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• Blockchain in Banking A Measured Approach

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Executive Summary<br />

If market hype is any <strong>in</strong>dication, blockcha<strong>in</strong> — the<br />

underly<strong>in</strong>g technology for cryptocurrencies such<br />

as Bitco<strong>in</strong> — is poised to solve multiple challenges<br />

fac<strong>in</strong>g the bank<strong>in</strong>g <strong>in</strong>dustry by enabl<strong>in</strong>g faster,<br />

secure and more transparent transactions. Yet the<br />

story of blockcha<strong>in</strong> is one of un<strong>in</strong>tended consequences.<br />

<strong>Blockcha<strong>in</strong></strong>, also known as a distributed ledger<br />

technology, 1 was orig<strong>in</strong>ally created as a track<strong>in</strong>g<br />

database for Bitco<strong>in</strong> transactions. It was developed<br />

<strong>in</strong> 2009 to enable <strong>in</strong>dividuals and organizations<br />

to process transactions without the need for a<br />

central bank or other <strong>in</strong>termediary, us<strong>in</strong>g complex<br />

algorithms and consensus to verify transactions.<br />

Fast-forward seven years, and an array of startups<br />

and established technology, bank<strong>in</strong>g and f<strong>in</strong>ance<br />

players today are bett<strong>in</strong>g on blockcha<strong>in</strong> to provide<br />

a reliable alternative to systems that depend<br />

on <strong>in</strong>termediaries and third-party validation of<br />

transactions. Their goal is to leverage blockcha<strong>in</strong>’s<br />

distributed ledger approach to create a system<br />

that decentralizes trust — a radical departure<br />

from exist<strong>in</strong>g transaction process<strong>in</strong>g methods — to<br />

significantly slash all types of transaction fees and<br />

reduce process<strong>in</strong>g times.<br />

The disruptive potential of blockcha<strong>in</strong> is widely<br />

claimed to equal that of the early commercial<br />

Internet. A crucial difference, however, is that<br />

while the Internet enables the exchange of data,<br />

blockcha<strong>in</strong> could enable the exchange of value;<br />

that is, it could enable users to carry out trade and<br />

commerce across the globe without the need for<br />

payment processors, custodians and settlement<br />

and reconciliation entities.<br />

Although blockcha<strong>in</strong> is posited as an open system<br />

for transaction process<strong>in</strong>g across the f<strong>in</strong>ancial<br />

system, banks are look<strong>in</strong>g <strong>in</strong>ward, experiment<strong>in</strong>g<br />

with the distributed ledger approach to create<br />

efficiencies and a s<strong>in</strong>gle version of digital truth.<br />

Their goal is to automate processes, reduce data<br />

storage costs, m<strong>in</strong>imize data duplication and<br />

enhance data security.<br />

Similar to the Internet and e-commerce, an opento-all<br />

blockcha<strong>in</strong> that disrupts the traditional<br />

f<strong>in</strong>ancial market might only result from trial-anderror<br />

deployments with<strong>in</strong> limited parameters,<br />

whether through <strong>in</strong>ternal trials or partnerships<br />

between <strong>in</strong>cumbents and startups. However, to<br />

realize the full potential of blockcha<strong>in</strong> across the<br />

f<strong>in</strong>ancial system, the bank<strong>in</strong>g <strong>in</strong>dustry will need<br />

to come together and set standards that enable<br />

<strong>in</strong>teroperability.<br />

That said, banks plann<strong>in</strong>g to deploy blockcha<strong>in</strong>s<br />

need to answer a series of fundamental questions.<br />

For example, given that exist<strong>in</strong>g systems are built<br />

on reliable legacy solutions, how will they determ<strong>in</strong>e<br />

which process to move to a blockcha<strong>in</strong>? Further,<br />

given blockcha<strong>in</strong>’s fast-chang<strong>in</strong>g landscape, it<br />

is critical to develop a thoughtful, long-term plan of<br />

action (e.g., experiment<strong>in</strong>g, strategically deploy<strong>in</strong>g<br />

and then scal<strong>in</strong>g <strong>in</strong> a logical progression) to ensure<br />

a successful transition from centralized legacy to<br />

fully distributed digital transaction process<strong>in</strong>g.<br />

We believe the key considerations for banks<br />

explor<strong>in</strong>g blockcha<strong>in</strong> <strong>in</strong>clude:<br />

<strong>•</strong> Identify<strong>in</strong>g opportunities for <strong>in</strong>novation.<br />

<strong>•</strong> Determ<strong>in</strong><strong>in</strong>g feasibility and impact on exist<strong>in</strong>g<br />

systems.<br />

<strong>•</strong> Test<strong>in</strong>g proofs of concept.<br />

<strong>•</strong> Understand<strong>in</strong>g the regulatory and data security<br />

implications.<br />

<strong>•</strong> Dissect<strong>in</strong>g the blockcha<strong>in</strong> implementation:<br />

open vs. permissioned.<br />

<strong>•</strong> Plann<strong>in</strong>g for transaction scalability.<br />

<strong>•</strong> Form<strong>in</strong>g partnerships and cross-functional and<br />

cross-<strong>in</strong>dustry collaboration.<br />

<strong>Blockcha<strong>in</strong></strong>’s Promise: Bank<strong>in</strong>g and<br />

Beyond<br />

Ever s<strong>in</strong>ce the first Bitco<strong>in</strong> transaction was<br />

carried out <strong>in</strong> January 2009, the digital cryptocurrency<br />

has been a topic of debate. While banks<br />

and regulators have largely rema<strong>in</strong>ed wary of Bitco<strong>in</strong>,<br />

the underly<strong>in</strong>g technology of blockcha<strong>in</strong> and<br />

distributed ledger began attract<strong>in</strong>g the attention<br />

of banks and startups by the end of 2013.<br />

The lure of blockcha<strong>in</strong> was its method of<br />

verify<strong>in</strong>g and track<strong>in</strong>g transactions. Instead of<br />

a trusted third-party or a central bank, it relies<br />

on consensus among a peer-to-peer network<br />

of computers based on complex algorithms.<br />

Rather than be<strong>in</strong>g stored <strong>in</strong> a s<strong>in</strong>gle database,<br />

blocks of time-stamped transactions are stored<br />

on all systems across a value cha<strong>in</strong> (see Figure 1,<br />

next page). This elim<strong>in</strong>ation of middlemen and<br />

cognizant reports 2

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