Dear Big Bank CEO, Re: Blockchains: Obliterate, don’t Automate
A recent flurry of media reports and surveys have touted that some banking and financial services sector players are undertaking interesting projects with blockchains and decentralized ledgers in particular. But this burst of activity is hardly enough to prematurely claim victory on behalf of the few banks who have publicized such initiatives.
It is naive to assume that the blockchain will make the most impact where it is to be adopted early. Rather, it will make the most impact where change is hardest to achieve, and that might take a little longer, realistically.
The blockchain and its derivative technologies are one of the biggest opportunities for reengineering financial services. It’s a looming tsunami, and the big question is whether the banks will fail to reinvent themselves as they did with the Internet, or if they will dare to induce a self-inflicted shake-up and embrace the future.
Based on the early activity that I’m seeing, it appears that the banks are taking a narrow minded view of the opportunity being presented to them. Not unlike how they tackled the Internet in 1995.
If you’re a CEO or senior executive at a big bank or large financial institution, you will remember the advent of the Internet and its subsequent entry into the world of finance. That was around 1994-1997. Having been there too, and involved with some banks in an advisory capacity, I remember well that the banking sector didn’t take the Internet too seriously for at least the first 3-4 years of its commercialization. For example, when it came to Internet payments, banks didn’t want to touch them initially under the pretext that they “weren’t safe”.
Then, a handful of Internet-only banks and online brokerage startups were created, and banks followed by offering online banking, buying the brokerage companies, and much later rushed to develop smartphone Apps for their customers.
Even when the banking sector took the Internet seriously, they did so very slowly, and without much innovation and without rocking the boat. When I look at my online banking today, the features are mostly about convenience, but I can’t do too much beyond the basics. My foreign exchange account doesn’t link to my banking card, I can’t exchange money online, and can’t initiate a wire transfer unless I visit the bank or have a fancy business account.
If I was a millennial today, I wouldn’t think twice about not using a traditional bank because most of the services I am attracted to are offered by alternative financial services companies, primarily due to innovative FinTech startups that sprung up in the past decade. Here’s a typical millennial’s “financial stack”. In fact, a mere $2.3B have funded the production of 126 FinTech companies in the past few years only. That certainly pales in comparison to the $200B globally spent each year on IT by the banking sector, a high figure backed by the fact that the financial services industry consistently outspends other industries on technology. But we would be hard pressed to see real innovation coming out of that huge spending, because the bulk of those budgets are for keeping the lights on and infrastructure running.
Indeed, many banks have established so-called innovation and research centers with multi-million dollar budgets. But that’s not enough. These supposedly act as research laboratories with a mandate to run pilots and experiments. But are they really innovating at the pace of external innovation or are they being gatekeepers to the real innovation that’s happening outside banks? In reality, few of these centers are real innovators. They are still bound by the bank’s current and legacy business models. It is puzzling that your business units couldn’t innovate on their own. Why not issue innovation mandates everywhere, not just in the “innovation center”?
And that’s all before Bitcoin in the mix yet.
Enter Bitcoin, cryptocurrencies, blockchains, distributed ledgers, and more technical jargon.
Hello Bitcoin, another Banking Headache
Bitcoin is the “Internet of money” after all, so that should have gotten a banker’s attention from Day 1. Then we have the Blockchain, the infrastructure behind Bitcoin and other decentralization technologies. Well, let’s say it’s like a new type of database that has the potential to wreak havoc for your IT departments. It sounds like a perfect discussion between a CEO and their CIO.
I have said this before many times. The novel field is not Bitcoin, and it’s not just blockchain. It’s the intersection of cryptography technology with software engineering. We could call it CryptoTech for a lack of a better word.
CryptoTech is not a unidirectional phenomenon. It’s multi-dimensional, therefore it will have different bifurcations. It has multiple identities. And it’s more than just about Bitcoin or blockchains. It is simultaneously:
Currency with wings, and no borders
Software Technology with a new development architecture paradigm
Accounting Ledger that is distributed and decentralized
Consensus Clearing network that acts as a “trust layer” that can validate business logic, not just transactions
Real-Time Messaging System that’s built-in, therefore it’s very fast
Global Online Community with special network effects
Transactions Engine that can verify transactions and approval levels
Computing Infrastructure that is global and similar to a cloud-based one
Reengineering Catalyst that enables innovation and new processes focused on enabling decentralization
The larger the organization, the more it needs to address all of these pieces, because it will be touched by each one of them, sooner or later.
So, in addition to focusing on the decentralized ledger properties of the blockchain, the banking sector needs to take a more holistic approach to determining what blockchain technologies (including Bitcoin) can do for them.
Build On-Ramps not Barriers
Banks can’t really pick and choose a small subset of use cases and claim they are embracing the revolution. If you use “blockchains without Bitcoin” just to avoid public blockchains, you will be subjected to a huge market blind spot because there are millions of users that want to trade with Bitcoin, and you’ll be insulated from them.
