Blockchain Standards' Pivotal Moment

Blockchain technology has caught the imagination of capital markets players with its seductive promise of leapfrogging the costly work of modernizing legacy systems, transforming data normalization and reconciliation processes, sharing reference data and bringing more transparency to the markets. As the initial excitement dies down and various efforts get under way to find the best use cases for the technology, the conversation is turning to standardization.

Much of the discussion about distributed ledger technology (DLT) thus far has focused on the efficiencies and cost mutualization opportunities it offers in the post-trade arena, particularly in clearing and settlement.

It is hard to tell where exactly the technology's impact will be felt the most, says Jurgen Vroegh, global head of payments at ING in Amsterdam. "In general, we see several situations where DLT can bring benefits. The most obvious is where a shared ledger is necessary, where multiple parties need to work together and have the same source of truth, and where value is registered and transferred. For example, in international payments or clearing and settlement of financial assets," he says.

"But this is not always the easiest to achieve. We also see potential benefit in exploring the internal usage of DLT, where increased transparency, near real-time information and full auditability can make processes more efficient, more effective and ensure compliance upfront."

One of the things that will be important is the creation or emergence of standard blockchain ‘fabrics’ that underpin many implementations of DLT in different industries
Jurgen Vroegh, ING

Morgan Stanley believes that DLT could offer significant efficiencies for securities reference data. "Providing a rules-based standard on data could enhance quality and auditability as transactions occur. The history could enhance resolution management as well," the firm stated in its Global Insights Report released in April.

Other experts agree that reference data is an excellent place to start. "Within firms, everyone has reconciliation issues with reference data, and [with] mapping that against counterparty reference data, clearing and settlement utilities and money transfer utilities data. There are a number of places where the business use case exists today," said Robert Palatnick, managing director and chief technology architect at the Depository Trust & Clearing Corporation, at the ISITC conference in Boston in March.

"Look at the spaces where there are a lot of manual steps and a lot of paperwork. You wouldn't be displacing anything, so moving to a new technology, even as a pilot, could provide some value," said Palatnick.

More Fragmentation?

But with multiple vendors-such as Ethereum, Eris and Chain-emerging to provide various flavors of blockchain, and the industry moving towards private ledgers, there is a risk that DLT will simply add another layer of fragmentation to the market.

"What we'll start to see is deployments of different blockchains and different blockchain companies deploying those blockchains, or banks using different blockchains. What is important to us is that they all have a common protocol so that they communicate with each other," says Justin Chapman, global head of process management at Northern Trust in London.

"As the technology evolves, there won't be one blockchain for everything. We will find-much like markets and exchanges and depositories-that blockchain ecosystems will be created that must work together and live together, with assets that are moved across these ecosystems. You'll have the Ethereum chain here and a Hyperledger over there, with varying degrees of deployment, but they must be interoperable and they have to talk to each other."

The development of a protocol and a set of standards, therefore, is becoming the main topic of discussion at industry events and conferences, as well as in the whitepapers released by vendors and banks on the subject of the blockchain.

Standardization Initiatives

Chapman says standardization efforts are where industry consortiums will prove their importance. The best known of these initiatives is the R3 consortium, led by start-up R3CEV. Forty-two banks have signed up to the initiative, and R3 successfully trialed five different distributed ledgers earlier this year.

Northern Trust is one of the 42, but R3 is not its only exploration of DLT. Chapman says Northern Trust aims for a consistent approach across the organization, involving the private equity team, product organization teams and the chief technical officer. Externally, the bank engages with government, academics, other industry participants, regulators and policy-makers, as well as industry bodies such as the International Swaps and Derivatives Association.

Similarly, Vroegh says ING began its experimentation last year, building up knowledge within the organization, but also connecting with universities and research institutes "to find answers to some of the fundamental questions." ING joined the R3 consortium in November and works in partnership with other major Dutch banks. "At the end of 2015, we entered into several partnerships and quickly accelerated our work and our thinking," Vroegh says.

ING's experiments include validations of use cases in domains such as payments, trade finance and capital markets. "We also work on more technically driven topics like scalability, interoperability and privacy. We do this through technology reviews, working groups with other peers or technical experiments," says Vroegh. "Besides working on clear prioritization and experimentation, we believe that collaboration is the third essential ingredient for success."

Templates and Frameworks

Some skeptics have pointed out that financial institutions are hyper-competitive and difficult to organize, but Palatnick told the delegates at ISITC that the "overnight success" of ISO 15022, the standard for financial messaging, in 2002, shows that financial services firms can cooperate and move quickly when they have to.

He added that now is the time to start talking standards because DLT is so new. If standardization had been achieved in the past, blockchain would not be the big news that it is. "If we could have mandated years ago that everyone needs the same version of Oracle and has to have the same database schema, business logic, procedures and exact rules, then the conversation that the ledger is not bringing anything new would be true, because everyone would be sharing information in a synchronized way," he said.

So how are firms and industry consortia such as R3 thinking about standards at this stage? Vroegh says: "Most likely, a variety of DLT implementations will exist, so interoperability is something that should be top of mind from the beginning when developing solutions. One of the things that will be important is the creation or emergence of one or a few standard blockchain ‘fabrics' that underpin many implementations of DLT in different industries, with different parties involved and using different business logic."

Smart contracts will also play an important role, and templates for these are emerging, says Vroegh. Basically, smart contracts are programs that emulate the logic of a contractual document, encoding rules, benefits and consequences for the parties concerned, and allowing them to update the ledger.

"This kind of standardization will make the usage and adoption of DLT much easier," adds Vroegh. "Finally, there is also non-technical standardization that needs to happen or that at least would create a lot of benefit. And that is standardization in the definition of assets, in settlement processes and in legal frameworks that are used around the world. That's not an easy job, of course, but we already see that blockchain technology is triggering discussion across economic, geographic and legal borders."

So, although the hype may be dying down, DLT is starting to gain real traction in financial services, where it promises increased efficiencies and savings. But financial institutions and service providers are recognizing that without standardization, the technology's effectiveness will be compromised before proper adoption has even begun.