It may be early days in terms of how banking and wealth management firms incorporate distributed ledger technologies (DLTs) into their current and future business plans, but what is clear is that DLTs are here to stay - and that the benefits and impact they bring will likely be significant. What is also clear is that the investment in DLT by some firms has already been significant and is expected to increase further over the coming years.
The number of use cases that have been imagined and evaluated is already huge: payments, securities, trade finance and KYC, to name only a few. Almost any banking activity has been scrutinised to be ‘blockchainified’.
DLT has the potential, for instance, to replace or eliminate many existing forms of inter-bank communication. Message flows between institutions have been an essential part of banking for centuries, but they are more numerous than ever (28 million Swift FIN messages per day in 2017, up from around 25 million in 2015).
DLT, in contrast, provides a shared database as a ledger. Participants to a transaction share, de facto, the same data. They do not need to send messages around to synchronise their view on the trade anymore, nor do they need to perform reconciliations. This is now seen as a massive change which will dramatically impact back-office activities.
Moreover, the hope is that DLT will simplify trade between untrusted, and perhaps unknown, counterparties, by:
- Providing certainty that the counterparty has the assets it claims to have;
- Enabling irreversible and non-repudiable transactions with instant settlement;
- Facilitating atomic swaps, without any counterparty risk, via smart contracts.
The power of this concept has been proven with Bitcoin, but it can be generalised to any asset with newer DLT tech, and this threatens to disrupt or disintermediate third parties in several areas of financial services – particularly third parties whose value derives from their position of trust. To realise its full potential, DLT will require digital assets that are not themselves subject to counterparty risk.
$2 trillion within 10 years
While this may come soon enough in the form of central bank-issued digital currencies, there are, as of now, very few digital assets. They include crypto currencies like Bitcoin or digital tokens like Ethereum tokens. However, analysts are predicting a dramatic increase in digital adoption, with some anticipating the market of digital assets being worth in excess of $2 trillion within 10 years.
Cryptocurrencies are spearheading a permanent shift in the way that individuals store and exchange value. In our view, prudent wealth managers should have some form of crypto asset integration already on their road map.
For now, public ledgers like Bitcoin and Ethereum are nowhere near scalable nor private enough to serve as the back-bone of our financial system. But we are already seeing DLT being deployed as permissioned networks in financial settings, to improve efficiency and achieve operational excellence.
As digital assets become more prevalent, banks are likely to integrate crypto money and crypto assets directly into their offerings. Further to this, banks could also net transactions between accounts for customers who would not require segregated accounts for the sake of easier usage.
Avaloq’s own DLT strategy includes the integration of digital assets like Bitcoin and Ethereum into its financial solutions to enable comprehensive portfolio management and trade servicing for banks and wealth managers. Further to this, Avaloq is investigating how to use DLT to manage client identity securely and is engaging with a number of key players to deliver DLT powered payment and settlement solutions – an area expected to represent significant growth in the future.