Bitcoin’s adoption does not seek permission from any bank or government. The cat is already out of the bag, and a new parallel financial environment is forming around it and other cryptocurrency-related technologies, powered by networks of computers that secure it, validate it, enforce it and run it.
If financial services were to be re-invented today from scratch, we would be fine with virtual, online, Internet and blockchain-enabled services. There would be no traditional bricks and mortar branches. Instead of visiting a branch, we would do a video call with a remote service representative who can verify our identity, and it goes from there. Technically speaking, Bitcoin, blockchains and their related ecosystem can replicate a bank today without much difficult, both for consumer retail banking and business-to-business services.
Truth is there will be pressure from consumers who are already getting a taste of freedom from banks via alternative FinTech services. Blockchain-enabled solutions will take that freedom bar even higher via decentralization, peer-to-peer behaviors, and by putting more power at the edges of the network directly in the hands of users, or by granting more processing power at the nodes of the computing networks and software applications.
It’s very possible that startups in the blockchain space will also be chiseling at the banks’ business, just as dozens of successful FinTech startups have already dissected and unbundled many banking services.
Banks risk being on the outside looking in, if they don’t build on-ramps and exits to the new world of cryptocurrencies. Therefore, they risk becoming islands themselves.
No More Warnings from Bankers
We don’t need to hear warnings from banking executives about not using Bitcoin or cryptocurrencies. In 1995, several banks and financial institutions issued warnings about Internet payments and online commerce as not being safe. Then, a few years later, they all adopted online services and allowed Internet payments. Today, Amazon is bigger than Walmart in market value.
We don’t need to hear that cryptocurrencies are high-risk, because of anonymity, or other factors, just because banking executives don’t fully understand them yet, or because the banks are not yet ready to adopt them.
Business Drives Technology
We need to remember that “business drives technology choices”, and not the other way around. Business people need to understand technology’s possibilities, and technologists need to better explain what the technology can do. Only when the two come together with a harmonious understanding will we see real innovations come to life. The opportunities rest on what you make with all existing technologies, based on your willingness to make changes inside your business.
Blockchain Apps are being built to handle the next generation of services in trade settlements, digital ownerships, assets ownerships, assets transfers, origin verification, title transfers, and many other areas.
Here’s a proposed evolution of key application areas, depicting the various touch points and target segments. The broad categories of attention are in Consumer Services, B2B Services, Trading and Capital Markets, Back-end Processes, and Inter Industry Services.
There is a lot of work needed to bring this vision to reality. For example, inter-banking co-operation over new networks will not be easy, but it will be done. And reengineering efforts must be taken seriously.
Note that this segmentation is not splitting the market along permissioned (private) vs. permissionless blockchains (public), because that type of demarcation is a technical one. In reality, there will be a continuum of blockchains, and they will interconnect or interrelate to each other, just as databases do today, in the background, without us knowing about their technical intricacies. So, this is not about blindly ruling out public blockchains in favor of private ones. Rather, you may need to think about using both scenarios, depending on what’s best for each use case.
Putting Crypto-Tech on the Strategic Agenda
Where do you start? There are various approaches to get there from an enterprise implementation point of view. Corporate teams need to work with external players and technologies, and many of them are new and in early developmental stages. Most vendors and technologies have less than a dozen clients at the most, and some have less than a handful. So it is early days for sure, but there is no shortage of innovation. However, the banks must meet these startups half-way by dreaming-up how to apply their technology.
How it’s done
We will build you anything
IBM & Big IT Firms
You work directly with the blockchain’s tools and services
Frameworks for IT professionals
APIs & Overlays
DIY assembling pieces
Open Assets, Chain
This field has been maturing at the speed of dog years. And there are new advances pertaining to making it easier to implement decentralization stacks without worrying about building or assembling all of the required pieces from scratch. Some of the progress being made is equivalent to the evolution from building websites manually using HTML code in 1995 to automagically creating sites today using WordPress and via a few configuration steps. For example, Ethereum takes care of the complexities of writing decentralization applications so that developers can focus on the desired functionality, and not the intricacies of networked and decentralized peer-to-peer technologies.
What Should Banks Do?
Don’t just do pilots that automate old processes. Rather, launch major reengineering efforts across all processes, and ask the important question:
What could Crypto-Tech enable now if we reinvented it?
Here is a list of potential actions:
- Hire or promote a real leader from within, and give them the title of “Blockchain Czar”. That person should have experience in banking operations and know about reengineering business processes via technology implementations. Tough to find that person? Find them. Let them be your spokesperson in the marketplace, not an analyst in your research department or someone in charge of innovation. That person will be responsible for removing obstacles within your organization, education, best practices, and project managing the various implementations. This job is a tough one, but it involves finding and obliterating old processes, instead of blindly automating what you are currently doing.
