The first international blockchain transaction was completed on October 24. The Commonwealth Bank of Australia and Wells Fargo noted that the landmark commercial transaction led to a shipment of cotton to China from the U.S.
In a joint press release, Australian cotton trader Brighann Cotton Marketing announced it had purchased 88 bales cotton bound for Qingdao, China from U.S. division Brighann Cotton in Texas. This blockchain transaction had a net value of around $35,000.
Blockchain is the name for a distributed database system that can serve as an open “electronic ledger” to simplify business operations for all parties. Originally developed as the “accounting system” for the virtual currency Bitcoin, decentralized ledger systems such as blockchain are appearing in a variety of commercial applications today.
Advocates have suggested that this kind of electronic ledger system could be usefully applied to voting systems, weapon or vehicle registrations by the government, financial trade settlements, healthcare records, or even to confirm ownership of antiquities or artwork.
Given the potential of distributed ledger technology (DLT) to simplify current business operations, new operational models based on blockchain have already begun to replace the expensive and inefficient accounting and payment networks of the financial industry.
Simplified Operations From DLT Lead to Major Cost Savings
DLT systems make it possible for businesses and banks to streamline internal operations, dramatically reducing the expense, mistakes, and delays caused by traditional methods for reconciliation of records.
The widespread adoption of DLT will bring enormous cost savings in three areas. First, electronic ledgers are much cheaper to maintain than traditional accounting systems. Second, nearly fully automated DLT systems result in far fewer errors, which will lead to massive savings over the long run. Third, minimizing the processing delay also means less capital being held against the risks of pending transactions.
Hurdles to Be Overcome in Mainstream Adoption of Blockchain Technology
Although it is clearly almost there, blockchain technology is not quite ready for primetime. The roadblocks to DLT today are not technical. The real challenge is politics, regulatory approval, and the many thousands of hours of custom software design and front and back-end programming still required to link up the new blockchain ledgers to current business networks.
Problems that still need to be addressed include:
- DLT must interface with other parts of the operational processes seamlessly. Blockchain should enable more rapid setup, training, and reduce problem resolution time. Achieving the efficiency gains must be easy enough/cheap enough for all parties involved to grasp and leverage.
- Security also remains a concern. According to a February 2015 Bank of England research report: “Further research would also be required to devise a system which could utilize distributed ledger technology without compromising a central bank’s ability to control its currency and secure the system against systemic attack.”
- Banks are not interested in an open-source model for identity. Both banks and regulators want to maintain close control. The development of a single digital identity passport authorizer is a critical next step.
- Regulation is also critical in creating an open digital environment for commerce and financial transactions. Current physical certificates must be digitized to gain the full benefits of a fully digitized system. Other questions to be answered include: Who is responsible for maintaining and managing the blockchain? Who admits new participants to the blockchain? Who validates transactions? and who determines who sees which transactions?
R3 Consortium Developing Blockchain Technology
R3, a consortium of more than 70 of the world’s biggest financial institutions, is bankrolling research into methods to harness the speed, accuracy, and efficiency of blockchain.
Blockchain technology removes almost all human involvement from transaction processing. This is particularly beneficial in cross-border trades, which usually take much longer because of time zone issues and the fact that all parties must confirm payment processing.
With blockchain systems, you can set up “smart contracts” or payments triggered when certain conditions are met. The first international blockchain transaction mentioned above, for example, used a smart contract that automatically made partial payments when the cotton shipment reached specific geographic milestones.
Blockchain and the Bottom Line
Using global equities markets as an example of the potential of blockchain, a recent Goldman Sachs report argued that implementing this new technology could save stock market operators up to $6 billion a year.
Using DLT for clearing and settlement in the cash equities markets will produce savings mainly through lower employee headcounts and reductions in back office IT costs. The report highlights that distributed ledger technology allows the elimination of repetitive confirmation steps, notably reduces the settlement cycle, and minimizes risk.
Implementing DLT could lead to savings of up to $2 billion a year just in the U.S.. A big part of the savings will come from eliminating trading errors. Currently close to 10% of all trading volume ends up requiring time-consuming manual intervention, but nearly all of this manual processing is a thing of the past with DLT.
The report breaks down the cost savings that will be generated from the streamlining of back and middle office processes through reduced headcount to around $900 million, and the savings from reducing the number of software platforms and systems adds up to another $700 million.
Moreover, some smaller number of millions will be saved by shrinking the amount of capital that broker/dealers are required to put up to back unsettled, outstanding trades.
The Goldman report also projects that DLT will lead to cost savings of between $3 billion and $5 billion a year worldwide in anti-money laundering regulatory compliance because of greater transparency and ease of auditing.
If you sit down and do the math, starting with the $2 billion annual cost savings in the U.S. figure, and figuring there are around 4.68 billion total stock transactions on the NASDAQ (1.8 billion) and NYSE (2.88 billion) together every year, implementing blockchain tech leads to a savings of $0.427 on every stock trade. [2 billion /4.68 billion = 0.427]
As this example makes clear, efficiencies resulting from DLT can add up to some serious cost savings. Keep in mind, this example is just for one sector of the financial industry. The cost savings from getting rid of middle and back office confirmation and reconciliation processes with blockchain will easily add up to hundreds of billions of dollars when DLT becomes the global standard for financial transactions.
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