources.

To summarize, Blockchain solutions have significant potential and it’s important to start looking into how we can make the technology work now. Change isn’t going to happen tomorrow though. There are still some major hurdles for Blockchain-based solutions to overcome, not all of which can be solved purely through technology. While these obstacles aren’t insurmountable, it’s going to take time to get past them. In my next article I’ll look ahead at what I see as the path to adoption of Blockchain.

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