- How about getting your feet wet with some mining action? Buy a few extra computers and mine Bitcoin or other currencies so you can learn what it’s like be in the cryptocurrency waters. Here’s why Banks and Brokerages Should be Mining the Blockchain.
- Send the top 10% of your IT staff to courses on cryptocurrency platforms, tools and technology. Let them learn the Bitcoin blockchain and its various overlay technologies, Ethereum’s contract languages, and many other ready-to-use crypto technologies.
- Don’t invest in blockchain startups. Become one (if you can). Investing is not a spectator’s sports. You need to get involved, and not just watch. If an investment allows you to participate in the actual outcome of the technology solution, that’s one thing. But if your investment is so-called for learning purposes, you’re wasting that money. Invest in direct learning and by doing stuff, and not by watching others. Operating like a technology startup is very different from operating inside a bank. Yes it is about culture, and a bank doesn’t have a startup culture, nor does the word innovation mean the same thing to a nimble startup that is hungry and ambitious, as compared to what it means to an overhead-laden bank.
- Buy a Bitcoin exchange, immediately. The good thing about the proliferation of Bitcoin exchanges around the world, (and there are at least 50 viable ones) is that there is one for each large bank out there. The merging of Bitcoin trading inside banks is inevitable. Most of these exchanges have already developed the basic technology, but the biggest pain has been how new users fund and connect their wallets with their banking accounts. If you merge online banking with Bitcoin trading, you automatically eliminate the friction that currently exists for onboarding new users. OK, you’re afraid, I can tell. So, why not limit Bitcoin conversions to $1000 or something like that. Bitcoin to fiat conversions should be real-time. You know how to handle customer relationships. The Bitcoin exchanges have technical capabilities, but their CRM and customer support are not great. One of the big banks will blink first and buy one of the fledgling Bitcoin exchanges and delight their existing customers. Why not you?
- Re-invent trading and capital markets and remove the delays and intermediaries. Delays means more costs. Real-time levels off inefficiencies. Remove the steps that are not need during the settlement and clearing stages.
- Offer free (or really cheap) cross-border remittances services. Abolish wire transfer fees. That’s a tough one, and I’m sure you’re not going to do it. But if you used the Bitcoin network instead of SWIFT, I can guarantee your transfer costs will decrease by orders of magnitude.
- You like task forces & committees. Create an internal Cryptocurrency task force with members from each functional group, and let them have weekly meetings to share initiatives, projects, and learnings. Even better, get them all on a Slack group and invite anyone in the bank to participate in it.
A Strategic Roadmap
Most banking executives probably don’t even have a Bitcoin account, nor have used a Bitcoin wallet; yet they are in charge of their organization’s future when the future is staring them in the face with the word “blockchain” in it. This isn’t unlike the early Internet and email days, when corporate executives were laggard users and had their secretary print their email for them.
It is so important to get a first hand feel with a Bitcoin account in order to experience the flexibility, speed and innovations that are built-in. For example, you can send money to anyone in the world by just knowing their email address or Bitcoin address, without a banking relationship, and without going anywhere physical. That’s pretty awesome in itself. You can convert from fiat to Bitcoin and vice-versa, including wiring money to a fiat account for free. It is absolute freedom in terms of money movements, and it happens almost instantly and at the peer-to-peer level. Granted you can’t pay bills, and can’t easily use bitcoin at the cash register, but these aren’t show stoppers for now.
When every asset has a blockchain linkage, it puts it at par with bits that travel at Internet speeds. And that comes with a built-in trust layer that transports the transaction’s history and validation with itself. That’s a powerful capability (also called smart property), and it will free financial assets and instruments from the latency and inertia of legacy clearing and settlement processes and usher in efficiencies, speeds and innovations. At the end of the day, it’s about financial services, not the blockchain. The blockchain is just an enabler.
If you can disrupt your business successfully, then you can also disrupt your competitors, but if you just focus on protecting your business, you’re really living in the status quo. Internal disruption is always more benign than an external one, especially if it is done pro-actively and on your own terms. It’s better to shoot yourself in the foot, rather than having someone else shoot you in the head.
But the road to disruption is paved with some casualties. Because the blockchain is a value disruptor, it will change the role of existing intermediaries. Some will get replaced, others will see their powers, influence and usage diminished. In the trading space, some of the current intermediaries at risk include SWIFT, CCP, FIX and the DTCC.
So, who will blink first? That first blink means buying a Bitcoin Exchange and totally incorporating its wallet into online banking. I know some libertarians will say that’s not what Bitcoin was about. Bitcoin is about freedom to be your own bank. They are right, and with the passage of time and further sophistication, that might be possible. But in the meantime, you are the Bank, and you have a chance to keep that customer relationship going.
