Blockchain is disrupting traditional financial services in obvious and not so obvious ways. The cryptocurrency industry is poaching employees from the finance industry. To find how why click here. Two fixed income managers from BlackRock left the organization to launch a cryptocurrency hedge fund in early 2018. Financial services is evolving and adopting blockchain and cryptocurrency. Through the use of smart contracts, this technology will change the way information and money is exchanged in finance, and many other industries.
Financial Institutions Invest in Blockchain
The Depository Trust & Clearing Corporation (DTCC) has begun implementing blockchain for post-trade settlement in the $3 trillion Treasury bill repurchase market. DTCC and Digital Asset are currently working with market leaders to ensure the solution is aligned with industry needs. Specifically, the project will allow the “start” and “close” legs of repo transactions to net and settle on the blockchain, which will further reduce settlement risk and cost. Looking forward, DTCC has partnered with IBM and VC-backed blockchain startup Axoni to one day move the $11 trillion OTC derivatives market onto the blockchain as well. This is monumental for blockchain and finance alike, given that DTCC is the market leading clearinghouse for all financial products. Furthermore, Matt Levine at Bloomberg also recently talked about putting interest-rate swaps into a smart contract.
However, financial institutions have been aware of distributed ledger capabilities for several years. In 2015, Visa, Citi, and Nasdaq invested $30 million dollars in the blockchain startup Chain.com. We are just now starting to see the results of this relationship. Visa has recently rolled out a test version of cross-border payments, known as B2B Connect. The platform is designed to enable secure and transparent payments between enterprises. Commercial launch of this service is projected for mid-2018.
Accounting Data Reconciliation
Distributed ledger technology is set to revolutionize the way financial data is recorded and exchanged within a corporation, as well as between corporations. Some financial institutions have outdated, and thus inefficient databases and reporting systems. What’s worse, is that time and money is spent double-checking, and triple-checking data. As a former financial analyst involved in derivative transactions, I would see errors daily due to stale data and internal systems not operating in lockstep. This idea of a semi-manual data reconciliation should become obsolete when blockchains become interwoven into banks’ daily operations. This is because blockchains act as a public database that is secure and immutable. While this idea is still in the testing phase, this is a clear value added use case for the blockchain technology that will reduce errors and cost. Furthermore, this technology may even eliminate jobs across the financial industry, specifically in back office roles. It will almost certainly reduce headcount in these departments, and is likely to change the nature of the role altogether.
FX Transaction Settlements
In fact, companies are already experimenting with the idea of integrating blockchain technology into their systems. Goldman Sachs (among other banks) has announced that it has created its own cryptocurrency to allow instant post-trade settlement of financial transactions. This is huge step forward in increasing operational efficiency for a myriad of reasons. The global cash settlement for fixed income, equity, and derivative products in various currencies is slow, costly, and complicated. When a bank or individual would like to send funds overseas, the bank will usually use a correspondent bank to facilitate the transaction using SWIFT technology. Simply put, banks have relationships with other banks in order to move around currencies other than their own native currency. This usually takes 2–3 days to settle, and can cost up to $50 USD. Banks can drastically simplify this process by using a common cryptocurrency that will cost pennies (or less) in transaction fees and settle instantly. Ripple, the software company responsible for the Ripple payment protocol, operates a cryptocurrency (XRP) that is attempting to tackle this issue by working alongside banks. Even though SWIFT technology is largely intertwined in the current banking system, if it fails to innovate, it may become obsolete in years to come.
The Revenue Grab
While many claim that banks are nervous about cryptocurrency, it is not all bad news for the financial incumbents. In fact, some institutions see the booming cryptocurrency market as a revenue opportunity. Currently, Goldman Sachs and Morgan Stanley are profiting from crypto by clearing bitcoin futures. Taking one step further into uncharted territory, Goldman Sachs is setting up a cryptocurrency trading desk as early as June, 2018. This will allow digital asset hedge funds to trade using Goldman’s platform, further legitimizing and strengthening the crypto industry. In the current environment, the community is constantly concerned about the safety and reputability of exchanges, especially due to hacks such as Mt. Gox, and more recently Coincheck. Goldman making markets in this industry should provide much needed stability and help with mainstream adoption. Other banks seem content to sit on the sidelines and watch this unfold, so it appears Goldman will secure first mover advantage. It is important to distinguish between the implementation of blockchain technology and the cryptocurrency markets themselves. For context, corporations do have the ability to adopt the blockchain technology without creating a rogue cryptocurrency that is traded on the free market. This push by Goldman into trading and market making is signaling that banks are taking cryptocurrency seriously, and not just the blockchain technology itself.
Financial institutions are in the process of changing their infrastructure to integrate this new technology, which will translate into cost savings. While it may eliminate some roles in financial services in the short term, it should also create new jobs with new skill sets in the long run. When financial institutions fully adopt this technology, theoretically, we should see these gained efficiencies in the form of lower fees for consumers. A revenue grab by banks into the bitcoin futures market and the recent news of a trading desk for institutional clients indicates that cryptocurrency is here to stay. The cryptocurrency markets operate at a pace 10–20x faster than the equities market. Innovation and adoption of this technology within traditional finance appear to be moving at a similar pace.
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