Fueling Both Hope and Hype, Blockchain Offers a New Approach to Data Management

Massimo Young, Vice President, Data Scientist, BNY Mellon

Charles Wang, co-founder of CA Technologies, was infamously skeptical about the potential of the internet to revolutionize retail. In an interview in 1997, when e-commerce was still in its infancy, he told The New York Times: “People say the internet will replace stores. It will never happen.” Two years later, when the dot-com bubble burst, perhaps he felt vindicated. But now, twenty years later, his views seem shortsighted. It’s a classic example of Amara’s Law:  we tend to overestimate the effect of technology in the short-term and underestimate its effect in the long run.

To those of us in financial services, this likely brings to mind the hype that currently surrounds blockchain, which has been touted as a possible solution for everything from preventing ID fraud to ending world poverty. How can we distinguish between the hype and the real power of this new technology? How can we balance excitement with healthy skepticism in order to drive towards practical solutions?

This is a topic that I’ll be discussing in more detail when Eagle and BNY Mellon host the Engage 2016 conference in Orlando, Florida, November 13-16. In the meantime, understanding what blockchain is and why it’s getting people excited may help set the stage.

To get slightly technical for a moment, “blockchain” is the name for the database underpinning Bitcoin, the cryptocurrency.  It’s operated by a public peer-to-peer network with no central authority. Bitcoin transactions are just edits to this database, which is why it’s sometimes called a “ledger”. Transactions are collected, validated, and organized into blocks before being shared across a network of computers and added to existing blocks. This is where blockchain gets its name. More recently, “blockchain” has taken on a more general meaning: it refers to a new design pattern for databases, inspired by Bitcoin but usually divorced from the crypto-currency itself. In the context of capital markets, blockchain promises to go well beyond pseudonymous digital currency and help solve problems in capital markets posed by the complex systems of interconnected private databases that are currently used to process transactions.

For those of us involved in data management, this is an issue that we understand intimately. Anytime a transaction occurs today, multiple databases usually have to be updated, creating several layers between the buyer and seller when a transaction has occurred. This creates a number of issues. Updating multiple databases and dealing with a host of intermediaries creates a settlement lag. This often requires a central counterparty to hold assets as insurance against counterparty risk. There is also the issue of reconciliation. During the transaction process, these various databases may not match, and at any given point in time it can be difficult to know the ‘true’ state of affairs. A corollary is poor data quality. While central clearing houses address these two problems, some would argue that they create a third, far more serious problem by introducing a single point of failure.

As part of my presentation, I’ll discuss the progress being made across the industry in utilizing blockchain to solve these problems, and I will highlight some specific real-world use cases that are beginning to emerge. BNY Mellon, for example, is working with a small consortium to create a “Utility Settlement Coin”, an asset-backed digital cash instrument implemented on distributed ledger technology. We have also developed a test system using blockchain concepts to improve the resiliency of tri-party repo. I will pass along some of what we’ve learned, in particular how we identify applications where blockchain can serve as a solution and others where it would likely lead to a dead end.

Blockchain may not prove to be a panacea to solve every issue in capital markets, but it could be the solution to some specific problems that create cost and risk in the financial system. At the very least, it continues to serve as a catalyst for change: challenging the status quo and inspiring us to think of new and better ways to do things. In a market that thrives on efficiency, that can be no bad thing.

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