This revolution isn’t happening at Money 20/20, Finovate or Sibos . It’s happening elsewhere. It’s happening at the grass root levels in meetups, in stealth startups, accelerators and Github repositories.
And user-initiated blockchain Apps are coming. They will look like SaaS apps that users can launch without anyone’s permission. Wow, that’s a lot of change. If you’re a banking executive, maybe I’ve got more of your attention, now.
The banks have an opportunity to re-engineer themselves. They missed doing that when the Internet came along. It’s not about Bitcoin. It’s about exposing openness, decentralization, and speed. Consumers and business users want that. The meaning of trust and transactions changes with the blockchain. Every centralized and manual process is up for grabs due to what the blockchain enables: self-enforcement of trust and smarter transactions with longer end-points.
The blockchain has a diverse stack, and I hope that a bank can touch it at many levels.
Bitcoin isn’t easy to use, blockchains are difficult to program, most merchants aren’t accepting cryptocurrency, and it does sound risky to rely on computers and mathematics to govern a currency, but so what?
If you don’t take Bitcoin, blockchains and cryptocurrency seriously, I can predict that Bitcoin will be to banks what the iPhone was to BlackBerry. Yes, it was not perfect when it came out, and didn’t have a keyboard, didn’t have apps, and wasn’t “secure” for corporates, but so what?
The blockchain is not perfect, but it is that perfect catalyst for business process changes, and this type of opportunity doesn’t present itself that often. The last time it came was with the Internet. Let’s hope the banks see this as a big opportunity for change, not just a small one.
The possibilities that are enabled by the blockchain have a transformational impact, once you put them together.
You can go slow and be left behind, or you can go deep and leapfrog.
It is a case of experimentation, but also of determination.
An excellent well-rounded view of the disruptive effect that bitcoin is going to have in the coming decade.
Most of the misunderstanding and negativity around bitcoin at the moment comes from the lack of intellectual flexibility and ‘incumbent blinkered mindset’ to be found among the major financial institutions. Bitcoin just doesn’t fit, either into the existing regulatory climate or current interpretation of value transfer, in the new internet age we are entering.
To try and make this ‘never before available’ technology conform to a set of intermediary-based financial processes, based on decades old practices, where personal data and security passwords are passed along to numerous third parties via the CVV private key code, is not just foolish but destined to be shown too costly to continue as financial data hacking becomes the “preferred method of choice” for international criminal gangs.
One of the key features of bitcoin is that each transaction is not only recorded on the blockchain ledger, but is a “push” type of transfer. So any interception of a bitcoin transfer data stream can not change either the destination, or the amount of the transfer. This is very powerful. Current money transfers and card purchases are actually “pull” type transactions, which once intercepted give the hacker the ability to pull additional amounts of money directly from ones bank account.
The case for the unique bitcoin protocol – A decentralised ledger, combined with the Nakamoto consensus mechanism, brought about by Proof of Work activity, rewarded by a globally tradeable currency token – is unassailable. Banks and Financial Money Transmitters ignore this at their peril.
Thanks Prof. And great point about the push vs. pull.
It will take some time for change.
Thanks William, I agree about taking time to change.
But as the current “cash cow” protection rackets ( such as illegal gambling, cash-flow rich legal casinos, human trafficking, etc ) become more dangerous and crowded for the traditional Mafiosi cartels, they will turn more and more to financial data fraud crime. There are major hacking hubs already well developed in Eastern Europe and the old soviet union provenances which are hiring themselves out to the highest bidder.
The best Hackers are always one step ahead of Large Corporate Structures. Central data holding is fatally flawed in the internet age. There is an old adage among the hacking fraternity which goes .. ” there are two types of data protection companies, those who have inadequate security measures in place – and those who will shortly have inadequate security measures in place.”
The Rat is certain that the current “pull” system ( where Banks guarantee to cover depositors hacked transactions) will be put under huge pressure in the next three to four years as more and more stolen funds are electronically diverted into jurisdictions outside easy recovery. The cost of refunding these diverted funds to costumers will increase costs so much that , one after another, Banks will be forced to adopt push transactions ( which need all the four aspects and network effect of the bitcoin blockchain, to behave efficiently and securely ) – just saying!
I think you hit the nail on the head with “business drives technology choices; not the other way around”. Business in turn is driven by (consumer) demand. I don’t think anyone *loves* their bank and their fees; Merchants are not excited about paying the relatively high fees on taking card payments either. This is all begging for disruption. Consumers will respond to alternatives that offer speed and low cost quickly, especially if some of their peers do so. I’m sure paypal was deemed unreliable at first, but people accepted it. There’s a lot of great experience walking around at banks, I’m sure. It’s not all just about sending money around. But if they don’t adopt this new technology and find ways to make it useful to consumers, they may disappear sooner than we think.
Well written as usual William. Sorry for being late to the party….