Lessons from Distributed Ledger Technology and the Future of Banking

It’s no secret distributed ledger technologies (DLT) have been front-of-mind for financial institutions examining solutions to existing problems in institutional and retail banking. While blockchain technology is still a greenhorn in the wilderness of capital markets, the underlying concept should be heralded as a catalyst for innovation. Blockchain has been the inspiration for solutions like Baton Systems’ platform that translate complex processes between multiple global institutions, like Citi and CME, to facilitate more efficient settlement, workflow collaboration and lifecycle management between firms.

While it will be at least a few years before we see any wide adoption of distributed ledger technology or blockchain, there are several takeaways from these projects that should not be overlooked, and they should play a large role in the technology’s adoption across the banking sector in the years to come.

The Bank of England recently completed a proof of concept project for real-time gross settlement with Baton and three other fintech vendors, which tested various applications of distributed ledger technology. The findings of this project should serve as a microcosm to how distributed ledger technology can impact the broader banking landscape on both the retail and institutional side.

In the meantime, there are a few areas that we can expect to be impacted by what we already know about this technology.

Settlement processes

Distributed ledger technology can bring dramatic improvements to the efficiency, security and cost of this process. Several interbank settlement procedures for capital markets require prefunding and can take up to 48 hours to complete in some cases. The process does not stop there, as financial institutions need to reconcile across multiple parties and submit the appropriate regulatory reports

A recent report released by the Bank for International Settlements stated that settlement efficiency for securities and derivatives could be enhanced by distributed ledger technology, but more testing will need to be conducted in order to accurately evaluate its true viability for specific use cases and implementations.

Risk and Transparency

When outlining the impact of technologies of the future and what will resonate most with the evolving banking landscape, risk reduction and transparency surface as a benefit to greater management of market. While they are different, risk and lack of transparency in the settlement process are related. High value payments between institutions are complex multi-party transactions with assets in multiple commercial banks, custody banks, central banks and CSDs. They can be FOP (Free of Payments), PvP (Payment versus payment) or DvP/DvD (Delivery versus payment) between participants. These payments need to be made with settlement finality and must address counterparty as well as depository institutions’ default scenarios (hence the associated risks). In most cases, the senders and receivers of the funds have little control on the visibility or liquidity further adding risks to the ecosystem. In the ten years since the financial crisis, regulators have taken steps to address transparency. Companies like Baton Systems in consultation with banks and regulators are attempting to address this problem using DLT technologies, but settling assets using existing payment rails without crypto or digital currencies.

Regulators around the world have also become wiser as distributed ledger technology has matured. As with everything else in financial services, their decisions will have major implications on how quickly and how widely this technology is enacted.

Take countries in Asia, for instance. China has already taken an aggressive stance on regulating cryptocurrencies. However, these actions should not be interpreted as a damper on any demand for distributed ledger in banking. Keep in mind that distributed ledger technology and cryptocurrencies are not the same thing. There is a common misconception in the industry that the two can be used interchangeably.

Regulatory and compliance decisions will dictate how market structure evolves and will also impact how financial institutions approach transparency and settlement issues. In the years ahead, we can expect regulators – especially in the US and Europe – to put greater emphasis on the risk factors associated with distributed ledger technology.

While it will take a few more years before distributed ledger technology makes its way into the mainstream in some of the Asia-Pacific nations where regulatory oversight is air-tight around crypto and distributed ledger adoption, there’s no doubt it will have resounding influences on the world’s financial landscape.

– Arjun Jayaram is CEO and Founder of Baton Systems.